**UNITED
      STATES**


**SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        DC 20549**
  **FORM
        10-K**
  x
              **ANNUAL
                  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
                For
                  the fiscal year ended March 25, 2006ORo
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
 
 Commission
        File Number **** **333-118532**
 
 **LEINER
                  HEALTH PRODUCTS INC.**(Exact
                  name of registrant as specified in its
                  charter)
 
 **DELAWARE**
              
              **94-3431709**(State
                  or other jurisdiction of incorporation or organization)
              
              (I.R.S.
                  EmployerIdentification
                  Number)
 
 **901
                  East 233rd Street, Carson, California**
              
              **90745**(Address
                  of principal executive offices)
              
              (Zip
                  Code)
 
 **(310)
                  835-8400**Registrant’s
                  telephone number, including area
                  code
  Securities
        registered pursuant to Section 12(b) of the Act: **None**
 Securities
        registered pursuant to Section 12(g) of the Act: **None**
  Indicate
        by check mark if the registrant is a well-known seasoned issuer, as defined
        in
        Rule 405 of the Securities Act. Yes o No x
  Indicate
        by check mark if the registrant is not required to file reports pursuant
        to
        Section 13 or Section 15(d) of the Act. Yes x No o
  Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. Yes x No o
  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. x
  Indicate
        by check mark whether the Registrant is an accelerated filer (as defined
        in Rule
        12b-2 of the Act). Yes o No x
  Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). Yes o No x
  The
        aggregate market value of the registrant’s common stock held by non-affiliates
        as of September 24, 2005 (the last business day of the registrant’s most
        recently completed second fiscal quarter) is not applicable.
  **APPLICABLE
                  ONLY TO ISSUERS INVOLVED IN BANKRUPTCY****PROCEEDINGS
                  DURING THE PRECEDING FIVE
                  YEARS:**
  Indicate
        by check mark whether the registrant has filed all documents and reports
        required to be filed by Section 12, 13, or 15(d) of the Securities Exchange
        Act
        of 1934 subsequent to the distribution of securities under a plan confirmed
        by
        the court. YES x * NO
        o
  **APPLICABLE
                  ONLY TO CORPORATE
                  REGISTRANTS**
 
 Indicate
        the number of shares outstanding of each of the registrant’s classes of common
        stock, as of the latest practicable date.
  Common
                  Stock, $0.01 par value, 1,000 shares outstanding as of March 25,
                  2006
 
 *
        No
        reports were required to be filed under Section 12, 13, or 15(d) of the
        Securities Exchange Act of 1934.
 
 
 
 
  **LEINER
        HEALTH PRODUCTS INC.**
 
 **Form
        10-K**
 **For
        the Fiscal Year Ended March 25, 2006**
 
 **TABLE
        OF CONTENTS**
 
 **PART
                  I**ITEM
                  1.
              BUSINESS
              3ITEM
                  1A.
              RISK
                  FACTORS
              11ITEM
                  1B.
              UNRESOLVED
                  STAFF COMMENTS
              18ITEM
                  2.
              PROPERTIES
              19ITEM
                  3.
              LEGAL
                  PROCEEDINGS
              19ITEM
                  4.
              SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY HOLDERS
              21**PART
                  II**ITEM
                  5.
              MARKET
                  FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
                  ISSUER
                  PURCHASES OF EQUITY SECURITIES
              21ITEM
                  6.
              SELECTED
                  FINANCIAL DATA
              22ITEM
                  7.
              MANAGEMENT'S
                  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                  OPERATIONS
              23ITEM
                  7A.
              QUANTITATIVE
                  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
              39ITEM
                  8.
              FINANCIAL
                  STATEMENTS AND SUPPLEMENTAL DATA
              39ITEM
                  9.
              CHANGES
                  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE
              39ITEM
                  9A.
              CONTROLS
                  AND PROCEDURES
              39ITEM
                  9B.
              OTHER
                  INFORMATION
              39**PART
                  III**ITEM
                  10.
              DIRECTORS
                  AND EXECUTIVE OFFICERS OF THE REGISTRANT
              40ITEM
                  11.
              EXECUTIVE
                  COMPENSATION
              42ITEM
                  12.
              SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF RELATED
                  STOCKHOLDER MATTERS
              45ITEM
                  13.
              CERTAIN
                  RELATIONSHIPS AND RELATED TRANSACTIONS
              47ITEM
                  14.
              PRINCIPAL
                  ACCOUNTANTS FEES AND SERVICES
              50**PART
                  IV**ITEM
                  15.
              EXHIBITS
                  AND FINANCIAL STATEMENTS SCHEDULES
              50
  The
        data
        contained in this Form 10-K with respect to our relative market share and
        competitive positions are based on retail sales, and approximations based
        on our
        estimates and industry sources, including Information Resources, Inc. (“IRI”),
        Empower IT (U.S. military sales data), government publications and reports
        from
        government agencies, published independent industry sources, public filings
        and
        industry publications by companies covering business in the vitamins, minerals
        and nutritional supplements (“VMS”) and over-the-counter (“OTC”) markets. We
        believe that such data are inherently imprecise, but are generally indicative
        of
        our relative market share and competitive position. Market share data are
        for
        the food, drug and mass merchant and warehouse club (“FDMC”) in the U.S. only
        and do not include Canadian market share information for Vita Health Products
        Inc.
  
  **PART** **I** .
 
 **ITEM
        1.**  **BUSINESS**
 
 **History**
 
 Leiner
        Health Products Inc. (which may be referred to as “Leiner”, “we”, “us” or “our”)
        is the ultimate successor to the vitamin product division of P. Leiner &
Sons, America, Inc. The division, founded in 1973, was purchased in 1979
        by
        management and Booker plc through Leiner. In May 1992, we were acquired by
        Leiner Health Products Group Inc. (“Leiner Group”). Leiner Group was a holding
        company incorporated under the laws of the State of Delaware with no significant
        operations or assets other than the stock of Leiner, which it held through
        its
        sole direct subsidiary, PLI Holdings, Inc., itself a holding company.
 
 In
        May
        1992, Leiner Group acquired privately held XCEL Laboratories, Inc., a major
        U.S.
        private label OTC pharmaceuticals manufacturer and on March 8, 1993, XCEL
        Laboratories, Inc. was merged into Leiner.
 
 In
        January 1997, we acquired Vita Health Company (1985) Ltd., one of the leading
        manufacturers of private label and branded vitamins, minerals and OTC
        pharmaceuticals in Canada. Vita Health Company (1985) Ltd. changed its name
        in
        1998 to Vita Health Products Inc. (“Vita”).
 
 In
        June
        1997, Leiner Group completed a leveraged recapitalization transaction pursuant
        to which Leiner Group repurchased common stock from its existing shareholders,
        issued new shares of the recapitalized Leiner Group to North Castle Partners
        I,
        LLC, issued senior subordinated notes, and established a senior secured credit
        facility. Immediately upon consummation of the recapitalization, we assumed
        Leiner Group’s obligations under the subordinated notes and the senior credit
        facility.
 
 In
        December 1999, we acquired substantially all of the assets of Granutec, Inc.,
        a
        manufacturer and distributor of private label, OTC pharmaceutical drugs in
        the
        United States, and Vita acquired substantially all of the assets of Stanley
        Pharmaceuticals Ltd., a manufacturer and distributor of private label, OTC
        pharmaceutical drugs and vitamin supplement products in Canada, both of which
        were subsidiaries of Novopharm Limited of Ontario, Canada. We also acquired
        some
        related assets of Novopharm.
 
 In
        April
        2002, in conjunction with the Bankruptcy Court confirmation of our plan of
        reorganization under Chapter 11 of the U.S. Bankruptcy Code, Leiner Group
        was
        merged into PLI Holdings, and PLI Holdings was then merged into Leiner, with
        Leiner as the surviving entity.
 
 In
        April
        2004, Mergeco entered into a recapitalization agreement and plan of merger
        with
        us. The recapitalization was effected on May 27, 2004 by merging Mergeco
        with
        and into Leiner. Mergeco was a new corporation formed by the investment funds
        affiliated with Golden Gate Private Equity, Inc. (the “Golden Gate Investors”)
        and North Castle Partners III-A, L.P. (“NCP III-A”) and an affiliate of NCP
        III-A (the “North Castle Investors”) solely for the purpose of completing the
        recapitalization. Each share of the common stock of Mergeco became a share
        of
        our common stock. Pursuant to the recapitalization Mergeco issued senior
        subordinated notes and established a new senior credit facility. Immediately
        upon consummation of the recapitalization, the obligations of Mergeco under
        the
        new senior credit facility and the notes were assigned to and assumed by
        us. The
        recapitalization was accounted for as a recapitalization of Mergeco which
        had no
        impact on the historical basis of assets and liabilities as reflected in
        our
        consolidated financial statements . We
        are
        the surviving corporation in the merger. Each holder of our common stock
        then
        exchanged such stock for voting preferred stock of Holdings, a newly formed
        company that became our new parent company.
 
 In
        September 2005, the Company acquired substantially all of the assets of
        Pharmaceutical Formulations, Inc. (“PFI”), a manufacturer of private label OTC
        products in the United States, related to its OTC pharmaceutical business
        (the
“Acquisition”), except for assets related to PFI’s Konsyl Pharmaceuticals Inc.
        subsidiary and other scheduled assets (the “PFI Business”).
 
 **Fiscal
        year**
 
 Effective
        fiscal 2003, we changed our reporting period to a fifty-two/fifty-three week
        fiscal year. Our fiscal year end will fall on the last Saturday of March
        each
        year. Our fiscal years ended March 27, 2004, March 26, 2005, and March 25,
        2006
        were each comprised of 52 weeks.
  3
  **General**
 
 We
        are
        the leading manufacturer of store brand VMS products and the second largest
        supplier of store brand OTC pharmaceuticals in the U.S. FDMC retail market,
        as
        measured by U.S. retail sales in 2005. Most of our products are manufactured
        for
        our customers to sell as their own store brands. We have long-term relationships
        with leading FDMC retailers and focus on the fastest-growing of these
        retailers—the mass merchants and warehouse clubs. In addition to our primary VMS
        and OTC products, we provide contract manufacturing services to consumer
        products and pharmaceutical companies. We believe few competitors in the
        industry can provide our level of service, innovation, high quality and
        competitive pricing. In our view, the critical factor in the purchase decision
        of our customers is our reputation for high levels of customer service and
        for
        producing quality products that are safe, effective and manufactured to the
        highest industry standards.
 
 We
        have
        the leading position in the estimated $1.6 billion VMS FDMC store brand market,
        as measured by U.S. retail sales in 2005, with an estimated 40% share. We
        estimate that we have a 44% share of the VMS store brand segment for Wal-Mart,
        Sam’s Club and Costco—three of the fastest-growing retailers in this market. We
        offer a wide breadth of products in VMS, including multi-vitamins, vitamins
        C
        and E and joint care products, as well as minerals and supplements. We sell
        our
        VMS products under our customers’ store brands as well as our own brand, *Your
        Life* ® .
        We have
        created value for our VMS customers for over 20 years by identifying promising
        new store brand products, utilizing our product development and manufacturing
        expertise to allow them to bring these products to market quickly, often
        ahead
        of their competitors, and providing sales and marketing support.
 
 We
        are
        the second largest supplier of OTC pharmaceuticals in the estimated $2.2
        billion
        OTC FDMC store brand market, as measured by U.S. retail sales in 2005, with
        an
        estimated 23% share. Our products principally consist of analgesics, cough,
        cold
        and allergy medications and digestive aids. We sell our OTC pharmaceuticals
        under our customers’ store brands as well as our own brand, *Pharmacist
        Formula* ® .
        Our
        current OTC products include the national brand equivalents of *Advil* ® (ibuprofen), *Aleve* ® (naproxen), *Claritin* ® (loratadine), *TUMS* ® (calcium
        antacid), *Tylenol* ® (acetaminophen)
        and *Zantac* *®* ** (ranitidine).
        We have partnered with several pharmaceutical companies to manufacture and
        distribute OTC products.
 
 We
        also
        provide contract manufacturing services to consumer products and pharmaceutical
        companies. We utilize our existing facilities, production equipment and
        personnel to manufacture and package products for our customers. We have
        entered
        into a long-term contract to provide contract manufacturing services to a
        leading multi-vitamin national brand under which we produced over 2.3 billion
        pills in fiscal year 2006. We believe our contract manufacturing services
        business allows us to drive profitability by increasing capacity utilization
        and
        leveraging our fixed costs. We believe our expertise in the VMS and OTC FDMC
        markets and our focus on high quality products and low-cost manufacturing
        will
        allow us to expand our existing relationships and gain new relationships
        with
        consumer products and pharmaceutical companies.
 
 **Products**
 
 The
        following table sets forth the net sales of our VMS, OTC and contract
        manufacturing services products from fiscal year 2004 through fiscal year
        2006:
  **Year
                  Ended****March
                  27,**
                **2004**
              
              **%**
              
              
              **March
                  26, 2005**
              
              **%**
              
              **March
                  25,**
                **2006**
              ****
              **%****(dollars
                  in thousands)**VMS
                  products
              
              $
              413,679
              
              
              63
              %
              $
              419,491
              
              
              61
              %
              $
              421,959
              
              
              63
              %OTC
                  products
              
              
              191,196
              
              
              29
              %
              
              213,402
              
              
              31
              %
              
              199,004
              
              
              30
              %Contract
                  manufacturing services/Other
              
              
              56,170
              
              
              8
              %
              
              52,008
              
              
              8
              %
              
              48,598
              
              
              7
              %Total
              
              $
              661,045
              
              
              100
              %
              $
              684,901
              
              
              100
              %
              $
              669,561
              
              
              100
              %
  ***VMS
        Products*** ***.*** We  offer
        a
        wide breadth of VMS products, including more than 258 products in approximately
        1,845 SKUs in the United States. Our products are sold in tablet and capsule
        forms, and in varying sizes with different potencies, flavors and coatings.
        Our
        vitamin products include national brand equivalents that compare to the dietary
        ingredients in *Caltrate* *®* , *Centrum* *®*  and *One-A-Day* *®* *,* vitamin
        products such as vitamins C and E and folic acid, minerals such as calcium,
        supplements such as chondroitin, glucosamine, fish oil, Co-Q10 and herbal
        products. We sell VMS products primarily under our customers’ store names and
        estimate that store brands accounted for approximately 93.9% of our fiscal
        year
        2006 VMS gross sales in the United States. In addition, our own brand, *Your
        Life* ® ,
        is the
        largest VMS brand provided to the U.S. military. For the fiscal year 2006,
        our
        VMS business comprised approximately 63% of net sales.
  4
 
 Vita
        Health produces approximately 116 different types of VMS products in
        approximately 411 different SKUs. However, the majority of Vita’s sales in this
        segment are concentrated in a few core products categories. The top 5 product
        categories, which comprise over one-half of Vita’s vitamin sales, are
        multivitamins, herbal products, supplement products, mineral products and
        vitamin C products.
 
 ***OTC
        Products*** ***.*** We market
        more than 80 different OTC pharmaceutical products in approximately 950
        different SKUs, including those products comparable to most major national
        brands in the analgesic, cough and cold remedy and digestive aid categories.
        Our
        current OTC products include national brand equivalents of *Advil* *®* (ibuprofen), *Aleve* *®* (naproxen), *Claritin* *®* (loratadine), *TUMS* ® (calcium
        antacid), *Tylenol* *®* (acetaminophen)
        and *Zantac* ® (ranitidine).
        We sell our OTC pharmaceuticals under our customers’ store brands as well as our
        own brand, *Pharmacist
        Formula* ® .
        We have
        signed an agreement with Dr. Reddy’s Laboratories Limited (“Dr. Reddy’s
        Laboratories”) (NYSE: RDY), an emerging generic pharmaceutical company based in
        India, for the exclusive U.S. marketing rights for all Dr. Reddy’s Laboratories’
products that switch from prescription to OTC to take advantage of the
        anticipated wave of prescription drug patent expirations in the
        future.
 
 Vita
        Health produces approximately 78 different types of OTC products in
        approximately 946 different SKUs. Vita’s OTC pharmaceutical sales are primarily
        analgesic products, digestive aids, cough and cold products, and allergy
        products. In Canada, there are two primary classes of analgesics products,
        those
        with codeine and those without. Vita produces both types of
        products.
 
 ***Contract
        Manufacturing Services*** ***.*** We provide
        contract manufacturing and packaging services to consumer products and
        pharmaceutical companies. We utilize our existing facilities, production
        equipment and personnel to manufacture and package products for our customers,
        generally under long-term contracts.
 
 Subject
        to a long-term exclusive agreement, we supply Bayer HealthCare LLC (“Bayer”)
        with some vitamin and mineral supplements under the *One-A-Day* ® brand
        name. Since 2000, the business with Bayer has grown significantly, fueled
        by the
        introduction of new products and Bayer consumer advertising. New product
        concepts are developed in conjunction with Bayer’s Consumer Care input, and are
        then formulated, tested, and ultimately manufactured by us. New products
        have
        driven the business, led by *One-A-Day
        WeightSmart* TM, *One-A-Day
        CarbSmart* TM and
        the
        introduction of *One-A-Day
        Cholestrol* TM .
        Our
        contract manufacturing sales have declined since fiscal 2004 primarily due
        to
        decreases in certain new products sales which were launched in prior fiscal
        years by our key contract manufacturing customer. We expect our contract
        manufacturing services business to grow in fiscal 2007 as we have signed
        and/or
        expect to sign a number of major contracts with certain pharmaceutical
        companies.
 
 **Geographical
        Business Units**
 
 We
        operate under two separate geographical units, one in the United States and
        one
        in Canada. Our U.S. business consists of our U.S. operating subsidiaries,
        principally Leiner Health Products, LLC. Our Canadian business consists of
        Vita.
        Our U.S. operations consist of our corporate headquarters as well as five
        FDA
        approved facilities, which manufacture, package and distribute VMS and OTC
        solid
        dosage forms. For the fiscal year 2006, our U.S. operations generated
        approximately 91.8% of our net sales.
 
 Vita
        is
        one of the leading manufacturers of store brand VMS and OTC products in Canada.
        Vita is located in Winnipeg, Manitoba, where it maintains manufacturing,
        packaging and distribution facilities. For the fiscal year 2006, Vita comprised
        approximately 8.2% of our net sales.
 
 **Customers**
 
 Our
        VMS
        and OTC store brand products are sold in all 50 states through over 50,000
        outlets. These include nine of the 10 largest food retailers, the top six
        largest drug chains, all of the largest mass and dollar merchants and the
        top
        three warehouse clubs in the United States. In addition, Leiner is the number
        one VMS supplier to U.S. military outlets worldwide. In fiscal 2006, two
        customers accounted for approximately 44.1% and 23.5%, respectively, of our
        gross sales. However, our largest customer has two distinct retail divisions
        that, if viewed as separate entities, would constitute 24.2% and 19.9% of
        our
        gross sales for fiscal 2006. Each of our other major customers accounted
        for
        less than 10% of our gross sales for fiscal 2006. Our top ten customers in
        the
        aggregate accounted for approximately 86.7% of our gross sales for fiscal
        2006.
  5
 
 **Raw
        Materials**
 
 We
        purchase globally from third party suppliers of raw materials. We have multiple
        suppliers for most of our raw materials. For four of our top 10 raw materials,
        we purchase only from a single source. No supplier provided approximately
        more
        than 10% of the materials purchased during the fiscal year 2006 by us excluding
        purchases by Vita, our Canadian business.
 
 **Competition**
 
 The
        markets for our products are highly competitive. We compete on the basis
        of
        customer service, product quality, range of products offered, pricing and
        marketing support. In the VMS FDMC market, we believe that our major U.S.
        competitors are NBTY, Inc., Pharmavite LLC, Weider Nutrition International,
        Inc.
        and Perrigo Company. In the OTC FDMC market, we believe our major U.S.
        competitor is Perrigo Company. In the United States, we sell approximately
        85.2%
        of our VMS products to FDMC retailers. We do not currently participate
        significantly in or sell to other channels such as health food stores, direct
        mail and direct sales and, therefore, may face competition from such alternative
        channels if more customers utilize these channels of distribution to obtain
        VMS
        products.
 
 **Employees**
 
 As
        of
        March 25, 2006, we had 1,995 full-time employees. Of these employees, 318
        were
        engaged in executive or administrative capacities and 1,677 were engaged
        in
        manufacturing, packaging or distribution. In addition, we employed approximately
        693 temporary workers. The large number of temporary workers gives us
        significant flexibility to adjust staffing levels in response to seasonal
        fluctuations in demand. Approximately 12.5% of our employees are represented
        by
        a collective bargaining agreement for Vita. We consider our relations with
        our
        employees to be good.
 
 **Research
        and Development**
 
 We
        conduct our research and development activities at our own manufacturing
        facilities located in Garden Grove, California, and Fort Mill, South Carolina,
        and with strategic third parties. Our principal emphasis in our research
        and
        development activities is the development of new products and the enhancement
        of
        existing products. The amount, excluding capital expenditures, spent on research
        and development activities was approximately $5.7 million, $5.3 million and
        $4.6
        million, in fiscal years 2004, 2005 and 2006, respectively.
 
 **Government
        Regulation**
 
 The
        formulation, manufacturing, packaging, labeling, advertising, distribution
        and
        sale of our products are subject to regulation by one or more United States
        and
        Canadian federal agencies, including the FDA, the FTC, the CPC, Health Canada
        and also by various agencies of the states, provinces and localities in which
        our products are sold. In particular, the FDA, pursuant to the Federal Food,
        Drug, and Cosmetic Act (“ FDCA ”),
        regulates the formulation, manufacturing, packaging, labeling, distribution
        and
        sale of dietary supplements, including vitamins, minerals and herbs, and
        of OTC
        drugs, while the FTC has jurisdiction to regulate advertising of these products.
 
 The
        FDCA
        has been amended several times with respect to dietary supplements, in
        particular by the Dietary Supplement Health and Education Act of 1994
        (“ DSHEA ”).
        DSHEA
        established a new framework governing the composition and labeling of dietary
        supplements. With respect to composition, DSHEA defined “dietary supplements” as
        vitamins, minerals, herbs, other botanicals, amino acids and other dietary
        substances for human use to supplement the diet, as well as concentrates,
        metabolites, constituents, extracts or combinations of such dietary ingredients.
        Generally, under DSHEA, dietary ingredients that were on the market before
        October 15, 1994 may be used in dietary supplements without notifying the
        FDA.
        However, a “new” dietary ingredient (i.e., a dietary ingredient that was “not
        marketed in the United States before October 15, 1994”) must be the subject of a
        new dietary ingredient notification submitted to the FDA unless the ingredient
        has been “present in the food supply as an article used for food” without the
        food being “chemically altered.” A new dietary ingredient notification must
        provide the FDA evidence of a “history of use or other evidence of safety”
establishing that use of the dietary ingredient under the conditions suggested
        in the labeling “will reasonably be expected to be safe.” A new dietary
        ingredient notification must be submitted to the FDA at least 75 days before
        the
        initial marketing of the new dietary ingredient. There can be no assurance
        that
        the FDA will accept the evidence of safety for any new dietary ingredients
        that
        we may want to market, and the FDA’s refusal to accept such evidence could
        prevent the marketing of such dietary ingredients.
 
 DSHEA
        permits “statements of nutritional support” to be included in labeling for
        dietary supplements without FDA pre-approval. Such statements may describe
        how a
        particular dietary ingredient affects the structure, function or general
        well-being of the body, or the mechanism of action by which a dietary ingredient
        may affect body structure, function or well-being (but may not state that
        a
        dietary supplement will diagnose, cure, mitigate, treat, or prevent a disease
        unless such claim has been reviewed and approved by the FDA). A company that
        uses a statement of nutritional support in labeling must possess evidence
        substantiating that the statement is truthful and not misleading. In some
        circumstances it is necessary to disclose on the label that the FDA has not
        “evaluated” the statement, to disclose the product is not intended to diagnose,
        treat, cure or prevent a disease, and to notify the FDA about our use of
        the
        statement within 30 days of marketing the product. However, there can be
        no
        assurance that the FDA will not determine that a particular statement of
        nutritional support that a company wants to use is an unacceptable drug claim
        or
        an unauthorized version of a “health claim.” Such a determination might prevent
        a company from using the claim.
  6
 
 In
        addition, DSHEA provides that some so-called “third party literature,” e.g., a
        reprint of a peer reviewed scientific publication linking a particular dietary
        ingredient with health benefits, may be used “in connection with the sale of a
        dietary supplement to consumers” without the literature being subject to
        regulation as labeling. Such literature must not be false or misleading;
        the
        literature may not “promote” a particular manufacturer or brand of dietary
        supplement; and a balanced view of the available scientific information on
        the
        subject matter must be presented and must not have appended to it any other
        information. There can be no assurance, however, that all third party literature
        that we would like to disseminate in connection with our products will satisfy
        each of these requirements, and our failure to satisfy all requirements could
        prevent use of the literature or subject the product involved to regulation
        as
        an unapproved drug.
 
 As
        authorized by DSHEA, the FDA proposed Good Manufacturing Practices (“GMPs”)
        specifically for dietary supplements. These new GMP regulations, if finalized,
        would be more detailed than the GMPs that currently apply to dietary supplements
        and may, among other things, require dietary supplements to be prepared,
        packaged and held in compliance with some rules, and might require quality
        control provisions similar to those in the GMP regulations for drugs. There
        can
        be no assurance that, if the FDA adopts GMP regulations for dietary supplements,
        we will be able to comply with the new rules without incurring substantial
        expenses.
 
 ***OTC
        Pharmaceuticals*** ***.*** The
        majority of our OTC pharmaceuticals are regulated under the OTC Monograph
        System
        and are subject to some FDA regulations. Under the OTC Monograph System,
        selected OTC drugs are generally recognized as safe and effective and do
        not
        require the submission and approval of a New Drug Application (“NDA”) or
        Abbreviated New Drug Application (“ANDA”) prior to marketing. The FDA OTC
        Monograph System includes well-known ingredients and specifies requirements
        for
        permitted indications, required warnings and precautions, allowable combinations
        of ingredients and dosage levels. Drug products marketed under the OTC Monograph
        System must conform to specific quality and labeling requirements; however,
        these products generally may be developed under fewer restrictive conditions
        than those products that require the filing of an NDA or ANDA. It is, in
        general, less costly to develop and bring to market a product produced under
        the
        OTC Monograph System. From time to time, adequate information may become
        available to the FDA regarding some drug products that will allow the
        reclassification of those products as generally recognized as safe and effective
        and not misbranded and, therefore, no longer requiring the approval of an
        NDA or
        ANDA prior to marketing. For this reason, there may be increased competition
        and
        lower profitability related to a particular product should it be reclassified
        to
        the OTC Monograph System. In addition, regulations may change from time to
        time,
        requiring formulation, packaging or labeling changes for some
        products.
 
 We
        also
        market products that have switched from prescription to OTC status. These
        prescription to OTC switch products require approval by the FDA through our
        NDA
        or ANDA process before they can be commercialized. Based on current FDA
        regulations, all chemistry, manufacturing and control issues, bioequivalency
        and
        labeling related to these products are defined by the information included
        in
        the NDA or ANDA. The ANDA process generally reduces the time and expense
        related
        to FDA approval compared to the NDA process. For approval, we must demonstrate
        that the product is essentially the same as a product that has previously
        been
        approved by the FDA and is on the market and that our manufacturing process
        and
        other requirements meet FDA standards. This approval process may require
        that
        bioequivalence and/or efficacy studies be performed using a small number
        of
        subjects in a controlled clinical environment. Approval time is generally
        eighteen months to four years from the date of submission of the application.
        Changes to a product with an ANDA are governed by specific FDA regulations
        and
        guidelines that define when proposed changes, if approved by the FDA, can
        be
        implemented.
 
 The
        Drug
        Price Competition and Patent Term Restoration Act of 1984 (the Hatch-Waxman
        Amendments to the Federal Food, Drug, and Cosmetic Act) can grant a three-year
        period of marketing exclusivity to a company that obtains FDA approval of
        a
        prescription to OTC switch product when we have conducted new clinical
        investigations essential to the OTC approval. Unless we establish relationships
        with the companies having exclusive marketing rights, our ability to market
        prescription to OTC switch products and offer our customers products comparable
        to the national brand products would be delayed until the expiration of the
        three year exclusivity granted to those initiating the switch. There can
        be no
        assurance that, in the event that we apply for FDA approvals, we will obtain
        the
        approvals to market prescription to OTC switch products or, alternatively,
        that
        we will be able to obtain these products from other manufacturers.
  7
 
 The
        FDA
        Modernization Act of 1997 and the Best Pharmaceuticals for Children Act of
        2002
        amended the law regarding market exclusivity. In general, this legislation
        may
        grant an additional six months of exclusivity if the innovator conducted
        pediatric studies on the product. This policy will, in some instances, defer
        sales by us of some products.
 
 The
        law
        regarding exclusivity and stays of approval for ANDA applications changed
        in
        late 2003. Consequently, the old law will apply to some ANDA applications
        filed
        or licensed by us and other companies and the new law will apply to other
        ANDAs.
        Because the two laws have some differing provisions, they will be discussed
        separately where necessary for clarity.
 
 Under
        both versions of the law, if we are first to file our ANDA and meet some
        requirements, the FDA may grant a 180-day exclusivity for that product as
        to
        subsequently-filed ANDAs. During the ANDA approval process, patent certification
        is required and may result in legal action by the product innovator. The
        legal
        action generally would not result in material damages but could result in
        us
        being prevented from introducing the product if we are not successful in
        the
        legal action. We would, however, incur the cost of defending the legal action,
        and that action could have the effect of triggering a statutorily mandated
        delay
        in the FDA approval of the drug application for a period of up to 30 months,
        subject to court action lengthening or shortening the stay period. Under
        the old
        law (as amended retroactively by the new law) if there is a court decision
        in a
        patent litigation case related to the drug product that is favorable to us,
        the
        180-day exclusivity period may commence on the date of the decision even
        though
        a petition for certiorari may be filed and the final decision is not entered
        until sometime later. We may, however, decide not to assume the risk of
        marketing an approved product prior to the final decision on review of the
        certiorari petition of the favorable opinion of an appellate court.
 
 If
        we are
        not first to file an ANDA, the FDA may grant 180-day exclusivity to another
        company, thereby effectively delaying the launch of our product. Our 180-day
        exclusivity period will be triggered only by our own commercial marketing
        of the
        ANDA drug. On the other hand, we could lose our 180-day exclusivity period
        if we
        do not commence marketing before some “forfeiture events” occur. These
“forfeiture events” include the later of (1) the expiration of 75 days after the
        ANDA is granted or the expiration of 30 months after it is filed, whichever
        is
        earlier, or (2) 75 days after some court actions with respect to patents
        for
        which we have “lawfully maintained” paragraph IV certifications, or after the
        withdrawal of such patents from the Orange Book. The new law provides for
        other
        specified forfeiture events as well.
 We
            are
            also subject to the requirements of the Comprehensive Methamphetamine
            Control
            Act of 1996, a law designed to allow the Drug Enforcement Administration
            (“DEA”)
            to monitor transactions involving chemicals that may be used illegally
            in the
            production of methamphetamine. The Comprehensive Methamphetamine Control
            Act of
            1996 amended the Controlled Substances Act to establish specified registration,
            recordkeeping and reporting requirements for manufacturers and distributors
            of
            OTC cold, allergy, asthma and diet medicines that contain ephedrine,
            pseudoephedrine or phenylpropanolamine (“PPA”). While some of our OTC
            pharmaceutical products contain pseudoephedrine, our products contain
            neither
            ephedrine, a chemical compound that is distinct from pseudoephedrine,
            nor PPA.
            Pseudoephedrine is a common ingredient in decongestant products manufactured
            by
            us and other pharmaceutical companies. We have discontinued all products
            containing PPA. We believe that we are in compliance with all applicable
            DEA
            requirements.
 
 On
            March
            9, 2006, President Bush signed into Law the USA Patriot Act, of which
            Title VII
            is the Combat Methamphetamine Epidemic Act (CMEA) of 2005. The CMEA imposes
            restrictions on the retail sale of all cough and cold products that contain
            the
            methamphetamine precursor chemicals ephedrine, pseudoephedrine and
            phenylpropanolamine. It also limits the amounts of these products that
            consumers
            can purchase within a 30-day period. The Act impacts Leiner in that
            manufacturers and repackagers of pseudoephedrine-containing products
            must submit
            quota procurement requests to the DEA on an annual basis. These quota
            requests
            will need to identify the amount of psuedoephedrine active ingredient
            and
            finished dosage forms that Leiner will expect to handle/process in our
            facilities. As this quota procurement program is new, there is no assurance
            that
            DEA will approve Leiner's quota requirements.
 ***Manufacturing
        and Packaging*** *.* All
        facilities where foods (including dietary supplements) and pharmaceuticals
        are
        manufactured, packed, warehoused, or sold must comply with the FDA manufacturing
        standards applicable to that type of product. The FDA performs periodic audits
        to ensure that our facilities remain in compliance with the cGMP regulations.
        The failure of a facility to be in compliance may lead to a breach of
        representations made to store brand customers or to regulatory action against
        the products made in that facility, including seizure, injunction or recall.
        Our
        facilities are in compliance in all material respects with the cGMPs and
        other
        applicable requirements for each facility.
 
 ***CPSC*** ***.*** The
        Consumer Product Safety Commission (“CPSC”) has authority, under the Poison
        Prevention Packaging Act, to designate those products, including vitamin
        products and OTC pharmaceuticals that require child resistant closures to
        help
        reduce the incidence of poisonings. The CPSC has adopted regulations requiring
        numerous OTC pharmaceuticals and iron-containing dietary supplements to have
        such closures, and has adopted rules on the testing of such closures by both
        children and adults. We, working with our packaging suppliers, believe that
        we
        are in compliance with all CPSC requirements.
 
 ***FTC*** ***.*** The
        FTC
        exercises primary jurisdiction over the advertising and other promotional
        practices of food and OTC pharmaceuticals marketers, and has concurrent
        jurisdiction with the FDA over the advertising and promotional practices
        of
        marketers of dietary supplements. The FTC has historically applied a different
        standard to health-related claims than the FDA; the FTC has applied a
“substantiation standard,” which is less restrictive than the standard under the
        Nutritional Labeling Education Act (“NLEA”). The FTC NLEA enforcement policy
        uses FDA regulations as a baseline (and safe harbor) and permits (1) nutrient
        content descriptions that are reasonable synonyms of FDA-permitted terms,
        and
        (2) qualified health claims not approved by the FDA where adequate
        substantiation exists for the qualified or limited claims.
  8
 
 ***State
        Regulation*** ***.*** All
        states regulate foods and drugs under local laws that parallel federal statutes.
        Because the NLEA gave the states the authority to enforce many labeling
        prohibitions of the Federal Food, Drug, and Cosmetic Act after notification
        to
        the FDA, we, and other dietary supplement manufacturers, may be subject to
        increasing state scrutiny for NLEA compliance, as well as increasing FDA
        review.
        We are also subject to California Proposition 65 (the Safe Drinking Water
        and
        Toxic Enforcement Act of 1986) and state consumer health and safety regulations,
        which could have a potential impact on our business if any of our products
        were
        ever found not in compliance. We are not engaged in any enforcement or other
        regulatory actions and are not aware of any products that are not in compliance
        with California Proposition 65 and other similar state regulations.
 
 ***USP*** ***.*** The
        USP
        is a non-governmental, voluntary standard-setting organization. Its drug
        monographs and standards are incorporated by reference into the FDCA as the
        standards that must be met for the listed drugs, unless compliance with those
        standards is specifically disclaimed. USP standards exist for most OTC
        pharmaceuticals. The FDA would typically require USP compliance as part of
        cGMP
        compliance and with respect to ANDA drugs.
 
 The
        USP
        has adopted standards for vitamin and mineral dietary supplements that are
        codified in the USP Monographs and the USP Manufacturing Practices. These
        standards cover composition (nutrient ingredient potency and combinations),
        disintegration, dissolution, manufacturing practices and testing requirements.
        While USP standards for vitamin and mineral dietary supplements are voluntary
        and not incorporated into federal law, our customers may demand that products
        supplied to them meet these standards. Label claims of compliance with the
        USP
        may expose a company to FDA scrutiny for those claims. In addition, the FDA
        may
        in the future require compliance, or such a requirement may be included in
        new
        dietary supplement legislation. All of our products labeled USP meet the
        USP
        standards.
 
 ***Canadian
        Regulation*** ***.*** In
        Canada, our products are subject to federal and provincial law, particularly
        federal drug legislation. Government regulation under the Canadian Food and
        Drugs Act and the regulations thereunder require regulatory approvals of
        such
        products through a DIN, DIN-HM or NPN by Health Canada. All substances sold
        for
        ingestion by humans are regulated either as a food or drug under the Canadian
        Food and Drugs Act. In addition, some of our products are subject to government
        regulation under the CDSA. The Canadian Food and Drugs Act and the CDSA are
        enforced by Health Canada and other authorities.
 
 On
        January 1, 2004, the Natural Health Products Regulations made under the Canadian
        Food and Drugs Act came into force, requiring all natural health products,
        including vitamin and mineral supplements, to have a Natural Health Product
        license. Health Canada has provided a transition period of six years ending
        December 31, 2009, during which compliance action for Natural Health Products
        (“NHP”) will be governed by the Health Products and Food Branch Inspectorate’s
“Compliance Policy on Natural Health Products.” Natural Health Products are a
        subset of Drugs in the Food and Drugs Act.
 
 The
        Canadian Food and Drugs Act governs the processing, formulation, packaging,
        labeling, advertising and sale of our products and regulates what may be
        represented in Canada on labels and in promotional material, in respect of
        the
        properties of the various products. The Canadian Food and Drugs Act also
        provides that any drugs sold in Canada must have a label affixed thereto
        that
        shows specified information, such as its proper scientific or common name,
        the
        name and address of the manufacturer, its lot number, adequate directions
        for
        use, a quantitative list of its medical ingredients and its expiration date.
        In
        addition, no person may sell a drug unless it has been assigned a DIN, DIN-HM
        or
        NPN, which are obtained through an application to Health Canada. Regulations
        under the Canadian Food and Drugs Act require all manufacturers to pay annual
        fees for their DINs. Health Canada approval for the sale of our products
        may be
        subject to significant delays.
 
 The
        office of Controlled Substances of Health Canada regulates the manufacture
        and
        sale of controlled substances as defined in the CDSA. The Controlled Drugs
        and
        Substances Act contains requirements for licenses of the factory, approved
        security, a qualified person in charge of the factory and detailed record
        keeping in connection with the manufacturing of controlled substances.
 
 Regulations
        under the Canadian Food and Drugs Act set out mandatory and rigorous procedures,
        practices and standards for manufacturers. Health Canada performs inspections
        of
        companies in the industry to ensure compliance with the Canadian Food and
        Drugs
        Act and the CDSA. For each of our drug products, the development process,
        the
        manufacturing procedures, the use of equipment, and laboratory practices
        and
        premises must comply with Good Manufacturing Practices and Establishment
        Licensing regulations under the Canadian Food and Drugs Act.
  9
 
 Our
        Natural Health Products require regulatory approval in the form of a DIN-HM
        or
        NPN issued by Health Canada. Approvals are based on formulation and evidence
        of
        safety and efficacy. All of our products in the NHP category must comply
        with
        the Good Manufacturing Practices and Site Licensing requirements per the
        Natural
        Health Product Regulations under the Canadian Food and Drugs Act.
 
 **Intellectual
        Property**
 
 We
        regard
        our trademarks and other intellectual property rights as valuable assets
        and
        believe they are important in the marketing of our products. Among our most
        significant trademarks are *Your
        Life* ®
and *Pharmacist
        Formula* ®.
        We
        have registered these and other material trademarks in the United States
        and
        some foreign countries. We intend to maintain the foreign and domestic
        registrations of our trademarks so long as they remain valuable to our business.
        Generally, registered trademarks have perpetual life provided they are renewed
        on a timely basis and continue to be used properly as trademarks. Our business
        is not dependent to a material degree on our patents, copyrights or trade
        secrets. We have no licenses to intellectual property that, if lost, would
        have
        a material adverse effect on our business.
 
 **Environmental
        Matters**
 
 We
        are
        subject to various United States and Canadian federal, state, provincial
        and
        local environmental laws and regulations. The costs of complying with such
        laws
        and regulations have not had, and are not expected to have, a material adverse
        effect on our business.
 
 **Available
        Information**
 
 Our
        Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
        on
        Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d)
        of
        the Securities Exchange Act of 1934, as amended, are available free of charge
        on
        our web site at www.leiner.com as soon
        as reasonably practicable after we electronically file such material with,
        or
        furnish them to, the Securities and Exchange Commission. To access these
        reports, go to our website at www.leiner.com/financials.
  10
  **ITEM
        1A.**  **RISK
        FACTORS**
 
 ***Unfavorable
        research and negative publicity could adversely affect our sales of VMS
        products*** **.**
 
 We
        are dependent upon consumer perception regarding the safety and quality of our
        products, as well as similar products distributed by other companies. Consumer
        perception of products can be significantly influenced by scientific research
        or
        findings, national media attention and other publicity about product use.
        We
        believe the growth experienced in the last several years in the VMS FDMC
        market
        is based largely on national media attention regarding recent scientific
        research suggesting potential health benefits from regular consumption of
        some
        VMS products.
 
 Some
        recent studies relating to some antioxidants have produced results contrary
        to
        the favorable indications of other prior and subsequent studies. For example,
        vitamin E sales declined significantly since fiscal 2005 due to negative
        media
        reports. The scientific research to date with respect to antioxidants and
        some
        other of our VMS products is not conclusive, and future scientific results
        and
        media attention may not be favorable or consistent. In the event of future
        scientific results or media attention that is perceived by our consumers
        as less
        favorable or that questions earlier research or publicity, our sales of VMS
        products could be materially adversely affected. Adverse publicity in the
        form
        of published scientific research or otherwise, whether or not accurate, that
        associates consumption of our products or any other similar products with
        illness or other adverse effects, that questions the benefit of our or similar
        products or that claims that any such products are ineffective could have
        a
        material adverse effect on our financial position, results of operations
        or cash
        flows.
 
 ***Regulatory
        matters governing our industry could have a significant negative effect on
        our
        business*** ***.***
 
 The
        manufacturing, processing, formulation, packaging, labeling, advertising
        and
        sale of our products are subject to regulation by one or more U.S. and Canadian
        federal agencies, including the U.S. Food and Drug Administration (the “FDA”),
        the U.S. Federal Trade Commission (the “FTC”), the U.S. Consumer Product Safety
        Commission (the “CPSC”) and Health Canada. Our activities are also regulated by
        various agencies of the states, provinces, localities and countries in which
        some of our products are sold. In addition, we manufacture and market some
        of
        our products in compliance with the guidelines promulgated by voluntary standard
        organizations, such as the United States Pharmacopeia (“USP”).
 
 If
        we
        fail to comply with federal, state or foreign regulations, we could be required
        to:
 
 · change
        product labeling, packaging or advertising or take other corrective
        action;
 · change
        product formulations;
 · suspend
        the sale of products with non-complying specifications;
 · initiate
        product recalls;
 · prepare
        and submit a new drug application (“NDA”) or abbreviated NDA (“ANDA”) or foreign
        equivalent; or
 · suspend
        manufacturing operations.
 
 Any
        of
        these actions could have a material adverse effect on our financial position,
        results of operations or cash flows.
 
 We
        expect
        that the FDA soon will adopt its proposed rules on good manufacturing practices
        in manufacturing, packaging or holding dietary ingredients and dietary
        supplements, which may apply to the VMS products we manufacture. These
        regulations would require dietary supplements to be prepared, packaged and
        held
        in compliance with several rules, and may require quality control provisions
        similar to those in the good manufacturing practice regulations for drugs.
        If
        the FDA adopts the good manufacturing practice regulations, we would incur
        additional, and potentially substantial, expenses to comply with the new
        rules.
 
 In
        Canada, our products are subject to government regulation under the Food
        and
        Drugs Act and the regulations thereunder (the “Canadian Food and Drugs Act”)
        which require regulatory approvals of such products through a drug
        identification number (“DIN”), natural product number (“NPN”) or DIN-HM for
        homeopathic medicines by Health Canada. The loss of a particular DIN, DIN-HM
        or
        NPN would adversely affect the ability to continue to sell the particular
        product to which it was assigned. Material noncompliance with the provisions
        of
        the Canadian Food and Drugs Act may result in the loss of a DIN, DIN-HM or
        NPN
        or the seizure and forfeiture of products which are sold in noncompliance
        with
        the Canadian Food and Drugs Act. We are currently seeking regulatory approvals
        for some of our products. Regulatory approvals may not be received and receipt
        of such approvals may be subject to significant delays.
 
 Some
        of
        our products are subject to government regulation under the Canadian Controlled
        Drugs and Substances Act and the regulations thereunder (the “CDSA”), which
        includes requirements for licenses of the factory, approved security, a
        qualified person in charge of the factory and detailed record keeping in
        connection with the manufacturing of controlled substances.
  11
  The
        loss
        of a license or the failure to meet any of these requirements would adversely
        affect the ability to continue to manufacture and to sell products containing
        controlled substances.
 
 Our
        Natural Health Products (NHP) requires regulatory approval in the form of
        a
        DIN-HM or NPN issued by Health Canada. Approvals are based on formulation
        and
        evidence of safety and efficacy. All of our products in the NHP category
        must
        comply with the Good Manufacturing Practices and Site Licensing requirements
        per
        the Natural Health Product Regulations under the Canadian Food and Drugs
        Act.
 
 In
        addition, we cannot predict whether new legislation or regulation governing
        our
        activities will be enacted by legislative bodies or promulgated by agencies
        regulating our activities, or what the effect of any such legislation or
        regulation on our business would be. Any such developments could, however,
        require reformulation of some products to meet new standards, recalls or
        discontinuance of some products not able to be reformulated, additional or
        different labeling or other new requirements. Any such new legislation or
        regulation, including changes to existing laws and regulations, could have
        a
        material adverse effect on our financial position, results of operations
        or cash
        flows.
 
 ***We
        depend on a limited number of customers for most of our net sales and the
        loss
        of one or more of these customers could reduce our net
        sales*** ***.***
 
 In
        fiscal
        2006, our two largest customers accounted for approximately 44.1% and 23.5%,
        respectively, of our gross sales. Our top 10 customers, in the aggregate,
        accounted for approximately 86.7% of our gross sales for fiscal 2006. Retail
        customers in our industry do not generally offer or enter into long-term
        sales
        contracts with their suppliers. Consequently, we do not have long-term sales
        contracts with most of our retail customers. Should our relationship with
        one or
        more of our major customers change adversely, the resulting loss of business
        could have a material adverse effect on our financial position, results of
        operations or cash flows. In addition, if one or more of our major customers
        substantially reduced their volume of purchases from us, it could have a
        material adverse effect on our financial position, results of operations
        or cash
        flows. Furthermore, the impact of retailer consolidation could have an adverse
        impact on future sales growth. Should one of our major customers encounter
        financial difficulties, the exposure on uncollectible receivables and unusable
        inventory could have a material adverse effect on our financial position,
        results of operations or cash flows.
 
 ***A
        significant, unexpected disruption of operations at our facilities could
        adversely affect our financial position, results of operations or cash
        flows*** ***.***
 
 We operate
        three U.S. manufacturing facilities, one manufacturing, packaging and
        distribution facility and one sales, packaging and distribution facility,
        located in California, North Carolina and South Carolina. We also operate
        manufacturing, packaging and distribution facilities located in Manitoba,
        Canada. The primary manufacturing facilities for our VMS and OTC products
        are in
        California, North Carolina and South Carolina. A significant, unexpected
        disruption at any of our facilities could have a material adverse effect
        on our
        financial position, results of operations or cash flows.
 
 ***Our
        industry is highly competitive and price competition could diminish our sales
        volumes and revenues and our gross profits*** ***.***
 
 The
        market for our products is highly competitive. We compete with other VMS
        and OTC
        pharmaceuticals manufacturers, including national brand companies and generic
        prescription companies. Among other factors, competition among these
        manufacturers is based upon price. If one or more manufacturers significantly
        reduce their prices in an effort to gain market share, our financial position,
        results of operations or market position could be materially adversely affected.
        Some of our competitors, particularly manufacturers of nationally advertised
        brand name products, are larger and have resources substantially greater
        than we
        do, and are less leveraged than we are. In the future, one or more of these
        companies could seek to compete more directly with us by manufacturing store
        brand products or by significantly lowering the prices of their national
        brand
        products. Due to the high degree of price competition, we have not always
        been
        able to fully pass on cost increases to our customers. The inability to pass
        on
        future cost increases, the impact of direct store brand competitors and the
        impact of national brand companies lowering prices of their products or directly
        operating in the store brand market could have a material adverse effect
        on our
        financial position, results of operations or cash flows.
 
 We
        sell
        substantially all of our VMS products to FDMC retailers. Although we do not
        currently participate significantly in or sell to other channels such as
        health
        food stores, direct mail and direct sales, our products may face competition
        from such alternative channels if more customers utilize these channels of
        distribution to obtain VMS products. We have evaluated, and will continue
        to
        evaluate, the products and product categories in which we do business. Future
        product line extensions, or deletions, could have a material adverse effect
        on
        our financial position, results of operations or cash flows.
  12
  ***Our
        inability to continue to execute our business plan could adversely affect
        our
        business*** **.**
 
 Our
        competitive strengths include our reputation for supplying quality products,
        low-cost focus, sales and marketing strategies (including the wide range
        of
        products offered), and our customer service commitment (including adaptability
        to customer needs and speed of delivery). If we are unable, for any reason,
        to
        continue to control manufacturing costs or maintain our other competitive
        strengths, we may not be able to continue to execute our business plan, which
        could have a material adverse effect on our financial position, results of
        operations or cash flows.
 
 *Our
        failure to meet our industry’s demand for new products could adversely affect
        our financial position, results of operations or cash flows* *.*
 
 The
        industry we serve is characterized by rapid and frequent changes in demand
        for
        products and new product introductions. Some of our competitors may invest
        more
        heavily in research and/or product development than we do. The success of
        our
        new product offerings depends upon a number of factors, including our ability
        to:
 
 ·
        accurately anticipate customer
        needs;
 ·innovate
        and develop new
        products;
 · successfully
        commercialize new
        products in a timely manner;
 · price
        our products competitively and
        manufacture and deliver our products in sufficient volumes and on time;
        and
 · differentiate
        our product offerings
        from those of our competitors.
 
 If
        we do
        not introduce new products or make enhancements to meet the changing needs
        of
        our customers in a timely manner, some of our products could become obsolete,
        our sales could suffer, and we could lose market share, which could have
        a
        material adverse effect on our financial position, results of operations
        or cash
        flows.
 
 ***We
        rely on third-party suppliers for some important ingredients and products
        that
        we cannot manufacture*** ***.*** ****
 
 We
        purchase from third-party suppliers some important ingredients and products
        that
        we cannot manufacture. We currently have supply agreements with several
        suppliers of most of these ingredients and products. However, in some instances,
        including for four of our top 10 raw materials, we purchase only from a single
        source. Furthermore, our suppliers and vendors may not provide these ingredients
        and products in the quantities requested, in a timely manner or at a price
        we
        are willing to pay. An unexpected interruption of supply could materially
        adversely affect our financial position, results of operations or cash flows.
        A
        loss of any of our key single source suppliers could have a material adverse
        effect on our financial position, results of operations or cash
        flows.
 
 Increased
        demand for some of our products can occasionally exceed the existing supply
        of
        some important ingredients and components that we do not manufacture. An
        interruption in supply of such ingredients and components that we are unable
        to
        remedy could result in our inability to deliver our products on a timely
        basis,
        which, in turn, could have a material adverse effect on our financial position,
        results of operations or cash flows.
 
 In
        addition, we expect that the FDA may soon adopt its proposed rules on good
        manufacturing practices in manufacturing, packaging or holding dietary
        ingredients and dietary supplements. Our suppliers and vendors may be subject
        to, and may not be able to comply with, these regulations. Even if our suppliers
        and vendors are able to comply with these regulations, their compliance may
        increase the cost of some ingredients and products that we purchase from
        them.
 
 ***A
        rise in raw material prices could increase our product costs and dilute our
        margins.***
 
 Raw
        materials account for a significant portion of our manufacturing costs. We
        are
        exposed to risks in the raw materials market, which include limited supply
        of
        key raw materials and material fluctuations in pricing. We have encountered
        material fluctuations in the pricing of key raw materials in the past such
        as
        glucosamine and chondroitin. Consequently, the price of key raw materials
        may
        not remain relatively constant and product costs could increase significantly
        if
        raw material prices increase by amounts substantially above current prices,
        which would dilute our margins and adversely affect our profitability. We
        have
        not always in the past been, and may not in the future always be, able to
        raise
        customer prices quickly enough to fully offset the effects of any increase
        in
        raw material prices.
  13
  ***If
        we are unable to protect our intellectual property rights, our ability to
        compete could be negatively impacted*** **.** ****
 
 Our  ability
        to compete effectively depends in part upon our rights in the trademarks,
        designs, processes, technologies and materials owned by, used by or licensed
        to
        us. The market for our products depends to some extent upon the goodwill
        associated with our trademarks and trade names.
 
 Our
        attempts to protect our trademarks and other intellectual property in the
        United
        States and in the foreign countries in which we operate through a combination
        of
        trademark, patent and trade secret laws and nondisclosure agreements may
        be
        insufficient. In addition, because of the differences in foreign trademark,
        patent and other intellectual property laws, our intellectual property rights
        may not receive the same protection in foreign countries as they would in
        the
        United States.
 
 Other
        parties may infringe our intellectual property rights and may thereby dilute
        our
        brands in the marketplace. We may not always be successful in protecting
        or
        enforcing our intellectual property rights against competitors or other
        challenges. Litigation may be required to protect our intellectual property
        rights; the accompanying costs of time and money may be substantial. A
        successful claim of trademark, patent or other intellectual property
        infringement against us could prevent us from manufacturing or selling products,
        which could have a material adverse effect on our financial position, results
        of
        operations or cash flows.
 
 The
        packaging of some of our branded products identifies nationally branded products
        with which our products are comparable. In addition, the formulations for
        our
        store brand products are comparable to the national brands with which they
        compete. We have received letters from other companies alleging that our
        trademarks, trade dress and/or patents have infringed their intellectual
        property which could subject us to legal actions in the future.
 
 ***The
        unfavorable resolution of pending product liability claims or of any additional
        product liability claims brought in the future could have a material adverse
        effect on our financial position, results of operations or cash
        flows*** ***.***
 
 As
        a
        manufacturer of products designed for human consumption, we are subject to
        product liability claims if the use of our VMS products is alleged to have
        resulted in injury. Our VMS products consist of vitamins, minerals, herbs
        and
        other ingredients that are classified as foods or dietary supplements and
        are
        not subject to pre-market regulatory approval in the United States. Our OTC
        products are subject to strict FDA regulations. We have in the past been
        and are
        currently subject to various product liability claims and may be subject
        to
        additional claims in the future.
 
 There
        are
        currently seven pending individual product liability complaints filed against
        us
        and other defendants regarding allegations of damages sustained from ingestion
        of products containing phenylpropanolamine (“PPA”). Prior to the FDA revising
        its opinion regarding PPA in November 2000, we manufactured cold remedy products
        and diet aids that contained PPA. Two of the seven PPA claims involve products
        that were neither manufactured nor distributed by us.
 
 A
        supplier of chocolate laxatives to us, which also manufactures its own national
        brand laxatives, has been served with many complaints regarding product
        liability. The complaints allege a variety of injuries including bowel
        impaction, dependence and colon issues. Pursuant to our supply agreement,
        the
        supplier has asked us for indemnification regarding 47 of the individual
        complaints and one class action complaint.
 
 A
        complaint has been filed against 40 defendants, including us, alleging business
        practice violations in connection with the manufacture, labeling and sale
        of
        kava kava products. We no longer manufacture or distribute products containing
        kava kava.
 
 In
        addition, on February 6, 2004, the FDA issued a regulation prohibiting the
        sale
        of dietary supplements containing ephedrine alkaloids (“ephedra”). We and some
        of our predecessors have sold products containing ephedra. Although several
        claims have been filed against other manufacturers and distributors of products
        containing ephedra, the only complaint against us concerns a product that
        was
        not manufactured by us and for which we received a voluntary dismissal without
        prejudice. Other claims may be filed against us in the future. In addition,
        we
        briefly manufactured products containing bitter orange, an ephedra alternative.
 
 Two
        other
        product liability complaints have been filed against us. The first involves
        women’s laxative tablets allegedly to have been expired and the second claim
        alleges the erroneous dispensation of acetylsalicylic acid (aspirin) in lieu
        of
        acetaminophen with codeine.
 
 The
        unfavorable resolution of any of these pending product liability claims or
        of
        any additional product liability claims brought in the future could have
        a
        material adverse effect on our financial position, results of operations
        or cash
        flows if the judgments awarded in such cases exceed our insurance coverage.
        Since June 2004, we no longer have product liability coverage for new claims
        related to the use of PPA. Product liability insurance may not continue to
        be
        available to us at an economically reasonable cost and the coverage of these
        policies may not be adequate to cover liability incurred by us in respect
        of
        product liability claims. If we do not have adequate insurance, product
        liabilities relating to our products could have a material adverse effect
        on our
        financial position, results of operations or cash flows. For more information
        regarding our product liability claims, see “Item 3— Legal
        Proceedings.”
  14
  ***Product
        recalls costs could hurt our business*** ***.*** ****
 
 The
        FDA
        or Health Canada may take action with respect to any of our products that
        it
        deems fall within its jurisdiction. These actions could require us to change
        our
        product labeling or remove a particular product from the market. Any future
        recall or removal would result in additional costs to us, and could give
        rise to
        product liability litigation, either of which could be material. We cannot
        predict whether the FDA or Health Canada will take action with respect to
        any of
        our products and any such product recalls or removals could have a material
        adverse effect on our financial position, results of operations or cash
        flows.
 
 ***We
        have limited long-term human consumption experience for some products; if
        adverse reactions from long-term consumption of these products occur, we
        could
        be subject to product liability claims*** ***.*** ****
 
 Some
        of
        our products contain ingredients which do not have long histories of human
        consumption, and our products may not have the effects intended. Previously
        unknown adverse reactions resulting from the long-term human consumption
        of
        these ingredients could occur. If our products are alleged to have resulted
        in
        injury or death, we could be subject to product liability claims, which could
        have a material adverse effect on our financial position, results of operations
        or cash flows. We are currently party to several product liability claims
        alleging injury or death from the use of our products. See “—The unfavorable
        resolution of pending product liability claims or of any additional product
        liability claims brought in the future could have a material adverse effect
        on
        our financial position, results of operations or cash flows.”
 
 ***We
        depend on key personnel for our current and future
        performance*** ***.*** ****
 
 The
        operation of our business requires managerial and operational expertise.
        Our
        future success depends to a significant degree upon the continued contributions
        of our senior management, many of whom would be difficult to replace. We
        do not
        have employment contracts with several of our executive officers, including
        our
        Chief Executive Officer. If, for any reason, key personnel do not continue
        to be
        active in our management, such loss could have a material adverse effect
        on our
        financial position, results of operations or cash flows.
 
 ***Rising
        insurance costs and changes in the availability of insurance could have a
        material adverse effect on our financial position, results of operations
        or cash
        flows*** ***.*** ****
 
 We maintain
        insurance, including property, general and product liability, workers’
compensation and directors’ and officers’ liability, to protect ourselves
        against potential loss exposures. To the extent that losses occur, there
        could
        be a material adverse effect on our financial position, results of operations
        or
        cash flows depending on the nature of the loss and the level of insurance
        coverage. Deductible or retention amounts may increase and coverages may
        be
        reduced in the future. For example, since June 2004, we no longer have product
        liability coverage for new claims related to the use of PPA.
 
 Our
        operating cash flow has been impacted by rising insurance costs. The cost
        to
        obtain all types of insurance continues to increase throughout the nation
        due to
        circumstances beyond our control. A continued trend of rising insurance costs
        could have a material adverse effect on our financial position, results of
        operations or cash flows.
 
 ***Our
        2002 restructuring could result in significant tax
        exposures*** ***.*** ****
 
 In
        April
        2002, we underwent a restructuring under Chapter 11 of the Bankruptcy Code.
        As
        part of the restructuring, we and our affiliates undertook some transactions
        which we believe should qualify as tax-free and should not have resulted
        in
        recognition of any gain or loss by us or our affiliates. If, however, such
        transactions were ultimately determined not to be tax-free, we could be required
        to pay a substantial amount of U.S. federal income tax and interest, which
        could
        have a material adverse effect on our financial position, results of operations
        or cash flows.
  15
  ***Our
        substantial level of indebtedness could adversely affect our financial condition
        and prevent us from fulfilling our obligations on the
        Notes*** ***.*** ****
 
 We have
        substantial indebtedness. As of March 25, 2006, we had approximately $402.6
        million of total indebtedness. In addition, subject to restrictions in the
        indenture and our New Credit Facility, we may incur additional indebtedness.
        In
        particular, as of March 25, 2006, we have $35.4 million of additional borrowing
        capacity under the revolving portion of our New Credit Facility, net of $9.6
        million of outstanding letters of credit.
 
 Our
        high
        level of indebtedness could have important consequences to the holders of
        Notes.
        For example, it could:
  ·
              make
                  it more difficult for us to satisfy our obligations on the
                  Notes;
 ·
              require
                  us to dedicate a substantial portion of our cash flow from operations
                  to
                  interest and principal payments on our indebtedness, thereby reducing
                  the
                  availability of our cash flow for other purposes, such as capital
                  expenditures, acquisitions and working
                  capital;
 ·
              limit
                  our flexibility in planning for, or reacting to, changes in our
                  business
                  and the industry in which we operate; ·
              increase
                  our vulnerability to general adverse economic and industry
                  conditions; ·
              place
                  us at a disadvantage compared to our competitors that have less
                  debt; ·
              expose
                  us to fluctuations in the interest rate environment because the
                  New Credit
                  Facility is at a variable rate of interest;
                  and ·
              limit
                  our ability to borrow additional
                  funds.
  We
        expect
        to pay our expenses and the principal and interest on the Notes, our New
        Credit
        Facility and other debt from cash flow from our operations and from additional
        loans under our New Credit Facility. Our ability to meet our expenses thus
        depends on our future performance, which will be affected by financial,
        business, economic and other factors. We will not be able to control many
        of
        these factors, such as economic conditions in the markets where we operate
        and
        pressure from competitors. Our cash flow may not be sufficient to allow us
        to
        pay principal and interest on our debt (including the Notes) and meet our
        other
        obligations. If we do not have enough money, we may be required to refinance
        all
        or part of our existing debt (including the Notes), sell assets or borrow
        more
        money. We may not be able to do so on terms acceptable to us. In addition,
        the
        terms of existing or future debt agreements, including our New Credit Facility
        and the indenture, may restrict us from adopting any of these alternatives.
        The
        failure to generate sufficient cash flow or to achieve such alternatives
        could
        significantly adversely affect the value of the Notes and our ability to
        pay
        principal of and interest on the Notes.
 
 ***The
        right of holders of Notes to receive payments on the Notes and guarantees
        is
        subordinated to our and the guarantors’ senior debt.***
 
 Payment
        on the Notes and guarantees is subordinated in right of payment to all of
        our
        and the guarantors’ senior debt, including our New Credit Facility. As a result,
        upon any distribution to our creditors or the creditors of the guarantors
        in a
        bankruptcy, liquidation or reorganization or similar proceeding relating
        to us
        or the guarantors or our or their property, the holders of senior debt will
        be
        entitled to be paid in full in cash before any payment may be made on these
        Notes or the subsidiary guarantees. In these cases, we and the subsidiary
        guarantors may not have sufficient funds to pay all of our creditors, and
        holders of Notes may receive less, ratably, than the holders of senior debt
        and,
        due to the turnover provisions in the indenture, less, ratably, than the
        holders
        of unsubordinated obligations, including trade payables. In addition, all
        payments on the Notes and the guarantees will be blocked in the event of
        a
        payment default on designated senior debt and may be blocked for up to 179
        consecutive days in the event of specified non-payment defaults on designated
        senior debt.
 
 As
        of
        March 25, 2006, the Notes and the guarantees were subordinated to $252.6
        million
        of senior debt, and $35.4 million was available for borrowing as additional
        senior debt under the revolving portion of our New Credit Facility, net of
        $9.6
        million of outstanding letters of credit. We are permitted to incur substantial
        additional indebtedness, including senior debt, in the future under the terms
        of
        the indenture.
 
 ***The
        indenture for the Notes and our New Credit Facility impose significant operating
        and financial restrictions, which may prevent us from capitalizing on business
        opportunities and taking some actions.*** ****
 
 The
        indenture for the Notes and our New Credit Facility impose significant operating
        and financial restrictions on us. These restrictions limit the ability of
        us and
        our subsidiaries to, among other things, incur additional indebtedness, make
        investments, sell assets, incur liens, enter into agreements restricting
        our
        subsidiaries’ ability to pay dividends, or merge or consolidate. In addition,
        our New Credit Facility requires us to maintain specified financial ratios.
        These covenants may adversely affect our ability to finance our future
        operations or capital needs or to pursue available business opportunities.
        A
        breach of any of these covenants or our inability to maintain the required
        financial ratios could result in a default under the related indebtedness.
        If a
        default occurs, the relevant lenders could elect to declare the indebtedness,
        together with accrued interest and other fees, to be immediately due and
        payable
        and proceed against any collateral securing that indebtedness.
  16
 
 ***Claims
        of creditors of our non-guarantor subsidiaries will generally have priority
        with
        respect to the assets and earnings of these subsidiaries over the claims
        of
        holders of the Notes.*** ****
 
 Our
        foreign subsidiaries are not guaranteeing the Notes. Claims of creditors
        of the
        non-guarantor subsidiaries, including trade creditors, secured creditors
        and
        creditors holding indebtedness, and claims of preferred stockholders (if
        any) of
        the non-guarantor subsidiaries, will generally have priority with respect
        to
        their assets and earnings over the claims of creditors of our company, including
        holders of the Notes, even if the obligations of the subsidiaries do not
        constitute senior indebtedness, except to the extent that the issuer is itself
        recognized as a creditor of the subsidiary, in which case the claims of the
        issuer would still be subordinate to any security in the assets of the
        subsidiary and any indebtedness of the subsidiary senior to that held by
        the
        issuer. As of March 25, 2006, our non-guarantor subsidiaries had $5.4 million
        of
        liabilities (including trade payables) outstanding.
 
 ***We
        may not be able to purchase the Notes upon a change of
        control.*** ****
 
 Upon
        the
        occurrence of a “change of control,” as defined in the indenture, each holder of
        the Notes will have the right to require us to purchase the Notes at a price
        equal to 101% of the principal amount, together with any accrued and unpaid
        interest. Our failure to purchase, or give notice of purchase of, the Notes
        would be an event of default under the indenture, which would in turn be
        an
        event of default under our New Credit Facility. In addition, a change of
        control
        may constitute an event of default under our New Credit Facility. A default
        under our New Credit Facility would result in an event of default under the
        indenture if the lenders accelerate the debt under our New Credit
        Facility.
 
 If
        a
        change of control occurs, we may not have enough assets to satisfy all
        obligations under our New Credit Facility and the indenture related to the
        Notes. Upon the occurrence of a change of control, we could seek to refinance
        the indebtedness under our New Credit Facility and the Notes or obtain a
        waiver
        from the lenders or holders of the Notes. We may not be able to obtain a
        waiver
        or refinance our indebtedness on commercially reasonable terms, if at
        all.
 
 ***We
        are controlled by our principal stockholders, which may have interests in
        conflict with the interests of holders of the Notes.*** ****
 
 The
        Golden Gate Investors and the North Castle Investors each own or control
        49.6%
        (46.8% including our delayed delivery share awards and Series C preferred
        stock)
        of the voting power of the outstanding shares of our new parent company.
        The
        Golden Gate Investors and the North Castle Investors effectively control
        the
        outcome of matters requiring a stockholder vote, including the election of
        directors. Moreover, under the terms of a stockholders agreement, the Golden
        Gate Investors and the North Castle Investors possess approval rights over
        some
        significant transactions that may be pursued by us, including mergers or
        sales.
 
 The
        interests of the Golden Gate Investors or the North Castle Investors could
        conflict with the interests of holders of the Notes. For example, if we
        encounter financial difficulties or are unable to pay our debts as they mature,
        the interests of the Golden Gate Investors or the North Castle Investors
        might
        conflict with the interests of holders of the Notes. The Golden Gate Investors
        or the North Castle Investors may also have an interest in pursuing
        acquisitions, divestitures, financings or other transactions that, in their
        judgment, could enhance their equity investments, even though such transactions
        might involve risks to the holders of the Notes.
 
 ***The
        Notes and guarantees may be voided under specific legal
        circumstances.*** ****
 
 The
        Notes
        are guaranteed by all of our existing and future domestic restricted
        subsidiaries. The Notes and guarantees may be subject to review under U.S.
        federal bankruptcy law and comparable provisions of state fraudulent conveyance
        laws if a bankruptcy or reorganization case or lawsuit is commenced by or
        on
        behalf of our or one of a guarantor’s unpaid creditors. Under these laws, if a
        court were to find in such a bankruptcy or reorganization case or lawsuit
        that,
        at the time the issuer of Notes incurred the debt evidenced by the Notes
        or any
        guarantor issued a guarantee of the Notes:
  ·
              it
                  received less than reasonably equivalent value or fair consideration
                  for
                  issuing the Notes or the guarantee, as applicable, and at the
                  time; ·
              it
                  was insolvent or rendered insolvent by reason of issuing the Notes
                  or the
                  guarantee, as applicable; ·
              it
                  was engaged, or about to engage, in a business or transaction for
                  which
                  its remaining unencumbered assets constituted unreasonably small
                  capital
                  to carry on its business;  17
  ·
              it
                  intended to incur, or believed that it would incur, debts beyond
                  its
                  ability to pay as they mature; ·
              it
                  was a defendant in an action for money damages, or had a judgment
                  for
                  money damages docketed against it if, in either case, after final
                  judgment, the judgment is unsatisfied; or ·
              it
                  issued the Notes or the guarantee, as applicable, to delay, hinder
                  or
                  defraud present or future
                  creditors,
 
 then
        the
        court could void the obligations under the Notes or the guarantee, as
        applicable, subordinate the Notes or the guarantee of the Notes, as applicable,
        to other debt or take other action detrimental to the holders of the
        Notes.
 
 We
        cannot
        be sure as to the standard that a court would use to determine whether the
        issuer or a guarantor was solvent at the relevant time, or, regardless of
        the
        standard that the court uses, that the issuance of the Notes or the guarantees
        would not be voided or the Notes or the guarantees would not be subordinated
        to
        other debt. If such a case were to occur, the guarantee could also be subject
        to
        the claim that, since the guarantee was incurred for our benefit, and only
        indirectly for the benefit of the guarantor, the obligations of the applicable
        guarantor were incurred for less than fair consideration. A court could thus
        void the obligations under the guarantee, subordinate the guarantee to the
        applicable guarantor’s other debt or take other action detrimental to holders of
        the Notes.
 
 **ITEM
        1B.**  **UNRESOLVED
        STAFF COMMENTS**
 
 None.
  18


**ITEM
        2.**  **PROPERTIES**
 
 The
        following table sets forth the location, type of facility, square footage
        and
        ownership interest in each of our principal facilities. We also lease certain
        additional office space throughout the United States.
 
 **Location**
              
              **Type
                  of Facility**
              
              **Approx.**
                **Square**
                **Feet**
              
              **Leased**
                **or**
                **Owned**
              
              **Date
                  of**
                **Lease**
                **Expiration**Fort
                  Mill, SC
              
              
              Manufacturing,
                  Packaging and Distribution
              
              
              680,000
              
              
              Leased
              
              
              8/31/2013Carson,
                  CA
              
              
              HQ,
                  Sales, Packaging, Distribution
              
              
              488,000
              
              
              Leased
              
              
              3/31/2014Winnipeg,
                  Manitoba
              
              
              Manufacturing,
                  Packaging,
              
              
              185,000
              
              
              Owned
              
              
              -Distribution
              
              
              34,500
              
              
              Leased
              
              
              8/31/2008Garden
                  Grove, CA
              
              
              Manufacturing
              
              
              165,000
              
              
              Leased
              
              
              12/31/2011Wilson,
                  NC
              
              
              Manufacturing
              
              
              125,000
              
              
              Owned
              
              
              -Valencia,
                  CA
              
              
              Manufacturing
              
              
              52,500
              
              
              Leased
              
              
              8/31/2012
 
 We
        believe that our facilities and equipment are generally well maintained and
        in
        good operating condition.
 
 Our
        active manufacturing and distribution facilities consist of approximately
        1.7
        million square feet of owned or leased plant and office facilities in six
        locations, in three U.S. states and one Canadian Province. We are one of
        the
        largest manufacturers in the North American vitamin products industry and
        are
        capable of packaging over 40.8 billion doses each year.
 
 We
        have
        four U.S. manufacturing facilities, which are located in Garden Grove,
        California, Valencia, California, Wilson, North Carolina and Fort Mill, South
        Carolina. The primary manufacturing facilities for our vitamin products and
        OTC
        pharmaceuticals are our 165,000 square foot Garden Grove plant, our 125,000
        square foot Wilson plant and our 680,000 square foot Fort Mill facility.
        In the
        event of a catastrophic casualty to one of our primary vitamin or OTC tableting
        facilities, we have the ability to shift production to other facilities.
        In
        fiscal 2006, we operated two packaging and distribution facilities in the
        U.S.,
        which are located in Carson, California and Fort Mill, South
        Carolina.
 
 Vita
        Health currently tablets, bottles and packages its products in a 185,000
        square
        foot facility in Manitoba of which approximately 20,000 square feet is office
        space.
 
 **ITEM
        3.**  **LEGAL
        PROCEEDINGS**
 
 We
        are
        from time to time engaged in litigation. We regularly review all pending
        litigation matters in which we are involved and establish reserves deemed
        appropriate by management for these litigation matters. However, some of
        these
        matters are material and an adverse outcome in these matters could have a
        material adverse effect on our financial condition, results of operations
        or
        cash flows. We are vigorously defending each of these claims. We maintain
        insurance against product liability claims, but it is possible that our
        insurance coverage will not continue to be available on terms acceptable
        to us
        or that such coverage will not be adequate for liability actually
        incurred.
 
 **Product
        Liability**
 
 There
        are
        currently seven pending individual product liability complaints filed against
        us
        and/or our customers alleging damages sustained from ingestion of PPA, a
        substance that previously was an ingredient in some of our diet aid and cold
        remedy products. These complaints were filed between August 9, 2001 and August
        27, 2003 in both state and federal courts in Pennsylvania, New York, Arkansas,
        Texas, Louisiana and Michigan. The complaints include allegations such as
        subarachnoid hemorrhage, aneurysm, intracranial hemorrhage, debilitating
        neurological injuries and headaches. We previously manufactured products
        that
        contained PPA, but removed that ingredient from all of our product formulations
        promptly after the FDA revised their opinion regarding PPA in November 2000.
        Two
        of the seven PPA claims involve products that were neither manufactured nor
        distributed by us.
 
 A
        supplier of chocolate laxatives to us, which also manufactures its own national
        brand laxatives, has been served with many product liability complaints.
        The
        complaints allege a variety of injuries including bowel impaction, dependence
        and colon issues. Pursuant to our supply agreement, the supplier has asked
        us
        for indemnification for 47 individual complaints and one class action
        complaint.
  19
  In
        addition, on February 6, 2004, the FDA issued a regulation prohibiting the
        sale
        of dietary supplements containing ephedra. We and some of our predecessors
        have
        sold products containing ephedra. Although claims have been filed against
        other
        manufacturers and distributors of products containing ephedra, the only
        complaint against us concerns a product that was not manufactured by us and
        for
        which we have received a voluntary dismissal without prejudice. In addition,
        we
        briefly manufactured products containing bitter orange, an ephedra
        alternative.
 
 **Breach
        of Contract**
 
 A
        supplier of Chondroitin supplied sub-potent product to us which was partially
        paid prior to the discovery of the quality issues. This material was not
        incorporated into finished products that were supplied to customers. We filed
        a
        complaint against the manufacturer in the Supreme Court of the State of
        California, County of Orange, alleging breach of contract and negligence
        among
        other claims. The supplier filed a counter-claim against us for breach of
        contract due to our refusal to pay the outstanding balance owed for the product.
        This matter is currently in discovery.
 
 **Intellectual
        Property**
 
 The
        packaging of some of our branded products identifies nationally branded products
        with which our products are comparable. In addition, the formulations for
        our
        store brand products are comparable to the national brands with which we
        compete. We have received letters from other companies alleging that our
        trademarks, trade dress and/or patents have infringed their intellectual
        property. We design our packaging and manufacture products to avoid infringing
        the intellectual property rights of other companies.
 
 On
        September 28, 2005, we received a cease and desist letter from attorneys
        for
        Vital Basics, Inc. alleging that our Focus Smart® trademark and tradedress
        infringed their Focus Factor trademark and tradedress rights. We revised
        the
        tradedress for the product sold at one of our retail customers, but we do
        not
        believe there are any other valid infringement claims. On June 6, 2006, we
        received a notice from attorneys for Vital Basics, Inc. alleging that our
        Focus
        Smart® formulation infringes the patent application of their Focus Factor®
dietary supplement. In a letter dated June 9, 2006, our outside patent counsel
        informed counsel for Vital Basics, Inc. that its patent infringement claim
        is
        without merit. In the event Vital Basics, Inc. sues us in court for this
        alleged
        infringement, we will defend such claim vigorously.
 
 **Other
        Civil Litigation**
 
 On
        December 22, 2005, a complaint was filed in the District Court for Cotton
        County
        in the State of Oklahoma against 5 manufacturers including us, 7 retailer
        companies and 1 individual. The complaint, which has not been served on us
        to
        date, alleges that pseudoephedrine manufacturers and retailers knew or should
        have known that pseudoephedrine is illegally used to manufacture methamphetamine
        and that it is foreseeable that such illegal use would result in the death
        of a
        police officer.
 
 From
        time
        to time, we are involved in other various legal proceedings arising in the
        ordinary course of our business operations, such as personal injury claims,
        employment matters, intellectual property and contractual disputes.
 
 **ITEM
        4.**  **SUBMISSION
        OF MATTERS TO A VOTE OF SECURITY HOLDERS**
 
 There
        were no matters submitted to a vote of security holders during the fourth
        quarter of fiscal 2006.
 
 **PART
        II**
 
 **ITEM
                5.**
              **MARKET
                  FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND****ISSUER
                  PURCHASES OF EQUITY
                  SECURITIES**
 
 There
        is
        no trading market for our Common Stock. All of the outstanding shares of
        our
        Common Stock are held by Leiner Holdings Corp. We did not pay any dividends
        in
        fiscal 2006.
  20
 
 **ITEM
        6.**  **SELECTED
        FINANCIAL DATA**
 
 The
        following table presents selected historical financial data derived from
        our
        consolidated financial statements. This data should be read in conjunction
        with
“Item 7. Management’s Discussion and Analysis of Financial Condition and Results
        of Operations” and “Item 8. Financial Statements and Supplementary Data.”
Effective fiscal 2003, we changed our reporting period to a 52-week or 53-week
        fiscal year, falling on the last Saturday in March each year. Each of the
        fiscal
        years ended March 29, 2003, March 27, 2004, March 26, 2005 and March 25,
        2006
        were comprised of 52-week periods.
 **Year
                    Ended****March
                    31,**
                  **2002**
                
                **March
                    29,**
                  **2003
                    (1)**
                
                **March
                    27,**
                  **2004**
                
                **March
                    26,**
                  **2005**
                
                **March
                    25,**
                  **2006****(dollars
                    in thousands)****Consolidated
                  Statement of Operations Data:**Net
                    sales
                
                $
                585,625
                
                $
                574,281
                
                $
                661,045
                
                $
                684,901
                
                $
                669,561Cost
                    of sales
                
                
                467,047
                
                
                430,090
                
                
                486,554
                
                
                512,871
                
                
                533,215Gross
                    profit
                
                
                118,578
                
                
                144,191
                
                
                174,491
                
                
                172,030
                
                
                136,346Marketing,
                    selling and distribution expenses
                
                
                54,110
                
                
                48,600
                
                
                56,448
                
                
                58,532
                
                
                58,444General
                    and administrative expenses
                
                
                59,119
                
                
                43,931
                
                
                41,041
                
                
                34,134
                
                
                35,725Research
                    and development expenses
                
                
                6,223
                
                
                5,487
                
                
                5,670
                
                
                5,299
                
                
                4,551Amortization
                    of goodwill and other intangibles
                
                
                6,682
                
                
                1,585
                
                
                447
                
                
                250
                
                
                638Restructuring
                    charges
                
                
                4,440
                
                
                (245
                )
                
                -
                
                
                -
                
                
                3,836Recapitalization
                    expenses
                
                
                -
                
                
                -
                
                
                -
                
                
                87,982
                
                
                -Other
                    operating expense (income) (2)
                
                
                (27,446
                )
                
                (77,708
                )
                
                1,528
                
                
                2,386
                
                
                1,113Operating
                    income (loss)
                
                
                15,450
                
                
                122,541
                
                
                69,357
                
                
                (16,553
                )
                
                32,039Loss
                    from investment in joint venture
                
                
                274
                
                
                -
                
                
                -
                
                
                -
                
                
                -Interest
                    expense, net
                
                
                34,951
                
                
                18,809
                
                
                18,954
                
                
                32,346
                
                
                36,869Income
                    (loss) before income taxes
                
                
                (19,775
                )
                
                103,732
                
                
                50,403
                
                
                (48,899
                )
                
                (4,830
                )Provision
                    for (benefit from) income taxes
                
                
                (10,248
                )
                
                15,587
                
                
                11,347
                
                
                (987
                )
                
                (1,062
                )Income
                    (loss) before extraordinary item and cumulativeeffect
                    of change in accounting principle
                
                
                (9,527
                )
                
                88,145
                
                
                39,056
                
                
                (47,912
                )
                
                (3,768
                )Extraordinary
                    gain, net
                
                
                -
                
                
                68,106
                
                
                -
                
                
                -
                
                
                -Cumulative
                    effect of change in accounting principle, net
                
                
                -
                
                
                (10,521
                )
                
                -
                
                
                -
                
                
                -Net
                    income (loss)
                
                
                (9,527
                )
                
                145,730
                
                
                39,056
                
                
                (47,912
                )
                
                (3,768
                )Accretion
                    on preferred stock
                
                
                -
                
                
                (8,083
                )
                
                (12,105
                )
                
                (39,212
                )
                
                -Net
                    income (loss) attributable to common shareholders
                
                $
                (9,527
                )
                $
                137,647
                
                $
                26,951
                
                $
                (87,124
                )
                $
                (3,768
                )**Other
                  Financial Data:**Cash
                    flow from (used in) operating activities
                
                $
                31,171
                
                $
                87,368
                
                $
                37,766
                
                $
                (39,605
                )
                $
                19,301Cash
                    flow from (used in) investing activities
                
                
                386
                
                
                (8,807
                )
                
                (13,175
                )
                
                (20,935
                )
                
                (35,601
                )Cash
                    flow from (used in) financing activities
                
                
                (37,791
                )
                
                (82,851
                )
                
                (9,834
                )
                
                40,867
                
                
                10,980Capital
                    expenditures
                
                
                1,325
                
                
                5,648
                
                
                10,413
                
                
                17,991
                
                
                13,244**Consolidated
                    Balance Sheet Data (as of end of period):**Cash
                    and cash equivalents
                
                $
                21,236
                
                $
                17,547
                
                $
                33,824
                
                $
                16,951
                
                $
                7,731Working
                    capital
                
                
                71,406
                
                
                103,805
                
                
                135,928
                
                
                135,643
                
                
                134,680Total
                    assets
                
                
                333,460
                
                
                337,529
                
                
                387,727
                
                
                416,798
                
                
                416,098Total
                    debts
                
                
                336,287
                
                
                174,630
                
                
                171,006
                
                
                396,526
                
                
                402,617Series
                    A redeemable preferred stock
                
                
                -
                
                
                28,083
                
                
                40,188
                
                
                -
                
                
                -Shareholders'
                    equity (deficit)
                
                
                (127,649
                )
                
                23,183
                
                
                51,014
                
                
                (122,974
                )
                
                (115,082
                )
 ________________________
 (1)
        We
        consummated a plan of reorganization under Chapter 11 of the U.S. Bankruptcy
        Code and emerged from court protection on April 19, 2002.
 (2)
        Other
        operating expense (income) includes $40,778 and $98,380 in fiscal 2002 and
        2003,
        respectively, representing settlement awards received in connection with
        an
        antitrust suit against some of our raw material suppliers, net of legal and
        consulting fees and other costs of approximately $9,930 and $19,186,
        respectively.
  21
 
 **ITEM
                7.**
              **MANAGEMENT'S****DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND****RESULTS
                  OF OPERATIONS**
 
 *As
        used in the management’s discussion and analysis section of this report, unless
        the context indicates otherwise the terms “our company”, “we”, “our”, and “us”
refer collectively to Leiner Health Products Inc. and its subsidiaries (the
        “Company”), including Vita Health Products Inc. of Canada (“Vita”), a wholly
        owned subsidiary. The following discussion and analysis of our financial
        condition and results of operations should be read in conjunction with our
        consolidated financial statements contained elsewhere in this report. We
        report
        on* *a
        52-week or 53-week fiscal year, falling on the last Saturday in March each
        year.
        Each of the fiscal years ended March 27, 2004, March 26, 2005 and March 25,
        2006
        were comprised of 52-week periods.*
 
 **Overview**
 
 We
        are
        the leading manufacturer of store brand vitamins, minerals and nutritional
        supplements (“VMS”) products and the second largest supplier of store brand
        over-the-counter (“OTC”) pharmaceuticals in the U.S. Food, drug and mass
        merchant and warehouse club (“FDMC”) retail market, as measured by U.S. retail
        sales in 2005. Most of our products are manufactured for our customers to
        sell
        as their own store brands. We have long-term relationships with leading FDMC
        retailers and focus on the fastest-growing of these retailers—the mass merchants
        and warehouse clubs. In addition to our primary VMS and OTC products, we
        provide
        contract manufacturing services to consumer products and pharmaceutical
        companies.
 
 We
        generated 62.7%, 61.2% and 63.0 % of our net sales from VMS products and
        28.9%,
        31.2% and 29.7% of our net sales from OTC products in fiscal 2004, 2005 and
        2006, respectively. Contract manufacturing services accounted for 8.3%, 7.6%
        and
        7.3% of our net sales in fiscal 2004, 2005 and 2006, respectively. Our VMS
        products include multi-vitamins, vitamins C and E, joint care products, as
        well
        as minerals and supplements. Our OTC products principally consist of analgesics,
        cough, cold and allergy medications and digestive aids. Most of our products
        are
        manufactured for our customers to sell as their own store brands, although
        we
        also sell our VMS products under our own *Your
        Life* *®* brand
        and
        our OTC products under our own *Pharmacist
        Formula* ® brand.
 
 We
        believe that trends in the VMS and OTC FDMC store brand markets are the most
        significant trends impacting our financial performance. We estimate that
        over
        the last 10 years, the VMS FDMC and OTC FDMC markets have grown to approximately
        $4.0 billion and $10.7 billion, respectively, as measured by 2005 retail
        sales.
        Over the same period, we estimate that the VMS FDMC market has grown at a
        compound annual growth rate of approximately 6.7% and the OTC FDMC market
        has
        grown at a compound annual growth rate of approximately 4.2%. Within the
        VMS
        FDMC and OTC FDMC markets, store brands have grown faster than national brands.
        Over the last 10 years, we estimate that the VMS FDMC store brand market
        has
        grown at a compound annual growth rate of approximately 9.5% and the OTC
        FDMC
        store brand market has grown at a compound annual growth rate of approximately
        7.1%. This growth in the VMS and OTC FDMC markets is driven by (1) the aging
        of
        the U.S. population and the increased life expectancy, (2) the increase in
        healthcare costs, which has driven managed care companies and legislators
        to
        seek to enhance the availability of lower cost healthcare alternatives such
        as
        OTC drugs and generic drugs, and (3) what we believe is the increasing use
        by
        Americans of self-care techniques prior to seeing a doctor. In addition,
        the
        growth experienced in the last several years in the VMS FDMC market has also
        been based on national media attention in regards to recent scientific research
        suggesting potential health benefits from regular consumption of some VMS
        products. However, as has been the case in the past, negative scientific
        research or publicity concerning the health benefits of vitamin consumption
        could adversely impact the growth of the VMS market. The highly publicized
        GAIT
        study has had only a slightly positive effect on sales of our joint care
        products. However, the recent positive publicity in “Consumer Reports” on joint
        care products has had a marked positive effect on our sales.
 
 We
        operate under two separate geographical units, one in the United States and
        one
        in Canada. Our U.S. business consists of our U.S. subsidiaries, principally
        Leiner Health Products, LLC. Our Canadian business consists of Vita Health
        Products Inc. (“Vita”).
 
 Vita
        is
        one of the leading manufacturers of store brand VMS and OTC products in Canada.
        Vita generated 32.2%, 33.4% and 33.9% of its net sales from VMS products
        and
        66.1%, 65.8% and 65.3% of its net sales from OTC products, respectively,
        for the
        fiscal years 2004, 2005 and 2006. Vita’s contract manufacturing services
        accounted for 1.7%, 0.8% and 0.8% of its net sales for the fiscal years 2004,
        2005 and 2006, respectively.
 
 Vita
        is
        located in Winnipeg, Manitoba, where it maintains manufacturing, packaging
        and
        distribution facilities. For the fiscal years 2004, 2005 and 2006, Vita
        comprised 8.9%, 10.8% and 8.2% of our net sales, respectively.
  22
  **General**
 
 We
        generate revenue through the sale of our manufactured products and the
        distribution to customers of products manufactured by third parties.
        I n
        accordance with the SEC Staff Accounting Bulletin (“SAB”) No. 101, *Revenue
        Recognition in Financial Statements* and SAB
        No. 104, *Revenue
        Recognition* ,
        we
        recognize product revenue when the following fundamental criteria are met:
        (i)
        persuasive evidence of an arrangement exists; (ii) delivery has occurred
        or
        services have been rendered; (iii) the price to the customer is fixed or
        determinable; and (iv) collection of the resulting receivable is reasonably
        assured. These criteria are usually met upon receipt of products by the
        customer. Our net sales represent gross sales invoiced to customers less
        certain
        related charges for contractual allowances, estimated future chargebacks
        and
        estimated product returns. Accruals provided for these items are presented
        in
        the consolidated financial statements as reductions to sales. Cost of
        sales includes all direct material and labor costs and indirect costs such
        as
        indirect labor, depreciation, insurance and supplies. Selling, general and
        administrative expenses (“SG&A”) consist of: (1) marketing, selling and
        distribution expenses, which include components such as advertising costs,
        selling costs, warehousing, shipping and handling and (2) general and
        administrative expenses, which include components such as administrative
        functions to support manufacturing activities, salaries, wages and benefit
        costs, travel and entertainment, professional services and facility costs.
        Research and development expenses (“R&D”) include the costs associated with
        developing new products.
 
 Restructuring
        charges relate to severance and other related costs incurred in connection
        with
        the workforce reduction in fiscal 2006.
 
 Other
        operating expense primarily relate to the professional fees incurred in
        connection with the Amendment and the settlement of a supplier dispute. For
        further details see notes 10 and 16 to our audited consolidated financial
        statements included elsewhere in this report.
 
 **Amendments
        to our New Credit Facility**
 
 In
        connection with our acquisition of certain OTC assets of Pharmaceutical
        Formulations, Inc. (“PFI”), which is discussed below and to provide us with
        operating flexibility, we obtained Amendment No. 1 and Acknowledgement
        (“Amendment”) from our senior lenders under the New Credit Facility on September
        23, 2005. The Amendment acknowledges the acquisition of substantially all
        of the
        assets of PFI related to its OTC pharmaceutical business, except for assets
        related to PFI’s Konsyl Pharmaceuticals Inc. subsidiary and other scheduled
        assets (the “PFI Business”) for approximately $22.9 million in cash as a
        Permitted Acquisition. The Amendment, among other things, (a) modified the
        “applicable margin” rate, (b) modified existing financial and operating
        covenants that require, among other things, the maintenance of certain financial
        ratios, (c) added a Minimum Liquidity provision providing that in the event
        the
        net revolver availability plus the cash balance falls below $20.0 million,
        the
        equity sponsors have committed to contributing to us an additional $6.5 million
        in equity, and (d) modified the calculation of consolidated credit agreement
        EBITDA. As a condition to obtaining the consent of the lenders to the foregoing
        amendments, we paid an Amendment fee equal to 0.25% of the aggregate total
        commitments of senior lenders, or approximately $0.7 million, and recorded
        it
        under other non-current assets in the condensed consolidated balance sheet
        at
        March 25, 2006. The Amendment was effective for the quarter ended September
        24,
        2005 and subsequent quarters through the maturity of the New Credit Facility.
        For additional details, see “-Covenant Restrictions” and “−Credit Agreement
        EBITDA” below.
 
 **Acquisition**
 
 On
        September 9, 2005, we entered into an agreement to acquire substantially
        all of
        the assets of PFI, a manufacturer of private label OTC products in the United
        States, related to its OTC pharmaceutical business (the “Acquisition”), except
        for assets related to PFI’s Konsyl Pharmaceuticals Inc. subsidiary and other
        scheduled assets (the “PFI Business”). The Acquisition is expected to broaden
        our existing customer base, expand our OTC product offerings, and increase
        our
        manufacturing scale.
 
 On
        September 26, 2005, we acquired these assets for a purchase price consisting
        of
        (i) approximately $22.9 million in cash, and (ii) the assumption by us of
        certain related liabilities, including trade payables related solely to the
        PFI
        Business. The purchase price was funded, in part, by a $13.0 million capital
        contribution from our ultimate parent, LHP Holdings, which received such
        amount
        from the sale of equity securities to its current stockholders. The balance
        of
        the purchase price was funded from our Revolving Facility.
 
 On
        March
        7, 2006, we reached a final settlement agreement with PFI on the working
        capital
        adjustment provided for in the acquisition agreement and, as a result, PFI
        paid
        us $1.5 million. We recorded the final adjustments to the purchase price
        allocation during the fourth quarter of fiscal 2006. The allocation and
        valuation of purchase price is determined by management based on many factors,
        including a valuation performed by a third-party valuation firm. Acquired
        intangibles totaling $5.8 million represents the fair value of customer base
        and
        accelerated new drug applications. These intangibles are being amortized
        over
        their estimated useful lives of five years.
  23
 
 The
        Components of the purchase price and the allocation are as follows (in
        millions):
 
 Consideration
                  and acquisition costs:Cash
                  paid to PFI
              
              $
              22.9Acquisition
                  costs
              
              
              1.5Working
                  capital adjustment
              
              
              (1.5
              )$
              22.9Allocation
                  of purchase price:Current
                  assets
              
              $
              13.8Property,
                  plant and equipment
              
              
              2.4Acquired
                  intangibles
              
              
              5.8Goodwill
              
              
              5.8Other
                  liabilities assumed
              
              
              (4.9
              )$
              22.9
  The
        following unaudited pro forma financial information presents the consolidated
        results of operations as if the Acquisition had occurred at the beginning
        of
        fiscal 2005 and does not purport to be indicative of the results that would
        have
        occurred had the Acquisition occurred at such date or of results which may
        occur
        in the future (in millions):
  **Year
                  ended****March
                  26,**
                **2005**
              
              **March
                  25,**
                **2006**Net
                  sales
              
              $
              747.5
              
              $
              698.2Operating
                  income (loss)
              
              
              (24.5
              )
              
              24.7Net
                  loss
              
              
              (56.2
              )
              
              (11.2
              )
  **Recapitalization
        (“Recapitalization”)**
 
 On
        April
        15, 2004, Mergeco entered into a recapitalization agreement and plan of merger
        with us. The Recapitalization was effected on May 27, 2004 by merging Mergeco
        with and into our company. Mergeco was a new corporation formed by the Golden
        Gate Investors and the North Castle Investors, solely for the purpose of
        completing the Recapitalization. Each share of the common stock of Mergeco
        became a share of our common stock. We are the surviving corporation in the
        merger. Each holder of our common stock then exchanged such stock for voting
        preferred stock of Holdings, a newly formed company that became our new parent
        company. As a result of the Recapitalization, excluding the delayed delivery
        share awards, the Golden Gate Investors and the North Castle Investors each
        own
        or control 49.6% of Holdings. Including delayed delivery share awards made
        in
        connection with the Recapitalization and issuance of Series C preferred stock
        in
        connection with the PFI Business acquisition, the Golden Gate Investors and
        the
        North Castle Investors each own or control 46.8% of Holdings, and our management
        and certain former employees own equity in Holdings, constituting 6.4% of
        Holdings. In connection with the Recapitalization, Mergeco entered into a
        new
        senior credit facility (“New Credit Facility”), consisting of a $240.0 million
        term loan, which we refer to as the “new term loan B” and a $50.0 million
        revolving credit facility (“Revolving Facility”), under which $5.0 million was
        borrowed immediately after the Recapitalization by Mergeco. In addition,
        Mergeco
        issued $150.0 million of 11% senior subordinated notes due 2012 (“Notes”).
        Immediately upon consummation of the Recapitalization, the obligations of
        Mergeco under the New Credit Facility and the Notes were assigned to and
        assumed
        by us. The Recapitalization was accounted for as a recapitalization of Mergeco
        which had no impact on the historical basis of assets and liabilities as
        reflected in our consolidated financial statements .
 
 Simultaneously
        with the initial sale of the 11% senior subordinated notes due 2012, we entered
        into a registration rights agreement, under which we agreed to file the
        Registration Statement with the SEC and to complete an exchange offer. Under
        the
        exchange offer, which commenced on September 28, 2004 and expired on October
        27,
        2004, 99.93% of the senior subordinated notes were tendered and exchanged
        for
        publicly registered notes with substantially identical terms.
  24
  Results
        of operations for foreign subsidiaries expressed in functional currencies
        other
        than the U.S. dollar are translated using average exchange rates during the
        year. Assets and liabilities of these foreign subsidiaries are translated
        using
        the exchange rates in effect at the balance sheet date and the resulting
        translation adjustments are recognized as a separate component of shareholder’s
        equity (deficit). Gains and losses arising from foreign currency transactions
        are recognized in the statement of operations as incurred.
 
 **Results
        of Operations**
 
 The
        following table summarizes our results of operations as a percentage of net
        sales for the fiscal years 2004, 2005 and 2006.
 **Percentage
                    of Net Sales****Year
                    Ended****March
                    27,**
                  **2004**
                
                **March
                    26,**
                  **2005**
                
                **March
                    25,**
                  **2006**Net
                    sales
                
                
                100.0
                %
                
                100.0
                %
                
                100.0
                %Cost
                    of sales
                
                
                73.6
                
                
                74.9
                
                
                79.6Gross
                    profit
                
                
                26.4
                
                
                25.1
                
                
                20.4Marketing,
                    selling and distribution expenses
                
                
                8.5
                
                
                8.5
                
                
                8.7General
                    and administrative expenses
                
                
                6.2
                
                
                5.0
                
                
                5.3Research
                    and development expenses
                
                
                0.9
                
                
                0.8
                
                
                0.7Amortization
                    of other intangibles
                
                
                0.1
                
                
                -
                
                
                0.1Restructuring
                    charges
                
                
                -
                
                
                -
                
                
                0.6Recapitalization
                    expenses
                
                
                -
                
                
                12.9
                
                
                -Other
                    operating expense
                
                
                0.2
                
                
                0.3
                
                
                0.2Operating
                    income (loss)
                
                
                10.5
                
                
                (2.4
                )
                
                4.8Interest
                    expense, net
                
                
                2.9
                
                
                4.7
                
                
                5.5Income
                    (loss) before income taxes
                
                
                7.6
                
                
                (7.1
                )
                
                (0.7
                )Provision
                    for (benefit from) income taxes
                
                
                1.7
                
                
                (0.1
                )
                
                (0.1
                )Net
                    income (loss)
                
                
                5.9
                
                
                (7.0
                )
                
                (0.6
                )Accretion
                    on preferred stock
                
                
                (1.8
                )
                
                (5.7
                )
                
                -Net
                    income (loss) attributable to common shareholders
                
                
                4.1
                %
                
                (12.7
                )%
                
                (0.6
                )%
  **Fiscal
        2006 Compared to Fiscal 2005**
 
 Net
        Sales
        were $669.6 million in fiscal 2006, a decrease of $15.3 million, or 2.2%,
        from
        $684.9 million in fiscal 2005. The decrease in net sales for the year reflects
        the lower sales of higher margin vitamin E, the absence of branded new product
        sales in fiscal 2006, the adjustment of inventory levels by retailers, the
        decision by a competitive OTC supplier in Canada to supply retail customers
        directly on selected items and lower sales of analgesics and multivitamins
        products in Canada. In addition, net sales in fiscal 2006 were impacted by
        the
        reserves established for customer returns and higher future chargeback expenses
        related to certain branded products in the first quarter of fiscal 2006.
        The
        decline in net sales was partly offset by higher sales of lower margin joint
        care products and $17.4 million sales of PFI acquired products. The net sales
        of
        vitamin E decreased by approximately $20.4 million in fiscal 2006 compared
        to
        the same period of fiscal 2005. Our product mix continued to move away from
        higher margin vitamin E and into an increased share of lower margin natural,
        store brand, joint care products.
 
 U.S.
        net
        sales were $614.7 million in fiscal 2006, an increase of $3.7 million, or
        0.6%
        from $610.9 million in fiscal 2005. The U.S. year-to-year increase for the
        fiscal year 2006 was the result of higher sales of joint care products and
        the
        sales of PFI acquired products partly offset by lower sales of vitamin E,
        absence of branded new products sales in fiscal 2006, the adjustments of
        inventory levels by retailers, and the establishment of reserves for product
        returns and higher future chargeback expenses related primarily to certain
        branded products in the first quarter of fiscal 2006.
  25
  Net
          sales
          attributable to our Canadian operations were $54.9 million in fiscal 2006,
          a
          decrease of $19.1 million, or 25.8%, from $74.0 million in fiscal 2005.
          The
          Canadian year-to-year decrease for the fiscal year 2006 resulted from the
          decision by a competitive OTC supplier in Canada to supply retail customers
          directly on selected items and lower sales of analgesics and multivitamin
          products in Canada.
  Regarding
          our three principal product categories:
 
 ·
            VMS
                products net sales were $422.0 million in fiscal 2006, an increase
                of $2.5
                million, or 0.6%, from $419.5 million in fiscal 2005. The VMS category
                was
                impacted in fiscal 2006 by product mix changes, the absence of branded
                new
                products sales, the establishment of reserves for product returns,
                higher
                future chargebacks expenses and lower sales in Canada as described
                above. 
 ·
            OTC
                product net sales were $199.0 million in fiscal 2006, a decrease
                of $14.4
                million, or 6.7%, from $213.4 million in fiscal 2005. The decrease
                was
                primarily attributable to price adjustments in our Loratadine products
                in
                the U.S. and lower sales of OTC products in Canada. In addition, the
                decrease in sales of our OTC products was partly offset by $17.4
                million
                sales of PFI acquired products. 
 ·
            Contract
                manufacturing services net sales were $48.6 million in fiscal 2006,
                a
                decrease of $3.4 million, or 6.6% from $52.0 million in fiscal 2005.
                The
                decrease was primarily due to a decline in new product sales in fiscal
                2006 by our key contract manufacturing customer.We
                expect our contract manufacturing services business to grow in fiscal
                2007
                as we have signed and/or expect to sign a number of major contracts
                with
                certain pharmaceutical companies. 
 Cost
        of
        sales was $533.2 million, or 79.6% of net sales, in fiscal 2006, an increase
        of
        $20.3 million, or 4.0%, from $512.9 million, or 74.9% of net sales, in fiscal
        2005. The increase in cost of sales as a percentage of net sales in fiscal
        2006
        is principally due to the decline in sales of higher margin vitamin E, the
        building of market share in other key product categories with lower margins
        such
        as joint care products, price adjustments in our Loratadine products, and
        higher
        costs incurred in connection with the PFI acquired inventory.
 
 Gross
        profit was $136.3 million, or 20.4% of net sales, in fiscal 2006, a decrease
        of
        $35.7 million, or 20.7%, from $172.0 million, or 25.1% of net sales in fiscal
        2005. The decrease in gross profit as a percentage of net sales in fiscal
        2006
        is primarily due to continued movement in our product mix away from higher
        margin products such as vitamin E and into lower margin joint care products,
        reserves established for product returns and higher future chargeback
        expenses related to certain branded products, price adjustments in our
        Loratadine products, and higher costs incurred in connection with the PFI
        acquired inventory as described above. Our gross profit in the second half
        of
        fiscal 2006 was 23.8% compared to 16.5% in the first half of fiscal 2006.
        We
        expect that the gross profit we achieved in the second half of fiscal 2006
        to
        remain steady during the first half of fiscal 2007.
 
 SG&A,
        as defined above under “General,” were $94.2
        million, or 14.1% of net sales, in fiscal 2006, an increase of $1.5 million,
        or
        1.6%, from $92.7 million, or 13.5% of net sales, in fiscal 2005. The fiscal
        2005, SG&A included the expenditures incurred on management reorganization
        of approximately $2.0 million. Excluding expenditure on management
        reorganization, the SG&A in fiscal 2006 increased by $3.5 million compared
        to fiscal 2005. The increase in SG&A was primarily driven by higher
        incentive compensation, freight, outside commissions, depreciation charges,
        and
        PFI integration costs.
 
 R&D
        expenses were $4.6 million in fiscal 2006, a decrease of $0.7 million compared
        to fiscal 2005 due primarily to lower compensation, new product development
        and
        product testing activities compared to the same periods in the prior
        year.
 
 Amortization
        of other intangibles was $0.6 million in fiscal 2006, an increase of $0.4
        million, from $0.3 million in fiscal 2005. The increase was primarily
        attributable to PFI acquired intangibles.
 
 The
        restructuring charges of $3.8 million in fiscal 2006 reflect severance and
        other
        related costs resulted from our continued drive to control expenses by reducing
        head count. We eliminated approximately 104 positions in fiscal 2006. The
        restructuring charges include the severance accrued for the president, who
        resigned effective March 31, 2006.
 
 The
        Recapitalization expenses of $88.0 million in fiscal 2005 consist primarily
        of
        compensation expenses related to the in-the-money value of stock options
        and
        other equity rights issued to certain management personnel of $54.3 million,
        management bonuses of $1.0 million, and expenses incurred in connection with
        our
        capital raising activities of $32.7 million.
  26
 
 Other
        operating expenses were $1.1 million in fiscal 2006, a decrease of $1.3 million
        compared to fiscal 2005. Other operating expense in fiscal 2006 decreased
        primarily due to lower management fees of $2.0 million offset by the receipt
        of
        $0.8 million from the settlement of a supplier dispute. The management fees
        in
        fiscal 2006 primarily represent professional fees incurred in connection
        with
        the Amendment.
 
 In
        fiscal
        2006, net interest expense of $36.9 million represents an increase of $4.5
        million, compared to fiscal 2005. The increase in fiscal 2006 was primarily
        due
        to an increase in average interest rate charged on the average outstanding
        indebtedness, higher level of indebtedness itself, and the full year impact
        of
        the increase in our average outstanding indebtedness. The prior year interest
        expense included the expense related to the accelerated amortization of deferred
        financing charges related to our old credit facility that was repaid in
        connection with the fiscal 2005 recapitalization.
 
 We
        recorded an income tax benefit for the fiscal year 2006 of $1.1 million or
        a 22%
        effective rate compared to a provision of $1.0 million or a 2% effective
        rate in
        fiscal 2005. During fiscal 2006 there were certain adjustments to valuation
        allowances, contingent tax liabilities and other deferred tax attributes
        which
        accounts for the difference between fiscal 2006 and 2005 effective
        rates.
 
 Primarily
        as a result of factors discussed above, net loss of $3.8 million was recorded
        in
        fiscal 2006 compared to a net loss of $47.9 million in fiscal 2005. Excluding
        the Recapitalization expenses of $88.0 million, and the related tax impact
        of
        $14.6 million, net income would have been approximately $25.5 million in
        fiscal
        2005.
 
 Credit
        Agreement EBITDA was $74.8 million in fiscal 2006 compared to the Credit
        Agreement EBITDA of $88.4 million in fiscal 2005. The decline in Credit
        Agreement EBITDA was primarily driven by the shift in product mix, the
        adjustment of inventory levels by retailers, and decline in our
        Canadian sales. Details of the definition and calculation of the Credit
        Agreement EBITDA can be found under “−Covenant Restrictions” and “−Credit
        Agreement EBITDA” below.
 
 **Fiscal
        2005 Compared to Fiscal 2004**
 
 Net
        Sales
        were $684.9 million in fiscal 2005, an increase of $23.9 million, or 3.6%,
        from
        $661.0 million in fiscal 2004. The increase in net sales for the year resulted
        from new product introductions, increases in sales of our joint care products
        and strong off-shelf category promotions from our largest customers, partially
        offset by pronounced product landscape changes caused by product mix within
        our
        VMS category. The net sales of vitamin E decreased by $14.4 million in fiscal
        2005 compared to the same period of fiscal 2004. Our product mix is moving
        away
        from vitamin E into an increased share of the natural, store brand, joint
        care
        category with lower near-term margins.
 
 U.S.
        net
        sales were $610.9 million in fiscal 2005, an increase of $9.0 million, or
        1.5%
        from $602.0 million in fiscal 2004. The U.S. year-to-year increase for the
        fiscal year 2005 was the result of new product sales and promotions, partially
        offset by the pronounced product mix changes mentioned above, mainly in the
        fourth quarter of fiscal 2005. Net sales attributable to our Canadian operations
        were $74.0 million in fiscal 2005, an increase of $14.9 million, or 25.2%,
        from
        $59.1 million in fiscal 2004. The Canadian year-to-year increase for the
        fiscal
        year 2005 was the result of new product sales of multivitamins as well as
        improved fulfillment rates on cough and cold products to one of our major
        customers.
 
 Regarding
        our three principal product categories:
 
 ·
            VMS
                products net sales were $419.5 million in fiscal 2005, an increase
                of $5.8
                million, or 1.4%, from $413.7 million in fiscal 2004. The VMS category
                was
                impacted in fiscal 2005 by the launch of new products in the U.S.
                and
                Canada as described above, partially offset in the U.S. by the pronounced
                product mix changes mentioned above. We expect the transition of
                vitamin E
                sales to joint care sales to continue in fiscal
                2006. 
 ·
            OTC
                product net sales were $213.4 million in fiscal 2005, an increase
                of $22.2
                million, or 11.6%, from $191.2 million in fiscal 2004. The increase
                was
                primarily attributable to higher sales of analgesic products and
                the
                annualized effect of the Loratadine 10mg launched in fiscal 2004. 
 ·
            Contract
                manufacturing services net sales were $52.0 million in fiscal 2005,
                a
                decrease of $4.2 million, or 7.4% from $56.2 million in fiscal 2004.
                The
                decrease was primarily due to a decline in new product sales in fiscal
                2005 by our key contract manufacturing
                customer. 
 Cost
        of
        sales was $512.9 million, or 74.9% of net sales, in fiscal 2005, an increase
        of
        $26.3 million, or 5.4%, from $486.6 million, or 73.6% of net sales, in fiscal
        2004. The increase in cost of sales as a percentage of net sales in fiscal
        2005
        is principally due to the decline in sales of Naproxen and of vitamin E,
        a
        product with an above average margin, the building of market share in other
        key
        product categories with lower near-term margins, decreased plant volumes
        and
        higher raw material costs in the joint care category. We expect continued
        pressure on margins into fiscal 2006 as those factors continue along with
        the
        additional effect of changing customer mix and product mix. During the first
        quarter ended June 26, 2004, we refined our aging based inventory reserves
        estimation model. The impact of this change resulted in lower cost of sales
        and
        higher gross profit of approximately $0.4 million, and the net loss was lower
        by
        approximately $0.2 million for the period ended March 26, 2005 as a
        consequence.
  27
 
 SG&A,
        as defined above under “General,” were $92.7
        million, or 13.5% of net sales, in fiscal 2005, a decrease of $4.8 million,
        or
        4.9%, from $97.5 million, or 14.7% of net sales, in fiscal 2004. The decrease
        in
        SG&A was primarily driven by lower compensation, consumer advertising,
        consultant and outside commission expense partly offset by expenditures incurred
        on management reorganization and freight expenses. Costs continue to be
        aggressively controlled by reducing head count (we eliminated 32 positions
        in
        the first quarter and 45 positions in the fourth quarter of fiscal 2005)
        and
        monitoring all discretionary costs. In the second quarter of fiscal 2005,
        we
        also completed a number of organizational changes designed to fortify our
        contract manufacturing and new product development teams, increase speed
        to
        market and reduce costs.
 
 R&D
        expenses were $5.3 million in fiscal 2005, a decrease of $0.4 million compared
        to fiscal 2004 due primarily to lower headcount and temporary labor expense
        offset by higher product development and research expenses.
 
 Amortization
        of other intangibles was $0.3 million in fiscal 2005, a decrease of $0.2
        million, from $0.4 million in fiscal 2004. The decrease was primarily
        attributable to a lower remaining carrying amount of other intangible assets
        in
        fiscal 2005.
 
 The
        Recapitalization expenses of $88.0 million in fiscal 2005 consist primarily
        of
        compensation expenses related to the in-the-money value of stock options
        and
        other equity rights issued to certain management personnel of $54.3 million,
        management bonuses of $1.0 million, and expenses incurred in connection with
        our
        capital raising activities of $32.7 million.
 
 Other
        operating expenses were $2.4 million in fiscal 2005, an increase of $0.8
        million
        compared to fiscal 2004. Other operating expense in fiscal 2005 increased
        primarily due to increase in management fees of $1.7 million offset by the
        receipt of $0.8 million from the settlement of a supplier dispute.
 
 In
        fiscal
        2005, net interest expense of $32.3 million represents an increase of $13.4
        million, compared to fiscal 2004. The increases in fiscal 2005 were primarily
        due to an increase in our average outstanding indebtedness and the accelerated
        amortization in the first quarter of fiscal 2005 of deferred financing charges
        related to our old credit facility that were repaid in connection with the
        Recapitalization.
 
 We
        recorded an income tax benefit for the fiscal year 2005 of $1.0 million or
        a
        2.0% effective tax rate compared to a provision of $11.3 million or a 22.5%
        effective tax rate in fiscal 2004. The effective tax rate for fiscal 2005
        is
        substantially different from the effective tax rate for fiscal 2004 primarily
        due to certain recapitalization transaction costs incurred by us in fiscal
        2005.
 
 Primarily
        as a result of factors discussed above, net loss of $47.9 million was recorded
        in fiscal 2005 compared to net income of $39.1 million in fiscal 2004. Excluding
        the Recapitalization expenses of $88.0 million, and the related tax impact
        of
        $14.6 million, net income would have been approximately $25.5 million in
        fiscal
        2005.
 
 Credit
        Agreement EBITDA was $88.4 million in fiscal 2005 compared to the Credit
        Agreement EBITDA of $88.6 million in fiscal 2004. Credit Agreement EBITDA
        in
        fiscal 2005 includes $2.0 million ($0.5 million in the first quarter, $0.8
        million in the second quarter and $0.7 million in the fourth quarter) of
        management reorganization expenses. Details of the definition and calculation
        of
        the Credit Agreement EBITDA can be found under “−Covenant Restrictions” and
“−Credit Agreement EBITDA” below.
 
 **Liquidity
        and Capital Resources**
 
 Our
        liquidity needs arise primarily from debt service on our substantial
        indebtedness and from the funding of our capital expenditures, ongoing operating
        costs and working capital.
 
 The
        following financing transactions (the “Financing Transactions”) were entered
        into in connection with the Recapitalization:
 
 ·
            We
                entered into our New Credit Facility with several lenders on May
                27, 2004.
                The New Credit Facility provides for aggregate maximum borrowings
                of
                $290.0 million under (i) the Term Facility providing for term B loan
                in an
                aggregate principal amount of $240.0 million and (ii) the Revolving
                Facility providing for up to $50.0 million in revolving loans (including
                standby and commercial letters of credit and swingline loans) outstanding
                at any time.  28
  ·
              On
                  May 27, 2004, after the Recapitalization, we assumed $150.0 million
                  in
                  Notes.
  ·
            The
                repayment of all outstanding amounts under our pre-existing senior
                credit
                facilities was made and commitments under those facilities were
                terminated.  As
        of
        March 25, 2006, we had outstanding debt of an aggregate amount of $402.6
        million, consisting primarily of $236.4 million in principal amount under
        the
        Term Facility, $5.0 million under the Revolving Facility, $150.0 million
        under
        the Notes and an aggregate amount of $11.2 million under our other debt
        facilities.
 
 Principal
        and interest payments under the Term Facility and the Revolving Facility,
        together with principal and interest payments on the Notes, represent
        significant liquidity requirements for us. We
        are
        required to repay the $236.4 million in term loan outstanding as of March
        25,
        2006 under the New Credit Facility by May 27, 2011 with scheduled principal
        payments of $3.0 million in fiscal 2007, $1.8 million in fiscal 2008, $2.4
        million in each of fiscal 2009 through fiscal 2011, and $224.4 million in
        fiscal
        2012. All outstanding revolving credit borrowings under the New Credit Facility
        will become due on May 27, 2009. We are also required to repay the $150.0
        million of the Notes in fiscal 2013.
 
 On
        September 23, 2005, we obtained the Amendment from our senior lenders under
        the
        New Credit Facility. The Amendment acknowledges the acquisition of the PFI
        Business for approximately $22.9 million in cash as a Permitted Acquisition.
        The
        Amendment, among other things, (a) modified the “applicable margin” rate, (b)
        modified existing financial and operating covenants that require, among other
        things, the maintenance of certain financial ratios, (c) added a new financial
        covenant of minimum liquidity (as defined) of not less than $20.0 million,
        and
        (d) modified the calculation of consolidated credit agreement EBITDA. As
        a
        condition to obtaining the consent of the lenders to the foregoing amendments,
        we paid an Amendment fee equal to 0.25% of the aggregate total commitments
        of
        senior lenders, or approximately $0.7 million, and recorded it under other
        non-current assets in the consolidated balance sheet at March 25, 2006. The
        Amendment is effective for the quarter ended September 24, 2005 and subsequent
        quarters through the maturity of the New Credit Facility. For additional
        details
        see “Covenant Restrictions” and “Credit Agreement EBITDA” below.
 
 Borrowings
        under the New Credit Facility bear interest at a base rate per annum plus
        an
“applicable margin” that is based on our leverage ratio. We can choose a base
        rate of (i) ABR (Alternate base rate) or (ii) ** LIBOR
        for
        our Term Facility and Revolving Facility. The ABR rate is determined based
        on
        the higher of federal funds effective rate plus 0.5% or the prime commercial
        lending rate of UBS AG. The LIBOR rate is determined based on interest periods
        of one, two, three or six months. As of March 25, 2006, our average interest
        rates were 7.7% under the New Credit Facility. In addition to specified agent
        and up-front fees, the New Credit Facility requires a commitment fee of up
        to
        0.5% per annum of the average daily unused portion of the Revolving Facility.
        The Notes bear interest at a rate of 11% per annum.
 
 At
        March
        25, 2006, we had $35.4 million available under our Revolving Facility. In
        accordance with our debt agreements, the availability under the Revolving
        Facility has been reduced by the amount of standby letters of credit issued
        of
        approximately $9.6 million as of March 25, 2006. These letters of credit
        are
        used as security against our lease obligations, inventory purchasing
        obligations, and an outstanding note payable. These letters of credit expire
        annually and need extensions each year to various dates through
        2014.
 
 Based
        upon current levels of operations, anticipated cost-savings and expectations
        as
        to future growth, we believe that cash generated from operations, together
        with
        amounts available under our Revolving Facility will be adequate to permit
        us to
        meet our debt service obligations, capital expenditure program requirements,
        ongoing operating costs and working capital needs, although no assurance
        can be
        given in this regard. Our future financial and operating performance, ability
        to
        service or refinance our debt and ability to comply with the covenants and
        restrictions contained in the Amendment will be subject to future economic
        conditions and to financial, business and other factors, many of which are
        beyond our control and will be substantially dependent on the selling prices
        and
        demand for our products, raw material costs, and our ability to successfully
        implement our overall business and profitability strategies.
 
 If
        our
        future cash flow from operations and other capital resources are insufficient
        to
        pay our obligations as they mature or to fund our liquidity needs, we may
        be
        forced to reduce or delay our business activities and capital expenditures,
        sell
        assets, obtain additional debt or equity capital or restructure or refinance
        all
        or a portion of our debt, including the Notes, on or before maturity. We
        cannot
        assure that we would be able to accomplish any of these alternatives on a
        timely
        basis or on satisfactory terms, if at all. In addition, the terms of our
        existing and future indebtedness, including the Notes and New Credit Facility,
        may limit our ability to pursue any of these alternatives.
  29
  *Other
        Factors Affecting Liquidity*
 
 We
        have
        incurred approximately $12.5 million, $18.3 million and $20.6 million of
        capital
        expenditures, including capital leases, in fiscal 2004, 2005 and 2006,
        respectively. We continue to invest in increasing our internal manufacturing
        capability and expect that our capital expenditures for fiscal 2007 will
        be
        slightly higher than our capital expenditures in fiscal 2006.
 
 **Covenant
        Restrictions** ****
 
 The
        New
        Credit Facility contains various restrictive covenants. It prohibits us from
        prepaying other indebtedness, including the Notes, and it requires us to
        satisfy
        certain financial condition tests and to maintain specified financial ratios,
        such as a minimum liquidity, maximum total leverage ratio, minimum interest
        coverage ratio and limitation on capital expenditures. In addition, the New
        Credit Facility prohibits us from declaring or paying any dividends and
        prohibits us from making any payments with respect to the Notes if we fail
        to
        perform our obligations under, or fail to meet the conditions of, the New
        Credit
        Facility or if payment creates a default under the New Credit Facility.
 
 The
        indenture governing the Notes, among other things: (1) restricts our ability
        and
        the ability of our subsidiaries to incur additional indebtedness, issue shares
        of preferred stock, incur liens, pay dividends or make other specified
        restricted payments and enter into some transactions with affiliates; (2)
        prohibits specified restrictions on the ability of some of our subsidiaries
        to
        pay dividends or make some payments to us; and (3) places restrictions on
        our
        ability and the ability of our subsidiaries to merge or consolidate with
        any
        other person or sell, assign, transfer, lease, convey or otherwise dispose
        of
        all or substantially all of our assets. The indenture related to these Notes
        and
        the New Credit Facility also contains various covenants that limit our
        discretion in the operation of our businesses.
  30
 
 The
        financial covenants in the New Credit Facility specify, among other things,
        the
        following requirements as of the last day of any test period during any period
        set forth in the table below:
 ****
                  **Test Period**
                
                **Consolidated
                    Indebtedness to**
                    **Credit
                      Agreement EBITDA (1)**
                      **Leverage
                        Ratio**September
                    24, 2005
                
                
                5.85
                    to 1.00December
                    24, 2005
                
                
                5.85
                    to 1.00March
                    25, 2006
                
                
                5.85
                    to 1.00June
                    24, 2006
                
                
                5.65
                    to 1.00September
                    23, 2006
                
                
                5.65
                    to 1.00December
                    23, 2006
                
                
                5.65
                    to 1.00March
                    31, 2007
                
                
                5.50
                    to 1.00June
                    30, 2007
                
                
                5.50
                    to 1.00September
                    29, 2007
                
                
                5.00
                    to 1.00December
                    29, 2007
                
                
                5.00
                    to 1.00March
                    29, 2008
                
                
                4.50
                    to 1.00June
                    28, 2008
                
                
                4.50
                    to 1.00September
                    27, 2008
                
                
                4.00
                    to 1.00December
                    27, 2008
                
                
                4.00
                    to 1.00March
                    28, 2009 and thereafter
                
                
                3.75
                    to 1.00**Credit
                    Agreement EBITDA (1)**
                    **to
                      Consolidated**
                      **Interest
                        Expense Ratio**September
                    24, 2005
                
                
                1.85
                    to 1.00December
                    24, 2005
                
                
                1.85
                    to 1.00March
                    25, 2006
                
                
                1.85
                    to 1.00June
                    24, 2006
                
                
                1.85
                    to 1.00September
                    23, 2006
                
                
                1.85
                    to 1.00December
                    23, 2006
                
                
                1.85
                    to 1.00March
                    31, 2007
                
                
                1.85
                    to 1.00June
                    30, 2007
                
                
                2.00
                    to 1.00September
                    29, 2007
                
                
                2.00
                    to 1.00December
                    29, 2007
                
                
                2.25
                    to 1.00March
                    29, 2008
                
                
                2.25
                    to 1.00June
                    28, 2008
                
                
                2.25
                    to 1.00September
                    27, 2008
                
                
                2.25
                    to 1.00December
                    27, 2008
                
                
                2.50
                    to 1.00March
                    28, 2009 and thereafter
                
                
                2.75
                    to 1.00
 **Note:**
 (1)
        See
“—“Credit Agreement EBITDA” for more information regarding this
        term.
 
 We
        were
        in compliance with all such financial covenants and have exceeded our
        Minimum Liquidity Provision as of March 25, 2006. Our ability to comply in
        future periods with the financial covenants in the New Credit Facility will
        depend on our ongoing financial and operating performance, which in turn
        will be
        subject to economic conditions and to financial, business and other factors,
        many of which are beyond our control and will be substantially dependent
        on the
        selling prices and demand for our products, raw material costs, and our ability
        to successfully implement our overall business and profitability strategies.
        If
        a violation of any of the covenants occurred, we would attempt to obtain
        a
        waiver or an amendment from our lenders, although no assurance can be given
        that
        we would be successful in this regard. The New Credit Facility and the indenture
        governing the Notes have covenants as well as specified cross-default or
        cross-acceleration provisions; failure to comply with these covenants in
        any
        agreement could result in a violation of such agreement which could, in turn,
        lead to violations of other agreements pursuant to such cross-default or
        cross-acceleration provisions.
  31
  The
        New
        Credit Facility is collateralized by substantially all of our assets. Borrowings
        under the New Credit Facility are a key source of our liquidity. Our ability
        to
        borrow under the New Credit Facility is dependent on, among other things,
        our
        compliance with the financial ratio covenants referred to in the preceding
        paragraphs. Failure to comply with the financial ratio covenants would result
        in
        a violation of the New Credit Facility and, absent a waiver or amendment
        from
        the lenders under such agreement, permit the acceleration of all outstanding
        borrowings under the New Credit Facility.
 
 **Credit
        Agreement EBITDA**
 
 The
        table
        below sets forth EBITDA as defined in our Amendment, which we refer to as
        “Credit Agreement EBITDA.” Credit Agreement EBITDA as presented below is a
        financial measure that is used in our Amendment. Credit Agreement EBITDA
        is not
        a defined term under U.S. generally accepted accounting principles and should
        not be considered as an alternative to income from operations or net income
        (loss) as a measure of operating results or cash flows as a measure of
        liquidity. Credit Agreement EBITDA is calculated by adjusting net income
        (loss)
        to exclude interest expense, depreciation and amortization, income tax expense,
        expenses incurred in connection with the recapitalization, aggregate amount
        of
        all other non-cash items (including non-cash compensation charges), proceeds
        from business interruption insurance, management fees, expenses related to
        any
        permitted acquisition (other than the PFI Acquisition), fees and expenses
        in
        connection with the exchange of the Notes, expenses incurred to the extent
        reimbursed by third parties pursuant to indemnification provisions, any non-cash
        charges outside the normal course of business that result in an accrual of
        a
        reserve for cash charges in any future period, expenses incurred or accrued
        representing joint care customer in-stock investments, inventory reduction
        impact and other expenses, expenses incurred in connection with any
        restructuring, expenses incurred in connection with the employment of
        professionals to assist restructuring, integration of the PFI Business and
        the
        Amendment, non-capitalized transition and integration expenses incurred in
        connection with the PFI Acquisition, any non-cash charges that result from
        final
        accounting adjustments associated with the PFI Acquisition, expenses incurred
        in
        connection with operating facilities to provide adequate inventory and to
        ensure
        continuous supplies to customers of the PFI Business. In addition, Credit
        Agreement EBITDA also adjusts net income by all non-cash items increasing
        consolidated net income (other than accrual of revenue or recording of
        receivables in the ordinary course of the business) and the reversal of any
        reserve or the payment of any amount that was reserved. The New Credit Facility
        also provides for adjustments to consolidated net income including, among
        other
        things, for asset write-downs. The Amendment requires us to comply with a
        specified debt to Credit Agreement EBITDA leverage ratio and a specified
        consolidated Credit Agreement EBITDA to interest expense ratio for specified
        periods. The specific ratios are set out under “Liquidity and Capital Resources”
above.
 
 The
        calculation of Credit Agreement EBITDA is set forth below (in
        thousands):
 **Year
                    Ended****March
                    26,**
                  **2005**
                
                
                **March
                    25,**
                  **2006**Net
                    income (loss)
                
                $
                (47,912
                )
                $
                (3,768
                )Interest
                    expense, net
                
                
                32,346
                
                
                36,869Provision
                    for (benefit from) income taxes
                
                
                (987
                )
                
                (1,062
                )Depreciation
                    and amortization
                
                
                13,722
                
                
                16,634Recapitalization
                    expenses (1)
                
                
                87,982
                
                
                -Asset
                    write-down (2)
                
                
                -
                
                
                5,659Non-cash
                    stock compensation expense (3)
                
                
                5
                
                
                20Expenses
                    related to permitted acquisition (4)
                
                
                -
                
                
                1,937Expenses
                    related to joint care and other products (5)
                
                
                -
                
                
                12,400Restructuring
                    charges (6)
                
                
                -
                
                
                3,000Price
                    difference between PFI's purchased inventoryand
                    Leiner's manufacturing cost (7)
                
                
                -
                
                
                572Expenses
                    related to supplies to customers of PFI (8)
                
                
                -
                
                
                1,279Management
                    fees (9)
                
                
                3,258
                
                
                1,262Credit
                    Agreement EBITDA (10)
                
                $
                88,414
                
                $
                74,802
 
 (1)  Represents
        consulting, transaction, legal and accounting fees associated with the May
        2004
        Recapitalization. These fees were included as a separate item in the
        consolidated statement of operations and in operating activities in the
        consolidated statement of cash flows.
 (2)  Represents
        the establishment of a reserve for anticipated customer returns and the
        reduction of the carrying value of inventory related to certain branded products
        in the first quarter of fiscal 2006. This charge resulted in a reduction
        to
        gross profit in the consolidated statement of operations and in operating
        activities in the consolidated statement of cash flows.
  32
  (3)  Non-cash
        compensation expenses are included in the general and administrative expenses
        in
        the consolidated statement of operations and in operating activities in the
        consolidated statement of cash flows.
 (4)  Represents
        internal expenses incurred in connection with the PFI Acquisition. These
        expenses are included in the general and administrative expenses in the
        consolidated statement of operations and in operating activities in the
        consolidated statement of cash flows.
 (5)  Represents
        add back of expense incurred in connection with the joint care customer in-stock
        investments, inventory reduction impact and other expenses as stipulated
        in the
        Amendment. These expenses resulted in a reduction to gross profit in the
        consolidated statement of operations for the year ended March 25,
        2006.
 (6)  Represents severance
        and other related costs incurred in connection with the reduction in workforce
        in fiscal 2006. The
        total restructuring charges incurred were $3.8 million and included as a
        separate line item in the consolidated statement of operations and in operating
        activities in the consolidated statement of cash flows. However, the
        restructuring charges allowed under the Amendment were $3.0
        million.
 (7)  Represents
        the value of inventory purchased solely in connection with the PFI Acquisition
        for prices above our manufacturing cost. This charge resulted in a reduction
        to
        gross profit in the consolidated statement of operations and in operating
        activities in the consolidated statement of cash flows.
 (8)  Represents
        expenses incurred in connection with operating facilities that prior to the
        PFI
        Acquisition were operated by the PFI Business and to provide adequate inventory
        and to ensure continuous supplies to customers of PFI Business. This charge
        resulted in a reduction to gross profit in the consolidated statement of
        operations and in operating activities in the consolidated statement of cash
        flows.
 (9)  Management
        fees, which primarily include professional fees incurred in connection with
        the
        Amendment, are included in other operating expenses in the consolidated
        statement of operations and in operating activities in the consolidated
        statement of cash flows.
 (10)  Credit
        Agreement EBITDA is calculated in accordance with the definitions contained
        in
        our Amendment described under “Credit Agreement EBITDA.”
 
 **Sources
        and Uses of Cash**
 
 Net
        cash
        used in operating activities totaled $39.6 million in fiscal 2005 compared
        to
        the net cash provided by operating activities which totaled $19.3 million
        in
        fiscal 2006. The increase in fiscal 2006 compared to fiscal 2005 was primarily
        the result of the Recapitalization in the first quarter of fiscal 2005. In
        fiscal 2006, the most significant change in our operating activities was
        the
        reduction of accounts payable by $29.1 million due primarily to the product
        mix
        change in our business and the movement toward Chinese and Indian raw materials.
        These new suppliers have generally required shorter payment terms than our
        customary terms.
 
 Net
        cash
        used in investing activities totaled $20.9 million and $35.6 million in fiscal
        2005 and fiscal 2006, respectively. The increase was primarily related to
        the
        acquisition of PFI Business in the third quarter of fiscal 2006.
 
 Net
        cash
        provided by financing activities was $40.9 million and $11.0 million in fiscal
        2005 and fiscal 2006, respectively. Net cash provided in fiscal 2005 represents
        primarily the financing transactions and related indebtedness incurred in
        connection with the Recapitalization offset by repayments of pre-existing
        indebtedness and an increase in deferred financing charges of $15.7 million
        primarily related to the New Credit Facility and Notes. Net cash provided
        in
        fiscal 2006 represents primarily the borrowings from our Revolving Facility
        and
        capital contribution of $13.0 million received from our ultimate parent,
        LHP
        Holdings, which received such amount from the sale of equity securities to
        its
        current shareholders. The financing activities in fiscal 2006 were offset
        by the
        scheduled repayments of our Term Facility and other long-term debt and increase
        in deferred financing charges of $0.8 million primarily related to the
        Amendment.
  33
  **C** **ontractual
        Obligations**
 
 We
        are
        obligated to make future payments under various contracts such as debt
        agreements, capital lease agreements, and operating lease obligations. The
        following table represents information concerning our contractual obligations
        and commercial commitments as of March 25, 2006 (in thousands):
  **Payments
                    Due by Period****Less
                    than**
                
                **1
                    to 2**
                
                **2
                    to 3**
                
                **3
                    to 4**
                
                **4
                    to 5**
                
                **After
                    5****Contractual
                    obligations**
                
                **Total**
                
                **1
                    year**
                
                **years**
                
                **years**
                
                **years**
                
                **years**
                
                **years**New
                    Term B Loan
                
                $
                236,400
                
                $
                3,000
                
                $
                1,800
                
                $
                2,400
                
                $
                2,400
                
                $
                2,400
                
                $
                224,400Revolving
                    Credit Facility
                
                
                5,000
                
                
                -
                
                
                -
                
                
                -
                
                
                5,000
                
                
                -
                
                
                -Senior
                    Subordinated Notes
                
                
                150,000
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                150,000Industrial
                    Development Revenue Bond
                
                
                4,100
                
                
                500
                
                
                500
                
                
                500
                
                
                500
                
                
                500
                
                
                1,600Capitalized
                    leases
                
                
                7,117
                
                
                1,998
                
                
                1,766
                
                
                1,879
                
                
                1,080
                
                
                394
                
                
                -Operating
                    lease obligations
                
                
                53,724
                
                
                7,990
                
                
                7,653
                
                
                7,345
                
                
                7,237
                
                
                9,714
                
                
                13,785Restructuring
                    charges
                
                
                2,346
                
                
                2,298
                
                
                24
                
                
                24
                
                
                -
                
                
                -
                
                
                -Total
                
                $
                458,687
                
                $
                15,786
                
                $
                11,743
                
                $
                12,148
                
                $
                16,217
                
                $
                13,008
                
                $
                389,785
  **Critical
        Accounting Policies and Estimates**
 
 *Estimates*
 
 Our
        discussion and analysis of our financial condition and results of operations
        are
        based on our consolidated financial statements, which have been prepared
        in
        accordance with U.S. generally accepted accounting principles. The preparation
        of financial statements in conformity with U.S. generally accepted accounting
        principles requires management to make estimates and assumptions that affect
        the
        reported amounts of assets and liabilities and disclosure of contingent assets
        and liabilities at the date of the consolidated financial statements and
        the
        reported amounts of revenues and expenses during the reporting period. By
        their
        nature, these estimates and judgments are subject to an inherent degree of
        uncertainty. We review our estimates on an ongoing basis, including those
        related to revenue recognition, sales returns and customer allowances, the
        allowance for doubtful accounts, inventories and related reserves, cash flows
        used to evaluate the recoverability of long-lived assets, certain accrued
        liabilities, deferred tax assets and litigation. We base these estimates
        on
        historical experience and on various other factors that we believe to be
        reasonable under the circumstances, the results of which form the basis for
        making judgments about the carrying values of assets and liabilities that
        are
        not readily apparent from other sources. These estimates and assumptions
        by
        their nature involve risks and uncertainties, and may prove to be inaccurate.
        In
        the event that any of our estimates or assumptions are inaccurate in any
        material respect, any such inaccuracy could have a material effect on our
        reported amounts of assets and liabilities at the date of the financial
        statements and the reported amounts of revenue and expenses during the reporting
        periods.
 
 *Revenue
        Recognition*
 
 In
        accordance with the SEC Staff Accounting Bulletin (“SAB”) No. 101, *Revenue
        Recognition in Financial Statements* and SAB
        No. 104, *Revenue
        Recognition* ,
        we
        recognize product revenue when the following fundamental criteria are met:
        (i)
        persuasive evidence of an arrangement exists; (ii) delivery has occurred
        or
        services have been rendered; (iii) the price to the customer is fixed or
        determinable; and (iv) collection of the resulting receivable is reasonably
        assured. These criteria are usually met upon receipt of products by the
        customer. Our net sales represent gross sales invoiced to customers less
        certain
        related charges for contractual allowances, estimated future chargebacks
        and
        estimated product returns. Accruals provided for these items are presented
        in
        the consolidated financial statements as reductions to sales.
 
 *Contractual
        Allowances* :
        The
        contractual allowances are previously agreed upon deductions for co-op
        advertisements, rebates, etc., the majority of which are recorded as a liability
        and shown as a separate line item on our consolidated balance sheet. Deductions
        from revenues for contractual allowances were approximately $40.1 million,
        $44.2
        million and $46.0 million in fiscal 2004, 2005 and 2006, respectively.
 
 *Future
        Chargebacks* :
        The
        allowances for future chargebacks generally represent special selling incentives
        offered to customers that will be charged back to us at a later date, which
        are
        presented as reductions of accounts receivable within our consolidated balance
        sheet. Our procedures for estimating amounts accrued for future chargebacks
        are
        based upon quantitative and qualitative factors. Quantitatively, we use
        historical sales and expenses, and apply forecasting techniques in order
        to
        estimate our provision amounts. Qualitatively, management’s judgment is
        applied to these items to modify, if appropriate, the estimated provision
        amounts. Deductions from revenues for such allowances were approximately
        $6.2
        million, $4.8 million and $8.4 million in fiscal 2004, 2005 and 2006,
        respectively. Historically, actual chargebacks have been generally consistent
        with management’s estimates.
  34
  *Product
        Returns* :
        We
        generally sell products to our customers that are not subject to a contractual
        right of return. However, we accept some product returns as an accommodation
        to
        the customer to ensure a positive ongoing business relationship. As a result,
        we
        record an allowance at the time of original sale based on estimated product
        returns that may be accepted at a later date. The allowances for future product
        returns are reflected as a reduction to accounts receivable within our
        consolidated balance sheet. Quantitatively, we use data regarding historical
        sales and product returns supplemented by other information including, but
        not
        limited to, customer and third party point of sale data and inventory levels
        as
        reported by certain customers. Qualitatively, management’s judgment is applied
        to these items to modify, if appropriate, the estimated liability amount.
        We
        believe we are able to make reasonable estimates of expected product returns
        on
        the basis that, historically, actual product returns have generally been
        consistent with management’s estimates except in the first quarter of fiscal
        2006 in which we recorded an additional reserve of $4.7 million for anticipated
        customer returns related to certain branded products which were launched
        in the
        prior year. Deductions from revenues for product returns were approximately
        $0.4
        million, $3.0 million and $6.6 million in fiscal 2004, 2005 and 2006,
        respectively.
 
 As
        with
        any set of assumptions and estimates, there is a range of reasonably likely
        amounts that may be calculated for each accrual above. However, in our case,
        estimates associated with product returns are most at-risk for adjustment.
        The
        sensitivity of our estimates varies by type of product. Historically, our
        product returns of branded products have generally been substantially higher
        than our private label products. Currently, we cannot predict whether or
        not
        this trend will continue in the future. For fiscal 2004, 2005 and 2006, our
        branded product net sales comprised less than 6% of our consolidated net
        sales.
        We regularly review the factors that influence our estimates and, if necessary,
        make adjustments when we believe that actual product returns may differ
        materially from established reserves.
 
 The
        following table summarizes the activities our accruals for contractual
        allowances, future chargebacks and product returns (in thousands):
  **Reserve
                    for Contractual Allowances**
                
                **Reserve
                    for Future Chargebacks**
                
                **Reserve
                    for Product Returns**Balance
                    at March 29, 2003
                
                $
                11,157
                
                $
                916
                
                $
                1,762Current
                    provision
                
                
                40,051
                
                
                6,167
                
                
                368Actual
                    returns or credits
                
                
                (41,773
                )
                
                (6,348
                )
                
                (1,500
                )Balance
                    at March 27, 2004
                
                
                9,436
                
                
                735
                
                
                630Current
                    provision
                
                
                44,197
                
                
                4,823
                
                
                2,996Actual
                    returns or credits
                
                
                (43,447
                )
                
                (4,955
                )
                
                (2,865
                )Balance
                    at March 26, 2005
                
                
                10,186
                
                
                603
                
                
                762Current
                    provision
                
                
                46,037
                
                
                8,391
                
                
                6,618Actual
                    returns or credits
                
                
                (45,036
                )
                
                (7,923
                )
                
                (4,515
                )Balance
                    at March 25, 2006
                
                $
                11,187
                
                $
                1,071
                
                $
                2,865
  Actual
        returns included products sold in prior fiscal periods of $367,000, $404,000
        and
        $3,584,000 for fiscal 2004, 2005 and 2006, respectively. We do not have the
        ability to track actual credits for contractual allowances and future
        chargebacks by fiscal period because a significant time lag exists between
        the
        date on which we determine our contractual liability and when we actually
        pay
        the liability. In addition, the documentation provided to us by our customers
        for such deductions are generally insufficient for us to determine the exact
        date when the liability may have been accrued on our balance sheet.
 
 *Allowance
        for Uncollectible Accounts*
 
 We
        maintain reserves for potential credit losses, estimating the collectibility
        of
        customer receivables on an ongoing basis by periodically reviewing accounts
        outstanding over a period of time. We have recorded reserves for receivables
        deemed to be at risk for collection, as well as a general reserve based on
        historical collections experience. A considerable amount of judgment is required
        in assessing the ultimate realization of these receivables, including the
        current creditworthiness of each customer. Customer receivables are generally
        unsecured. If the financial conditions of our customers in the markets we
        serve
        were to deteriorate, resulting in an impairment of their ability to make
        required payments, additional allowances might be required which could adversely
        affect our operating results.
 
 35
  *Inventories*
 
 Our
        inventories include material, direct labor and related manufacturing overhead,
        and are stated at the lower of cost or market, with cost being determined
        by the
        first-in, first-out method. We provide reserves for potentially excess and
        obsolete inventory and inventory that has aged over a specified time period
        based on the difference between the cost of the inventory and its estimated
        market value. In estimating the reserve, we consider factors such as excess
        or
        slow moving inventories, product aging and expiration dating, current and
        future
        customer demand and market conditions. During the first quarter of fiscal
        2005,
        we refined our aging based reserve estimation model by increasing the number
        of
        aging categories and revising the reserve estimation percentages applied
        to the
        aging categories. We believe that the refined estimation model results in
        a
        better estimate of potentially excess and obsolete inventory.
 
 *Property,
        Plant and Equipment*
 
 Property,
        plant and equipment are stated at cost, net of accumulated depreciation and
        amortization. Depreciation and amortization are provided using the straight-line
        method, at rates designed to distribute the cost of assets over their estimated
        service lives or for leasehold improvements, the shorter of their estimated
        service lives, or their remaining lease terms. Amortization of assets recorded
        under capital leases is included in depreciation expense. Repairs and
        maintenance costs are expensed as incurred. Certain web site development
        costs
        are capitalized in accordance with EITF 00-2, *Accounting
        for website development cost* .
 
 *Goodwill*
 
 Goodwill
        represents the excess of the purchase price over the fair values of the net
        assets of acquired entities. On April 1, 2002, we adopted SFAS 142 and we
        discontinued amortizing the remaining balances of goodwill as of the beginning
        of fiscal 2003. All remaining and future acquired goodwill is subject to
        an
        impairment test in the fourth quarter of each year. The test for impairment
        requires us to make several estimates about the fair value, most of which
        are
        based on projected future cash flows. The estimates associated with the goodwill
        impairment tests are considered critical due to the judgments required in
        determining fair value amounts, including projected future cash flows. Changes
        in these estimates may result in the recognition of an impairment loss. The
        required annual testing was performed in the fourth quarter of fiscal 2006
        and
        resulted in no impairment charges for fiscal 2006. The change in the carrying
        amount of goodwill for the year ended March 25, 2006, includes $5.8 million
        related to goodwill recorded in the acquisition of PFI Business as well as
        foreign currency translation adjustments.
 
 *Recoverability
        of Long-Lived Assets*
 
 We
        review
        long-lived assets and certain intangibles for impairment whenever events
        or
        changes in circumstances indicate that the carrying amount of an asset may
        not
        be recoverable. The recoverability test is performed at the lowest level
        at
        which undiscounted net cash flows can be directly attributable to long-lived
        assets. The determination of related estimated useful lives and whether or
        not
        these assets are impaired involves significant judgments, related primarily
        to
        the future profitability and/or future value of the assets. Changes in our
        strategic plan and/or market conditions could significantly impact these
        judgments and could require adjustments to recorded asset balances.
 
 *Income
        Taxes*
 
 We
        utilize the liability method of accounting for income taxes as set forth
        in
        SFAS No. 109, *Accounting
        for Income Taxes* (“SFAS 109”).
        Under the liability method, deferred taxes are determined based on the temporary
        differences between the financial statement and tax bases of assets and
        liabilities using enacted tax rates. A valuation allowance is recorded when
        it
        is more likely than not that some of the deferred tax assets will not be
        realized. We also determine our tax contingencies in accordance with
        SFAS No. 5, *Accounting
        for Contingencies.* We
        record estimated tax liabilities to the extent the contingencies are probable
        and can be reasonably estimated.
  **New
        Accounting Pronouncements**
 
 In
        May
        2005, the FASB issued SFAS No. 154, *Accounting
        Changes and Error Corrections* ,
        a
        replacement of Accounting Principles Board Opinion No. 20, *Accounting
        Changes,* and
        SFAS
        No. 3, *Reporting
        Accounting Changes in Interim Financial Statements* (“SFAS No. 154”).
        SFAS No. 154 changes the requirements for the accounting for, and reporting
        of,
        a change in accounting principle. Previously, voluntary changes in accounting
        principles were generally required to be recognized by way of a cumulative
        effect adjustment within net income during the period of the change. SFAS
        No.
        154 requires retrospective application to prior periods’ financial statements,
        unless it is impracticable to determine either the period-specific effects
        or
        the cumulative effect of the change. SFAS No. 154 is effective for accounting
        changes made in fiscal years beginning after December 15, 2005; however,
        the
        statement does not change the transition provisions of any existing accounting
        pronouncements. The adoption of SFAS No. 154 is not expected to have a
        significant impact on our financial statements.
 
 36
  **Forward-looking
        Statement** **s**
 
 This
        report contains “forward-looking statements” that are subject to risks and
        uncertainties. These statements often include words such as “may,” “will,”
“should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,”
“potential” or “continue,” the negative of such terms or similar expressions.
        These statements are only predictions. In addition to risks and uncertainties
        noted in this report, there are risks and uncertainties that could cause
        our
        actual operating results to differ materially from those anticipated by some
        of
        the statements made. Such risks and uncertainties include: (i) slow or negative
        growth in the vitamin, mineral, supplement or over-the-counter pharmaceutical
        industry; (ii) adverse publicity regarding the consumption of vitamins,
        minerals, supplements or over-the-counter pharmaceuticals; (iii) increased
        competition; (iv) increased costs; (v) increases in the cost of borrowings
        and/or unavailability of additional debt or equity capital; (vi) changes
        in
        general worldwide economic and political conditions in the markets in which
        we
        may compete from time to time; (vii) our inability to gain and/or hold market
        share with our customers; (viii) exposure to and expenses of defending and
        resolving product liability claims and other litigation; (ix) our ability
        to
        successfully implement our business strategy; (x) our inability to manage
        our
        operations efficiently; (xi) consumer acceptance of our products; (xii)
        introduction of new federal, state, local or foreign legislation or regulation
        or adverse determinations by regulators; (xiii) the mix of our products and
        the
        profit margins thereon; (xiv) the availability and pricing of raw materials;
        and
        (xv) other factors beyond our control. We expressly disclaim any obligation
        to
        update or revise publicly any forward-looking statements, whether as a result
        of
        new information, future events or otherwise.
 
 You
        should carefully consider the risks described above and in “Item 1A. - Risk
        Factors.” Any of these risks could materially and adversely affect our financial
        condition, results of operations or cash flows.
  37
 
 **ITEM
        7A.**  **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
 
 Market
        risk represents the risk of changes in the value of market risk sensitive
        instruments caused by fluctuations in interest rates and foreign exchange
        rates.
        Changes in these factors could cause fluctuations in the results of our
        operations and cash flows. In the ordinary course of business, we are primarily
        exposed to foreign currency and interest rate risks. We do not use derivative
        financial instruments in connection with these market risks.
 
 *Foreign
        Exchange Rate Market Risk*
 
 We
        are
        subject to the risk of foreign currency exchange rate changes in the conversion
        from local currencies to the U.S. dollar of the reported financial position
        and
        operating results of our non-U.S. based subsidiary. Vita transacts business
        in
        the local currency, thereby creating exposures to changes in exchange rates.
        We
        do not currently have hedging or similar foreign currency contracts. While
        only
        a relatively small portion of our business is done in Canada, significant
        currency fluctuations could adversely impact foreign revenues. However, we
        do
        not expect any significant changes in foreign currency exposure in the near
        future.
 
 *Interest
        Rate Market Risk*
 
 We
        are
        exposed to changes in interest rates on our variable rate debt facilities.
        Our
        New Credit Facility is variable rate debt. On March 25, 2006, our total debt
        was
        $402.6 million, of which $245.5 million is variable rate debt and $157.1
        million
        is fixed rate debt. Our total annual interest expense (excluding deferred
        financing charges), assuming interest rates as they were at March 25, 2006,
        would be approximately $35.8 million. A one percent increase in variable
        interest rates would increase our total annual interest expense by $2.5 million.
        Changes in interest rates do not have a direct impact on the interest expense
        relating to our remaining fixed rate debt.
 
 **ITEM
        8.**  **FINANCIAL
        STATEMENTS AND SUPPLEMENTAL DATA**
 
 The
        consolidated financial statements, including an index thereto and the report
        of
        Ernst & Young LLP, the Company’s Independent Registered Public Accountants,
        begin on Page F-1 and are incorporated herein by reference.
  **ITEM
                  9.**
                **CHANGES
                      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND****FINANCIAL
                      DISCLOSURE**
 None
 
 **ITEM
        9A.**  **CONTROLS
        AND PROCEDURES**
 
 The
        Company’s management, with the participation of the Company’s Chief Executive
        Officer and Executive Vice President, Chief Operating Officer and Chief
        Financial Officer, has evaluated the effectiveness of the Company’s disclosure
        controls and procedures as of March 25, 2006. Based on that evaluation, the
        Company’s Chief Executive Officer and Executive Vice President, Chief Operating
        Officer and Chief Financial Officer concluded that the Company’s disclosure
        controls and procedures were effective as of March 25, 2006. There were no
        material changes in the Company’s internal control over financial reporting
        during the fourth quarter of fiscal 2006 that have materially affected, or
        are
        reasonably likely to materially affect, the Company’s internal control over
        financial reporting.
 
 **ITEM
        9B.**  **OTHER
        INFORMATION**
 
 None
  38


**PART
      III**





**ITEM
                10.**
              **DIRECTORS
                  AND EXECUTIVE OFFICERS OF THE
                  REGISTRANT**





Currently,
      we do not pay any compensation for service as director on our Board of
      Directors. However, all directors are reimbursed for travel expenses incurred
      in
      connection with the rendering of services as a director. Directors who are
      not
      our employees may in the future receive fees in exchange for their service
      as
      directors.





The
      following is a list of our directors, executive officers and key employees
      as of
      March 25, 2006.


**Name**
                
                **Age**
                
                **Position**Robert
                    M. Kaminski
                
                55
                
                Chief
                    Executive Officer and Vice Chairman of the Board of DirectorsRobert
                    K. Reynolds
                
                49
                
                Executive
                    Vice President, Chief Operating Officer and Chief
                    Financial OfficerRobert
                    J. La Ferriere
                
                56
                
                Executive
                    Vice President, Supply ChainKevin
                    J. Lanigan
                
                59
                
                Executive
                    Vice President and Corporate General ManagerCharles
                    F. Baird, Jr.
                
                52
                
                Chairman
                    of the Board of DirectorsPrescott
                    H. Ashe
                
                38
                
                DirectorPeter
                    J. Shabecoff
                
                43
                
                DirectorDavid
                    C. Dominik [a]
                
                49
                
                DirectorGale
                    K. Bensussen [b]
                
                59
                
                DirectorMonty
                    Sharma
                
                41
                
                DirectorG.V.
                    Prasad [c]
                
                45
                
                Director
 [a]
        Effective June 9, 2006, David C. Dominik resigned as Director of Leiner.
        The
        Board has appointed Ken Diekroeger as Director of Leiner, effective June
        9, 2006
        to replace Mr. Dominik.
 [b]
        Effective March 31, 2006, Gale K. Bensussen resigned as President of Leiner.
        Mr.
        Bensussen will continue to serve as a member of the Leiner Board.
 [c]
        Effective March 27, 2006, G.V. Prasad resigned as Director of
        Leiner.
  **Robert
        M. Kaminski,** *Chief
        Executive Officer and Vice Chairman of the Board of Directors,* has
        been
        the Chief Executive Officer of Leiner since May 1992 and a Director of Leiner
        since June 1992. In July 1996, Mr. Kaminski was appointed Vice Chairman of
        Leiner. From 1988 to 1992, Mr. Kaminski was Chief Operating Officer of Leiner
        and from 1982 to 1988, he was Vice President-Sales. Mr. Kaminski joined Leiner
        in 1978 from Procter & Gamble, where he was in Sales
        Management.
 
 **Robert
        K. Reynolds,** *Executive
        Vice President, Chief Operating Officer and Chief Financial Officer.* Mr.
        Reynolds has been Chief Operating Officer of Leiner since February 1, 2006.
        Prior to this promotion, Mr. Reynolds ** has
        served as Executive Vice President and Chief Financial Officer since January
        2002 and he will continue to serve as the Chief Financial Officer of the
        Company
        until the Company appoints a new Chief Financial Officer. Prior to joining
        Leiner, Mr. Reynolds was Chief Executive Officer and Co-Founder of Luxul
        Corp, a
        wireless communications company, from 2000 to 2001, Chief Operating Officer
        and
        Chief Financial Officer of Weider Nutrition International, Inc., a sports
        nutrition and VMS manufacturer, from 1990 to 1999.
 
 **Robert
        J. La Ferriere,** *Executive
        Vice President, Supply Chain.* Effective
        January 2006, Mr. La Ferriere’s title has been changed to reflect his expanded
        role to include the Company’s supply chain functions. ** Prior
        to
        this title change, Mr. La Ferriere was Executive Vice President, Sales and
        Marketing since April 2000. He became Senior Vice President-Marketing of
        Leiner
        in February 1997 and was a consultant to Leiner from 1996 to 1997. Mr. La
        Ferriere was President and Chief Executive Officer of Slim Fast Foods from
        1992
        to 1996. From 1984 until 1990, Mr. La Ferriere was first Vice President,
        then
        Senior Vice President-Purchasing, at Thrifty Drug and Discount
        Stores.
 
 **Kevin
        J. Lanigan,** *Executive
        Vice President and Corporate General Manager,* has
        been
        Executive Vice President and Corporate General Manager since April 2000.
        During
        his 32 years with Leiner, Mr. Lanigan held positions of Executive Vice President
        and Chief Operations Officer from 1992 to 2000, Senior Vice President-Operations
        Planning from 1986 to 1992 and Vice President-Operations from 1979 to 1986.
        Prior to joining Leiner, Mr. Lanigan held various engineering positions in
        the
        aerospace industry.


39


**Charles
        F. Baird, Jr.,** *Chairman* ,
        has
        been a Director since October 1997 and Chairman since June 1998. Mr. Baird
        is a
        Managing Director and Founder of North Castle Partners, L.L.C. He has spent
        more
        than 25 years as an investor and partner to CEOs with emphasis on the emerging
        healthy living and aging marketplace. Prior to founding North Castle, Mr.
        Baird
        served as managing director of AEA Investors, Inc. where he was involved
        in
        initiating, negotiating, financing, monitoring and exiting principal
        investments. From 1978 to 1989, Mr. Baird worked at Bain & Company, where as
        an executive vice president and North American Management committee member,
        he
        was involved in developing strategy and implementing profit improvement
        initiatives for companies. From 1975 to 1977, Mr. Baird worked in mergers
        and
        acquisitions at the First Boston Corporation. He received an A.B. from Harvard
        College and an M.B.A. from Harvard Business School.
 
 **Prescott
        H. Ashe,** *Director,* has
        been
        a Director of Leiner since May 2004. Since 2000, he has been a Managing Director
        of Golden Gate Capital. Prior to joining Golden Gate Capital, Mr. Ashe was
        an
        investment professional at Bain Capital, which he initially joined in 1991.
        Prior to Bain Capital, Mr. Ashe was a consultant at Bain & Company. Mr. Ashe
        received his J.D. from Stanford Law School and his Bachelor of Science in
        Business Administration from the University of California at Berkeley. He
        is
        currently a director of several private companies.
 
 **Peter
        J. Shabecoff** , *Director,* has
        been
        a Director since April 2001, and a Managing Director of North Castle Partners,
        L.L.C. since 1999. Prior to joining North Castle, Mr. Shabecoff was an attorney
        in the New York and Paris offices of Debevoise & Plimpton, where he focused
        on representing financial sponsors. From 1985 to 1987, Mr. Shabecoff was
        a
        consultant on environmental and resource policy at ICF Incorporated. Mr.
        Shabecoff also sits on the board of directors of Naked Juice Company. He
        received a B.A. from Wesleyan University, a J.D. from Harvard Law School
        and a
        masters degree in public policy from the Kennedy School of Government at
        Harvard
        University.
 
 **David
        C. Dominik,** *Director* ,
        has
        been a Director of Leiner since May 2004. Since 2000, he has been a Managing
        Director of Golden Gate Capital. Prior to joining Golden Gate Capital, Mr.
        Dominik was a Managing Director at Bain Capital from 1990 to 2000. Prior
        to
        joining Bain Capital, Mr. Dominik was a general partner of Zero Stage Capital,
        a
        venture capital firm focused on early-stage companies. Previously, Mr. Dominik
        was a venture capital investor and assistant to the Chairman of Genzyme
        Corporation, a biotechnology firm, and a consultant at Bain & Company. Mr.
        Dominik received his J.D. from Harvard Law School and his Bachelor of Arts
        from
        Harvard College. He is currently a director of Therma-Wave, Inc., Integrated
        Circuit Systems, Inc. and several private companies. Mr. Dominik resigned
        as
        Director of Leiner, effective June 9, 2006.
 
 **Gale
        K. Bensussen,** *Director,* has
        been
        a Director of Leiner since June 1992 and President of Leiner since May 1992.
        Mr.
        Bensussen was Senior Vice President-Marketing and Corporate Development of
        Leiner from May 1991 to May 1992. From July 1988 to May 1991, Mr. Bensussen
        was
        Senior Vice President-Sales and Marketing of Leiner. Mr. Bensussen joined
        Leiner
        in 1974. Mr. Bensussen resigned as President of Leiner, effective March 31,
        2006. Mr. Bensussen will continue to serve as a member of the Board of
        Directors.
 
 **Monty
        Sharma** , *Director* ,
        has
        been a Director of Leiner since June 2005. Mr. Sharma has been the Chief
        Executive Officer of the Naked Juice Company since May 2005. Prior to Naked
        Juice, he held the positions of Chief Operating Officer, President and CEO
        of
        Experimental and Applied Sciences (“EAS”) from 1999 to 2005. Mr. Sharma has also
        served as the Chief Financial Officer and Senior Vice President of Operations
        for Brunswick Corporation from 1996 to 1999. Mr. Sharma received his Masters
        of
        Business Administration from the Southern Illinois University.
 
 **Ken
        Diekroeger,** *Director,* has
        been
        appointed as Director of Leiner, effective June 9, 2006. Mr. Diekroeger has
        been
        a Managing Director of Golden Gate Capital since 1990. Prior to joining Golden
        Gate Capital, Mr. Diekroeger also served as a Managing Director at American
        Industrial Partners, a private equity firm specialized in operationally -
        intensive industrial buyouts. Mr. Diekroeger received his Bachelor of Science
        in
        Industrial Engineering and his Masters of Business Administration from Stanford
        University.
 
 **G.V.
        Prasad,** *Director,* has
        been
        a Director since June 2003. Since 2001, Mr. Prasad has served as Executive
        Vice
        Chairman and Chief Executive Officer of Dr. Reddy’s Laboratories Limited. From
        1990 to 2001, Mr. Prasad was Managing Director of Cheminor Drugs Ltd., which
        merged with Dr. Reddy’s Laboratories Limited. Prior to that he was the founding
        director of Benzex Labs, which manufactured Active Pharmaceutical Ingredients.
        He currently serves as member of the boards of Diana Hotels Limited, Nipuna
        Services Ltd., Vijaya Productions Ltd., Diana Projects and Engineers Ltd.
        and
        Green Park Hotels and Resorts Ltd. Mr. Prasad has a bachelors degree in Chemical
        Engineering from Illinois Institute of Technology, Chicago, and a masters
        degree
        in Industrial Administration from Purdue University. Mr. Prasad resigned
        as
        Director of Leiner, effective March 27, 2006.


There
      are
      no family relationships among any of our executive officers and
      directors.





40


**Audit
      Committee Financial Expert**





The
      Audit
      Committee as of March 25, 2006 consisted of Mr. Peter J. Shabecoff.





The
      Board
      has determined that Mr. Shabecoff has the requisite attributes of an "audit
      committee financial expert" under the rules of the Securities and Exchange
      Commission (“SEC”) and that such attributes were acquired through relevant
      education and work experience. The Board has determined that Mr. Shabecoff
      is
      not an independent director. The Audit Committee met 4 times during fiscal
      2006.





**Code
      of Ethics**





The
      Company has adopted a code of ethics that applies to all of its directors,
      officers (including its chief executive officer, chief financial officers,
      chief
      accounting officer, controller, and any person performing similar functions)
      and
      employees. The Company’s Code of Ethics was filed as Exhibit 14.1 to the Form
      10-K for the year ended March 26, 2005 on file with the SEC.




**ITEM
              11.**
            **EXECUTIVE
                COMPENSATION**




The
      following table sets out the compensation for our Chief Executive Officer and
      our other four most highly compensated officers, or the “Named Executive
      Officers”.




**Summary
                  Compensation Table****Annual
                  Compensation**
              
              **Long
                  Term Compensation Awards****Name
                  and Principal Position**
              
              **Salary**
              
              **Bonus
                  (1)**
              
              **Other
                  Annual Compensation (2)**
              
              **Common
                  Shares Underlying Options**
              
              **All
                  Other Compensation**Robert
                    M. Kaminski (3)
                    *Chief
                      Executive Officer*
              
              $
              475,000
              
              $
              118,750
              
              $
              10,815
              
              
              -
              
              
              -Robert
                    K. Reynolds
                    *Chief
                      Operating Officer and**Chief
                  Financial Officer*
              
              
              355,288
              
              
              93,750
              
              
              7,428
              
              
              -
              
              
              -Gale
                    K. Bensussen [a]*President*
              
              
              325,000
              
              
              81,250
              
              
              13,234
              
              
              -
              
              
              -Robert
                      J. La Ferriere*Executive
                    Vice President,**Supply
                  Chain*
              
              
              288,846
              
              
              76,250
              
              
              9,292
              
              
              -
              
              
              -Kevin
                      J. Lanigan*Executive
                    Vice President/**Corporate
                  General Manager*
              
              
              265,000
              
              
              66,250
              
              
              4,895
              
              
              -
              
              
              -


_________________


[a]
      Effective March 31, 2006, Gale K. Bensussen resigned as President of Leiner.
      Mr.
      Bensussen will continue to serve as a member of the Leiner Board.





(1)
      The
      amounts represent bonuses earned for reaching the second half targeted fiscal
      2006 EBITDA goals. No bonuses were earned or paid under the Company’s 2005
      EBITDA goals since the targets were not met.


(2)
      Other
      compensation consists of the cost of life insurance coverage over the $50,000
      salary limitation as well as other taxable fringe benefits paid by the company
      on behalf of the Named Executive Officers.


(3)
      Effective April 1, 2006, Mr. Kaminski's salary was
      increased to $550,000 per annum.




The
      Company did not grant any options under the 2004 Option Plan or sell any shares
      under the Stock Plan during fiscal 2006.




41


**Compensation
      Committee Interlocks and Insider Participation**





Our
      Board
      of Directors had a compensation committee composed of Messrs. Ashe, Baird,
      and
      Shabecoff during fiscal 2006. During fiscal 2006, all members of the Board
      of
      Directors participated in the deliberations concerning compensation of our
      executive officers, except that neither Mr. Kaminski nor Mr. Bensussen
      participated in any discussions regarding their own compensation. Mr. Kaminski
      served in fiscal 2006 as a director of Enzymatic Therapy, Inc. (“Enzymatic”) and
      as a member of the compensation committee of that board.





**Employment
      Contracts and Severance Benefit Agreements**





Messrs.
      Kaminski, Bensussen, La Ferriere and Lanigan do not have employment agreements
      with us. However, we have entered into a Severance Benefit Agreement with each
      of these executives. We have entered into an employment agreement with Mr.
      Reynolds.





Pursuant
      to the Severance Benefit Agreements with each of Messrs. Kaminski, Bensussen,
      La
      Ferriere and Lanigan, if the executive terminates his employment for “good
      reason” (as defined in the agreements) or his employment is terminated by us
      without “cause” (as defined in the agreements), each such executive will be
      entitled to the following severance benefits: (1) the severance payment set
      forth opposite to such executive’s name on the table set forth below, (2) out
      placement assistance at our expense and (3) such rights under our applicable
      plans or programs (including any stock options or incentive plans), as may
      be
      determined pursuant to the terms of such plans or programs. In the event any
      such executive is discharged for cause, or if the executive voluntarily resigns
      without good reason, all payments of base salary and performance bonus, as
      well
      as all of such executive’s benefits, shall immediately cease, except for any
      accrued and unpaid salary, bonuses and benefits.




**Executive**
              ****
              **Severance
                  Benefits Payment**Robert
                  M. Kaminski
              
              $2,000,000
                  in cash, payable in four equal quarterly installments.Gale
                  K. Bensussen [a]
              
              $1,500,000
                  in cash, payable in four equal quarterly installments.Kevin
                  J. Lanigan
              
              a
                  lump-sum payment equal to three times the sum of one
                  year'sbase
                  salary, plus any annual individual performance bonus ortargeted
                  commission, both as in effect at the time of thetermination.Robert
                  J. La Ferriere
              
              a
                  lump-sum payment equal to one year's base salary, plus
                  anyannual
                  individual performance bonus or targeted commission,both
                  as in effect at the time of the
                  termination.




[a]
      Effective March 31, 2006, Gale K. Bensussen resigned as President of Leiner.
      Mr.
      Bensussen’s severance benefits are recorded under restructuring charges in the
      consolidated statement of operations and in operating activities in the
      consolidated statement of cash flows.





The
      employment agreement for Mr. Reynolds, dated January 28, 2002, sets forth an
      annual base salary of $375,000, which may be adjusted by the Board of Directors
      in its sole and absolute discretion. In addition, Mr. Reynolds may receive
      an
      annual bonus equal to up to 50% of his base salary, which shall be payable
      based
      on the achievement of specified performance targets set by the Board of
      Directors. The employment agreement for Mr. Reynolds contemplates an initial
      employment term ending on January 28, 2005 and provides for automatic renewal
      for periods of one year unless either party gives 60-days prior written notice
      of non-extension. In the event the executive is terminated for any reason,
      the
      executive will receive any accrued and unpaid salary and bonus. In the event
      the
      executive is terminated by us without cause (as defined in such executive’s
      employment agreement) or if we give the executive a non-extension notice, such
      executive shall be entitled to: (1) 24 months of continued regular salary,
      and
      (2) a one-time payment in an amount equal to the actual bonus paid to such
      executive for the year immediately preceding the date of termination of such
      executive’s employment. In order to be eligible for such severance payment, the
      executive must execute a full release of claims against us. The employment
      agreement for Mr. Reynolds contains non-competition, non-solicitation and
      confidentiality provisions.




42


**Board
      Compensation Committee Report on Executive Compensation**





*Compensation
      Policy*





The
      objective of the Company’s executive compensation committee is to review and
      monitor compensation arrangements so that the Company continues to retain,
      attract, and motivate quality management consistent with the annual strategic
      plan and budget, and the directions of the Board.





During
      fiscal 2006, the Compensation Committee (“Committee”) of the Board of Directors
      was composed of three non-employee directors: Prescott H. Ashe, Charles F.
      Baird, Jr., and Peter J. Shabecoff. The Board of Directors has adopted a
      Compensation Committee Charter, which specifies the composition and
      responsibilities of the Committee. The Board reviews the charter annually based
      on input from the Committee.





The
      charter of the compensation committee gives the Committee responsibilities
      to:





·
            review
                the basic philosophy and policy governing the compensation of the
                Company’s management and other
                personnel;


·
            review
                at least annually the salaries of members of senior management and
                their
                performance against objectives and
                potential;


·
            review
                and approve the methodology and implementation of an annual incentive
                bonus program. Factors to be considered include the financial and
                strategic performance of the Company versus objectives, individual
                performance and comparative industry compensation
                information;


·
            review
                and approve salary and incentive programs for all
                employees;


·
            review
                and recommend to the board adoption of, and changes to, stock option
                and
                other incentive programs and plans for key
                employees;


·
            consider
                and approve, upon recommendation of the chief executive, individuals
                eligible for, and the number, kind and terms of stock
                options;


·
            review
                other employee benefits plans such as pension, 401(k) and other retirement
                plans;


·
            review
                medical plans and other health plans;
                and


·
            consider
                and approve, upon recommendation of the chief executive, employer
                contributions to the 401(k) benefit
                plan.





The
      Chief
      Executive Officer’s salary and bonus under the 2006 Management Bonus Plan and
      any stock-based incentive awards granted to him under the 2004 Restricted Stock
      Plan are approved by the independent directors after review and recommendation
      by the Committee. The Committee reviews and approves the compensation
      arrangements for all other executive officers with respect to their salaries,
      bonuses and stock-based incentive awards under the 2004 Restricted Stock
      Plan.





*Compensation
      of the Chief Executive Officer*





The
      Chief
      Executive Officer’s compensation plan for fiscal 2006 consisted of salary at a
      rate of $475,000 per annum and an earned bonus of $118,750 under the 2006
      Management Bonus Plan. The Company did not grant any options under the 2004
      Option Plan or sell any shares under the Stock Plan during fiscal 2006.
      Effective April 1, 2006, Mr. Kaminski's salary was increased to $550,000 per
      annum.




43




**ITEM
              12.**
            **SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF RELATED
                  STOCKHOLDER MATTERS**





Upon
      consummation of the Recapitalization, we became a wholly-owned subsidiary of
      Holdings, whose stockholders include the Golden Gate Investors, the North Castle
      Investors and members of management.





The
      following table summarizes shares authorized, issued and outstanding and
      reserved for future issuance of Holdings;




**Number
                  of shares****Description**
              
              
              **Authorized**
              
              
              **Issued
                  and Outstanding**
              
              
              
              
              **Reserved
                  for Future Issuance**Series
                  A Preferred Stock
              
              
              3,000,000
              
              
              2,651,832
              
              
              
              
              -Series
                  B Preferred Stock
              
              
              1,000,000
              
              
              195,676
              
              (1
              )
              
              600,000
              
              
              (2
              )Series
                  C Preferred Stock
              
              
              200,000
              
              
              130,000
              
              (3
              )
              
              -Common
                  Stock
              
              
              6,000,000
              
              
              195,676
              
              (1
              )
              
              5,600,000
              
              
              (2
              )


________________________


(1)
      Restricted stock issued and outstanding under the LHP Holdings Corp. 2004
      Restricted Stock Plan (the “Stock Plan”). The restricted stock has various
      restrictive Call Rights retained by us after issuance. Although the timing
      of
      the removal of the Call Rights is dependant upon the future employment status
      of
      the employee, generally, the Call Rights are removed over a pro-rata period
      of
      six years from the date of the Recapitalization.





(2)
      600,000 shares reserved for conversion of delayed delivery shares (“DDS”) Series
      B Preferred Stock. 600,000 shares reserved for issuance of DDS Common Stock
      and
      5,000,000 shares reserved for conversion of Series A Preferred
      Stock.





(3)
      In
      fiscal 2006, 130,000 shares of Series C Preferred Stock under the LHP Holdings
      were issued and outstanding in connection with the PFI acquisition.




44


The
      following table sets forth information regarding beneficial ownership of common
      stock of Holdings as of March 25, 2006 by: (i) each person or entity known
      to us
      to own more than 5% of any class of Holdings’ outstanding securities; and (ii)
      each known member of Holdings’ board of directors, each of our named executive
      officers and all members of the board of directors and executive officers as
      a
      group. To our knowledge, each of such security holders will have sole voting
      and
      investment power as to the shares shown unless otherwise noted. Beneficial
      ownership of the securities listed in the table has been determined in
      accordance with the applicable rules and regulations promulgated under the
      Exchange Act.




**Securities
                  Beneficially Owned (1)****Name**
              
              **Preferred
                  Stock (2)**
              
              **Common
                  Stock (3)****Number
                  of Shares**
              
              
              
              **Percentage
                  of Class**
              
              **Number
                  of Shares**
              
              **Percentage
                  of Class****Principal
                  Stockholders:**GGC
                  Investment Fund II, L.P. and Related Entities (4)
              
              
              1,380,000
              
              
              (11
              )
              
              46.82
              %
              
              -
              
              
              -North
                  Castle Partners III-A, L.P. and Related Entities (5)
              
              
              1,380,000
              
              
              (10
              )
              
              46.82
              %
              
              -
              
              
              -**Directors
                  and Executive Officers:**Robert
                  M. Kaminski (6)
              
              
              29,320
              
              
              
              
              
              0.99
              %
              
              48,888
              
              
              21.77
              %Robert
                  K. Reynolds (6)
              
              
              14,358
              
              
              
              
              
              0.49
              %
              
              24,142
              
              
              10.75
              %Gale
                  K. Bensussen (6)
              
              
              27,233
              
              
              
              
              
              0.92
              %
              
              37,017
              
              
              16.48
              %Robert
                  J. La Ferriere (6)
              
              
              3,850
              
              
              
              
              
              0.13
              %
              
              8,742
              
              
              3.89
              %Kevin
                  J. Lanigan (6)
              
              
              42,204
              
              
              
              
              
              1.43
              %
              
              38,346
              
              
              17.07
              %Charles
                  F. Baird, Jr. (7) (8)
              
              
              50,000
              
              
              
              
              
              1.70
              %
              
              -
              
              
              -Peter
                  J. Shabecoff (7)
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              -David
                  C. Dominik (9)
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              -Prescott
                  H. Ashe (9)
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              -Monty
                  Sharma (6)
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              -All
                  directors and executive officers as a group
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              -(10
                  persons)
              
              
              166,965
              
              
              
              
              
              5.66
              %
              
              157,135
              
              
              69.96
              %


__________________


(1)
      Pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, as amended,
      a
      person has beneficial ownership of any securities as to which such person,
      directly or indirectly, through any contract, arrangement, undertaking,
      relationship or otherwise has or shares voting power and/or investment power
      and
      as to which such person has the right to acquire such voting and/or investment
      power within 60 days. Percentage of beneficial ownership as to any person as
      of
      a particular date is calculated by dividing the number of shares beneficially
      owned by such person by the sum of the number of shares outstanding as of such
      date and the number of shares as to which such person has the right to acquire
      voting and/or investment power within 60 days.


(2)
      Preferred Stock includes Series A Preferred Stock, issued and outstanding,
      Series B Preferred Stock, reserved for delayed delivery, and Series C Preferred
      Stock, issued and outstanding.


(3)
      Common stock includes common stock reserved for delayed delivery, exercisable
      Restricted Stock and exercisable Options granted on Common Stock.


(4)
      The
      address is 1 Embarcadero Center, 33rd Floor, San Francisco, California
      94111.


(5)
      The
      address is 183 Putnam Avenue, Greenwich, Connecticut 06831.


(6)
      The
      address is c/o Leiner Health Products Inc., 901 East 233rd Street, Carson,
      California 90745.


(7)
      The
      address is c/o North Castle Partners III-A, L.P., 183 Putnam Avenue, Greenwich,
      Connecticut 06831. Messrs. Baird and Shabecoff are Managing Directors of North
      Castle Partners, L.L.C., which is the manager of North Castle Partners III-A,
      L.P. By virtue of their status, Messrs. Baird and Shabecoff may be deemed to
      have or share voting and investment power with respect to the shares in which
      North Castle Partners, L.L.C. and North Castle Partners III-A, L.P. have direct
      or indirect beneficial ownership but each disclaim the beneficial ownership
      of
      the shares held directly or indirectly by such entities except to the extent
      of
      his proportionate ownership interests therein.


(8)
      Includes 50,000 shares of Series A Preferred Stock held of record by North
      Castle GP III-A, L.L.C., which is general partner of the general partner of
      North Castle Partners III-A, L.P. and of which Mr. Baird is the managing member.
      By virtue of his status as the managing member of North Castle GP III-A, L.L.C.,
      Mr. Baird may be deemed to have voting and investment power with respect to
      the
      50,000 shares of Series A Preferred Stock held of record by North Castle GP
      III-A, L.L.C.




45




(9)
      The
      address is c/o GGC Investment Fund II, L.P., 1 Embarcadero Center, 33rd Floor,
      San Francisco, California 94111. Messrs. Dominik and Ashe are Managing Directors
      of Golden Gate Capital which is the general partner of the GGC Investment Fund
      II, L.P. Messrs Dominik and Ashe each disclaim the beneficial ownership of
      the
      shares held by such entities except to the extent of his proportionate ownership
      interests therein.


(10)
      Consists of (i) 1,265,000 shares of Series A preferred stock owned by North
      Castle Partners III-A, L.P., (ii) 50,000 shares of Series A Preferred Stock
      held
      of record by North Castle GP III-A, L.L.C., and (iii) 65,000 shares of Series
      C
      Preferred Stock held of record by North Castle GP III-A, L.L.C.


(11)
      Consists of: (i) 361,976.73 shares of Series A preferred stock and 19,223 shares
      of Series C preferred stock owned by CCG Investment Fund, L.P., (ii) 18,196.22
      shares of Series A preferred stock and 966 shares of Series C preferred stock
      owned by CCG Associates— QP, LLC, (iii) 1,691.94 shares of Series A preferred
      stock and 90 shares of Series C preferred stock owned by CCG Associates— AI,
      LLC, (iv) 4,849.27 shares of Series A preferred stock and 258 shares of Series
      C
      preferred stock owned by CCG Investment Fund — AI, L.P., (v) 36,694.06 shares of
      Series A preferred stock and 1,948 shares of Series C preferred stock owned
      by
      CCG AV, LLC-Series C, (vi) 14,085 shares of Series A preferred stock and 748
      shares of Series C preferred stock owned by CCG AV, LLC-Series F, (vii)
      657,433.77 shares of Series A preferred stock and 36,058 shares of Series C
      preferred stock owned by Golden Gate Capital Investment Fund II, L.P., (viii)
      17,411.28 shares of Series A preferred stock and 925 shares of Series C
      preferred stock owned by Golden Gate Capital Associates II-QP, LLC, (ix)
      91,001.64 shares of Series A preferred stock owned by CCG CI, LLC, (x) 92,678.63
      shares of Series A preferred stock and 3,776 shares of Series C preferred stock
      owned by Golden Gate Capital Investment Fund II-A, L.P., (xi) 16,395 shares
      of
      Series A preferred stock and 899 shares of Series C preferred stock owned by
      Golden Gate Capital Investment Fund II, (AI) L.P., (xii) 2,311.21 shares of
      Series A preferred stock and 94 shares of Series C preferred stock owned by
      Golden Gate Capital Investment Fund II-A, (AI) L.P., and (xiii) 275.25 shares
      of
      Series A preferred stock and 15 shares of Series C preferred stock owned by
      Golden Gate Capital Associates II-AI, LLC.




**ITEM
              13.**
            **CERTAIN
                  RELATIONSHIPS AND RELATED
                  TRANSACTIONS**





**Stockholders
      Agreement**





As
      part
      of the Recapitalization, Holdings, the North Castle Investors, the Golden Gate
      Investors and our management stockholders entered into a stockholders agreement.
      We refer to the North Castle Investors, the Golden Gate Investors, the
      management stockholders party to the stockholders agreement and their permitted
      transferees collectively as the “Stockholders.” The stockholders agreement
      contains the following principal provisions:




· *Board
        of Directors*.
        The
        stockholders agreement sets the size of Holdings’ board of directors and our
        board of directors at nine members each and requires all parties to the
        agreement to vote their shares and take all steps within their power to elect
        three nominees selected by the North Castle Investors, three nominees selected
        by the Golden Gate Investors and two nominees who are members of management
        and
        one nominee that is an outside director, in each case selected jointly by
        the
        North Castle Investors and the Golden Gate Investors. As of March 25, 2006,
        the
        Company had eight directors on its board. A vacant position created by the
        resignation of Mr. Grad remained open as of the date of this report. The
        North
        Castle Investors and the Golden Gate Investors each will have these rights
        for
        so long as it meets the definition of a Major Investor. As defined in the
        stockholders agreement, a Major Investor (i) owns at least 40% of the shares
        held as of the date of the agreement and (ii) has not transferred to any
        single
        person more than 50% of the greater of the shares held by it on the date
        of the
        agreement or at the time of the transfer, in which case such transferee will
        succeed to such rights for so long as it holds 20% of the common stock
        outstanding on the date of the agreement. As of the date of the stockholders
        agreement, the directors nominated by North Castle were Messrs. Baird, James
        and
        Shabecoff and the directors nominated by Golden Gate were Messrs. Ashe, Dominik
        and Grad. As of March 25, 2006, Messrs. James and Grad resigned from the
        Leiner
        board effective April 30, 2005 and September 23, 2005, respectively. The
        board
        has not yet filled those vacant positions. Effective June 9, 2006, Mr. Dominik
        resigned from the Leiner board and was replaced by Mr. Diekroeger. The
        management directors will be Mr. Kaminski and Mr. Bensussen for so long as
        they
        serve as Chief Executive Officer and President, respectively. Mr. Bensussen
        resigned as President of Leiner effective March 31, 2006. At March 25, 2006,
        Mr.
        Prasad was the outside director. Mr. Prasad resigned as a member of the Board
        of
        Directors of Leiner effective March 27, 2006. The board has not yet filled
        the
        vacant position as of the date of this report.
  · *Approval
        of Significant Transactions.*****The
        Golden Gate Investors and North Castle Investors, so long as they remain
        Major
        Investors, possess approval rights over some significant transactions that
        may
        be pursued by Holdings, including mergers or sales by Holdings or any
        subsidiary.
  · *Transfer
        Restrictions*.
        Without
        the consent of each of the Major Investors, until the earlier of the fifth
        anniversary of the stockholders agreement and six months after the consummation
        of a public offering, Stockholders may not transfer shares, other than in
        transfers permitted by the stockholders agreement. Any such permitted
        transferees will agree in writing to be bound by the provisions of the
        stockholders agreement.




46
 · *Participation
            Rights*.
            Pursuant to the stockholders agreement, Stockholders are granted “tag-along”
rights, which entitle them to participate in some sales by the Major
            Investors.
  · *Take-Along
            Sale of Capital Stock*.
            Subject
            to exceptions, if one or more Major Investors prior to a public offering
            approves a sale of more than 50% of Holdings’ capital stock to a non-affiliated
            third party and any Major Investor that has not initiated such sale approves
            such transfer, each of the Stockholders may be required to sell a pro
            rata share
            of capital stock. Prior to a public offering and during the period beginning
            on
            the third anniversary and ending on the fifth anniversary of the stockholders
            agreement, either Major Investor may effect a take-along sale without
            obtaining
            the approval of the other Major Investor if specified performance criteria
            are
            met. After the fifth anniversary of the stockholders agreement, either
            Major
            Investor may effect a take-along sale without obtaining the approval
            of the
            other Major Investor and without meeting any performance
            criteria.
  · *Piggyback
            Registration Rights.*****The
            Stockholders are entitled to request the inclusion of their securities
            in any
            registration statement at Holdings’ expense whenever it proposes to register any
            equity securities.
 · *Demand
            Registration.*****Under
            the
            stockholders agreement, any Major Investor has the right after the first
            anniversary of the consummation of a public offering, subject to some
            exceptions, to require Holdings to register any or all of their registrable
            securities under the Securities Act.
  · *Holdback
            Agreement for Demand Registrations*.
            Each
            Stockholder, if required by the managing underwriter in an underwritten
            offering, agrees not to sell or offer for public sale or distribution,
            any of
            such Stockholder’s capital stock within 15 days prior to or 180 days after the
            effective date of any demand registration, except as part of such
            registration.
 · *Preemptive
              Rights.*****The
              Stockholders Agreement contains customary preemptive rights in favor
              of each
              Major Investor.
  · *Indemnification.*In
              connection with all registrations pursuant to the stockholders agreement,
              Holdings has agreed to indemnify the Stockholders participating in
              such
              registrations, the officers and directors of such Stockholders and
              each person
              that controls such Stockholder against liabilities relating to the
              registration,
              including liabilities under the Securities Act.
  · *Affiliate
              Transactions.*Holdings
              has agreed not to engage in any transaction or series of related transactions
              (other than the consulting agreement and related transactions) with
              any of the
              Major Investors or any of their respective affiliates unless (i) such
              transaction or series of related transactions are on terms and conditions
              no
              less favorable than would be obtainable by Holdings in an arm’s-length
              transaction and its chief financial officer delivers to the Board of
              Directors a
              certificate to such effect and (ii) if the transaction or series of
              related
              transactions involve an amount greater than $1 million, a majority
              of the
              members of the Board of Directors who are not officers, employees or
              managing
              members of Holdings or the applicable Major Investor of any of its
              affiliates
              have approved such transactions in writing.
  **Consulting
          Agreement**





In
      connection with the Recapitalization, we and Holdings entered into a consulting
      agreement with Leiner Health Products, LLC, a wholly owned subsidiary of North
      Castle Partners, L.L.C., an affiliate of the North Castle Investors, and GGC
      Administration, LLC, an affiliate of the Golden Gate Investors (“GGC
      Administration”). Pursuant to the consulting agreement, North Castle Partners,
      L.L.C. and GGC Administration will be compensated for the financial, investment
      banking, management advisory and other services performed in connection with
      the
      recapitalization and for future financial, investment banking, management
      advisory and other services they perform on our behalf.





In
      consideration for their services in connection with the recapitalization,
      Holdings, Leiner and Leiner Health Products, LLC paid $6,190,000 to each of
      North Castle Partners, L.L.C. and GGC Administration. We have also paid $175,000
      in certain fees, costs and out-of-pocket expenses incurred in the aggregate
      by
      North Castle Partners, L.L.C. and GGC Administration in connection with the
      Recapitalization.





As
      compensation for their continuing services, Holdings, Leiner and Leiner Health
      Products, LLC will pay $1,315,000 in arrears annually to each of North Castle
      Partners and GGC Administration as long as Holdings, Leiner and Leiner Health
      Products, LLC meet a performance target, which we did not meet in fiscal 2006.
      We have also agreed to reimburse North Castle Partners and GGC Administration
      for their reasonable travel, other out-of-pocket expenses and administrative
      costs and expenses, including legal and accounting fees, and to pay additional
      transactions fees to them in the event Holdings, Leiner or any of its
      subsidiaries completes any acquisition (whether by merger, consolidation,
      reorganization, recapitalization, sale of assets, sale of stock or otherwise)
      financed by new equity or debt, a transaction involving a change of control,
      as
      defined in the consulting agreement, or sale, transfer or other disposition
      of
      all or substantially all of the assets of Holdings, Leiner or Leiner Health
      Products, LLC.





47


**Recapitalization
      Agreement and Plan of Merger**





On
      April
      15, 2004, Mergeco entered into a recapitalization agreement and plan of merger
      with Leiner. The Recapitalization was effected by merging Mergeco with and
      into
      Leiner. In connection with the Recapitalization, the Golden Gate Investors
      made
      a $131.5 million cash equity investment in Mergeco and the North Castle
      Investors made a $131.5 million equity investment in Mergeco, $126.5 million
      of
      which was a new cash investment by NCP III-A and $5.0 million of which was
      a
      rollover of existing Leiner equity by an affiliate of NCP III-A. Immediately
      after the merger, the holders of Leiner stock exchanged their stock for voting
      preferred stock of Holdings. In addition, some members of management exchanged
      existing Leiner equity rights for new equity rights in Holdings, which when
      combined with the equity rollover, represents an aggregate management rollover
      of $18.8 million. Holders of all of Leiner’s equity and equity rights received
      an aggregate of approximately $475.3 million in cash in exchange for their
      equity interests, approximately $286.4 million of which was paid to other
      investment funds affiliated with North Castle Partners, L.L.C. Such holders
      of
      Leiner capital stock and equity interests will receive any amounts remaining
      in
      the $6.5 million escrow fund after such escrow is released.





Merger
      consideration paid to members of our senior management is described below under
      “—Management Equity Arrangements.”





The
      recapitalization agreement and plan of merger contains customary representations
      and warranties and customary covenants of the parties thereto. In addition,
      the
      completion of the Recapitalization was conditioned upon the satisfaction or
      waiver of specified conditions. The recapitalization agreement and plan of
      merger does not provide for indemnification for losses relating to specified
      events, circumstances and matters, except as provided in the escrow agreement
      described below. See “—Escrow Agreement.”





Upon
      the
      closing of the Recapitalization and the related transactions, all of the capital
      stock of Leiner is owned by Holdings, which is owned by the North Castle
      Investors, the Golden Gate Investors and some members of
      management.





**Escrow
      Agreement**





As
      part
      of the Recapitalization, the Golden Gate Investors, the North Castle Investors,
      North Castle Partners, L.L.C., Leiner, Mergeco and an escrow agent entered
      into
      an escrow agreement. Pursuant to the recapitalization agreement and plan of
      merger, Mergeco deposited $6.5 million in cash in an escrow account to be held
      and disposed of as provided in the escrow agreement. The escrow funds will
      be
      used to pay specified product liability claims and tax claims as provided for
      in
      the escrow agreement. Any amounts remaining in the escrow account will be paid
      to the selling Leiner equity holders on a pro rata basis on the later of
      December 31, 2006 and other dates specified in the escrow agreement with respect
      to the contingent liabilities.





**Management
      Equity Arrangements**





In
      connection with the Recapitalization, Messrs. Kaminski, Bensussen, Lanigan
      and
      La Ferriere received $1.2 million, $2.5 million, $4.1 million and $0.3 million,
      respectively, in cash in exchange for some or all of their existing Leiner
      common stock. Mr. Lanigan also received $0.9 million of voting preferred stock
      of Holdings in connection with his rollover of existing Leiner common stock.





Each
      of
      Messrs. Kaminski, Bensussen, Reynolds, Perez, Lanigan and La Ferriere held
      options under our previous stock incentive plan, which were terminated in
      connection with the Recapitalization. Some outstanding options to purchase
      shares of common stock held by Messrs. Kaminski, Bensussen, Reynolds, Perez,
      Lanigan and La Ferriere were exchanged for a number of new delayed delivery
      shares equal to the quotient determined by dividing (1) the excess of the per
      share merger consideration payable to holders of common stock in the merger
      over
      the exercise price per share by (2) the per share cash purchase price paid
      by
      those investors purchasing Leiner common stock in connection with the
      recapitalization. In connection with the recapitalization, each of Messrs.
      Kaminski, Bensussen, Reynolds, Perez, Lanigan and La Ferriere received new
      awards of an aggregate of approximately 29,320, 27,233, 14,358, 710, 19,431
      and
      3,850 shares of delayed delivery common and preferred stock of Holdings,
      respectively, assuming a new common stock fair market value of $100. In
      addition, each of Messrs. Kaminski, Bensussen, Reynolds, Perez and La Ferriere
      received an amount equal to approximately $1.9 million, $0.4 million, $1.5
      million, $2.9 million and $1.4 million, respectively, in connection with the
      cash out of their options that were not exchanged for new delayed delivery
      share
      awards. Messrs. Kaminski, Bensussen and Lanigan held delayed delivery share
      awards under our former stock incentive plan, which was terminated in connection
      with the recapitalization. In connection with the recapitalization, each of
      Messrs. Kaminski and Bensussen received an aggregate of approximately $6.9
      million and $5.3 million, respectively, in connection with the cash out of
      his
      delayed delivery share awards. Mr. Lanigan rolled over his delayed delivery
      share awards for a new award of shares of delayed delivery common and preferred
      stock of Holdings. In connection with the recapitalization, Mr. Lanigan received
      an aggregate of approximately 14,023 new delayed delivery share
      awards.





48


Messrs.
      Kaminski, Bensussen and Lanigan each received $0.2 million in exchange for
      the
      cancellation of their existing warrants in connection with the
      Recapitalization.




**ITEM
                  14.**
                ****PRINCIPAL
                    ACCOUNTANTS FEES AND
                    SERVICES****


The
      following table presents fees for professional services rendered by Ernst &
Young LLP (“E&Y”) for the audit of the Company’s annual financial statements
      for the fiscal years ended March 26, 2005 and March 25, 2006, and fees billed
      for audit related services, tax services and all other services rendered by
      E&Y during those periods:




**Year
                Ended****March
                26, 2005**
            
            **March
                25,2006**Audit
                fees (1)
            
            $
            1,288,000
            
            $
            945,000Audit-related
                fees (2)
            
            
            73,000
            
            
            147,305Tax
                fees (3)
            
            
            207,000
            
            
            51,260Total
            
            $
            1,568,000
            
            $
            1,143,565




______________________


(1)
      Audit
      fees consisted of fees for professional services provided in connection with
      the
      audit of our annual consolidated financial statements, the performance of
      limited reviews of our quarterly unaudited financial information, and audit
      services provided in connection with SEC filings and other statutory or
      regulatory filings.


(2)
      Audit-related fees consisted primarily of professional services rendered in
      connection with other activities not explicitly related to the audit of our
      financial statements, including the consultations concerning financial
      accounting and reporting standards and the PFI Acquisition.


(3)
      Tax
      fees consisted primarily of services related to tax compliance, tax planning
      and
      tax advice.





**Audit
      Committee’s pre-approval policies and procedures**





We
      have a
      policy which outlines procedures intended to ensure that our Audit Committee
      pre-approves all audit and non-audit services provided to us by our auditors.
      The policy provides for (a) general pre-approval of certain audit and
      audit-related services which do not exceed $100,000 and (b) specific
      pre-approval of all other permitted services and any proposed services exceeding
      this pre-approved dollar amount.





The
      term
      of any general service subject to pre-approval is twelve months from the date
      of
      pre-approval, unless the Audit Committee considers a different period and states
      otherwise. The Audit Committee will annually review and pre-approve the services
      that may be provided by our auditors without obtaining specific pre-approval
      from the Audit Committee. The Audit Committee may modify the list of general
      pre-approved services from time to time, based on subsequent determinations.





In
      connection with this pre-approval policy, the Audit Committee will consider
      whether the categories of pre-approved services are consistent with the SEC’s
      rules on auditor independence. The Audit Committee will also consider whether
      the independent Accountant may be best positioned to provide the most effective
      and efficient service, for reasons such as its familiarity with our business,
      people, culture, accounting systems, risk profile and other factors, and whether
      the service might enhance our ability to manage or control risk or improve
      audit
      quality. All such factors will be considered as a whole, and no one factor
      should necessarily be determinative.





The
      Audit
      Committee is also mindful of the relationship between fees for audit and
      non-audit services, in deciding whether to pre-approve any such services and
      may
      determine, for each fiscal year, the appropriate ratio between the total amount
      of fees for Audit, Audit-related and Tax services and the total amount of fees
      for certain permissible non-audit services classified as “all other
      services.”


49





**PART
      IV**





**ITEM
                15.**
              **EXHIBITS
                  AND FINANCIAL STATEMENTS
                  SCHEDULES**





(a)
      The
      following documents are filed as part of this report:





**1.**
            **Financial
                Statement.**The
                following financial statements of the Company are included in a separate
                section of this Annual Report on Form 10-K commencing on the pages
                referenced below:





**Page**Index
                to Consolidated Financial Statements
            
            
            F-1Report
                of Independent Registered Public Accounting Firm
            
            
            F-2Consolidated
                Balance Sheets as of March 26, 2005 and March 25, 2006
            
            
            F-3Consolidated
                Statements of Operations for the years ended March 27, 2004, March
                26,
                2005 and March 25, 2006
            
            
            F-4Consolidated
                Statements of Shareholder's Equity (Deficit) for the years ended
                March 27,
                2004,
              March
                26, 2005 and March 25, 2006
            
            
            F-5Consolidated
                Statements of Cash Flows for the years ended March 27, 2004, March
                26,
                2005 and March 25, 2006
            
            
            F-6Notes
                to Consolidated Financial Statements
            
            
            F-7





**2.**
            **Financial
                Statement Schedules.**The
                following financial statement schedule of the Company is included
                in a
                separate section of this Annual Report on Form 10-K commencing on
                the page
                referenced below. All other schedules have been omitted because they
                are
                not applicable, not required, or the information is included in the
                Consolidated Financial Statements or notes
                thereto.





Schedule
                II—Consolidated Valuation and Qualifying Accounts
            S-1




50





**3.**
            **List
                of Exhibits.**





**Exhibit**
              **Number**
            
            **Exhibit
                Description**
            
            **Cross
                Reference**2.1
            
            Recapitalization
                Agreement and Plan of Merger, dated April 15, 2004, between Leiner
                Health
                Products Inc. and Leiner Merger Corporation.
            
            Filed
                as Exhibit 2.1 to the Registration Statement on Form S-4 and incorporated
                herein by reference.2.2
            
            First
                Amendment to the Recapitalization Agreement and Plan of Merger, dated
                May
                26, 2004, between Leiner Health Products Inc. and Leiner Merger
                Corporation.
            
            Filed
                as Exhibit 2.2 to the Registration Statement on Form S-4 and incorporated
                herein by reference.2.3
            
            Amendment
                and Restated Asset Purchase and Sale Agreement dated as of September
                9,
                2005, among Leiner Health Products L.L.C. and Pharmaceutical Formulations,
                Inc.
            
            Filed
                as Exhibit 10.11 to the Quarterly Report on Form 10-Q of Leiner Health
                Products Inc. for the Quarter Ended September 24, 2005, and incorporated
                herein by reference.3.1
            
            Amended
                and Restated Certificate of Incorporation of Issuer.
            
            Filed
                as Exhibit 3.1 to the Registration Statement on Form S-4 and incorporated
                herein by reference.3.2
            
            Bylaws
                of Issuer.
            
            Filed
                as Exhibit 3.2 to the Registration Statement on Form S-4 and incorporated
                herein by reference.3.3
            
            Certificate
                of Formation of Leiner Health Products, LLC.
            
            Filed
                as Exhibit 3.3 to the Registration Statement on Form S-4 and incorporated
                herein by reference.3.4
            
            Limited
                Liability Company Agreement of Leiner Health Products,
                LLC.
            
            Filed
                as Exhibit 3.4 to the Registration Statement on Form S-4 and incorporated
                herein by reference.3.5
            
            Certificate
                of Incorporation of Leiner Health Services Corp. and certificates
                of
                amendment.
            
            Filed
                as Exhibit 3.5 to the Registration Statement on Form S-4 and incorporated
                herein by reference.3.6
            
            Bylaws
                of Leiner Health Services Corp.
            
            Filed
                as Exhibit 3.6 to the Registration Statement on Form S-4 and incorporated
                herein by reference.4.1
            
            Indenture,
                dated as of May 27, 2004, among Leiner Merger Corporation, the companies
                named therein as guarantors, and U.S. Bank National Association,
                as
                Trustee.
            
            Filed
                as Exhibit 4.1 to the Registration Statement on Form S-4 and incorporated
                herein by reference.4.2
            
            Supplemental
                Indenture, dated as of May 27, 2004, among the Issuer, Leiner Health
                Services Corp. and Leiner Health Products, LLC, as Guarantors, and
                U.S.
                Bank National Association, as Trustee.
            
            Filed
                as Exhibit 4.2 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.1
            
            Credit
                Agreement, dated May 27, 2004, among Issuer, guarantors party thereto,
                UBSAG, Stamford Branch, as administrative agent and collateral agent,
                UBS
                Securities LLC and Morgan Stanley Senior Funding, Inc., as joint
                lead
                arrangers and joint book runners, Morgan Stanley Senior Funding,
                Inc., as
                syndication agent, Credit Suisse First Boston, as documentation agent,
                UBS
                Loan Finance LLC, as swingline lender, and the other financial
                institutions named therein.
            
            Filed
                as Exhibit 10.1 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.2
            
            Stockholders
                Agreement, dated May 27, 2004, among LHP Holding Corp. (“Parent”) and its
                stockholders named therein.
            
            Filed
                as Exhibit 10.2 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.3
            
            Amended
                and Restated Severance Benefit Agreement, dated as of July 11, 2002,
                between the Issuer and Gale Bensussen.
            
            Filed
                as Exhibit 10.3 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.4
            
            Amended
                and Restated Severance Benefit Agreement, dated as of July 1, 2002,
                between the Issuer and Robert Kaminski.
            
            Filed
                as Exhibit 10.4 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.5
            
            Severance
                Benefit Agreement, dated as of November 21, 1991, between P. Leiner
                Nutritional Products, Inc. and Kevin J. Lanigan and Assignment and
                Assumption Agreement, dated April 11, 2002, between the Issuer and
                Leiner
                Health Products, LLC.
            
            Filed
                as Exhibit 10.5 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.6
            
            Employment
                Agreement, dated January 28, 2002, between the Issuer and Robert
                K.
                Reynolds and Assignment and Assumption Agreement, dated February
                24, 2004
                between the Issuer and Leiner Health Products, LLC.
            
            Filed
                as Exhibit 10.6 to the Registration Statement on Form S-4 and incorporated
                herein by reference.




51




10.8
            
            Consulting
                Agreement, dated as of May 27, 2004, the Issuer, Leiner Health Products,
                LLC, LHP Holding Corp., North Castle Partners, L.L.C. and GGC
                Administration, LLC.
            
            Filed
                as Exhibit 10.8 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.9
            
            Severance
                and Release Agreement dated August 6, 2004 between Leiner Health
                Products,
                LLC and Gerardo Perez.
            
            Filed
                as Exhibit 10.9 to the Registration Statement on Form S-4 and incorporated
                herein by reference.10.10
            
            Consultant
                Agreement dated August 6, 2004 between Leiner Health Products, LLC
                and
                Gerardo Perez.
            
            Filed
                as Exhibit 10.10 to the Registration Statement on Form S-4 and
                incorporated herein by reference.10.11
            
            Amendment
                No. 1 and Acknowledgement dated September 23, 2005 to the Credit
                Agreement
                dated May 27, 2004 between Leiner Health Products Inc. and the senior
                lenders.
            
            Filed
                as Exhibit 10.11 to the Quarterly Report on Form 10-Q of Leiner Health
                Products Inc. for the Quarter Ended September 24, 2005, and incorporated
                herein by reference.14.1
            
            Code
                of Ethics.
            
            Filed
                as Exhibit 14.1 to the Company’s annual report Form 10-K for the year
                ended March 26, 2005.21.1
            
            Subsidiaries
                of Registrant.
            
            Filed
                as Exhibit 21.1 to the Registration Statement on Form S-4 and incorporated
                herein by reference.31.1
            
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a)
                of the Securities Exchange Act, as amended.
            
            Filed
                herewith.31.2
            
            Certification
                of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a)
                of the Securities Exchange Act, as amended.
            
            Filed
                herewith.32.1
            
            Certification
                of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
            
            Filed
                herewith.32.2
            
            Certification
                of Chief Financial Officer, pursuant to 18 U.S.C. 1350, as adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
            
            Filed
                herewith.





(b)
      Reports on Form 8-K filed in the fourth quarter of fiscal 2006





Incorporated
                by reference to the current report on Form 8-K filed by the registrant
                on
                January 13, 2006
              Incorporated
                by reference to the current report on Form 8-K filed by the registrant
                on
                January 31, 2006
              Incorporated
                by reference to the current report on Form 8-K filed by the registrant
                on
                March 3, 2006




52





**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, Leiner Health Products Inc. has duly caused this report to be signed
      on
      its behalf by the undersigned, thereunto duly authorized, in the City of Carson,
      State of California, on the 23rd day of June, 2006.





LEINER
                HEALTH PRODUCTS INC.By:
            /S/ROBERT
                  K.REYNOLDSName:
                Robert K. Reynolds
              Title:
                Executive Vice President, Chief Operating Officer and Chief Financial
                Officer





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





Name
            
            Title
            Date/s/
                CHARLES F. BAIRD, JR.
            
            Chairman
                of the Board and Director
            June
                23, 2006Charles
                F. Baird, Jr./s/
                ROBERT M. KAMINSKI
            
            Chief
                Executive Officer, (Principal Executive Officer) and
            June
                23, 2006Robert
                M. Kaminski
            
            Director/s/
                ROBERT K. REYNOLDS
            
            Executive
                Vice Present, Chief Operating Officer and Chief
            June
                23, 2006Robert
                K. Reynolds
            
            Financial
              Officer
              (principal financial and accounting
              officer)/s/
                GALE K. BENSUSSEN
            
            Director
            June
                23, 2006Gale
                K. Bensussen/s/
                PETER J. SHABECOFF
            
            Director
            June
                23, 2006Peter
                J. Shabecoff/s/
                PRESCOTT H. ASHE
            
            Director
            June
                23, 2006Prescott
                H. Ashe/s/
                KEN DIEKROEGER
            
            Director
            June
                23, 2006Ken
                Diekroeger/s/
                MONTY SHARMA
            
            Director
            June
                23, 2006Monty
                Sharma





53





**LEINER
      HEALTH PRODUCTS INC.**


**INDEX
      TO**


**CONSOLIDATED
      FINANCIAL STATEMENTS**





Report
                of Independent Registered Public Accounting Firm.
            F-2Consolidated
                Balance Sheets as of March 26, 2005 and March 25, 2006
            F-3Consolidated
                Statements of Operations for the years ended March 27, 2004, March
                26,
                2005 and March 25, 2006
            F-4Consolidated
                Statements of Shareholder’s Equity (Deficit) for the years ended March 27,
                2004, March 26, 2005 and March 25, 2006
            F-5Consolidated
                Statements of Cash Flows for the years ended March 27, 2004, March
                26,
                2005 and March 25, 2006
            F-6Notes
                to Consolidated Financial Statements
            F-7






F-1





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





The
      Board
      of Directors and Shareholder


Leiner
      Health Products Inc.





We
      have
      audited the accompanying consolidated balance sheets of Leiner Health Products
      Inc. as of March 26, 2005 and March 25, 2006, and the related consolidated
      statements of operations, shareholder’s equity (deficit), and cash flows for
      each of the three years in the period ended March 25, 2006. Our audits also
      included the financial statement schedule listed in the Index at Item 15(a).
      These financial statements and schedule are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these financial
      statements and schedule based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. We were not engaged to perform
      an
      audit of the Company’s internal control over financial reporting. Our audits
      included consideration of internal control over financial reporting as a basis
      for designing audit procedures that are appropriate in the circumstances, but
      not for the purpose of expressing an opinion on the effectiveness of the
      Company’s internal control over financial reporting. Accordingly we express no
      such opinion. An audit also includes examining, on a test basis, evidence
      supporting the amounts and disclosures in the financial statements, assessing
      the accounting principles used and significant estimates made by management,
      and
      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 Leiner Health Products
      Inc. at March 26, 2005 and March 25, 2006, and the consolidated results of
      its
      operations and its cash flows for each of the three years in the period ended
      March 25, 2006, in conformity with U.S generally accepted accounting principles.
      Also in our opinion, the related financial statement schedule, when considered
      in relation to the basic financial statements taken as a whole, present fairly
      in all material respects the information set forth herein.





/s/
      ERNST
& YOUNG LLP


Orange
      County, California


May
      24,
      2006


F-2


**LEINER
      HEALTH PRODUCTS INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(dollars
      in thousands, except share data)**


**ASSETS**
            
            **March
                26, 2005**
            
            **March
                25, 2006**Current
                assets:Cash
                and cash equivalents
            
            $
            16,951
            
            $
            7,731Accounts
                receivable, net of allowances of $3,113 and $3,545 at March 26,
                2005and
                March 25, 2006, respectively
            
            
            80,250
            
            
            73,211Inventories
            
            
            164,910
            
            
            165,714Income
                tax receivable
            
            
            2,310
            
            
            56Prepaid
                expenses and other current assets
            
            
            17,492
            
            
            16,484Total
                current assets
            
            
            281,913
            
            
            263,196Property,
                plant and equipment, net
            
            
            65,554
            
            
            72,618Goodwill
            
            
            52,317
            
            
            58,245Other
                noncurrent assets
            
            
            17,014
            
            
            22,039Total
                assets
            
            $
            416,798
            
            $
            416,098**LIABILITIES
                AND SHAREHOLDER'S DEFICIT**Current
                liabilities:Accounts
                payable
            
            $
            101,639
            
            $
            77,648Accrued
                compensation and benefits
            
            
            9,634
            
            
            9,994Customer
                allowances payable
            
            
            9,576
            
            
            10,522Accrued
                interest
            
            
            9,093
            
            
            10,436Other
                accrued expenses
            
            
            10,792
            
            
            14,418Current
                portion of long-term debt
            
            
            5,536
            
            
            5,498Total
                current liabilities
            
            
            146,270
            
            
            128,516Long-term
                debt
            
            
            390,990
            
            
            397,119Other
                noncurrent liabilities
            
            
            2,512
            
            
            5,545Total
                liabilities
            
            
            539,772
            
            
            531,180Commitments
                and contingenciesCommon
                stock, $0.01 par value; 3,000,000 shares authorized, 1,000 shares
                issuedand
                outstanding at March 26, 2005 and March 25, 2006
            
            
            -
            
            
            -Capital
                in excess of par value
            
            
            469
            
            
            13,489Accumulated
                deficit
            
            
            (126,357
            )
            
            (130,125
            )Accumulated
                other comprehensive income
            
            
            2,914
            
            
            1,554Total
                shareholder's deficit
            
            
            (122,974
            )
            
            (115,082
            )Total
                liabilities and shareholder's deficit
            
            $
            416,798
            
            $
            416,098




See
      accompanying notes to consolidated financial statements.




F-3





**LEINER
      HEALTH PRODUCTS INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(dollars
      in thousands)**


**Year
                  Ended****March
                  27, 2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006**Net
                  sales
              
              $
              661,045
              
              $
              684,901
              
              $
              669,561Cost
                  of sales
              
              
              486,554
              
              
              512,871
              
              
              533,215Gross
                  profit
              
              
              174,491
              
              
              172,030
              
              
              136,346Marketing,
                  selling and distribution expenses
              
              
              56,448
              
              
              58,532
              
              
              58,444General
                  and administrative expenses
              
              
              41,041
              
              
              34,134
              
              
              35,725Research
                  and development expenses
              
              
              5,670
              
              
              5,299
              
              
              4,551Amortization
                  of other intangibles
              
              
              447
              
              
              250
              
              
              638Restructuring
                  charges
              
              
              -
              
              
              -
              
              
              3,836Recapitalization
                  expenses
              
              
              -
              
              
              87,982
              
              
              -Other
                  operating expense
              
              
              1,528
              
              
              2,386
              
              
              1,113Operating
                  income (loss)
              
              
              69,357
              
              
              (16,553
              )
              
              32,039Interest
                  expense, net
              
              
              18,954
              
              
              32,346
              
              
              36,869Income
                  (loss) before income taxes
              
              
              50,403
              
              
              (48,899
              )
              
              (4,830
              )Provision
                  for (benefit from) income taxes
              
              
              11,347
              
              
              (987
              )
              
              (1,062
              )Net
                  income (loss)
              
              
              39,056
              
              
              (47,912
              )
              
              (3,768
              )Accretion
                  on preferred stock
              
              
              (12,105
              )
              
              (39,212
              )
              
              -Net
                  income (loss) attributable to common shareholder
              
              $
              26,951
              
              $
              (87,124
              )
              $
              (3,768
              )


See
        accompanying notes to consolidated financial statements.
  F-4
  **LEINER
        HEALTH PRODUCTS INC.**
 **CONSOLIDATED
        STATEMENTS OF SHAREHOLDER’S EQUITY (DEFICIT)**
 **(dollars
        in thousands except share data)**
 Preferred
                      Stock
                  
                  
                  
                  
                  
                  Capital
                      in
                  
                  Retained
                  
                  Accumulated
                  
                  TotalSeries
                      A Redeemable
                  
                  Series
                      B Junior Convertible
                  
                  Series
                      C Junior
                  
                  Common
                      Stock
                  
                  Excess
                    of
                      Par
                  
                  Earnings(Accumulated
                  
                  Other
                    Comprehensive
                  
                  Shareholder's
                    EquityShares
                  
                  Amount
                  
                  Shares
                  
                  Amount
                  
                  Shares
                  
                  Amount
                  
                  Shares
                  
                  Amount
                  
                  Value
                  
                  Deficit)
                  
                  Income
                      (Loss)
                  
                  (Deficit)Balance
                      at March 29, 2003
                  
                  
                  200,000
                  
                  $
                  28,083
                  
                  
                  7,500
                  
                  $
                  6,616
                  
                  
                  7,000
                  
                  $
                  6,178
                  
                  
                  1,139,394
                  
                  $
                  11
                  
                  $
                  21,841
                  
                  $
                  (10,692
                  )
                  $
                  (771
                  )
                  $
                  23,183Net
                      income
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  39,056
                  
                  
                  -
                  
                  
                  39,056Translation
                      adjustment
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  880
                  
                  
                  880Comprehensive
                      income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  39,936Accretion
                      on preferred stock
                  
                  
                  -
                  
                  
                  12,105
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (12,105
                  )
                  
                  -
                  
                  
                  (12,105
                  )Balance
                      at March 27, 2004
                  
                  
                  200,000
                  
                  
                  40,188
                  
                  
                  7,500
                  
                  
                  6,616
                  
                  
                  7,000
                  
                  
                  6,178
                  
                  
                  1,139,394
                  
                  
                  11
                  
                  
                  21,841
                  
                  
                  16,259
                  
                  
                  109
                  
                  
                  51,014Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (47,912
                  )
                  
                  -
                  
                  
                  (47,912
                  )Translation
                      adjustment
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  2,805
                  
                  
                  2,805Comprehensive
                      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (45,107
                  )Accretion
                      on preferred stock
                  
                  
                  -
                  
                  
                  29,812
                  
                  
                  -
                  
                  
                  8,578
                  
                  
                  -
                  
                  
                  822
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (39,212
                  )
                  
                  -
                  
                  
                  (29,812
                  )Repurchase
                      and retirement ofpreferred
                      stock
                  
                  
                  (200,000
                  )
                  
                  (70,000
                  )
                  
                  (7,500
                  )
                  
                  (15,194
                  )
                  
                  (7,000
                  )
                  
                  (7,000
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  
                  
                  
                  -
                  
                  
                  (22,194
                  )Recapitalization
                      (Note 5)
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (1,138,394
                  )
                  
                  (11
                  )
                  
                  (21,841
                  )
                  
                  (55,492
                  )
                  
                  -
                  
                  
                  (77,344
                  )Restricted
                      stock issued inconnection
                      with long-termincentive
                      program
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  464
                  
                  
                  -
                  
                  
                  -
                  
                  
                  464Share-based
                      compensation
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5Balance
                      at March 26, 2005
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,000
                  
                  
                  -
                  
                  
                  469
                  
                  
                  (126,357
                  )
                  
                  2,914
                  
                  
                  (122,974
                  )Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (3,768
                  )
                  
                  -
                  
                  
                  (3,768
                  )Translation
                      adjustment
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (1,360
                  )
                  
                  (1,360
                  )Comprehensive
                      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (5,128
                  )Capital
                      contribution from parent
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  13,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  13,000Share-based
                      compensation
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  20
                  
                  
                  -
                  
                  
                  -
                  
                  
                  20Balance
                      at March 25, 2006
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  1,000
                  
                  $
                  -
                  
                  $
                  13,489
                  
                  $
                  (130,125
                  )
                  $
                  1,554
                  
                  $
                  (115,082
                  )
  See
        accompanying notes to consolidated financial statements.


F-5


**LEINER
      HEALTH PRODUCTS INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**


**Year
                  Ended****March
                  27, 2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006****Operating
                  activities**Net
                  income (loss)
              
              $
              39,056
              
              $
              (47,912
              )
              $
              (3,768
              )Adjustments
                  to reconcile net income (loss) to net cash provided by(used
                  in) operating activities:Depreciation
              
              
              12,690
              
              
              11,948
              
              
              15,235Amortization
                  of other intangibles and other contracts
              
              
              1,978
              
              
              1,774
              
              
              1,399Amortization
                  of deferred financing charges
              
              
              8,037
              
              
              5,445
              
              
              1,866Provision
                  for doubtful accounts and allowances
              
              
              4,087
              
              
              4,791
              
              
              5,153Provision
                  for excess and obsolete inventory
              
              
              5,746
              
              
              8,028
              
              
              12,430Deferred
                  income taxes
              
              
              (3,488
              )
              
              (1,176
              )
              
              1,369(Gain)
                  loss on disposal of assets
              
              
              40
              
              
              (52
              )
              
              6Stock
                  compensation expense
              
              
              -
              
              
              5
              
              
              20Translation
                  adjustment
              
              
              (880
              )
              
              (2,805
              )
              
              1,360Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (24,739
              )
              
              (6,464
              )
              
              10,108Inventories
              
              
              (15,913
              )
              
              (26,842
              )
              
              (6,548
              )Income
                  tax receivable
              
              
              671
              
              
              (1,729
              )
              
              3,029Accounts
                  payable
              
              
              16,760
              
              
              9,840
              
              
              (29,125
              )Accrued
                  compensation and benefits
              
              
              (2,865
              )
              
              (4,992
              )
              
              302Customer
                  allowances payable
              
              
              (2,035
              )
              
              599
              
              
              910Accrued
                  interest
              
              
              781
              
              
              7,971
              
              
              1,340Other
                  accrued expenses
              
              
              529
              
              
              2,862
              
              
              2,784Other
              
              
              (2,689
              )
              
              (896
              )
              
              1,431Net
                  cash provided by (used in) operating activities
              
              
              37,766
              
              
              (39,605
              )
              
              19,301**Investing
                  activities**Additions
                  to property, plant and equipment
              
              
              (10,413
              )
              
              (17,991
              )
              
              (13,244
              )Acquisition
                  of business
              
              
              -
              
              
              -
              
              
              (22,922
              )Proceeds
                  from sale of property, plant and equipment
              
              
              -
              
              
              -
              
              
              625Increase
                  in other noncurrent assets
              
              
              (2,762
              )
              
              (2,944
              )
              
              (60
              )Net
                  cash used in investing activities
              
              
              (13,175
              )
              
              (20,935
              )
              
              (35,601
              )**Financing
                  activities**Net
                  borrowings under bank revolving credit facility
              
              
              -
              
              
              -
              
              
              5,000Borrowings
                  under bank term credit facility
              
              
              -
              
              
              240,000
              
              
              -Payments
                  under bank term credit facility
              
              
              -
              
              
              (1,200
              )
              
              (2,400
              )Payments
                  under old credit facility
              
              
              (6,604
              )
              
              (159,788
              )
              
              -Issuance
                  of senior subordinated debt
              
              
              -
              
              
              150,000
              
              
              -Increase
                  in deferred financing charges
              
              
              (1,774
              )
              
              (15,753
              )
              
              (760
              )Capital
                  contribution from parent
              
              
              -
              
              
              251,500
              
              
              13,000Repurchase
                  and retirement of preferred stock.
              
              
              -
              
              
              (92,194
              )
              
              -Repurchase
                  and retirement of common stock and common equity rights
              
              
              -
              
              
              (328,380
              )
              
              -Net
                  payments on other long-term debt
              
              
              (1,456
              )
              
              (3,318
              )
              
              (3,860
              )Net
                  cash provided by (used in) financing activities
              
              
              (9,834
              )
              
              40,867
              
              
              10,980Effect
                  of exchange rate changes
              
              
              1,520
              
              
              2,800
              
              
              (3,900
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              16,277
              
              
              (16,873
              )
              
              (9,220
              )Cash
                  and cash equivalents at beginning of period
              
              
              17,547
              
              
              33,824
              
              
              16,951Cash
                  and cash equivalents at end of period
              
              $
              33,824
              
              $
              16,951
              
              $
              7,731


See
      accompanying notes to consolidated financial statements.




F-6


**LEINER
      HEALTH PRODUCTS INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**MARCH
      25, 2006**








**1.**
            **Formation
                and Operations**




**General**





Leiner
      Health Products Inc. (“Leiner” or the “Company”) is primarily involved in the
      manufacture and distribution of vitamins, over-the-counter (“OTC”) drugs and
      other health products to mass market retailers and through other channels,
      primarily in the United States and Canada. These financial statements
      consolidate all of the Company’s subsidiaries, including all of its operating
      subsidiaries which are Leiner Health Products, L.L.C., Leiner Health Services
      Corp., and Vita Health Products Inc. (“Vita Health”) and its non-operating
      subsidiaries which are VH Vita Holdings Inc., Westcan Pharmaceuticals Ltd.,
      and
      6062199 Canada Inc.





**2.**
            **Summary
                of Significant Accounting
                Policies**





*Principles
      of Consolidation*





The
      accompanying consolidated financial statements include the accounts of the
      Company and its operating and non-operating subsidiaries. All significant
      intercompany accounts and transactions have been eliminated in the
      consolidation.





*Fiscal
      Year*





The
      Company maintains a fifty-two/fifty-three week fiscal year. The Company’s fiscal
      year end will fall on the last Saturday of March each year. Fiscal years 2004,
      2005 and 2006 were each comprised of 52-week periods.





*Use
      of Estimates*





The
      preparation of consolidated financial statements in conformity with U.S.
      generally accepted accounting principles requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of sales and expenses during the reporting
      periods. Actual results could differ from those estimates. Significant estimates
      made in preparing the consolidated financial statements include valuation
      allowances for accounts receivable, inventories, deferred tax assets, and future
      cash flows projection used to evaluate the recoverability of long-lived assets,
      and certain accrued liabilities.





*Cash
      Equivalents*





The
      Company considers all highly liquid investments with a maturity of three months
      or less when purchased to be cash equivalents.





*Fair
      Values of Financial Instruments*





Fair
      values of cash and cash equivalents approximate cost due to the short period
      of
      time to maturity. Fair values of the Company’s debt instruments have been
      determined based on borrowing rates currently available to the Company for
      loans
      with similar terms or maturity. The table below provides information about
      the
      fair value of the Company’s debt obligations under the New Credit Facility and
      Notes (in thousands):





**March
                  25, 2006****Total**
              
              **Fair
                  Value**Variable
                  rate ($US)
              
              $
              241,400
              
              $
              241,400Average
                  interest rate
              
              
              7.70
              %Fixed
                  rate ($US)
              
              $
              150,000
              
              $
              147,000Average
                  interest rate
              
              
              11.00
              %




The
        fair
        value of the Industrial Development Revenue Bond Loan could not be estimated
        because there is no active market for such debt instruments.
  F-7




*Revenue
      Recognition*





In
      accordance with the SEC Staff Accounting Bulletin (“SAB”) No. 101, *Revenue
      Recognition in Financial Statements* and SAB
      No. 104, *Revenue
      Recognition* ,
      the
      Company recognizes product revenue when the following fundamental criteria
      are
      met: (i) persuasive evidence of an arrangement exists; (ii) delivery has
      occurred or services have been rendered; (iii) the price to the customer is
      fixed or determinable; and (iv) collection of the resulting receivable is
      reasonably assured. These criteria are usually met upon receipt of products
      by
      the customer. The Company’s net sales represent gross sales invoiced to
      customers less certain related charges for contractual allowances, estimated
      future chargebacks and estimated product returns. Accruals provided for these
      items are presented in the consolidated financial statements as reductions
      to
      sales.





*Contractual
      Allowances* :
      The
      contractual allowances are previously agreed upon deductions for co-op
      advertisements, rebates, etc., the majority of which are recorded as a
      liability. Deductions from revenues for contractual allowances were
      approximately $40,051,000, $44,197,000 and $46,037,000 in fiscal 2004, 2005
      and
      2006, respectively.





*Future
      Chargebacks* :
      The
      allowances for future chargebacks generally represent special selling incentives
      offered to customers that will be charged back to the Company at a later date,
      which are presented as reductions of revenue and accounts receivable. The
      Company’s procedures for estimating amounts accrued for future chargebacks are
      based upon quantitative and qualitative factors. Quantitatively, the Company
      uses historical sales and related expenses, and applies forecasting techniques
      in order to estimate the Company’s provision amounts. Qualitatively,
      management’s judgment is applied to these items to modify, if appropriate, the
      estimated provision amounts. Deductions from revenues for such allowances
      were approximately $6,167,000, $4,823,000 and $8,391,000 in fiscal 2004, 2005
      and 2006, respectively.





*Product
      Returns* :
      The
      Company generally sells products to its customers that are not subject to a
      contractual right of return. However, the Company accepts some product returns
      as an accommodation to the customer to ensure a positive ongoing business
      relationship. As a result, the Company records an allowance at the time of
      original sale based on estimated product returns that may be accepted at a
      later
      date. The allowances for future product returns are reflected as a reduction
      of
      revenue and accounts receivable. Quantitatively, the Company uses data regarding
      historical sales and product returns supplemented by other information
      including, but not limited to, customer and third party point of sale data
      and
      inventory levels as reported by certain customers. Qualitatively, management’s
      judgment is applied to these items to modify, if appropriate, the estimated
      liability amount. Deductions from revenues for product returns were
      approximately $368,000, $2,996,000 and $6,618,000 in fiscal 2004, 2005 and
      2006,
      respectively.





*Allowances
      for Uncollectible Accounts*





The
      Company maintains reserves for potential credit losses, estimating the
      collectibility of customer receivables on an ongoing basis by periodically
      reviewing accounts outstanding over a certain period of time. The Company has
      recorded reserves for receivables deemed to be at risk for collection, as well
      as a general reserve based on historical collections experience. A considerable
      amount of judgment is required in assessing the ultimate realization of these
      receivables, including the current credit worthiness of each customer. Customer
      receivables are generally unsecured.





*Inventories*





Inventories
      include material, direct labor and related manufacturing overhead, and are
      stated at the lower of cost or market, with cost being determined by the
      first-in, first-out method. Reserves are provided for potentially excess and
      obsolete inventory and inventory that has aged over a specified period of time
      based on the difference between the cost of the inventory and its estimated
      market value. In estimating the reserve, management considers factors such
      as
      excess or slow moving inventories, product aging and expiration dating, current
      and future customer demand and market conditions. During the first quarter
      of
      fiscal 2005, the Company refined its aging based reserve estimation model by
      increasing the number of aging categories and revising the reserve estimation
      percentages applied to the aging categories. Management believes that the
      refined estimation model results in a better estimate of potentially excess
      and
      obsolete inventory. The
      impact of this change resulted in lower cost of sales and higher gross profit
      of
      approximately $448,000, and the net loss was lower by approximately $260,000
      for
      the period ended March 26, 2005. At
      March
      26, 2005 and March 25, 2006, the Company had reserved $10,990,000 and
      $15,365,000, respectively, for excess and obsolete inventory.





*Property,
      Plant and Equipment*





Property,
      plant and equipment (including assets recorded under capital leases) are stated
      at cost, net of accumulated depreciation and amortization. Depreciation and
      amortization are provided using the straight-line method, at rates designed
      to
      distribute the cost of assets over their estimated service lives or, for
      leasehold improvements, the shorter of their estimated service lives or their
      remaining lease terms. Amortization of assets recorded under capital leases
      is
      included in depreciation expense. Repairs and maintenance costs are expensed
      as
      incurred. Certain web site development costs are capitalized in accordance
      with
      EITF 00-2, *Accounting
      for website development cost.*





F-8


Prior
      to
      fiscal 2005, web site development costs incurred by the Company, which were
      not
      material, were expensed as incurred. During the fourth quarter of fiscal 2005,
      the Company changed its accounting policy and capitalized $517,000 of web site
      development costs in that quarter.





*Goodwill* **





Goodwill
      is subject to an impairment test in the fourth quarter of each year, or earlier
      if indicators of potential impairment exists, using a fair-value-based approach.
      During the fourth quarter of fiscal 2006, the Company updated its review, which
      indicated that there was no impairment. The goodwill impairment test is a
      two-step process that requires goodwill to be allocated to reporting units,
      which are reviewed by the units’ segment managers. In the first step, the fair
      value of the reporting unit is compared with the carrying value of the reporting
      unit. If the fair value of the reporting unit is less than the carrying value
      of
      the reporting unit, goodwill impairment exists, and the second step of the
      test
      is performed. In the second step, the implied fair value of the goodwill is
      compared with the carrying value of the goodwill, and an impairment loss is
      recognized to the extent that the carrying value of the goodwill exceeds the
      implied fair value of the goodwill. The change in the carrying amount of
      goodwill for the year ended March 25, 2006, includes $5,795,000 related to
      goodwill recorded in the acquisition of PFI Business (see Note 3) as well as
      foreign currency translation adjustments.





*Other
      Intangible Assets*





Other
      intangible assets arise principally from business acquisitions and primarily
      included accelerated new drug applications patents, customer base and
      trademarks. The net carrying amounts of other intangible assets are included
      in
      other non-current assets. A summary of amortizable intangible assets as of
      March
      26, 2005 and March 25, 2006 is as follows (in thousands):




**Gross
                    Carrying Value**
                
                **Accumulated
                    Amortization**
                
                **Net
                    CarryingValue**Balance
                    at March 26, 2005:Customer
                    base
                
                $
                1,747
                
                $
                1,747
                
                $
                -Purchased
                    patents
                
                
                2,728
                
                
                2,677
                
                
                51Trademarks
                
                
                200
                
                
                148
                
                
                52Total
                    intangibles assets
                
                $
                4,675
                
                $
                4,572
                
                $
                103Balance
                    at March 25, 2006:Customer
                    base
                
                $
                2,710
                
                $
                1,864
                
                $
                846Purchased
                    patents
                
                
                7,598
                
                
                3,214
                
                
                4,384Trademarks
                
                
                207
                
                
                161
                
                
                46Total
                    intangibles assets
                
                $
                10,515
                
                $
                5,239
                
                $
                5,276




Other
      intangible assets are amortized on a straight-line basis over their estimated
      economic lives. Amortization expense for other intangible assets was $447,000,
      $250,000 and $638,000 in fiscal 2004, 2005 and 2006, respectively. The amounts
      of other intangible assets amortization that will be charged to expenses over
      the next five years and thereafter are as follows (in thousands):




**Fiscal
                    year**2007
                
                $
                1,1692008
                
                
                1,1682009
                
                
                1,1682010
                
                
                1,1682011
                
                
                587Thereafter
                
                
                16Total
                
                $
                5,276
  F-9


*Recoverability
      of Long-Lived Assets*





The
      Company reviews for impairment of long-lived assets and certain intangibles
      held
      and used whenever events or changes in circumstances indicate that the carrying
      amount of an asset may not be recoverable. The recoverability test is performed
      at the lowest level at which undiscounted net cash flows can be directly
      attributable to long-lived assets.





*Deferred
      Market Development Costs*





The
      Company entered into a fifteen-year contract to distribute products developed
      by
      a pharmaceutical company. The Company paid fees for exclusivity rights and
      such
      payments were recorded as a deferred asset. Once the product receives regulatory
      approval, the deferred amounts made will be amortized over the expected product
      life cycle. On an ongoing basis, the Company reviews the balance remaining
      in
      the deferred asset account for impairment. As of March 25, 2006, the Company
      did
      not receive any products to market and there was no indication of impairment.
      At
      March 26, 2005 and March 25, 2006, the balance of the deferred asset related
      to
      this contract was approximately $2,346,000 and $2,991,000,
      respectively.





The
      Company also entered into contracts for supply and distribution of OTC products
      developed by certain pharmaceutical companies. The payments to these
      pharmaceutical companies are recorded as deferred assets. Amortization of the
      deferred assets is calculated using straight line method over the terms of
      the
      agreements or as related sales is recognized. The Company also reviews deferred
      assets for impairment whenever events or changes in circumstances indicate
      that
      the unamortized amount of an asset may not be recoverable. As of March 25,
      2006,
      based on the management review, there was no indication of impairment. At March
      26, 2005 and March 25, 2006, the Company had an unamortized balance of
      approximately $1,044,000 and $518,000, respectively, classified under other
      non-current assets in the accompanying consolidated balance sheet. In addition,
      the Company pays a certain percentage of contractually calculated net profit
      as
      royalties to these companies and they are expensed as related sales are
      recognized.





*Income
      Taxes*





The
      Company utilizes the liability method of accounting for income taxes as set
      forth in SFAS No. 109, *Accounting
      for Income Taxes* (“SFAS 109”).
      Under the liability method, deferred taxes are determined based on the temporary
      differences between the financial statement and tax bases of assets and
      liabilities using enacted tax rates. A valuation allowance is recorded when
      it
      is more likely than not that some of the deferred tax assets will not be
      realized. The Company also determines its tax contingencies in accordance with
      SFAS No. 5, *Accounting
      for Contingencies.* The
      Company records estimated tax liabilities to the extent the contingencies are
      probable and can be reasonably estimated.





*Foreign
      Currency Translation*





The
      Company translates the foreign currency financial statements of its Canadian
      subsidiary by translating balance sheet accounts at the year-end exchange rate
      and income statement accounts at the monthly weighted average exchange rate
      for
      the year. Translation gains and losses are recorded in shareholder’s equity
      (deficit), and realized gains and losses are reflected in results of operations.
      Translation gains (losses) were $880,000, $2,805,000 and ($1,360,000) for the
      years ended March 27, 2004, March 26, 2005 and March 25, 2006,
      respectively.





*Stock-Based
      Compensation*





Prior
      to
      fiscal 2005, the Company accounted for stock-based compensation using the
      intrinsic value recognition and measurement principles of APB Opinion No. 25
      ("APB 25"), Accounting for Stock Issued to Employees, and related
      interpretations. Under the provisions of APB 25, compensation expense is
      measured at the grant date for the difference between the estimated fair value
      of the stock and the exercise price of the option. Also prior to fiscal 2005,
      the Company adopted the disclosure, but not the accounting, requirements of
      SFAS
      No. 123, Accounting for Stock Based Compensation, ("SFAS 123") which established
      a fair-value based method of accounting and disclosure for stock-based employee
      compensation plans.





In
      fiscal
      2005, the Company adopted both the accounting and disclosure requirements of
      SFAS No. 123R, "Share-Based Payments" ("SFAS 123R"). SFAS 123R was adopted
      using
      the Modified Prospective Application Method which requires that the annual
      financial statements reflect share-based compensation pursuant to SFAS 123R
      in
      the year of adoption and subsequent periods.




F-10


*Shipping
      and Handling Fees and Costs*





The
      Company classifies shipping and handling costs as marketing, selling and
      distribution expenses in the accompanying consolidated statements of operations.
      Shipping and handling expenses for the years ended March 27, 2004, March 26,
      2005 and March 25, 2006, were $14,122,000, $16,082,000 and $17,055,000,
      respectively.





*Advertising
      Costs*





Advertising
      costs are expensed as incurred. Advertising expenses for the years ended March
      27, 2004, March 26, 2005 and March 25, 2006, were $2,689,000, $1,217,000 and
      $1,134,000, respectively.




*Reclassifications*





Certain
      reclassifications have been made to the fiscal 2004 and 2005 consolidated
      financial statements to conform to the fiscal 2006 presentation.





*New
      Accounting Pronouncements*





In
      May
      2005, the FASB issued SFAS No. 154, *Accounting
      Changes and Error Corrections* ,
      a
      replacement of Accounting Principles Board Opinion No. 20, *Accounting
      Changes,* and
      SFAS
      No. 3, *Reporting
      Accounting Changes in Interim Financial Statements* (“SFAS No. 154”).
      SFAS No. 154 changes the requirements for the accounting for, and reporting
      of,
      a change in accounting principle. Previously, voluntary changes in accounting
      principles were generally required to be recognized by way of a cumulative
      effect adjustment within net income during the period of the change. SFAS No.
      154 requires retrospective application to prior periods’ financial statements,
      unless it is impracticable to determine either the period-specific effects
      or
      the cumulative effect of the change. SFAS No. 154 is effective for accounting
      changes made in fiscal years beginning after December 15, 2005; however, the
      statement does not change the transition provisions of any existing accounting
      pronouncements. The adoption of SFAS No. 154 is not expected to have a
      significant impact on the Company’s financial statements.





**3.**
            **Acquisition**





On
      September 9, 2005, the Company entered into an agreement to acquire
      substantially all of the assets of Pharmaceutical Formulations Inc. (“PFI”), a
      manufacturer of private label OTC products in the United States, related to
      its
      OTC pharmaceutical business (the “Acquisition”), except for assets related to
      PFI’s Konsyl Pharmaceuticals Inc. subsidiary and other scheduled assets (the
“PFI Business”). The Acquisition is expected to broaden the Company’s existing
      customer base, expand its OTC product offerings, and increase its manufacturing
      scale.





On
      September 26, 2005, the Company acquired these assets for a purchase price
      consisting of (i) approximately $22,862,000 in cash, (ii) the assumption by
      the
      Company of certain related liabilities, including trade payables related solely
      to the PFI Business. The purchase price was funded, in part, by a $13,000,000
      capital contribution from the Company’s ultimate parent, LHP Holdings, which
      received such amount from the sale of equity securities to its current
      stockholders. The balance of the purchase price was funded from the Company’s
      Revolving Facility.





On
      March
      7, 2006, the Company reached a final settlement agreement with PFI on the
      working capital adjustment provided for in the acquisition agreement and, as
      a
      result, PFI paid the Company $1,477,000. The Company recorded the final
      adjustments to the purchase price allocation during the fourth quarter of fiscal
      2006. The allocation and valuation of purchase price is determined by management
      based on many factors, including a valuation performed by a third-party
      valuation firm. Acquired intangibles totaling $5,810,000 represents the fair
      value of customer base and accelerated new drug applications. These intangibles
      are being amortized over their estimated useful lives of five years.





F-11


The
      Components of the purchase price and the allocation are as follows (in
      thousands):




Consideration
                  and acquisition costs:Cash
                  paid to PFI
              
              $
              22,862Acquisition
                  costs
              
              
              1,537Working
                  capital adjustment
              
              
              (1,477
              )$
              22,922Allocation
                  of purchase price:Current
                  assets
              
              $
              13,859Property,
                  plant and equipment
              
              
              2,367Acquired
                  intangibles
              
              
              5,810Goodwill
              
              
              5,795Other
                  liabilities assumed
              
              
              (4,909
              )$
              22,922
  The
        following unaudited pro forma financial information presents the consolidated
        results of operations as if the Acquisition had occurred at the beginning
        of
        fiscal 2005 and does not purport to be indicative of the results that would
        have
        occurred had the Acquisition occurred at such date or of results which may
        occur
        in the future (in thousands):




**Year
                  ended****March
                  26, 2005**
              
              
              **March
                  25, 2006**Net
                  sales
              
              $
              747,543
              
              $
              698,180Operating
                  income (loss)
              
              
              (24,487
              )
              
              24,690Net
                  loss
              
              
              (56,216
              )
              
              (11,213
              )


**4.**
            **Restructuring
                charges**





In
      fiscal
      2006, the Company eliminated approximately 104 positions from its Carson, Garden
      Grove and Valencia, California, Fort Mill, South Carolina, and Wilson, North
      Carolina locations. Severance and other costs related to such reductions totaled
      $3,836,000 and are being paid to the terminated employees on a weekly basis
      through October 2006. The restructuring charges also include the severance
      accrued for the President, who resigned effective March 31, 2006. The accrued
      severance will be paid on a monthly basis through March 2009.





The
      following table summarizes the activities in the Company’s restructuring reserve
      (in thousands):




**Costs
                      for****Employees****Terminated**Balance
                  at March 26, 2005
              
              $
              -Additions
                  to reserve
              
              
              3,836Cash
                  payments
              
              
              (1,490
              )Balance
                  at March 25, 2006
              
              $
              2,346


**5.**
            **Recapitalization**





On
      April
      15, 2004, Leiner Merger Corporation (“Mergeco”), entered into a recapitalization
      agreement and plan of merger (the “Recapitalization”) with the Company. Mergeco
      was a new corporation formed by investment funds affiliated with Golden Gate
      Private Equity, Inc. (the “Golden Gate Investors”) and North Castle Partners
      III-A, L.P. (“NCP III-A”) and an affiliate of NCP III-A (the “North Castle
      Investors”) solely for the purpose of completing the Recapitalization. In
      connection with the Recapitalization, the Golden Gate Investors made a
      $131,500,000 cash equity investment in Mergeco and the North Castle Investors
      made a $131,500,000 equity investment in Mergeco, $126,500,000 of which was
      a
      new cash investment by NCP III-A and $5,000,000 of which was a roll over of
      existing Leiner equity by an affiliate of NCP III-A.





F-12


The
      Recapitalization was effected by merging Mergeco with and into Leiner on May
      27,
      2004. Each share of the common stock of Mergeco became a share of common stock
      of Leiner, which is the surviving corporation in the merger. Each holder of
      Leiner common stock then exchanged such stock for voting preferred stock of
      LHP
      Holding Corp. (“Holdings”), a newly formed company that became Leiner’s new
      parent company.





In
      addition, certain members of management cancelled existing Leiner equity rights
      and received new equity rights in Holdings, which represent an aggregate
      management rollover of approximately $18,774,000. Holders of all of Leiner’s
      other equity and equity rights have received an aggregate of approximately
      $475,332,000 in cash in exchange for their equity interests, approximately
      $286,351,000 of which was paid to other investment funds affiliated with North
      Castle Partners, L.L.C., and a contingent pro rata right in $6,500,000 deposited
      in an escrow fund. The Company also recorded approximately $54,294,000 as
      compensation expense related to the in-the-money value of stock options,
      warrants, and delayed delivery shares. The compensation expense represented
      the
      excess of the fair value of the underlying common stock over the exercise price
      or basis of the options and other equity rights repurchased and retired or
      rolled over in connection with the Recapitalization.





As
      a
      result of the Recapitalization, the Golden Gate Investors and the North Castle
      Investors each own 46.7% of Holdings equity and Leiner management and certain
      former employees own 6.6% of Holdings’ equity including delayed delivery share
      awards. In connection with the Acquisition of PFI (see Note 3. Acquisition),
      the
      Holdings issued 130,000 shares of Series C Preferred Stock to Golden Gate
      Investors and the North Castle Investors. Subsequent to the issuance of Series
      C
      Preferred Stock, the Golden Gate Investors and the North Castle Investors each
      own 46.8% of Holdings equity and the Leiner management owns 6.4% of Holdings
      equity including delayed delivery share awards. The Recapitalization was
      accounted for as a recapitalization of the Company which had no impact on the
      historical basis of assets and liabilities as reflected in the Company’s
      condensed consolidated financial statements.





In
      connection with the Recapitalization, Mergeco entered into a new credit facility
      (the “New Credit Facility”), consisting of a $240,000,000 term loan (the “Term
      Facility”) and a $50,000,000 revolving credit facility (the “Revolving
      Facility”), under which Leiner borrowed $5,000,000 immediately after the
      Recapitalization. In addition, Mergeco issued $150,000,000 of 11% senior
      subordinated notes due 2012 (the “Notes”). Immediately upon consummation of the
      Recapitalization, the obligations of Mergeco under the New Credit Facility
      and
      Notes became obligations of the Company. The Company repaid approximately
      $157,788,000 in pre-existing indebtedness and paid approximately $32,689,000
      in
      fees and expenses related to these transactions. In addition, deferred financing
      charges of approximately $12,470,000 related to the New Credit Facility and
      Notes were recorded under other non-current assets in the accompanying
      consolidated balance sheet. At March 26, 2005 and March 25, 2006, the remaining
      deferred financing changes, net of amortization, related to the New Credit
      Facility and Notes were $10,985,000 and $9,202,000, respectively.





The
      assumption of debt and the transfer of excess funds from the Recapitalization
      totaled approximately $77,344,000 and consisted of the following (in thousands):




Assumption
                  of Debt from Mergeco:New
                  Credit Facility
              
              $
              (245,000
              )Notes
              
              
              (150,000
              )
              $
              (395,000
              )Excess
                  funds from Mergeco
              
              
              
              
              
              317,656Recapitalization
              
              
              
              
              $
              (77,344
              )


The
      net
      Recapitalization amount above has been first applied against capital in excess
      of par value until that was exhausted and the remainder was applied against
      accumulated deficit.


F-13





**6.**
            **Debt**





Long-term
      debt consists of the following (in thousands):




**March
                  26, 2005**
              
              **March
                  25, 2006**New
                  Credit Facility:Revolving
                  facility
              
              $
              -
              
              $
              5,000Term
                  facility
              
              
              238,800
              
              
              236,400Total
                  credit facility
              
              
              238,800
              
              
              241,400Senior
                  subordinated notes
              
              
              150,000
              
              
              150,000Capital
                  lease obligations
              
              
              2,052
              
              
              7,117Industrial
                  development revenue bond loan
              
              
              4,600
              
              
              4,100Industrial
                  opportunities program loan
              
              
              1,074
              
              
              -396,526
              
              
              402,617Less
                  current portion
              
              
              (5,536
              )
              
              (5,498
              )Total
                  long-term debt
              
              $
              390,990
              
              $
              397,119
  *New
        Credit Facility*





In
      connection with the Company’s acquisition of the PFI Business, which is
      discussed in Note 3, and to provide the Company with operating flexibility,
      the
      Company obtained Amendment No. 1 and Acknowledgement (“Amendment”) from its
      senior lenders under the New Credit Facility on September 23, 2005. The
      Amendment acknowledges the acquisition of substantially all of the assets of
      PFI
      related to the PFI Business for approximately $22,862,000 in cash as a Permitted
      Acquisition, as defined. The Amendment, among other things, modified (a) the
      “applicable margin” rate, (b) existing financial and operating covenants that
      require, among other things, the maintenance of certain financial ratios, (c)
      added a Minimum Liquidity provision providing that in the event the net revolver
      availability plus the cash balance falls below $20,000,000, the equity sponsors
      have committed to contributing to the Company an additional $6,500,000 in
      equity, and (d) the calculation of consolidated credit agreement EBITDA, as
      defined. As a condition to obtain the consent of the lenders to the foregoing
      amendments, the Company paid an Amendment fee equal to 0.25% of the aggregate
      total commitments of senior lenders, or $719,000, and recorded it under other
      non-current assets in the consolidated balance sheet at March 25, 2006. The
      Amendment was effective for the quarter ended September 24, 2005 and subsequent
      quarters through the maturity of the New Credit Facility.





The
      New
      Credit Facility consists of the $240,000,000 Term Facility and the $50,000,000
      Revolving Facility, made available in U.S. dollars to the Company. The unpaid
      principal amount outstanding on the Revolving Facility is due and payable on
      May
      27, 2009. Commencing on May 27, 2004, the Term Facility required quarterly
      principal payments of approximately 1% per annum over the next six years and
      three quarters with the balance due on May 27, 2011. Principal payments
      scheduled during the period March 26, 2006 through March 31, 2007 total
      $3,000,000. Borrowings under the New Credit Facility bear interest at a base
      rate per annum plus an “applicable margin.” The Company can choose a base rate
      of (i) ABR (Alternate base rate) or (ii) London Interbank Offered Rate (“LIBOR”)
      for its Term Facility and Revolving Facility. The ABR rate is determined based
      on the higher of federal funds rate plus 0.5% or the prime commercial lending
      rates of UBS AG. The LIBOR rate is determined based on interest periods of
      one,
      two, three or six months. The amended “applicable margin” is based on the
      Company’s debt rating and the leverage ratio. The leverage ratio is defined
      generally as the ratio of consolidated indebtedness including letters of credit
      outstanding to the credit agreement EBITDA, as defined, and varies as follows:
      (a) 1.75% to 2.75% for all ABR based loans and (b) from 2.75% to 3.75% for
      all
      LIBOR based loans. As of March 25, 2006, the Company’s average interest rates
      were 7.7% under the New Credit Facility. In addition to certain agent and
      up-front fees, the New Credit Facility requires a commitment fee of up to 0.5%
      per annum of the average daily unused portion of the Revolving Facility. In
      addition, the New Credit Facility also provides for swingline loans (the
“Swingline Loans”) of $5,000,000 due prior to the Revolving Facility and also
      permits the Company to issue letters of credit up to an aggregate amount of
      $20,000,000. However, the Company’s total borrowings under the Revolving
      Facility, the Swingline Loans and letters of credit will not be permitted to
      exceed the Revolving Facility of $50,000,000. As of March 25, 2006, the Company
      had $35,395,000 available under its Revolving Facility and had $9,605,000 of
      letters of credit outstanding.





The
      New
      Credit Facility contains certain representations and warranties and affirmative
      and negative covenants which, among other things, limit the incurrence of
      additional indebtedness, guarantees, investments, distributions, transactions
      with affiliates, assets sales, acquisitions, capital expenditures, mergers
      and
      consolidations, prepayment of other indebtedness, liens and encumbrances and
      other matters customarily restricted in such agreements. In addition, the
      Company must also comply, every quarter end and on an annual basis, with certain
      financial ratios and tests under the Amendment, including without limitation,
      a
      minimum liquidity, a maximum total leverage ratio, a minimum interest coverage
      ratio and a maximum capital expenditure level. Following this Amendment, the
      Company was in compliance with all required financial covenants and has exceeded
      its Minimum Liquidity Provision as of March 25, 2006.





F-14


The
      Company’s ability to comply in future periods with the financial covenants in
      the Amendment will depend on its ongoing financial and operating performance,
      which in turn will be subject to economic conditions and to financial, business
      and other factors, many of which are beyond the Company’s control and will be
      substantially dependent on the selling prices and demand for the Company’s
      products, raw material costs, and the Company’s ability to successfully
      implement its overall business and profitability strategies. If a violation
      of
      any of the covenants occurred, the Company would attempt to obtain a waiver
      or
      an amendment from its lenders, although no assurance can be given that the
      Company would be successful in this regard.





The
      New
      Credit Facility and the indenture governing the Notes have covenants as well
      as
      certain cross-default or cross-acceleration provisions; failure to comply with
      the covenants in any applicable agreement could result in a violation of such
      agreement which could, in turn, lead to violations of other agreements pursuant
      to such cross-default or cross-acceleration provisions.





The
      New
      Credit Facility is collateralized by substantially all of the Company’s assets.
      Borrowings under the New Credit Facility are a key source of Leiner’s liquidity.
      Leiner’s ability to borrow under the New Credit Facility is dependent on, among
      other things, its compliance with the financial ratio covenants referred to
      in
      the preceding paragraphs. Failure to comply with these financial ratio covenants
      would result in a violation of the New Credit Facility and, absent a waiver
      or
      amendment from the lenders under such agreement, permit the acceleration of
      all
      outstanding borrowings under the New Credit Facility.





*Senior
      Subordinated Notes*





On
      May
      27, 2004, the Company assumed $150,000,000 of the Notes issued in connection
      with the Recapitalization. The Notes accrue interest at the rate of 11% per
      annum, payable semiannually on June 1 and December 1 of each year, commencing
      on
      December 1, 2004. The Company may be required to purchase the Notes upon a
      Change in Control (as defined in the indenture governing the Notes) and in
      certain circumstances with the proceeds of asset sales. The Notes are
      subordinated to the indebtedness under the New Credit Facility. The indenture
      governing the Notes imposes certain restrictions on the Company and its
      subsidiaries, including restrictions on its ability to incur additional debt,
      make dividends, distributions or investments, sell or otherwise dispose of
      assets, or engage in certain other activities.





*Capital
      Lease Obligations*





The
      capital lease obligations are payable in variable monthly installments through
      November 2008, bear interest at effective rates ranging from 2.75% to 8.94%.
      At
      March 25, 2006, the weighted average interest rate on the capital lease
      obligations is 7.6%. The capital leases are secured by equipment with a net
      book
      value of approximately $7,521,000 at March 25, 2006.





*Industrial
      Development Revenue Bond Loan (“IRB Loan”)*





The
      IRB
      Loan in the original aggregate principal amount of $8,100,000 is an obligation
      of Leiner Health Products, LLC, a subsidiary of the Company, and is due and
      payable in annual installments of $500,000, with the remaining outstanding
      principal amount due and payable on May 1, 2014. The interest rate on the IRB
      Loan (3.34% as of March 25, 2006) is variable and fluctuates on a weekly basis.
      At March 25, 2006, $4,100,000 aggregate principal amount was outstanding on
      the
      IRB Loan. The IRB Loan is secured by a letter of credit under our New Credit
      Facility. Under certain circumstances, the interest rate on the bonds may be
      converted to a fixed rate for the remainder of the term. On or prior to the
      date
      that the bonds are converted to a fixed rate, bondholders may elect to have
      their bonds or a portion thereof, in denominations of $100,000 and integral
      multiples of $5,000, in excess thereof, purchased at a price equal to par plus
      accrued interest upon seven days’ notice to the trustee. In the event a portion
      of the bonds are tendered for purchase, the bondholders must retain bonds in
      the
      denomination of at least $100,000. When any bonds shall have been delivered
      to
      the trustee for purchase, the remarketing agent shall use its best efforts
      to
      remarket such bonds at par plus accrued interest. In the event that sufficient
      funds are not available to the trustee to purchase tendered bonds, the Company
      is required to provide funds for such purchase, including funds drawn under
      the
      letter of credit securing the IRB Loan. Upon conversion to a fixed interest
      rate, the bondholders’ tender option will terminate.





*Industrial
      Opportunities Program Loan*





During
      fiscal 2000, the Company’s wholly owned subsidiary Vita Health Products entered
      into a loan agreement with the Manitoba Industrial Opportunities Program to
      fund
      the expansion and upgrading of the Company's manufacturing facility in Canada.
      The loan was secured principally by a pledge of certain real property of the
      Company’s Manitoba manufacturing facility and equipment purchased with the
      proceeds of the loan. Principal repayments were scheduled to be made in two
      equal payments of 50% of the final loan amount. The first scheduled payment
      of
      approximately $1,061,000 was made on September 30, 2004 and the remaining
      outstanding balance was paid on May 6, 2005. Interest on the loan prior to
      June
      1, 2004, was waived. Thereafter, the Company was required to pay interest on
      the
      outstanding loan amount at the rate of 7.125% per annum.





F-15


*Minimum
      payments*





Principal
      payments on long-term debt through fiscal 2011 and thereafter are as follows
      (in
      thousands):





**Fiscal
                  Year**2007
              
              $
              5,4982008
              
              
              4,0662009
              
              
              4,7792010
              
              
              8,9802011
              
              
              3,294Thereafter
              
              
              376,000$
              402,617


**7.**
            **Preferred
                Stock**





*Series
      A Redeemable Preferred Stock*





In
      fiscal
      2003, certain existing shareholders of the Company invested $20,000,000 in
      exchange for 200,000 shares of Series A Redeemable Preferred Stock of the
      Company. The Series A Redeemable Preferred Stock had a liquidation preference
      equal to the greater of (i) a minimum of three times and a maximum of six times
      invested capital, depending on the date on which the liquidation preference
      payment event occurred and (ii) the amount such stock would receive if, after
      payment of other outstanding preferred stock of the Company, such stock were
      treated ratably on a share for share basis with the common stock of the Company.





Pursuant
      to the Recapitalization, the Series A Redeemable Preferred Stock was redeemed
      at
      the liquidation preference value of $350 for each share of Series A Redeemable
      Preferred Stock and holders of such stock were paid the total aggregate amount
      of $70,000,000. The difference between the carrying value of the Series A
      Redeemable Preferred Stock on the date of the Recapitalization and the aggregate
      amount paid was recorded as accretion on preferred stock in the consolidated
      statement of operations for the year ended March 26, 2005.





*Series
      B Junior Convertible Preferred Stock*





In
      fiscal
      2003, the Company’s then current Senior Lenders were issued 7,500 shares of
      Series B Junior Convertible Preferred Stock of the Company, which was
      convertible into an aggregate of 3% of the fully diluted equity of the Company
      as of April 15, 2002 (52,620 shares of Common Stock), and paid a fixed
      liquidation preference of $7,500,000 but no dividend. The holders of Series
      B
      Junior Convertible Preferred Stock were entitled to one vote for each share
      of
      Preferred Stock on all matters submitted for a vote of the holders of shares
      of
      Common Stock.





Pursuant
      to the Recapitalization, the holders of Series B Junior Convertible Preferred
      Stock converted their shares into Common Stock of the Company and received
      an
      aggregate amount of $15,194,000 in cash. The difference between the carrying
      value of the Series B Junior Convertible Preferred Stock on the date of the
      Recapitalization and the aggregate consideration paid was recorded as accretion
      on preferred stock in the consolidated statement of operations for the year
      ended March 26, 2005.





*Series
      C Junior Preferred Stock*





The
      Series C Junior Preferred Stock had a $7,000,000 fixed liquidation preference
      that was pari passu with the liquidation preference of the Series B Junior
      Convertible Preferred Stock but did not pay dividends. The holders of Series
      C
      Junior Preferred Stock were entitled to one vote for each share of Preferred
      Stock on all matters submitted for a vote of the holders of shares of Common
      Stock.





Pursuant
      to the Recapitalization, the Series C Junior Preferred Stock was retired and
      the
      holders of Series C Junior Preferred Stock received an aggregate amount of
      $7,000,000. The difference between the carrying value of the Series C Junior
      Preferred Stock on the date of the Recapitalization and the aggregate amount
      paid was recorded as accretion on preferred stock in the consolidated statement
      of operations for the year ended March 26, 2005.





F-16


**8.**
            **Income
                Taxes**





United
      States and foreign income (loss) from continuing operations before taxes is
      as
      follows (in thousands):


**Year
                  Ended****March
                  27, 2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006**U.S.
              
              $
              46,921
              
              $
              (56,183
              )
              $
              (10,159
              )Foreign
              
              
              3,482
              
              
              7,284
              
              
              5,329$
              50,403
              
              $
              (48,899
              )
              $
              (4,830
              )
  The
      following is a reconciliation of the statutory federal income tax rate to the
      Company's effective income tax rate from continuing operations:




**Year
                  Ended****March
                  27, 2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006**Provision/(benefit)
                  at U.S. statutory rates
              
              
              35
              %
              
              (35
              )%
              
              (35
              )%State
                  income taxes, net of federal tax benefit
              
              
              3
              
              
              (2
              )
              
              21Non
                  deductible recapitalization expenses
              
              
              1
              
              
              22
              
              
              11Higher/(lower)
                  effective rate of foreign operations
              
              
              (2
              )
              
              (5
              )
              
              (14
              )Imputed
                  interest on foreign intercompany loan
              
              
              -
              
              
              1
              
              
              16Settlement
                  of IRS examinations
              
              
              (2
              )
              
              -
              
              
              -Non-deductible
                  goodwill
              
              
              -
              
              
              -
              
              
              37Property,
                  plant and equipment basis tax attributes
              
              
              -
              
              
              -
              
              
              46Other
              
              
              (1
              )
              
              1
              
              
              (2
              )Valuation
                  allowances
              
              
              (11
              )
              
              16
              
              
              (102
              )Effective
                  income tax rate
              
              
              23
              %
              
              (2
              )%
              
              (22
              )%
  Significant
      components of the provision (benefit) for income taxes from continuing
      operations are (in thousands):


**Year
                  Ended****March
                  27,2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006**Current:Federal
              
              $
              13,254
              
              $
              (237
              )
              $
              (3,678
              )State
              
              
              1,581
              
              
              264
              
              
              (455
              )Foreign
              
              
              -
              
              
              162
              
              
              1,749Total
                  current
              
              
              14,835
              
              
              189
              
              
              (2,384
              )Deferred:Federal
              
              
              (2,009
              )
              
              (1,172
              )
              
              3,789State
              
              
              (1,479
              )
              
              (4
              )
              
              (364
              )Foreign
              
              
              -
              
              
              -
              
              
              (2,103
              )Total
                  deferred
              
              
              (3,488
              )
              
              (1,176
              )
              
              1,322Total
                  provision for (benefit from) income taxes
              
              $
              11,347
              
              $
              (987
              )
              $
              (1,062
              )
  Deferred
        income taxes are computed using the liability method and reflect the effects
        of
        temporary differences between the carrying amounts of assets and liabilities
        for
        financial reporting purposes and the amounts used for income tax
        purposes.




F-17




Significant
      components of the Company's deferred tax assets and liabilities are (in
      thousands):





**March
                26, 2005**
            
            **March
                25, 2006**Deferred
                tax assets:Compensation
                related accruals
            
            $
            9,581
            
            $
            8,468Net
                operating loss carry forwards
            
            
            6,517
            
            
            2,398Property,
                plant and equipment and intangibles asset
            
            
            2,714
            
            
            1,500Inventory
                obsolescence reserves
            
            
            2,080
            
            
            4,638Inventory
                capitalization
            
            
            -
            
            
            966Restructuring
                charges
            
            
            -
            
            
            657Allowances
                for doubtful accounts and sales returns
            
            
            1,652
            
            
            568Other
            
            
            1,174
            
            
            1,045Total
                deferred tax assets
            
            
            23,718
            
            
            20,240Valuation
                allowance
            
            
            (11,750
            )
            
            (6,902
            )Deferred
                tax assets
            
            
            11,968
            
            
            13,338Deferred
                tax liabilities:Inventory
                capitalization
            
            
            (985
            )
            
            -Property,
                plant and equipment and intangibles asset
            
            
            (510
            )
            
            (4,186
            )Deferred
                tax liabilities
            
            
            (1,495
            )
            
            (4,186
            )Net
                deferred tax assets
            
            $
            10,473
            
            $
            9,152






At
      March
      26, 2005 the Company had elected to forego the carryback of its fiscal 2005
      federal net operating loss resulting in federal and state net operating loss
      carryforwards of $14,135,000 and $16,598,000, respectively. During fiscal 2006,
      the Company decided instead to carryback the allowable federal portion. The
      remaining federal net operating loss carryforward, in the amount of $2,357,000,
      will expire in fiscal 2026 if not previously utilized; state net operating
      loss
      carryforwards of $23,819,000 begin to expire in fiscal 2011.





At
      March
      25, 2006, the Company had federal and state research and development credit
      carryforwards of approximately $162,000 and $86,000, respectively. These
      research and development credit carryforwards begin to expire fiscal 2027 if
      not
      previously utilized. The federal research and development credit of $188,000
      at
      March 26, 2005 was carried back to fiscal 2004 to offset tax in that year,
      for
      which a refund was received during the current year.





Due
      to
      the “change of ownership” provisions of the Tax Reform Act of 1986, utilization
      of the Company’s net operating loss and research and development credit
      carryforwards may be subject to annual limitations in future periods. As a
      result of the annual limitations, a portion of these carryforwards may expire
      before ultimately becoming available to reduce future income tax liabilities.





In
      assessing the realizability of deferred tax assets, management considers whether
      it is “more likely than not” that some portion or all of the deferred tax assets
      will not be realized. The ultimate realization of deferred tax assets is
      dependent upon the generation of future taxable income during the periods in
      which those temporary differences become deductible. Management considers
      taxable income in carryback years, the scheduled reversal of deferred tax
      liabilities, tax planning strategies and projected future taxable income in
      making this assessment.





During
      fiscal 2005, a valuation allowance related to the portion of U.S. deferred
      tax
      assets attributable to compensation expense related to delayed delivery shares
      awarded as part of the Recapitalization was established due to the uncertainty
      of future realization. During fiscal 2006, the valuation allowance was reduced
      by $867,000 representing a “true-up” of delayed delivery shares awarded vs. cash
      amounts paid out and for the effective rate at which the underlying deferred
      tax
      asset was valued. Additionally, during fiscal 2006, the Company reduced its
      valuation allowance against net operating losses in its Canadian subsidiary
      in
      the amount of $3,981,000 due to the utilization of the net operating losses.
      In
      total, the valuation allowance decreased by $4,848,000.





During
      fiscal 2006, the Company finalized a study of the future deductibility of
      certain deferred tax attributes related to basis
      differences in property, plant and equipment. As a result, the Company recorded
      an income tax provision of $2,200,000.





Undistributed
      earnings of the Company’s foreign subsidiaries for which no U.S. federal or
      state liability has been recorded are considered to be indefinitely reinvested.
      Accordingly, no provision for U.S. federal and state income taxes or foreign
      withholding taxes has been provided on such undistributed earnings.
      Determination of the potential amount of unrecognized deferred U.S. income
      tax
      liability and foreign withholding taxes is not practicable because of the
      complexities associated with its hypothetical calculation; however, unrecognized
      foreign tax credits would be available to reduce some portion of the U.S.
      liability.




F-18


As
        of
        March 26, 2005 and March 25, 2006, current deferred tax assets of $10,629,000
        and $11,900,000, respectively, are classified under prepaid expenses and
        other
        current assets and other non-current assets in the accompanying consolidated
        balance sheet. Also, as of March 26, 2005 and March 25, 2006, non-current
        deferred tax liabilities of $156,000 and $2,748,000, respectively, are
        classified under other non-current liabilities in the accompanying consolidated
        balance sheet.


**9.**
            **Employee
                Benefits**





*Stock-Option
      Plan*





During
      fiscal 2004, the Company had one stock-based employee compensation plan. During
      fiscal 2005 and 2006, the Company had three stock-based employee compensation
      plans.





1997
      Option Plan:





The
      Company's Stock Option Plan, as amended in 1997 (the "1997 Option Plan"),
      provided for the issuance of nonqualified stock options to certain key employees
      and directors to purchase up to 252,222 shares of the Company's common stock.
      Options granted were at exercise prices as determined by the Company's Board
      of
      Directors, but not less than $100 per share. Options generally vested on a
      pro
      rata basis at a rate of 25% per year, with 25% immediate vesting on the date
      of
      the grant, and expired no later than ten years from the date of
      grant.





Activity
      under the 1997 Option Plan for the years ended March 27, 2004 and March 26,
      2005
      is set forth below:




**Options
                  Outstanding****Shares
                  Available for Grant**
              
              **Number**
                **of
                   Shares**
              
              **Exercise**
                **Price**
              
              **Weighted**
                **Average**
                **Exercise
                  Price**Balance
                  at March 29, 2003
              
              
              37,278
              
              
              214,944
              
              
              100-180
              
              
              118Options
                  granted
              
              
              (37,000
              )
              
              37,000
              
              
              225
              
              
              225Balance
                  at March 27, 2004
              
              
              278
              
              
              251,944
              
              
              100-225
              
              
              134Options
                  repurchased and retired
              
              
              (278
              )
              
              (251,944
              )
              $
              100-225
              
              $
              134Balance
                  at March 26, 2005
              
              
              -
              
              
              -





In
        connection with the Recapitalization, all options outstanding as of May 27,
        2004
        were repurchased and retired, and the 1997 Option Plan was assumed by Holdings.
        Options with a net value of $13,657,000 were rolled over into new equity
        rights
        in Holdings. The remaining options were purchased for approximately $25,402,000
        representing the difference between the per share Recapitalization purchase
        price and the exercise price of the stock options. The total amount of
        approximately $39,059,000 was incurred in stock-based compensation during
        the
        fiscal year ended March 26, 2005. The Company accounted for the 1997 Option
        Plan
        under the principles of APB 25 and no compensation expense was reported in
        the
        financial statements for the options granted in the year ended March 27,
        2004.
        The weighted-average fair value of options granted during the year ended
        March
        27, 2004 was $167.





2004
      Option Plan:





The
      Board
      of Directors of Holdings approved the LHP Holding Corp. 2004 Stock Option Plan
      (the "2004 Option Plan") on October 1, 2004. Under the 2004 Option Plan, common
      stock reserved up to an aggregate number of shares not to exceed 117,409 may
      be
      granted. Option awards are generally granted with an exercise price equal to
      the
      calculated market value of a share of Holdings common stock on the date of
      the
      grant. The option awards generally vest based on 4 years of continuous
      employment service and have ten year contractual terms to exercise. The option
      awards provide for accelerated vesting if there is a change in control (as
      defined in the 2004 Option Plan).





F-19





Activity
      under the 2004 Option Plan for the year ended March 25, 2006 is set forth
      below:




**Options
                    Outstanding****Shares**
                  **Available**
                  **for
                    Grant**
                
                **Number**
                  **of
                     Shares**
                
                **Exercise**
                  **Price**
                
                **Weighted**
                  **Average**
                  **Exercise
                    Price**Balance
                    at March 27, 2004
                
                
                -
                
                
                -
                
                $
                -
                
                $
                -2004
                    option plan approved
                
                
                117,409
                
                
                -
                
                
                -
                
                
                -Options
                    granted
                
                
                (39,138
                )
                
                39,138
                
                
                2.37
                
                
                2.37Balance
                    at March 26, 2005
                
                
                78,271
                
                
                39,138
                
                
                2.37
                
                
                2.37Options
                    forfeited
                
                
                5,166
                
                
                (5,166
                )
                
                2.37
                
                
                2.37Balance
                    at March 25, 2006
                
                
                83,437
                
                
                33,972
                
                $
                2.37
                
                $
                2.37
  The
      following table summarizes the information on the options granted as of March
      25, 2006:




**Outstanding**
              
              **Excercisable****Exercise
                  price**
              
              **Number
                  ofShares**
              
              **Average
                  Remaining Contractual Life (years)**
              
              **Weighted
                  Average Exercise Price**
              
              **Number
                  ofShares**
              
              **Weighted
                  Average Exercise Price**$
              2.37
              
              
              33,972
              
              
              8.75
              
              $
              2.37
              
              
              9,784
              
              $
              2.37
  The
      Company accounts for the stock option grants under the 2004 Option Plan under
      the principles of SFAS 123R. Amounts of $1,101 and $3,677 were recorded as
      share-based compensation under General and Administrative expense in the
      consolidated statements of operations for the years ended March 26, 2005 and
      March 25, 2006, respectively. The weighted-average fair value of options granted
      during fiscal 2005 was $0.45. As of March 25, 2006, there was $10,509 of total
      unrecorded and unrecognized compensation cost related to nonvested share based
      compensation under the 2004 Option Plan. That cost is expected to be recorded
      and recognized over a weighted average period of 2.75 years.





*Restricted
      Stock Plan:*





The
      Board
      of Directors of Holdings also approved the LHP Holding Corp. 2004 Restricted
      Stock Plan (the "Stock Plan") on October 1, 2004. Under the Stock Plan, common
      stock reserved up to an aggregate number of shares not to exceed 195,676 may
      be
      issued. Each issuance and purchase of shares under the Stock Plan will be
      completed pursuant to a subscription agreement which will include such terms
      and
      conditions not inconsistent with the Stock Plan as the Holdings Board of
      Directors determines. Restricted stock will generally be issued with a purchase
      price equal to the calculated market value of a share of Holdings common stock
      on the date of the subscription agreement. The restricted stock has various
      restrictive Call Rights retained by the Company after issuance. Although the
      timing of the removal of the Call Rights is dependant upon the future employment
      status of the employee, generally, the Call Rights are removed over a pro-rata
      period of six years from the date of the Recapitalization. The Stock Plan,
      however, also provides for accelerated removal of the restrictive Call Rights
      if
      there is a change in control (as defined in the Stock Plan).




F-20


Activity
      under the Stock Plan for the year ended March 25, 2006 is set forth
      below:




**Restricted
                    Shares Outstanding****Shares**
                  **Available**
                  **for
                    Issuance**
                
                **Number**
                  **of
                    Shares**
                
                **Purchase**
                  **Price**
                
                **Weighted**
                  **Average**
                  **Purchase
                    Price**Balance
                    at March 27, 2004
                
                
                -
                
                
                -
                
                $
                -
                
                $
                -2004
                    restricted stock plan approved
                
                
                195,676
                
                
                -Restricted
                    Stock Issued
                
                
                (195,676
                )
                
                195,676
                
                
                2.37
                
                
                2.37Balance
                    at March 26, 2005
                
                
                -
                
                
                195,676
                
                
                2.37
                
                
                2.37Restricted
                    Stock Issued
                
                
                -
                
                
                -
                
                
                -
                
                
                -Balance
                    at March 25, 2006
                
                
                -
                
                
                195,676
                
                $
                2.37
                
                $
                2.37
  The
      following table summarizes the information on the restricted stock granted
      as of
      March 25, 2006:




**Outstanding**
              
              **First
                  Call Rights Released****Purchase
                  price**
              
              **Number
                  of Shares**
              
              **Average
                  RemainingCall Right**
                **Life
                  (years)**
              
              **Weighted
                  Average Purchase**
                **Price**
              
              **Number
                  of**
                **Shares**
              
              **WeightedAverage
                  Purchase**
                **Price**$
              2.37
              
              
              195,676
              
              
              4.25
              
              $
              2.37
              
              
              48,919
              
              $
              2.37
  The
        Company accounts for the restricted stock issued under the Stock Plan under
        the
        principles of SFAS 123R. Amounts of $4,002 and $16,010 was recorded as
        share-based compensation under General and Administrative expense in the
        consolidated statement of operations for the years ended March 26, 2005 and
        March 25, 2006, respectively. The weighted-average fair value of restricted
        stock issued during fiscal 2005 was $0.45. As of March 25, 2006, there was
        $68,042 of total unrecorded and unrecognized compensation cost related to
        share
        based compensation under the Stock Plan. That cost is expected to be recorded
        and recognized over a weighted average period of 4.25 years.





The
      fair
      value of each option award under the 2004 Option Plan and of each restricted
      stock issued under the Stock Plan was estimated on the date of grant or issuance
      using the Black-Scholes Option Pricing Formula. The expected terms of the awards
      will represent the period of time that the awards are expected to be
      outstanding. Because the Company's common stock is neither publicly nor
      internally traded, a calculated value to represent the volatility of the
      Company's stock is derived using the historical volatility of a representative
      set of companies in the same industry sector to establish an appropriate
      industry sector index. The Black-Scholes Option Pricing Formula used by the
      Company is adjusted for the effect of the contractual dividends provided to
      the
      preferred shareholders. In addition, the Company adjusts the fair value of
      each
      option, as derived by the Black-Scholes Option Pricing Formula to consider
      the
      effects of non-transferability and the lack of control inherent in the minority
      interest that the common stock, which is being awarded, represents.





The
      following weighted average assumptions were used in valuing the share based
      awards granted under the 2004 Option Plan and the restricted stock issued under
      the Stock Plan in fiscal 2005. The Company did not grant any option or sell
      any
      shares in fiscal 2006:




**Year
                  Ended****March
                  26, 2005**Risk
                  free interest rate
              
              3.73
              %Expected
                  term in years
              
              
              5.00Expected
                  volatility
              
              
              56.34
              %Expected
                  dividend rate
              
              
              13.00
              %Expected
                  forfeiture rate
              
              
              -
              %


F-21





*Pro
      Forma Disclosures:*





Pro
      forma
      information regarding net income (loss) is required by SFAS 123R to be presented
      for periods prior to adoption of SFAS 123R as if the Company had accounted
      for
      stock-based awards to its employees under the fair value method pursuant to
      SFAS
      123R, rather than the intrinsic value method pursuant to APB 25. This pro forma
      presentation was not material for the fiscal year ended March 27, 2004.





The
      fair
      value of the option awards under the 1997 Option Plan were estimated at the
      date
      of grant based on the minimum-value method, which does not consider stock price
      volatility. The minimum value option valuation model requires the input of
      highly subjective assumptions. In management's opinion, the existing models
      do
      not necessarily provide a reliable single measure of the fair value of the
      1997
      Stock plan awards because the Company's employee stock options have
      characteristics different than those of traded options and because changes
      in
      the subjective input assumptions can materially affect the fair value
      estimate.





The
      following weighed average assumptions were used in valuing the options granted
      under the 1997 Option Plan:





**Year
                Ended****March
                27, 2004**Risk
                free interest rate
            
            
            4.0
            %Expected
                option life in year
            
            
            5.60Expected
                dividend rate
            
            
            -
            %




*Contributory
      Retirement Plans*





The
      Company has contributory retirement plans that cover substantially all of the
      Company’s employees who meet minimum service requirements. The Company’s
      contributions to the plans are discretionary and are determined by the Company’s
      Board of Directors. The Company did not contribute for the plan years ended
      December 31, 2003, 2004 and 2005. Also, as of March 25, 2006, the Company has
      not contributed for the current plan year which began January 1,
      2006.





**10.** **Related
          Party Transactions**





The
      Company, Leiner Health Products, LLC, a wholly owned subsidiary, and Holdings
      entered into a consulting agreement with North Castle Partners, L.L.C., an
      affiliate of the North Castle Investors, and certain administrative entities
      affiliated with the Golden Gate Investors (“GGC Administration”) to provide the
      Company with certain financial, investment banking, management advisory and
      other services performed in connection with the Recapitalization and for future
      financial, investment banking, management advisory and other services performed
      on the Company’s behalf. In exchange for such services in connection with the
      Recapitalization, the Company paid $6,190,000 to each of North Castle Partners,
      L.L.C. and GGC Administration in fiscal 2005. The Company has also paid $175,000
      in certain fees, costs and out-of-pocket expenses incurred in the aggregate
      by
      North Castle Partners, L.L.C. and GGC Administration in connection with the
      Recapitalization. As compensation for their continuing services, the Company
      pays a $1,315,000 management fee in arrears annually plus reasonable
      out-of-pocket expenses to each of North Castle Partners, L.L.C. and GGC
      Administration as long as the Company meets a performance target, which the
      Company did not meet in fiscal 2006. Other operating expenses in the
      accompanying statement of operations for the years ended March 27, 2004, March
      26, 2005 and March 25, 2006 included $1,578,000, $3,258,000 and $1,262,000,
      respectively, of management fees and out-of-pocket expenses. The management
      fees
      in fiscal 2006 represents primarily professional fees incurred in connection
      with the Amendment.





The
      Company has also agreed to reimburse North Castle Partners, L.L.C. and GGC
      Administration for their reasonable travel, other out-of-pocket expenses and
      administrative costs and expenses, including legal and accounting fees, and
      to
      pay additional transactions fees to them in the event Holdings or any of its
      subsidiaries completes any acquisition (whether by merger, consolidation,
      reorganization, recapitalization, sale of assets, sale of stock or otherwise)
      financed by new equity or debt, a transaction involving a change of control,
      as
      defined in the consulting agreement, or sale, transfer or other disposition
      of
      all or substantially all of the assets of Holdings, Leiner or Leiner Health
      Products, LLC.





In
      addition, as part of the Recapitalization, the Golden Gate Investors, the North
      Castle Investors, North Castle Partners, L.L.C., the Company, Mergeco and an
      escrow agent entered into an escrow agreement. Pursuant to the recapitalization
      agreement and plan of merger, Mergeco deposited $6,500,000 in cash in an escrow
      account to be held and disposed of as provided in the escrow agreement. The
      escrow funds will be used to pay specified product liability claims and tax
      claims as provided for in the escrow agreement. Any amounts remaining in the
      escrow account will be paid to the selling Leiner equity holders on a pro rata
      basis on the later of December 31, 2006 and other dates specified in the escrow
      agreement with respect to such claims.


F-22


**11.**  **Commitments**





The
      Company leases certain real estate for its manufacturing facilities, warehouses,
      corporate and sales offices, as well as certain equipment under operating leases
      (non-cancelable) that expire at various dates through March 2014 and contain
      renewal options. Total rents charged to operations for the years ended March
      27,
      2004, March 26, 2005 and March 25, 2006 were $13,876,000, $13,955,000 and
      $9,211,000, respectively.





Minimum
      future obligations on non-cancelable operating leases in effect at March 25,
      2006 are (in thousands):





**Fiscal
                year**2007
            
            $
            7,9902008
            
            
            7,6532009
            
            
            7,3452010
            
            
            7,2372011
            
            
            9,714Thereafter
            
            
            13,785Total
                minimum lease payments
            
            $
            53,724




The
      Company has certain operating leases that have escalating payment clauses.
      The
      Company recognizes expenses on a straight-line basis over the term of the
      respective leases. At March 26, 2005 and March 25, 2006, the Company had
      recorded deferred rent liabilities of $2,512,000 and $2,796,000,
      respectively.





**12.** **Contingencies**





The
      Company has been named a defendant in seven pending cases alleging adverse
      reactions associated with the ingestion of Phenylpropanolamine (PPA) containing
      products that the Company allegedly manufactured and sold. Currently, none
      of
      the cases has proceeded to trial, although the Company intends to vigorously
      defend these allegations if trials ensue. These
      actions have been tendered to the Company’s insurance carrier. The Company has
      recorded in its consolidated financial statements a liability for the entire
      estimated potential liability in the amount of $2,000,000, based on the opinion
      of outside counsel as to the probable settlement value of the cases based on
      the
      Company’s consultations with its primary insurance carrier and
      broker.





The
      Company is subject to other legal proceedings and claims that arise in the
      normal course of business. While the outcome of any of these proceedings and
      claims cannot be predicted with certainty, management believes that it has
      provided adequate reserves for these claims and does not believe the outcome
      of
      any of these matters will have a material adverse effect on the Company’s
      consolidated financial position, results of operations or cash
      flows.





**13.** **Concentration
          of Credit Risk and Significant Customers, Suppliers and
          Products**





Financial
      instruments, which potentially subject the Company to concentrations of credit
      risk, consist principally of trade receivables. The Company sells its products
      to a geographically diverse customer base in the food, drug, mass merchant
      and
      warehouse club (“FDMC”) retail market. The Company performs ongoing credit
      evaluations of its customers and maintains reserves for potential losses.





Two
      customers accounted for the following percentage of gross sales in each
      respective period:





**Year
                Ended** ******March
                27, 2004**
            
            **March
                26, 2005**
            
            **March
                25, 2006**Customer
                A
            
            
            42
            %
            
            43
            %
            
            44
            %Customer
                B
            
            
            18
            %
            
            20
            %
            
            24
            %




F-23


The
      Company’s largest customer has two retail divisions that, if viewed as separate
      entities, would constitute the following percentage of gross sales in each
      respective period:





**Year
                Ended** ******March
                  27, 2004**
            
            ****March
                26, 2005****
            
            ****March
                25, 2006****Division
                1
            
            
            24
            %
            
            25
            %
            
            24
            %Division
                2
            
            
            18
            %
            
            18
            %
            
            20
            %





The
      Company's top ten customers in the aggregate accounted for the following
      percentages of gross sales in each respective period:





**Year
                Ended** ******March
                27, 2004**
            
            **March
                26, 2005**
            
            **March
                25, 2006**Top
                ten customers
            
            
            87
            %
            
            85
            %
            
            87
            %





At
      March
      26, 2005 and March 25, 2006, the Company had receivables from two U.S. customers
      of approximately 41% and 28% and 43% and 32%, respectively, of U.S. gross
      receivables.





For
      the
      years ended March 27, 2004 and March 26, 2005, one supplier, excluding purchases
      by Vita, provided approximately 12% and 11%, respectively, of raw materials
      purchased. No other supplier accounted for more than 10% of the Company's
      purchases. For the year ended March 25, 2006, no supplier, excluding purchases
      by Vita, provided more than 10% of the Company’s raw material purchases.





Sales
      of
      vitamins C and E, in the aggregate, accounted for approximately 14% and 12%
      of
      the Company's gross sales in fiscal 2004 and 2005, respectively. For the fiscal
      year ended March 25, 2006, the sales of vitamins C and E, in the aggregate,
      did
      not account for more than 10% of the Company’s gross sales. The sales of vitamin
      E declined substantially in the current fiscal year as a result of negative
      media coverage in the third quarter of fiscal 2005.





If
      one or
      more of the Company's major customers substantially reduced their volume of
      purchases from the Company, the Company's results of operations could be
      materially adversely affected.





**14.** **Business
          Segment Information**





The
      Company operates in two business segments. One consists of the Company's U.S.
      Operations ("Leiner U.S.") and the other is the Company's Canadian operation
      ("Vita Health"). The Company's operating segments manufacture a range of VMS
      and
      OTC pharmaceuticals and distribute their products primarily through FDMC
      retailers. The accounting policies between the reportable segments are the
      same
      as those described in the summary of significant accounting policies. The
      Company evaluates segment performance based on operating profit, before the
      effect of non-recurring charges and gains, and inter-segment
      profit.


F-24





Selected
      financial information for the Company's reportable segments for the years ended
      March 27, 2004, March 26, 2005 and March 25, 2006 is as follows (in
      thousands):





**Leiner**
            
            **Vita**
            
            **Consolidated****U.S.**
            
            **Health**
            
            **Totals****Year
                ended March 27, 2004**Net
                sales to external customers
            
            $
            601,961
            
            $
            59,084
            
            $
            661,045Intersegment
                sales
            
            
            3,644
            
            
            30
            
            
            -Depreciation
                and amortization, excluding deferred financing charges
            
            
            12,272
            
            
            2,396
            
            
            14,668Segment
                operating income
            
            
            64,287
            
            
            5,070
            
            
            69,357Interest
                expense, net (1)
            
            
            17,366
            
            
            1,588
            
            
            18,954Income
                tax expense
            
            
            11,347
            
            
            -
            
            
            11,347Segment
                assets
            
            
            341,866
            
            
            45,933
            
            
            387,799Additions
                to property, plant and equipment
            
            
            11,046
            
            
            1,438
            
            
            12,484**Year
                ended March 26, 2005**Net
                sales to external customers
            
            $
            610,915
            
            $
            73,986
            
            $
            684,901Intersegment
                sales
            
            
            4,566
            
            
            21
            
            
            -Depreciation
                and amortization, excluding deferred financing charges
            
            
            11,107
            
            
            2,615
            
            
            13,722Segment
                operating income (loss)
            
            
            (25,485
            )
            
            8,932
            
            
            (16,553
            )Interest
                expense, net (1)
            
            
            30,698
            
            
            1,648
            
            
            32,346Income
                tax expense (benefit)
            
            
            (1,149
            )
            
            162
            
            
            (987
            )Segment
                assets
            
            
            367,036
            
            
            49,762
            
            
            416,798Additions
                to property, plant and equipment
            
            
            16,646
            
            
            1,630
            
            
            18,276**Year
                ended March 25, 2006**Net
                sales to external customers
            
            $
            614,662
            
            $
            54,899
            
            $
            669,561Intersegment
                sales
            
            
            2,244
            
            
            98
            
            
            -Depreciation
                and amortization, excluding deferred financing charges
            
            
            14,362
            
            
            2,272
            
            
            16,634Segment
                operating income
            
            
            26,820
            
            
            5,219
            
            
            32,039Interest
                expense (income), net (1)
            
            
            36,979
            
            
            (110
            )
            
            36,869Income
                tax expense (benefit)
            
            
            (708
            )
            
            (354
            )
            
            (1,062
            )Segment
                assets
            
            
            378,153
            
            
            37,945
            
            
            416,098Additions
                to property, plant and equipment
            
            
            19,460
            
            
            1,143
            
            
            20,603





(1)
            Interest
                expense, net includes the amortization of deferred financing
                charges.





The
      following table sets forth the net sales of the Company’s VMS, OTC
      pharmaceutical and other product lines for the periods indicated (dollar amounts
      in thousands):





****
            ****
            ****
            **Year
                Ended**
            ****
            ****
            ****
            ****
            ********
            ****
            **March
                27, 2004**
            ****
            **%**
            ****
            **March
                26, 2005**
            ****
            **%**
            ****
            **March
                25, 2006**
            ****
            **%**VMS
                products
            
            $
            413,679
            
            
            63
            %
            $
            419,491
            
            
            61
            %
            $
            421,959
            
            
            63
            %OTC
                products
            
            
            191,196
            
            
            29
            %
            
            213,402
            
            
            31
            %
            
            199,004
            
            
            30
            %Contract
                manufacturing services/Other
            
            
            56,170
            
            
            8
            %
            
            52,008
            
            
            8
            %
            
            48,598
            
            
            7
            %Total
            
            $
            661,045
            
            
            100
            %
            $
            684,901
            
            
            100
            %
            $
            669,561
            
            
            100
            %




F-25





**15.** **Financial
          information for subsidiary guarantor and subsidiary
          non-guarantor**





In
      connection with the issuance of the Notes, the Company’s U.S. based
      subsidiaries, Leiner Health Services, Corp. and Leiner Health Products, LLC,
      guaranteed the payment of principal, premium and interest on the Notes. Since
      the Company has no independent assets or operations of its own and owns 100%
      of
      the guarantor subsidiaries, the disclosure below is presented consolidating
      the
      financial information of the Company and its guarantor subsidiaries. Presented
      below is consolidating financial information for the Company and its subsidiary
      guarantors and subsidiary non-guarantors for the periods indicated.





F-26




**Leiner
      Health Products Inc.**


**Consolidating
      Balance Sheets**


**(in
      thousands)**





**March
                26, 2005****Company
                & Guarantor Subsidiaries**
            
            **Non-Guarantor
                Subsidiaries**
            
            **Eliminations
                and Consolidating Entries**
            
            **Consolidated****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            11,670
            
            $
            5,281
            
            $
            -
            
            $
            16,951Accounts
                receivable, net of allowances
            
            
            71,518
            
            
            8,732
            
            
            -
            
            
            80,250Inventories
            
            
            142,493
            
            
            22,417
            
            
            -
            
            
            164,910Income
                tax receivable
            
            
            2,310
            
            
            -
            
            
            -
            
            
            2,310Prepaid
                expenses and other current assets
            
            
            17,267
            
            
            225
            
            
            -
            
            
            17,492Total
                current assets
            
            
            245,258
            
            
            36,655
            
            
            -
            
            
            281,913Intercompany
                receivable
            
            
            42,240
            
            
            -
            
            
            (42,240
            )
            
            -Property,
                plant and equipment, net
            
            
            55,540
            
            
            10,014
            
            
            -
            
            
            65,554Goodwill
            
            
            49,224
            
            
            3,093
            
            
            -
            
            
            52,317Other
                noncurrent assets
            
            
            17,014
            
            
            
            
            
            -
            
            
            17,014Total
                assets
            
            $
            409,276
            
            $
            49,762
            
            $
            (42,240
            )
            $
            416,798**LIABILITIES
                AND SHAREHOLDER'S DEFICIT**Current
                liabilities:Accounts
                payable
            
            $
            92,974
            
            $
            8,665
            
            $
            -
            
            $
            101,639Accrued
                compensation and benefits
            
            
            8,024
            
            
            1,610
            
            
            -
            
            
            9,634Customer
                allowances payable
            
            
            8,513
            
            
            1,063
            
            
            -
            
            
            9,576Accrued
                interest
            
            
            9,024
            
            
            69
            
            
            -
            
            
            9,093Other
                accrued expenses
            
            
            9,884
            
            
            908
            
            
            -
            
            
            10,792Current
                portion of long-term debt
            
            
            4,453
            
            
            1,083
            
            
            -
            
            
            5,536Total
                current liabilities
            
            
            132,872
            
            
            13,398
            
            
            -
            
            
            146,270Intercompany
                payable
            
            
            -
            
            
            42,240
            
            
            (42,240
            )
            
            -Long-term
                debt
            
            
            390,970
            
            
            20
            
            
            -
            
            
            390,990Other
                noncurrent liabilities
            
            
            2,512
            
            
            -
            
            
            -
            
            
            2,512Total
                liabilities
            
            
            526,354
            
            
            55,658
            
            
            (42,240
            )
            
            539,772Shareholder's
                deficit:Capital
                in excess of par value
            
            
            469
            
            
            -
            
            
            -
            
            
            469Accumulated
                deficit
            
            
            (117,547
            )
            
            (8,810
            )
            
            -
            
            
            (126,357
            )Accumulated
                other comprehensive income
            
            
            -
            
            
            2,914
            
            
            -
            
            
            2,914Total
                shareholder's deficit
            
            
            (117,078
            )
            
            (5,896
            )
            
            -
            
            
            (122,974
            )Total
                liabilities and shareholder's deficit
            
            $
            409,276
            
            $
            49,762
            
            $
            (42,240
            )
            $
            416,798




F-27


**Leiner
      Health Products Inc.**


**Consolidating
      Balance Sheets**


**(in
      thousands)**





**March
                25, 2006****Company
                & Guarantor Subsidiaries**
            
            **Non-Guarantor
                Subsidiaries**
            
            **Eliminations
                and Consolidating Entries**
            
            **Consolidated****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            3,766
            
            $
            3,965
            
            $
            -
            
            $
            7,731Accounts
                receivable, net of allowances
            
            
            68,314
            
            
            4,897
            
            
            -
            
            
            73,211Inventories
            
            
            150,922
            
            
            14,792
            
            
            -
            
            
            165,714Income
                tax receivable
            
            
            56
            
            
            -
            
            
            -
            
            
            56Prepaid
                expenses and other current assets
            
            
            13,659
            
            
            2,825
            
            
            -
            
            
            16,484Total
                current assets
            
            
            236,717
            
            
            26,479
            
            
            -
            
            
            263,196Intercompany
                receivable
            
            
            32,875
            
            
            -
            
            
            (32,875
            )
            
            -Property,
                plant and equipment, net
            
            
            64,378
            
            
            8,240
            
            
            -
            
            
            72,618Goodwill
            
            
            55,019
            
            
            3,226
            
            
            -
            
            
            58,245Other
                noncurrent assets
            
            
            22,039
            
            
            
            
            
            -
            
            
            22,039Total
                assets
            
            $
            411,028
            
            $
            37,945
            
            $
            (32,875
            )
            $
            416,098**LIABILITIES
                AND SHAREHOLDER'S DEFICIT**Current
                liabilities:Accounts
                payable
            
            $
            75,122
            
            $
            2,526
            
            $
            -
            
            $
            77,648Accrued
                compensation and benefits
            
            
            8,749
            
            
            1,245
            
            
            -
            
            
            9,994Customer
                allowances payable
            
            
            9,831
            
            
            691
            
            
            -
            
            
            10,522Accrued
                interest
            
            
            10,370
            
            
            66
            
            
            -
            
            
            10,436Other
                accrued expenses
            
            
            12,323
            
            
            2,095
            
            
            -
            
            
            14,418Current
                portion of long-term debt
            
            
            5,487
            
            
            11
            
            
            -
            
            
            5,498Total
                current liabilities
            
            
            121,882
            
            
            6,634
            
            
            -
            
            
            128,516Intercompany
                payable
            
            
            -
            
            
            32,875
            
            
            (32,875
            )
            
            -Long-term
                debt
            
            
            397,110
            
            
            9
            
            
            -
            
            
            397,119Other
                noncurrent liabilities
            
            
            5,545
            
            
            -
            
            
            -
            
            
            5,545Total
                liabilities
            
            
            524,537
            
            
            39,518
            
            
            (32,875
            )
            
            531,180Shareholder's
                deficit:Capital
                in excess of par value
            
            
            13,489
            
            
            -
            
            
            -
            
            
            13,489Accumulated
                deficit
            
            
            (126,998
            )
            
            (3,127
            )
            
            -
            
            
            (130,125
            )Accumulated
                other comprehensive income
            
            
            -
            
            
            1,554
            
            
            -
            
            
            1,554Total
                shareholder's deficit
            
            
            (113,509
            )
            
            (1,573
            )
            
            -
            
            
            (115,082
            )Total
                liabilities and shareholder's deficit
            
            $
            411,028
            
            $
            37,945
            
            $
            (32,875
            )
            $
            416,098




F-28




**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Operations**


**(in
      thousands)**





**Year
                Ended March 27, 2004****Company
                & Guarantor Subsidiaries**
            
            **Non-Guarantor
                Subsidiaries**
            
            **Eliminations
                and Consolidating Entries**
            
            **Consolidated**Net
                sales
            
            $
            605,605
            
            $
            59,114
            
            $
            (3,674
            )
            $
            661,045Cost
                of sales
            
            
            443,901
            
            
            46,327
            
            
            (3,674
            )
            
            486,554Gross
                profit
            
            
            161,704
            
            
            12,787
            
            
            -
            
            
            174,491Marketing,
                selling and distribution expenses
            
            
            52,246
            
            
            4,202
            
            
            -
            
            
            56,448General
                and administrative expenses
            
            
            37,421
            
            
            3,620
            
            
            -
            
            
            41,041Research
                and development expenses
            
            
            5,670
            
            
            -
            
            
            -
            
            
            5,670Amortization
                of other intangibles
            
            
            414
            
            
            33
            
            
            -
            
            
            447Other
                operating expense (income)
            
            
            1,666
            
            
            (138
            )
            
            -
            
            
            1,528Operating
                income
            
            
            64,287
            
            
            5,070
            
            
            -
            
            
            69,357Interest
                expense, net
            
            
            17,366
            
            
            1,588
            
            
            -
            
            
            18,954Income
                before income taxes
            
            
            46,921
            
            
            3,482
            
            
            -
            
            
            50,403Provision
                for income taxes
            
            
            11,347
            
            
            -
            
            
            -
            
            
            11,347Net
                income
            
            
            35,574
            
            
            3,482
            
            
            -
            
            
            39,056Accretion
                on preferred stock
            
            
            (12,105
            )
            
            -
            
            
            -
            
            
            (12,105
            )Net
                income attributable to common shareholders
            
            $
            23,469
            
            $
            3,482
            
            $
            -
            
            $
            26,951




F-29





**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Operations**


**(in
      thousands)**





**Year
                Ended March 26, 2005****Company
                & Guarantor Subsidiaries**
            
            **Non-Guarantor
                Subsidiaries**
            
            **Eliminations
                and Consolidating Entries**
            
            **Consolidated**Net
                sales
            
            $
            615,481
            
            $
            74,007
            
            $
            (4,587
            )
            $
            684,901Cost
                of sales
            
            
            461,348
            
            
            56,110
            
            
            (4,587
            )
            
            512,871Gross
                profit
            
            
            154,133
            
            
            17,897
            
            
            -
            
            
            172,030Marketing,
                selling and distribution expenses
            
            
            53,711
            
            
            4,821
            
            
            -
            
            
            58,532General
                and administrative expenses
            
            
            30,031
            
            
            4,103
            
            
            -
            
            
            34,134Research
                and development expenses
            
            
            5,299
            
            
            -
            
            
            -
            
            
            5,299Amortization
                of other intangibles
            
            
            250
            
            
            -
            
            
            -
            
            
            250Recapitalization
                expenses
            
            
            87,950
            
            
            32
            
            
            -
            
            
            87,982Other
                operating expense
            
            
            2,377
            
            
            9
            
            
            -
            
            
            2,386Operating
                income (loss)
            
            
            (25,485
            )
            
            8,932
            
            
            -
            
            
            (16,553
            )Interest
                expense, net
            
            
            30,698
            
            
            1,648
            
            
            -
            
            
            32,346Income
                (loss) before income taxes
            
            
            (56,183
            )
            
            7,284
            
            
            -
            
            
            (48,899
            )Provision
                for (benefit from) income taxes
            
            
            (1,149
            )
            
            162
            
            
            -
            
            
            (987
            )Net
                income (loss)
            
            
            (55,034
            )
            
            7,122
            
            
            -
            
            
            (47,912
            )Accretion
                on preferred stock
            
            
            (39,212
            )
            
            -
            
            
            -
            
            
            (39,212
            )Net
                income (loss) attributable to common shareholders
            
            $
            (94,246
            )
            $
            7,122
            
            $
            -
            
            $
            (87,124
            )




F-30





**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Operations**


**(in
      thousands)**





**Year
                Ended March 25, 2006****Company
                & Guarantor Subsidiaries**
            
            **Non-Guarantor
                Subsidiaries**
            
            **Eliminations
                and Consolidating Entries**
            
            **Consolidated**Net
                sales
            
            $
            616,906
            
            $
            54,997
            
            $
            (2,342
            )
            $
            669,561Cost
                of sales
            
            
            493,534
            
            
            42,023
            
            
            (2,342
            )
            
            533,215Gross
                profit
            
            
            123,372
            
            
            12,974
            
            
            -
            
            
            136,346Marketing,
                selling and distribution expenses
            
            
            54,194
            
            
            4,250
            
            
            -
            
            
            58,444General
                and administrative expenses
            
            
            32,417
            
            
            3,308
            
            
            -
            
            
            35,725Research
                and development expenses
            
            
            4,275
            
            
            276
            
            
            -
            
            
            4,551Amortization
                of other intangibles
            
            
            638
            
            
            -
            
            
            -
            
            
            638Restructuring
                charges
            
            
            3,836
            
            
            -
            
            
            -
            
            
            3,836Other
                operating (income) expense
            
            
            1,192
            
            
            (79
            )
            
            -
            
            
            1,113Operating
                income
            
            
            26,820
            
            
            5,219
            
            
            -
            
            
            32,039Interest
                (income) expense, net
            
            
            36,979
            
            
            (110
            )
            
            -
            
            
            36,869Income
                (loss) before income taxes
            
            
            (10,159
            )
            
            5,329
            
            
            -
            
            
            (4,830
            )Benefit
                from income taxes
            
            
            (708
            )
            
            (354
            )
            
            -
            
            
            (1,062
            )Net
                income (loss)
            
            $
            (9,451
            )
            $
            5,683
            
            $
            -
            
            $
            (3,768
            )




F-31




**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Cash Flows**


**(in
      thousands)**




**Year
                  Ended March 27, 2004****Company
                  & Guarantor Subsidiaries**
              
              **Non-Guarantor
                  Subsidiaries**
              
              **Consolidated****Operating
                  activities**Net
                  income
              
              $
              35,574
              
              $
              3,482
              
              $
              39,056Adjustments
                  to reconcile net income to net cash provided by(used
                  in) operating activities:Depreciation
              
              
              10,329
              
              
              2,361
              
              
              12,690Amortization
                  of other intangibles and other contracts
              
              
              1,943
              
              
              35
              
              
              1,978Amortization
                  of deferred financing charges
              
              
              7,666
              
              
              371
              
              
              8,037Provision
                  for doubtful accounts and allowances
              
              
              4,087
              
              
              -
              
              
              4,087Provision
                  for excess and obsolete inventory
              
              
              5,746
              
              
              -
              
              
              5,746Deferred
                  income taxes
              
              
              (3,488
              )
              
              -
              
              
              (3,488
              )(Gain)
                  loss on disposal of assets
              
              
              74
              
              
              (34
              )
              
              40Translation
                  adjustment
              
              
              -
              
              
              (880
              )
              
              (880
              )Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (24,598
              )
              
              (141
              )
              
              (24,739
              )Inventories
              
              
              (11,237
              )
              
              (4,676
              )
              
              (15,913
              )Income
                  tax receivable
              
              
              198
              
              
              473
              
              
              671Accounts
                  payable
              
              
              15,282
              
              
              1,478
              
              
              16,760Accrued
                  compensation and benefits
              
              
              (3,012
              )
              
              147
              
              
              (2,865
              )Customer
                  allowances payable
              
              
              (1,913
              )
              
              (122
              )
              
              (2,035
              )Accrued
                  interest
              
              
              781
              
              
              -
              
              
              781Other
                  accrued expenses
              
              
              1,424
              
              
              (895
              )
              
              529Other
              
              
              (2,682
              )
              
              (7
              )
              
              (2,689
              )Net
                  cash provided by operating activities
              
              
              36,174
              
              
              1,592
              
              
              37,766**Investing
                  activities**Additions
                  to property, plant and equipment
              
              
              (8,975
              )
              
              (1,438
              )
              
              (10,413
              )Increase
                  in other noncurrent assets
              
              
              (2,516
              )
              
              (246
              )
              
              (2,762
              )Net
                  cash used in investing activities
              
              
              (11,491
              )
              
              (1,684
              )
              
              (13,175
              )**Financing
                  activities**Payments
                  under bank term credit facility
              
              
              (5,875
              )
              
              (729
              )
              
              (6,604
              )Net
                  payments on other long-term debt
              
              
              (1,343
              )
              
              (113
              )
              
              (1,456
              )Increase
                  in deferred financing charges
              
              
              (1,573
              )
              
              (201
              )
              
              (1,774
              )Net
                  cash used in financing activities
              
              
              (8,791
              )
              
              (1,043
              )
              
              (9,834
              )Intercompany
              
              
              (2,046
              )
              
              2,046
              
              
              -Effect
                  of exchange rate changes
              
              
              -
              
              
              1,520
              
              
              1,520Net
                  increase in cash and cash equivalents
              
              
              13,846
              
              
              2,431
              
              
              16,277Cash
                  and cash equivalents at beginning of period
              
              
              11,755
              
              
              5,792
              
              
              17,547Cash
                  and cash equivalents at end of period
              
              $
              25,601
              
              $
              8,223
              
              $
              33,824




F-32


**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Cash Flows**


**(in
      thousands)**




**Year
                  Ended March 26, 2005****Company
                  & Guarantor Subsidiaries**
              
              **Non-Guarantor
                  Subsidiaries**
              
              **Consolidated****Operating
                  activities**Net
                  income (loss)
              
              $
              (55,034
              )
              $
              7,122
              
              $
              (47,912
              )Adjustments
                  to reconcile net income (loss) to net cash provided by(used
                  in) operating activities:Depreciation
              
              
              9,333
              
              
              2,615
              
              
              11,948Amortization
                  of other intangibles and other contracts
              
              
              1,774
              
              
              -
              
              
              1,774Amortization
                  of deferred financing charges
              
              
              5,009
              
              
              436
              
              
              5,445Provision
                  for doubtful accounts and allowances
              
              
              4,791
              
              
              -
              
              
              4,791Provision
                  for excess and obsolete inventory
              
              
              8,028
              
              
              -
              
              
              8,028Deferred
                  income taxes
              
              
              (1,176
              )
              
              -
              
              
              (1,176
              )Gain
                  on disposal of assets
              
              
              (52
              )
              
              -
              
              
              (52
              )Stock
                  option compensation expense
              
              
              5
              
              
              -
              
              
              5Translation
                  adjustment
              
              
              -
              
              
              (2,805
              )
              
              (2,805
              )Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (4,431
              )
              
              (2,033
              )
              
              (6,464
              )Inventories
              
              
              (24,417
              )
              
              (2,425
              )
              
              (26,842
              )Income
                  tax receivable
              
              
              (1,827
              )
              
              98
              
              
              (1,729
              )Accounts
                  payable
              
              
              9,287
              
              
              553
              
              
              9,840Accrued
                  compensation and benefits
              
              
              (5,308
              )
              
              316
              
              
              (4,992
              )Customer
                  allowances payable
              
              
              614
              
              
              (15
              )
              
              599Accrued
                  interest
              
              
              8,184
              
              
              (213
              )
              
              7,971Other
                  accrued expenses
              
              
              2,623
              
              
              239
              
              
              2,862Other
              
              
              (817
              )
              
              (79
              )
              
              (896
              )Net
                  cash provided by (used in) operating activities
              
              
              (43,414
              )
              
              3,809
              
              
              (39,605
              )**Investing
                  activities**Additions
                  to property, plant and equipment
              
              
              (16,361
              )
              
              (1,630
              )
              
              (17,991
              )(Increase)
                  decrease in other noncurrent assets
              
              
              (2,952
              )
              
              8
              
              
              (2,944
              )Net
                  cash used in investing activities
              
              
              (19,313
              )
              
              (1,622
              )
              
              (20,935
              )**Financing
                  activities**Borrowings
                  under bank term credit facility
              
              
              240,000
              
              
              -
              
              
              240,000Payments
                  under bank term credit facility
              
              
              (1,200
              )
              
              -
              
              
              (1,200
              )Payments
                  under old credit facility
              
              
              (140,508
              )
              
              (19,280
              )
              
              (159,788
              )Issuance
                  of senior subordinated debt
              
              
              150,000
              
              
              -
              
              
              150,000Increase
                  in deferred financing charges
              
              
              (15,343
              )
              
              (410
              )
              
              (15,753
              )Capital
                  contribution from parent
              
              
              251,500
              
              
              -
              
              
              251,500Repurchase
                  and retirement of preferred stock
              
              
              (92,194
              )
              
              -
              
              
              (92,194
              )Repurchase
                  and retirement of common stock and common equity rights
              
              
              (328,380
              )
              
              -
              
              
              (328,380
              )Net
                  payments on other long-term debt
              
              
              (2,194
              )
              
              (1,124
              )
              
              (3,318
              )Net
                  cash provided by (used in) financing activities
              
              
              61,681
              
              
              (20,814
              )
              
              40,867Intercompany
              
              
              (12,885
              )
              
              12,885
              
              
              -Effect
                  of exchange rate changes
              
              
              -
              
              
              2,800
              
              
              2,800Net
                  decrease in cash and cash equivalents
              
              
              (13,931
              )
              
              (2,942
              )
              
              (16,873
              )Cash
                  and cash equivalents at beginning of period
              
              
              25,601
              
              
              8,223
              
              
              33,824Cash
                  and cash equivalents at end of period
              
              $
              11,670
              
              $
              5,281
              
              $
              16,951


F-33


**Leiner
      Health Products Inc.**


**Consolidating
      Statement of Cash Flows**


**(in
      thousands)**




**Year
                  Ended March 25, 2006****Company
                  & Guarantor Subsidiaries**
              
              **Non-Guarantor
                  Subsidiaries**
              
              **Consolidated****Operating
                  activities**Net
                  income (loss)
              
              $
              (9,451
              )
              $
              5,683
              
              $
              (3,768
              )Adjustments
                  to reconcile net income (loss) to net cash provided byoperating
                  activities:Depreciation
              
              
              12,963
              
              
              2,272
              
              
              15,235Amortization
                  of other intangibles and other contracts
              
              
              1,399
              
              
              -
              
              
              1,399Amortization
                  of deferred financing charges.
              
              
              1,866
              
              
              -
              
              
              1,866Provision
                  for doubtful accounts and allowances
              
              
              5,153
              
              
              -
              
              
              5,153Provision
                  for excess and obsolete inventory
              
              
              10,712
              
              
              1,718
              
              
              12,430Deferred
                  income taxes
              
              
              3,424
              
              
              (2,055
              )
              
              1,369(Gain)
                  loss on disposal of assets
              
              
              30
              
              
              (24
              )
              
              6Stock
                  option compensation expense
              
              
              20
              
              
              -
              
              
              20Translation
                  adjustment
              
              
              -
              
              
              1,360
              
              
              1,360Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              5,993
              
              
              4,115
              
              
              10,108Inventories
              
              
              (13,224
              )
              
              6,676
              
              
              (6,548
              )Income
                  tax receivable
              
              
              2,254
              
              
              775
              
              
              3,029Accounts
                  payable
              
              
              (22,762
              )
              
              (6,363
              )
              
              (29,125
              )Accrued
                  compensation and benefits
              
              
              727
              
              
              (425
              )
              
              302Customer
                  allowances payable
              
              
              1,319
              
              
              (409
              )
              
              910Accrued
                  interest
              
              
              1,346
              
              
              (6
              )
              
              1,340Other
                  accrued expenses
              
              
              2,439
              
              
              345
              
              
              2,784Other
              
              
              1,909
              
              
              (478
              )
              
              1,431Net
                  cash provided by operating activities
              
              
              6,117
              
              
              13,184
              
              
              19,301**Investing
                  activities**Additions
                  to property, plant and equipment
              
              
              (12,101
              )
              
              (1,143
              )
              
              (13,244
              )Acquisition
                  of business
              
              
              (22,922
              )
              
              -
              
              
              (22,922
              )Proceeds
                  from sale of fixed assets
              
              
              625
              
              
              -
              
              
              625(Increase)
                  decrease in other noncurrent assets
              
              
              (1,097
              )
              
              1,037
              
              
              (60
              )Net
                  cash used in investing activities
              
              
              (35,495
              )
              
              (106
              )
              
              (35,601
              )**Financing
                  activities**Net
                  borrowings under bank revolving credit facility
              
              
              5,000
              
              
              -
              
              
              5,000Payments
                  under bank term credit facility
              
              
              (2,400
              )
              
              -
              
              
              (2,400
              )Increase
                  in deferred financing charges
              
              
              (760
              )
              
              -
              
              
              (760
              )Capital
                  contribution from parent
              
              
              13,000
              
              
              -
              
              
              13,000Net
                  payments on other long-term debt
              
              
              (2,786
              )
              
              (1,074
              )
              
              (3,860
              )Net
                  cash provided by (used in) financing activities
              
              
              12,054
              
              
              (1,074
              )
              
              10,980Intercompany
              
              
              9,420
              
              
              (9,420
              )
              
              -Effect
                  of exchange rate changes
              
              
              -
              
              
              (3,900
              )
              
              (3,900
              )Net
                  decrease in cash and cash equivalents
              
              
              (7,904
              )
              
              (1,316
              )
              
              (9,220
              )Cash
                  and cash equivalents at beginning of period
              
              
              11,670
              
              
              5,281
              
              
              16,951Cash
                  and cash equivalents at end of period
              
              $
              3,766
              
              $
              3,965
              
              $
              7,731


F-34


**16.**
            **Composition
                of Certain Financial Statement
                Items**


**March
                  26, 2005**
              
              **March
                  25, 2006****(in 
                  thousands)**Inventories:Raw
                  materials, bulk vitamins and packaging materials
              
              $
              52,784
              
              $
              36,026Work-in-process
              
              
              49,100
              
              
              57,972Finished
                  products
              
              
              63,026
              
              
              71,716$
              164,910
              
              $
              165,714
 **Depreciable
                  Lives**Property,
                  plant and equipment:
              
              
              **(years)**Land
              
              
              -
              
              $
              718
              
              $
              727Buildings
                  and improvements
              
              
              31
                  - 40
              
              
              12,025
              
              
              12,465Leasehold
                  improvements
              
              
              7
                  - 40
              
              
              27,415
              
              
              29,777Machinery
                  and equipment
              
              
              3
                  - 20
              
              
              121,430
              
              
              134,365Furniture
                  and fixtures
              
              
              3
                  - 10
              
              
              3,241
              
              
              3,200164,829
              
              
              180,534Less
                  accumulated depreciation and amortization
              
              
              
              
              
              (99,275
              )
              
              (107,916
              )$
              65,554
              
              $
              72,618
 **Year
                  Ended****March
                  27,**
                **2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006****(in
                  thousands)**Other
                  operating expense(Gain)
                  loss on disposal of assets
              
              $
              40
              
              $
              (52
              )
              $
              6Management
                  fees (Note 10)
              
              
              1,578
              
              
              3,258
              
              
              1,262Other
              
              
              (90
              )
              
              (820
              )
              
              (155
              )$
              1,528
              
              $
              2,386
              
              $
              1,113


**17.**
            **Supplementary
                Cash Flow Information**




**Year
                  Ended****March
                  27, 2004**
              
              **March
                  26, 2005**
              
              **March
                  25, 2006****(in
                  thousands)**Cash
                paid during the year for:Interest
              
              $
              10,100
              
              $
              18,917
              
              $
              33,781Income
                  taxes, net of refunds received
              
              
              14,636
              
              
              (30
              )
              
              (7,259
              )Non
                  cash increase in capital leases
              
              
              2,071
              
              
              285
              
              
              7,359




F-35


**SCHEDULE
        II**
 
 **LEINER
        HEALTH PRODUCTS INC.**
 **VALUATION
        AND QUALIFYING ACCOUNTS**
 **(In
        thousands)**


**Balance
                  at Beginning of Period**
              
              **Charged
                  to Costs and Expenses**
              
              **Deductions**
              
              **Balance
                  at End of Period**Year
                  ended March 27, 2004:Accounts
                  receivable allowances
              
              $
              3,308
              
              $
              4,087
              
              $
              4,425
              
              $
              2,970Inventory
                  valuation reserve
              
              
              15,074
              
              
              5,746
              
              
              9,308
              
              
              11,512Year
                  ended March 26, 2005:Accounts
                  receivable allowances
              
              $
              2,970
              
              $
              4,791
              
              $
              4,648
              
              $
              3,113Inventory
                  valuation reserve
              
              
              11,512
              
              
              8,028
              
              
              8,550
              
              
              10,990Year
                  ended March 25, 2006:Accounts
                  receivable allowances
              
              $
              3,113
              
              $
              5,153
              
              $
              4,721
              
              $
              3,545Inventory
                  valuation reserve
              
              
              10,990
              
              
              12,430
              
              
              8,055
              
              
              15,365


S-1