**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549**

 

**FORM 10-K**

 
| **ý** | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------|
|       | ** ** | ** **                                                                                                    |
|       | ** ** | **For the  fiscal year ended March 26, 2005**                                                            |
|       | ** ** | ** **                                                                                                    |
| **OR**     |
|       |       |                                                                                                          |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**       |

 

**CommissionFile Number 333-118532**

 

**LEINERHEALTH PRODUCTS INC.**

(Exact name of registrant asspecified in its charter)

 
| **DELAWARE**                                                    | ** ** | **94-3431709**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or  other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification Number) |
|                                                            |       |                                     |
| **901 East 233rd Street, Carson, California**                   | ** ** | **90745**                                |
| (Address of  principal executive offices)                       |       | (Zip Code)                               |

 

**(310) 835-8400**

Registrant’s telephonenumber, including area code

 

Securities registered pursuantto Section 12(b) of the Act: **None**

 

Securities registered pursuantto Section 12(g) of the Act: **None**

 

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

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the Registrantis an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  o  No  ý

 

The aggregate market value of the registrant’scommon stock held by non-affiliates as of September 25, 2004 (the lastbusiness day of the registrant’s most recently completed second fiscal quarter)is not applicable.

 

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCY**

**PROCEEDINGSDURING THE PRECEDING FIVE YEARS:**

 

Indicate by check mark whether the registranthas filed all documents and reports required to be filed by Section 12,13, or15(d) of the Securities Exchange Act of 1934 subsequent to thedistribution of securities under a plan confirmed by the court.  YES  ý*   NO  o

 

**APPLICABLEONLY TO CORPORATE REGISTRANTS**

 

Indicate the number of shares outstanding ofeach of the registrant’s classes of common stock, as of the latest practicabledate. 

Common Stock, $0.01 par value,1,000 shares outstanding as of March 26, 2005

 

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* No reports were required to be filed under Section 12, 13, or 15(d) ofthe Securities Exchange Act of 1934.

 

 

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**LEINERHEALTH PRODUCTS INC.**

 

**Form 10-K**

**Forthe Fiscal Year Ended March 26, 2005**

 

**TABLEOF CONTENTS**

 
| **PART I**   |                                                                                                               |   |
|-------------------|--------------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                               |   |
| ITEM 1.           | BUSINESS                                                                                                           |   |
| ITEM 2.           | PROPERTIES                                                                                                         |   |
| ITEM 3.           | LEGAL PROCEEDINGS                                                                                                  |   |
| ITEM 4.           | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                                               |   |
|              |                                                                                                               |   |
| **PART II**  |                                                                                                               |   |
|              |                                                                                                               |   |
| ITEM 5.           | MARKET FOR REGISTRANT’S COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |   |
| ITEM 6.           | SELECTED FINANCIAL DATA                                                                                            |   |
| ITEM 7.           | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |   |
| ITEM 7A.          | QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK                                                        |   |
| ITEM 8.           | FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA                                                                         |   |
| ITEM 9.           | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                              |   |
| ITEM 9A.          | CONTROLS AND PROCEDURES                                                                                            |   |
| ITEM 9B.          | OTHER INFORMATION                                                                                                  |   |
|              |                                                                                                               |   |
| **PART III** |                                                                                                               |   |
|              |                                                                                                               |   |
| ITEM 10.          | DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT                                                                |   |
| ITEM 11.          | EXECUTIVE COMPENSATION                                                                                             |   |
| ITEM 12.          | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT OF RELATED STOCKHOLDER MATTERS                     |   |
| ITEM 13.          | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS                                                                    |   |
| ITEM 14.          | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                             |   |
|              |                                                                                                               |   |
| **PART IV**  |                                                                                                               |   |
|              |                                                                                                               |   |
| ITEM 15.          | EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES                                                                        |   |

 

The data contained in this Form 10-Kwith respect to our relative market share and competitive positions are basedon retail sales, and approximations based on our estimates and industrysources, including Information Resources, Inc. (“IRI”), Empower IT (U.S.military sales data), government publications and reports from governmentagencies, published independent industry sources, public filings and industrypublications by companies covering business in the vitamins, minerals and nutritionalsupplements (“VMS”) and over-the-counter (“OTC”) markets. We believe that suchdata are inherently imprecise, but are generally indicative of our relativemarket share and competitive position. Market share data are for the food, drugand mass merchant and warehouse club (“FDMC”) in the U.S. only and do notinclude Canadian market share information for Vita Health Products Inc.

 

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**PART I**.

 

## **ITEM1.**                             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, waspurchased in 1979 by management and Booker plc through Leiner. In May 1992,we were acquired by Leiner Health Products Group Inc. (“Leiner Group”). LeinerGroup was a holding company incorporated under the laws of the State ofDelaware with no significant operations or assets other than the stock ofLeiner, which it held through its sole direct subsidiary, PLI Holdings, Inc.,itself a holding company.

 

In May 1992, Leiner Group acquired privately held XCELLaboratories, Inc., a major U.S. private label OTC pharmaceuticalsmanufacturer and on March 8, 1993, XCEL Laboratories, Inc. was mergedinto Leiner.

 

In January 1997, we acquired Vita Health Company (1985) Ltd., oneof the leading manufacturers of private label and branded vitamins, mineralsand OTC pharmaceuticals in Canada. Vita Health Company (1985) Ltd. changed itsname in 1998 to Vita Health Products Inc. (“Vita”).

 

In June 1997, Leiner Group completed a leveraged recapitalizationtransaction pursuant to which Leiner Group repurchased common stock from itsexisting shareholders, issued new shares of the recapitalized Leiner Group toNorth Castle Partners I, LLC, issued senior subordinated notes, and establisheda senior secured credit facility. Immediately upon consummation of therecapitalization, we assumed Leiner Group’s obligations under the subordinatednotes and the senior credit facility.

 

In December 1999, we acquired substantially all of the assets ofGranutec, Inc., a manufacturer and distributor of private label, OTCpharmaceutical drugs in the United States, and Vita acquired substantially allof the assets of Stanley Pharmaceuticals Ltd., a manufacturer and distributorof private label, OTC pharmaceutical drugs and vitamin supplement products inCanada, 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 Courtconfirmation of our plan of reorganization under Chapter 11 of the U.S.Bankruptcy Code, Leiner Group was merged into PLI Holdings, and PLI Holdingswas then merged into Leiner, with Leiner as the surviving entity.

 

**2004 Recapitalization (“Recapitalization”)**

 

On April 15, 2004, Leiner Merger Corporation (“Mergeco”), enteredinto a recapitalization agreement and plan of merger (the “Recapitalization”)with us. Mergeco was a new corporation formed by investment funds affiliatedwith Golden Gate Private Equity, Inc. (the “Golden Gate Investors”) andNorth 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 theRecapitalization. In connection with the Recapitalization, the Golden GateInvestors made a $131.5 million cash equity investment in Mergeco and the NorthCastle Investors made a $131.5 million equity investment in Mergeco, $126.5million of which was a new cash investment by NCP III-A and $5.0 million ofwhich was a rollover of existing Leiner equity by an affiliate of NCP III-A.

 

The Recapitalization was effected by merging Mergeco with and into uson May 27, 2004. Each share of the common stock of Mergeco became a shareof common stock of us, which is the surviving corporation in the merger. Eachholder of our common stock then exchanged such stock for voting preferred stockof LHP Holding Corp. (“Holdings”), a newly formed company that became our newparent company.

 

In addition, certain members of management cancelled existing Leinerequity rights and received new equity rights in Holdings, which represent anaggregate management rollover of approximately $18.8 million. Holders of all ofour other equity and equity rights have 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 withNorth Castle Partners, L.L.C., and a contingent pro rata right in $6.5 milliondeposited in an escrow fund.  We alsorecorded approximately $54.3 million as compensation expense related to thein-the-money value of stock options, warrants, and delayed delivery shares. Thecompensation expense represented the excess of the fair value of the underlyingcommon stock over the exercise price or basis of the options and other equityrights repurchased and retired or rolled over in connection with theRecapitalization.

 

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As a result of the Recapitalization, the Golden Gate Investors and theNorth Castle Investors each own 46.7% of Holdings equity and our management andcertain former employees own 6.6% of Holdings’ equity including delayeddelivery share awards. The Recapitalization was accounted for as arecapitalization of Mergeco which had no impact on the historical basis ofassets and liabilities as reflected in our consolidated financial statements.

 

In connection with the Recapitalization, Mergeco entered into a newcredit facility (the “New Credit Facility”), consisting of a $240.0 millionterm loan (the “Term Facility”) and a $50.0 million revolving credit facility(the “Revolving Facility”), under which we borrowed $5.0 million immediatelyafter the Recapitalization. In addition, Mergeco issued $150.0 million of 11%senior subordinated notes due 2012 (the “Notes”). Immediately upon consummationof the Recapitalization, the obligations of Mergeco under the New CreditFacility and Notes became our obligations. We repaid approximately $157.8million in pre-existing indebtedness and paid approximately $32.7 million infees and expenses related to these transactions. In addition, deferredfinancing charges of approximately $12.5 million related to the New CreditFacility and Notes were recorded under other non-current assets in theaccompanying consolidated balance sheet at March 26, 2005.

 

The assumption of debt and the transfer of excess funds from theRecapitalization totaled approximately $77.3 million and consisted of thefollowing (in millions):

 
| Assumption  of Debt from Mergeco: |   |   |   |   |   |
|-----------------------------------|--------|--------|--------|--------|--------|
| New Credit  Facility              |   | $      | (245.0 | )      |   |   |
| Notes                             |   | (150.0 | )      | $      | (395.0 | ) |
| Excess funds  from Mergeco        |   |   |   | 317.7  |   |
| Recapitalization                  |   |   |   | $      | (77.3  | ) |
|                                   |        |        |        |        |        |  |  |

 

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

 

**Fiscal year**

 

Effective fiscal 2003, we changed our reporting period to afifty-two/fifty-three week fiscal year. Our fiscal year end will fall on thelast Saturday of March each year. Our fiscal years ended March 29,2003, March 27, 2004, and March 26, 2005 were each comprised of 52weeks.

 

**General**

 

We are the leading manufacturer of store brand VMS products and thesecond largest supplier of store brand OTC pharmaceuticals in the U.S. FDMCretail market, as measured by U.S. retail sales in 2004. Most of our productsare manufactured for our customers to sell as their own store brands. We havelong-term relationships with leading FDMC retailers and focus on thefastest-growing of these retailers—the mass merchants and warehouse clubs. Inaddition to our primary VMS and OTC products, we provide contract manufacturingservices to consumer products and pharmaceutical companies. We believe few competitorsin the industry can provide our level of service, innovation, high quality andcompetitive pricing. In our view, the critical factor in the purchase decisionof our customers is our reputation for high levels of customer service and forproducing quality products that are safe, effective and manufactured to thehighest industry standards.

 

We have the leading position in the estimated $1.5 billion VMS FDMCstore brand market, as measured by U.S. retail sales in 2004, with an estimated40% share. We estimate that we have a 44% share of the VMS store brand segmentfor Wal-Mart, Sam’s Club and Costco—three of the fastest-growing retailers inthis market. We offer a wide breadth of products in VMS, includingmulti-vitamins, vitamins C and E and joint care products, as well as mineralsand supplements. We sell our VMS products under our customers’ store brands aswell as our own brand, *YourLife*®. We have created value for our VMS customers for over 20years by identifying promising new store brand products, utilizing our productdevelopment and manufacturing expertise to allow them to bring these productsto market quickly, often ahead of their competitors, and providing sales andmarketing support.

 

We are the second largest supplier of OTC pharmaceuticals in theestimated $2.2 billion OTC FDMC store brand market, as measured by U.S. retailsales in 2004, with an estimated 20% share. Our products principally consist ofanalgesics, cough, cold and allergy medications and digestive aids. We sell ourOTC pharmaceuticals under our customers’ store brands as well as our own brand,*Pharmacist Formula*®. Our currentOTC products include the national brand equivalents of *Advil*®

 

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(ibuprofen), *Aleve*® (naproxen), *Claritin*® (loratadine), *TUMS*®(calcium antacid), *Tylenol*® (acetaminophen) and *Zantac**®*(ranitidine). Wehave partnered with several pharmaceutical companies to manufacture anddistribute OTC products.

 

We also provide contract manufacturing services to consumer productsand pharmaceutical companies. We utilize our existing facilities, productionequipment and personnel to manufacture and package products for our customers.We have entered into a long-term contract to provide contract manufacturingservices to a leading multi-vitamin national brand under which we produced over2.4 billion pills in fiscal year 2005. We believe our contract manufacturing services business allows us todrive profitability by increasing capacity utilization and leveraging our fixedcosts. We believe our expertise in the VMS and OTC FDMC markets and our focuson high quality products and low-cost manufacturing will allow us to expand ourexisting relationships and gain new relationships with consumer products andpharmaceutical companies.

 

**Products**

 

The following table sets forth the net sales of our VMS, OTC andcontract manufacturing services products from fiscal year 2003 through fiscalyear 2005:

 
| ** **                             | ** ** | **Year Ended**           | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | **March 29,  2003** | ** ** | **%** | ** ** | **March 27,  2004** | ** ** | **%** | ** ** | **March 26,  2005** | ** ** | **%** | ** ** |
| VMS products                           |       | $                        | 384,182    |   | 67 | % | $ | 413,679 |   | 63 | % | $ | 419,491 |   | 61 | % |
| OTC products                           |       | 148,983                  |       | 26 | % | 191,196 |   | 29 | % | 213,402 |   | 31 | % |
| Contract  manufacturing services/Other |       | 41,116                   |       | 7 | % | 56,170 |   | 8 | % | 52,008 |   | 8 | % |
|                                   |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Total                                  |       | $                        | 574,281    |   | 100 | % | $ | 661,045 |   | 100 | % | $ | 684,901 |   | 100 | % |

 

***VMS Products. ***We offer a wide breadth of VMS products, including more than269 products in approximately 2,197 SKUs in the United States. Our products aresold in tablet and capsule forms, and in varying sizes with differentpotencies, flavors and coatings. Our vitamin products include national brandequivalents that compare to the dietary ingredients in *Caltrate**®*, *Centrum**®* and *One-A-Day**®,*vitaminproducts such as vitamins C and E and folic acid, minerals such as calcium,supplements such as glucosamine, Fish Oil, Co-Q10 and herbal products. We sellVMS products primarily under our customers’ store names and estimate that storebrands accounted for approximately 92.7% of our fiscal year 2005 VMS grosssales in the United States. In addition, our own brand, *Your Life*®, is the largest VMS brand provided tothe U.S. military. For the fiscal year 2005, our VMS business comprisedapproximately 61.2% of net sales. Sales of vitamins C and E, in the aggregate,accounted for approximately 11.5% of our gross sales in fiscal 2005.

 

Sales in fiscal 2005 were affected by pronounced product landscapechanges in our VMS category; that is, higher sales ofjoint care products and lower sales of Vitamin E.  Vitamin E sales declined significantly infiscal 2005 due to negative media reports and we expect our sales of Vitamin Ein fiscal 2006 to continue to reflect the effects of the negative media asconsumers consult their healthcare professionals to better understand theissues and the self-care alternatives. On the other hand, our sales in the joint-care market grew significantlyin fiscal 2005 and we expect to continue to grow our joint care sales andmarket share in fiscal 2006.

 

Vita Health produces approximately 173 different types of VMS productsin approximately 510 different SKUs. However, the majority of Vita’s sales inthis segment are concentrated in a few core products categories. The top 5product categories, which comprise over one-half of Vita’s vitamin sales, aremultivitamins, herbal products, mineral products, supplement products andvitamin C products.

 

***OTC Products.***Wemarket more than 55 different OTC pharmaceuticalproducts in approximately 640 different SKUs, including those productscomparable to most major national brands in the analgesic, cough and coldremedy and digestive aid categories. Our current OTC products include nationalbrand equivalents of *Advil**®*(ibuprofen), *Aleve**®*(naproxen), *Claritin**®*(loratadine), *TUMS*® (calciumantacid), *Tylenol**®*(acetaminophen) and *Zantac*® (ranitidine).We sell our OTC pharmaceuticals under our customers’ store brands as well asour own brand, *Pharmacist Formula*®. We havesigned an agreement with Dr. Reddy’s Laboratories Limited (“Dr. Reddy’sLaboratories”) (NYSE: RDY), an emerging generic pharmaceutical company based inIndia, for the exclusive U.S. marketing rights for all Dr. Reddy’sLaboratories’ products that switch from prescription to OTC to take advantageof the anticipated wave of prescription drug patent expirations in the future.

 

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Vita Health produces approximately 99 different types of OTC productsin approximately 1,201 different SKUs. Vita’s OTC pharmaceutical sales areprimarily analgesic products, allergy products, digestive aids and cough andcold products. In Canada, there are two primary classes of analgesics products,those with codeine and those without. Vita produces both types of products.

 

***ContractManufacturing Services.***We provide contract manufacturing and packaging services to consumerproducts and pharmaceutical companies. We utilize our existing facilities,production equipment and personnel to manufacture and package products for ourcustomers, generally under long-term contracts.

 

Subject to a long-term exclusive agreement, we supply Bayer HealthCareLLC (“Bayer”) with some vitamin and mineral supplements under the *One-A-Day*® brand name. Since 2000, the businesswith Bayer has grown significantly, fueled by the introduction of new productsand Bayer consumer advertising. New product concepts are developed inconjunction with Bayer’s Consumer Care input, and are then formulated, tested,and ultimately manufactured by us. New products have driven the business, ledby *One-A-Day WeightSmart*TM and theintroduction of *One-A-Day CarbSmart*TM.

 

**Geographical Business Units**

 

We operate under two separate geographical units, one in the UnitedStates and one in Canada. Our U.S. business consists of our U.S. operatingsubsidiaries, principally Leiner Health Products, LLC. Our Canadian businessconsists of Vita. Our U.S. operations consist of our corporate headquarters aswell as five FDA approved facilities, which manufacture, package and distributeVMS and OTC solid dosage forms. For the fiscal year 2005, our U.S. operationsgenerated approximately 89.2% of our net sales.

 

Vita is one of the leading manufacturers of store brand VMS and OTCproducts in Canada. Vita is located in Winnipeg, Manitoba, where it maintainsmanufacturing, packaging and distribution facilities. For the fiscal year 2005,Vita comprised approximately 10.8% of our net sales.

 

**Customers**

 

Our VMS and OTC store brand products are sold in all 50 states throughover 40,000 outlets. These include nine of the 10 largest food retailers, allsix of the largest drug chains, eight of the 10 largest mass merchants and thetop three warehouse clubs in the United States. In addition, Leiner is thenumber one VMS supplier to U.S. military outlets worldwide. In fiscal 2005, twocustomers accounted for approximately 43.1% and 20.4% of our gross sales.However, our largest customer has two distinct retail divisions that, if viewedas separate entities, would constitute 24.6% and 18.5% of our gross sales forfiscal 2005. Each of our other major customers accounted for less than 10% ofour gross sales for fiscal 2005. Our top ten customers in the aggregateaccounted for approximately 84.5% of our gross sales for fiscal 2005.

 

**Raw Materials**

 

We purchase globally from third party suppliers of raw materials. Wehave multiple suppliers for most of our raw materials. For one of our top 10raw materials, we purchase only from a single source. One supplier providedapproximately 11.4% of the materials purchased during the fiscal year 2005 byus excluding purchases by Vita, our Canadian business. No other single supplieraccounts for more than 10% of our material purchases.

 

**Competition**

 

The markets for our products are highly competitive. We compete on thebasis of customer service, product quality, range of products offered, pricingand 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 approximately82.7% of our VMS products to FDMC retailers. We do not currently participatesignificantly in or sell to other channels such as health food stores, directmail and direct sales and, therefore, may face competition from such alternativechannels if more customers utilize these channels of distribution to obtain VMSproducts.

 

**Employees**

 

As of March 26, 2005, we had 2,217 full-time employees. Of theseemployees, 368 were engaged in executive or administrative capacities and 1,849were engaged in manufacturing, packaging or distribution. In addition, weemployed approximately 565 temporary workers. The large number of temporaryworkers gives us significant flexibility to adjust

 

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staffing levels in response to seasonal fluctuations in demand.Approximately 16.8% of our employees are represented by a collective bargainingagreement for Vita. We consider our relations with our employees to be good.

 

**Research and Development**

 

We conduct our research and development activities at our ownmanufacturing facilities located in Garden Grove, California, and Fort Mill,South Carolina, and with strategic third parties. Our principal emphasis in ourresearch and development activities is the development of new products and theenhancement of existing products. The amount, excluding capital expenditures,spent on research and development activities was approximately $5.5 million,$5.7 million and $5.3 million, in fiscal years 2003, 2004 and 2005, respectively.

 

**Government Regulation**

 

The formulation, manufacturing, packaging, labeling, advertising,distribution and sale of our products are subject to regulation by one or moreUnited States and Canadian federal agencies, including the FDA, the FTC, theCPC, Health Canada and also by various agencies of the states, provinces andlocalities in which our products are sold. In particular, the FDA, pursuant tothe 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 toregulate advertising of these products.

 

The FDCA has been amended several times with respect to dietarysupplements, in particular by the Dietary Supplement Health and Education Actof 1994 (“DSHEA”). DSHEAestablished a new framework governing the composition and labeling of dietarysupplements. With respect to composition, DSHEA defined “dietary supplements”as vitamins, minerals, herbs, other botanicals, amino acids and other dietarysubstances for human use to supplement the diet, as well as concentrates,metabolites, constituents, extracts or combinations of such dietaryingredients. Generally, under DSHEA, dietary ingredients that were on themarket before October 15, 1994 may be used in dietary supplements withoutnotifying the FDA. However, a “new” dietary ingredient (i.e., a dietaryingredient that was “not marketed in the United States before October 15,1994”) must be the subject of a new dietary ingredient notification submittedto the FDA unless the ingredient has been “present in the food supply as an article usedfor food” without the food being “chemically altered.” A new dietary ingredientnotification must provide the FDA evidence of a “history of use or otherevidence of safety” establishing that use of the dietary ingredient under theconditions suggested in the labeling “will reasonably be expected to be safe.”A new dietary ingredient notification must be submitted to the FDA at least 75days before the initial marketing of the new dietary ingredient. There can beno assurance that the FDA will accept the evidence of safety for any newdietary ingredients that we may want to market, and the FDA’s refusal to acceptsuch evidence could prevent the marketing of such dietary ingredients.

 

DSHEA permits “statements of nutritional support” to be included inlabeling for dietary supplements without FDA pre-approval. Such statements maydescribe how a particular dietary ingredient affects the structure, function orgeneral well-being of the body, or the mechanism of action by which a dietaryingredient may affect body structure, function or well-being (but may not statethat a dietary supplement will diagnose, cure, mitigate, treat, or prevent adisease unless such claim has been reviewed and approved by the FDA). A companythat uses a statement of nutritional support in labeling must possess evidencesubstantiating that the statement is truthful and not misleading. In somecircumstances 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, cureor prevent a disease, and to notify the FDA about our use of the statementwithin 30 days of marketing the product. However, there can be no assurancethat the FDA will not determine that a particular statement of nutritionalsupport that a company wants to use is an unacceptable drug claim or anunauthorized version of a “health claim.” Such a determination might prevent acompany from using the claim.

 

In addition, DSHEA provides that some so-called “third partyliterature,” e.g., a reprint of a peer reviewed scientific publication linkinga particular dietary ingredient with health benefits, may be used “inconnection with the sale of a dietary supplement to consumers” without theliterature being subject to regulation as labeling. Such literature must not befalse or misleading; the literature may not “promote” a particular manufactureror brand of dietary supplement; and a balanced view of the available scientificinformation on the subject matter must be presented and must not have appendedto it any other information. There can be no assurance, however, that all thirdparty literature that we would like to disseminate in connection with ourproducts will satisfy each of these requirements, and failure to satisfy allrequirements could prevent use of the literature or subject the productinvolved 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 supplementsand may, among other things, require dietary supplements to be prepared,packaged and held in compliance with some rules,

 

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and might require quality control provisions similar to those in theGMP regulations for drugs. There can be no assurance that, if the FDA adoptsGMP regulations for dietary supplements, we will be able to comply with the newrules without incurring substantial expenses.

 

***OTC Pharmaceuticals.***The majority of our OTCpharmaceuticals are regulated under the OTC Monograph System and are subject tosome FDA regulations. Under the OTC Monograph System, selected OTC drugs aregenerally recognized as safe and effective and do not require the submissionand approval of an New Drug Application (“NDA”) or Abbreviated New DrugApplication (“ANDA”) prior to marketing. The FDA OTC Monograph System includeswell-known ingredients and specifies requirements for permitted indications,required warnings and precautions, allowable combinations of ingredients anddosage levels. Drug products marketed under the OTC Monograph System mustconform to specific quality and labeling requirements; however, these productsgenerally may be developed under fewer restrictive conditions than thoseproducts that require the filing of an NDA or ANDA. It is, in general, lesscostly to develop and bring to market a product produced under the OTCMonograph System. From time to time, adequate information may become availableto the FDA regarding some drug products that will allow the reclassification ofthose products as generally recognized as safe and effective and not misbrandedand, therefore, no longer requiring the approval of an NDA or ANDA prior tomarketing. For this reason, there may be increased competition and lowerprofitability related to a particular product should it be reclassified to theOTC 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 OTCstatus. These prescription to OTC switch products require approval by the FDAthrough our NDA or ANDA process before they can be commercialized. Based oncurrent FDA regulations, all chemistry, manufacturing and control issues,bioequivalency and labeling related to these products are defined by theinformation included in the NDA or ANDA. The ANDA process generally reduces thetime and expense related to FDA approval compared to the NDA process. Forapproval, we must demonstrate that the product is essentially the same as aproduct that has previously been approved by the FDA and is on the market andthat our manufacturing process and other requirements meet FDA standards. Thisapproval process may require that bioequivalence and/or efficacy studies beperformed using a small number of subjects in a controlled clinicalenvironment. Approval time is generally eighteen months to four years from thedate of submission of the application. Changes to a product with an ANDA aregoverned by specific FDA regulations and guidelines that define when proposedchanges, if approved by the FDA, can be implemented.

 

The Drug Price Competition and Patent Term Restoration Act of 1984 (theHatch-Waxman Amendments to the Federal Food, Drug, and Cosmetic Act) can granta three-year period of marketing exclusivity to a company that obtains FDAapproval of a prescription to OTC switch product when we have conducted newclinical investigations essential to the OTC approval. Unless we establishrelationships with the companies having exclusive marketing rights, our abilityto market prescription to OTC switch products and offer our customers productscomparable to the national brand products would be delayed until the expirationof the three year exclusivity granted to those initiating the switch. There canbe no assurance that, in the event that we apply for FDA approvals, we willobtain the approvals to market prescription to OTC switch products or,alternatively, that we will be able to obtain these products from othermanufacturers.

 

The FDA Modernization Act of 1997 and the Best Pharmaceuticals forChildren Act of 2002 amended the law regarding market exclusivity. In general,this legislation may grant an additional six months of exclusivity if theinnovator conducted pediatric studies on the product. This policy will, in someinstances, defer sales by us of some products.

 

The law regarding exclusivity and stays of approval for ANDAapplications changed in late 2003. Consequently, the old law will apply to someANDA applications filed or licensed by us and other companies and the new lawwill 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 andmeet some requirements, the FDA may grant a 180-day exclusivity for thatproduct as to subsequently-filed ANDAs. During the ANDA approval process,patent certification is required and may result in legal action by the productinnovator. The legal action generally would not result in material damages butcould result in us being prevented from introducing the product if we are notsuccessful in the legal action. We would, however, incur the cost of defendingthe legal action, and that action could have the effect of triggering astatutorily mandated delay in the FDA approval of the drug application for aperiod of up to 30 months, subject to court action lengthening or shorteningthe stay period. Under the old law (as amended retroactively by the new law) ifthere is a court decision in a patent litigation case related to the drugproduct that is favorable to us, the 180-day exclusivity period may commence onthe date of the decision even though a petition for certiorari may be filed andthe final decision is not entered until sometime later. We may, however, decidenot to assume the risk of marketing an approved product prior to the finaldecision on review of the certiorari petition of the favorable opinion of anappellate court.

 

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If we are not first to file an ANDA, the FDA may grant 180-dayexclusivity to another company, thereby effectively delaying the launch of ourproduct. Under the old law, if exclusivity is granted to us, there can be noassurance that the beginning of the exclusivity period will coincide with ourability to market the product, as FDA regulations potentially allowed thetriggering of the exclusivity period by events that were outside of ourcontrol. Under the new law, our 180-day exclusivity period will be triggeredonly by our own commercial marketing of the ANDA drug. On the other hand, wecould lose our 180-day exclusivity period if we do not commence marketingbefore some “forfeiture events” occur. These “forfeiture events” include thelater of (1) the expiration of 75 days after the ANDA is granted or theexpiration of 30 months after it is filed, whichever is earlier, or (2) 75days after some court actions with respect to patents for which we have “lawfullymaintained” paragraph IV certifications, or after the withdrawal of suchpatents from the Orange Book. The new law provides for other specifiedforfeiture events as well.

 

We are also subject to the requirements of the ComprehensiveMethamphetamine Control Act of 1996, a law designed to allow the DEA to monitortransactions involving chemicals that may be used illegally in the productionof methamphetamine. The Comprehensive Methamphetamine Control Act of 1996amended the Controlled Substances Act to establish specified registration,recordkeeping and reporting requirements for manufacturers and distributors ofOTC cold, allergy, asthma and diet medicines that contain ephedrine,pseudoephedrine or PPA.  While some ofour OTC pharmaceutical products contain pseudoephedrine, our products containneither ephedrine, a chemical compound that is distinct from pseudoephedrine,nor PPA.  Pseudoephedrine is a commoningredient in decongestant products manufactured by us and other pharmaceuticalcompanies. We have discontinued all products containing PPA. We believe that weand our products are in compliance with all applicable DEA requirements.

 

***Manufacturing andPackaging****.*All facilities where foods (including dietary supplements)and pharmaceuticals are manufactured, packed, warehoused, or sold must complywith the FDA manufacturing standards applicable to that type of product. TheFDA performs periodic audits to ensure that our facilities remain in compliancewith the cGMP regulations. The failure of a facility to be in compliance maylead to a breach of representations made to store brand customers or toregulatory action against the products made in that facility, includingseizure, injunction or recall. Our facilities are in compliance in all materialrespects with the cGMPs and other applicable requirements for each facility.

 

***CPSC.***The Consumer Product Safety Commission (“CPSC”) hasauthority, under the Poison Prevention Packaging Act, to designate thoseproducts, including vitamin products and OTC pharmaceuticals that require childresistant closures to help reduce the incidence of poisonings. The CPSC hasadopted regulations requiring numerous OTC pharmaceuticals and iron-containingdietary supplements to have such closures, and has adopted rules on thetesting of such closures by both children and adults. We, working with ourpackaging suppliers, believe that we are in compliance with all CPSCrequirements.

 

***FTC.***The FTC exercises primary jurisdiction over the advertisingand other promotional practices of food and OTC pharmaceuticals marketers, andhas concurrent jurisdiction with the FDA over the advertising and promotionalpractices of marketers of dietary supplements. The FTC has historically applieda different standard to health-related claims than the FDA; the FTC has applieda “substantiation standard,” which is less restrictive than the standard underthe Nutritional Labeling Education Act (“NLEA”).  The FTC NLEA enforcement policy uses FDAregulations as a baseline (and safe harbor) and permits (1) nutrientcontent descriptions that are reasonable synonyms of FDA-permitted terms, and (2) qualifiedhealth claims not approved by the FDA where adequate substantiation exists forthe qualified or limited claims.

 

***State Regulation.***All states regulate foods and drugs under local laws thatparallel federal statutes. Because the NLEA gave the states the authority toenforce many labeling prohibitions of the Federal Food, Drug, and Cosmetic Actafter notification to the FDA, we, and other dietary supplement manufacturers,may be subject to increasing state scrutiny for NLEA compliance, as well asincreasing FDA review. We are also subject to California Proposition 65 (theSafe Drinking Water and Toxic Enforcement Act of 1986) and state consumerhealth and safety regulations, which could have a potential impact on ourbusiness if any of our products were ever found not in compliance. We are notengaged in any enforcement or other regulatory actions and are not aware of anyproducts that are not in compliance with California Proposition 65 and othersimilar state regulations.

 

***USP.***The USP is a non-governmental, voluntary standard-settingorganization. Its drug monographs and standards are incorporated by referenceinto the FDCA as the standards that must be met for the listed drugs, unlesscompliance with those standards is specifically disclaimed. USP standards existfor most OTC pharmaceuticals. The FDA would typically require USP compliance aspart of cGMP compliance and with respect to ANDA drugs.

 

The USP has adopted standards for vitamin and mineral dietarysupplements that are codified in the USP Monographs and the USP ManufacturingPractices.  These standards covercomposition (nutrient ingredient potency and combinations), disintegration,dissolution, manufacturing practices and testing requirements. While USPstandards for vitamin and mineral

 

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dietary supplements are voluntary, and not incorporated into federallaw, our customers may demand that products supplied to them meet thesestandards. Label claims of compliance with the USP may expose a company to FDAscrutiny for those claims. In addition, the FDA may in the future requirecompliance, or such a requirement may be included in new dietary supplementlegislation. All of our products labeled USP meet the USP standards.

 

***Canadian Regulation.***In Canada, our productsare subject to federal and provincial law, particularly federal druglegislation. Government regulation under the Canadian Food and Drugs Act andthe regulations thereunder require regulatory approvals of such productsthrough a DIN, DIN-HM or NPN by Health Canada. All substances sold foringestion by humans are regulated either as a food or drug under the Canadian Foodand Drugs Act. In addition, some of our products are subject to governmentregulation under the CDSA. The Canadian Food and Drugs Act and the CDSA areenforced by Health Canada and other authorities.

 

On January 1, 2004, the Natural Health Products Regulations madeunder the Canadian Food and Drugs Act came into force, requiring all naturalhealth products, including vitamin and mineral supplements, to have a NaturalHealth Product license. Health Canada has provided a transition period of sixyears ending December 31, 2009, during which compliance action for NaturalHealth Products (“NHP”) will be governed by the Health Products and Food BranchInspectorate’s “Compliance Policy on Natural Health Products.” Natural HealthProducts 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 whatmay be represented in Canada on labels and in promotional material, in respectof the properties of the various products. The Canadian Food and Drugs Act alsoprovides that any drugs sold in Canada must have a label affixed thereto thatshows specified information, such as its proper scientific or common name, thename and address of the manufacturer, its lot number, adequate directions foruse, a quantitative list of its medical ingredients and its expiration date. Inaddition, no person may sell a drug unless it has been assigned a DIN, DIN-HMor NPN, which are obtained through an application to Health Canada. Regulationsunder the Canadian Food and Drugs Act require all manufacturers to pay annualfees for their DINs.  Health Canadaapproval for the sale of our products may be subject to significant delays.

 

The office of Controlled Substances of Health Canada regulates themanufacture and sale of controlled substances as defined in the CDSA. TheControlled Drugs and Substances Act contains requirements for licenses of thefactory, approved security, a qualified person in charge of the factory anddetailed record keeping in connection with the manufacturing of controlledsubstances.

 

Regulations under the Canadian Food and Drugs Act set out mandatory andrigorous procedures, practices and standards for manufacturers. Health Canadaperforms inspections of companies in the industry to ensure compliance with theCanadian Food and Drugs Act and the CDSA. For each of our drug products, thedevelopment process, the manufacturing procedures, the use of equipment, andlaboratory practices and premises must comply with Good Manufacturing Practicesand Establishment Licensing regulations under the Canadian Food and Drugs Act.

 

Our Natural Health Products require regulatory approval in the form ofa DIN-HM or NPN issued by Health Canada. Approvals are based on formulation andevidence of safety and efficacy. All of our products in the NHP category mustcomply with the Good Manufacturing Practices and Site Licensing requirementsper the Natural Health Product Regulations under the Canadian Food and DrugsAct.

 

**Intellectual Property**

 

We regard our trademarks and other intellectual property rights asvaluable assets and believe they are important in the marketing of ourproducts. Among our most significant trademarks are *Your Life*® and *PharmacistFormula*®. We have registered these and other material trademarks inthe United States and some foreign countries. We intend to maintain the foreignand domestic registrations of our trademarks so long as they remain valuable toour business. Generally, registered trademarks have perpetual life providedthey are renewed on a timely basis and continue to be used properly astrademarks. 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 complyingwith such laws and regulations have not had, and are not expected to have, amaterial adverse effect on our business.

 

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**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 toSections 13(a) and 15(d) of the Securities Exchange Act of 1934, asamended, are available free of charge on our web site at www.leiner.com as soonas reasonably practicable after we electronically file such material with, orfurnish them to, the Securities and Exchange Commission. To access thesereports, go to our website at www.leiner.com/financials.

 

**Risk Factors**

 

*Unfavorable research and publicity couldnegatively affect our sales of VMS products***.**

 

We are dependent upon consumerperception regarding the safety and quality of our products, as well as similarproducts distributed by other companies. Consumer perception of products can besignificantly influenced by scientific research or findings, national mediaattention and other publicity about product use. We believe the growthexperienced in the last several years in the VMS FDMC market is based largelyon national media attention regarding recent scientific research suggestingpotential health benefits from regular consumption of some VMS products.

 

Various studies published since 1992 by researchers at majoruniversities have suggested an association between regular consumption ofantioxidant supplements such as vitamins C and E and a reduced risk of somediseases, including heart disease, cancer and Alzheimer’s disease. In addition,other studies have reported that consumption of folic acid (a B vitamin) canaid in the prevention of heart disease and neural tube birth defects. Such researchhas been described in major medical journals, magazines, newspapers andtelevision programs. However, some recent studies relating to some antioxidantshave produced results contrary to the favorable indications of other prior andsubsequent studies.  For example, VitaminE sales declined significantly in fiscal 2005 due to negative media reports.  The scientific research to date with respectto antioxidants and some other of our VMS products is not conclusive, andfuture scientific results and media attention may not be favorable orconsistent. In the event of future scientific results or media attention thatis perceived by our consumers as less favorable or that questions earlierresearch or publicity, our sales of VMS products could be materially adverselyaffected. Adverse publicity in the form of published scientific research orotherwise, whether or not accurate, that associates consumption of our productsor any other similar products with illness or other adverse effects, thatquestions the benefit of our or similar products or that claims that any suchproducts are ineffective could have a material adverse effect on our financialposition, results of operations or cash flows.

 

*Regulatory matters governing our industrycould 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 moreU.S. and Canadian federal agencies, including the U.S. Food and DrugAdministration (the “FDA”), the U.S. Federal Trade Commission (the “FTC”), theU.S. Consumer Product Safety Commission (the “CPSC”) and Health Canada. Ouractivities 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 theguidelines promulgated by voluntary standard organizations, such as the UnitedStates Pharmacopeia (“USP”).

 

If we fail to comply with federal, state orforeign regulations, we could be required to:

•change product labeling, packaging or advertising or take other correctiveaction;

•change product formulations;

•suspend the sale of products with non-complying specifications;

•initiate product recalls;

• prepare and submit a new drugapplication (“NDA”) or abbreviated NDA (“ANDA”) or foreign equivalent; or

•suspend manufacturing operations.

 

Any of these actions could have a material adverse effect on ourfinancial position, results of operations or cash flows.

 

We expect that the FDA soon will adopt its proposed rules on goodmanufacturing practices in manufacturing, packaging or holding dietaryingredients and dietary supplements, which may apply to the VMS products wemanufacture. These regulations would require dietary supplements to beprepared, packaged and held in compliance with several rules, and may requirequality control provisions similar to those in the good manufacturing practiceregulations for drugs. If the FDA adopts the good manufacturing practiceregulations, we would incur additional, and potentially substantial, expensesto comply with the new rules.

 

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In Canada, our products are subject to government regulation under theFood and Drugs Act and the regulations thereunder (the “Canadian Food and DrugsAct”) which require regulatory approvals of such products through a drugidentification number (“DIN”), natural product number (“NPN”) or DIN-HM forhomeopathic medicines by Health Canada. The loss of a particular DIN, DIN-HM orNPN would adversely affect the ability to continue to sell the particularproduct to which it was assigned. Material noncompliance with the provisions ofthe Canadian Food and Drugs Act may result in the loss of a DIN, DIN-HM or NPNor the seizure and forfeiture of products which are sold in noncompliance withthe Canadian Food and Drugs Act. We are currently seeking regulatory approvalsfor some of our products. Regulatory approvals may not be received and receiptof such approvals may be subject to significant delays.

 

Some of our products are subject to government regulation under theCanadian Controlled Drugs and Substances Act and the regulations thereunder(the “CDSA”), which includes requirements for licenses of the factory, approvedsecurity, a qualified person in charge of the factory and detailed recordkeeping in connection with the manufacturing of controlled substances. The lossof a license or the failure to meet any of these requirements would adverselyaffect the ability to continue to manufacture and to sell products containingcontrolled substances.

 

Our Natural Health Products (NHP) require regulatory approval in theform of a DIN-HM or NPN issued by Health Canada. Approvals are based on formulationand evidence of safety and efficacy. All of our products in the NHP categorymust comply with the Good Manufacturing Practices and Site Licensingrequirements per the Natural Health Product Regulations under the Canadian Foodand Drugs Act.

 

In addition, we cannot predict whether new legislation or regulationgoverning our activities will be enacted by legislative bodies or promulgatedby agencies regulating our activities, or what the effect of any suchlegislation or regulation on our business would be. Any such developmentscould, 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 legislationor regulation, including changes to existing laws and regulations, could have amaterial adverse effect on our financial position, results of operations orcash flows.

 

*We depend on a limited number of customersfor most of our net sales and the loss of one or more of these customers couldreduce our net sales.*

 

In fiscal 2005, we had approximately 50 active U.S. customers and ourtwo largest customers accounted for approximately 43.1% and 20.4%, respectively,of our gross sales. Our top 10 customers, in the aggregate, accounted forapproximately 84.5% of our gross sales for fiscal 2005. Retail customers in ourindustry do not generally offer or enter into long-term sales contracts withtheir suppliers. Consequently, we do not have long-term sales contracts withmost of our retail customers. Should our relationship with one or more of ourmajor customers change adversely, the resulting loss of business could have amaterial adverse effect on our financial position, results of operations orcash flows. In addition, if one or more of our major customers substantiallyreduced their volume of purchases from us, it could have a material adverseeffect on our financial position, results of operations or cash flows.Furthermore, the impact of retailer consolidation could have an adverse impacton future sales growth. Should one of our major customers encounter financialdifficulties, the exposure on uncollectible receivables and unusable inventorycould have a material adverse effect on our financial position, results ofoperations or cash flows.

 

*A significant, unexpected disruption ofoperations at our facilities could adversely affect our financial position,results of operations or cash flows.*

 

We operate three U.S. manufacturingfacilities, one manufacturing, packaging and distribution facility and onesales, packaging and distribution facility, located in California, NorthCarolina and South Carolina. We also operate manufacturing, packaging anddistribution facilities located in Manitoba, Canada. The primary manufacturingfacilities for our VMS and OTC products are in California, North Carolina andSouth Carolina. A significant, unexpected disruption at any of our facilitiescould have a material adverse effect on our financial position, results ofoperations or cash flows.

 

*Our industry is highly competitive and pricecompetition could diminish our sales volumes and revenues and our grossprofits.*

 

The market for our products is highly competitive. We compete withother VMS and OTC pharmaceuticals manufacturers, including national brandcompanies and generic prescription companies. Among other factors, competitionamong these manufacturers is based upon price. If one or more manufacturerssignificantly reduce their prices in an effort to gain market share, ourfinancial position, results of operations or market position could bematerially adversely affected. Some of our

 

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competitors, particularly manufacturers of nationally advertised brandname 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 thesecompanies could seek to compete more directly with us by manufacturing storebrand products or by significantly lowering the prices of their national brandproducts. Due to the high degree of price competition, we have not always beenable to fully pass on cost increases to our customers. The inability to pass onfuture cost increases, the impact of direct store brand competitors and theimpact of national brand companies lowering prices of their products ordirectly operating in the store brand market could have a material adverseeffect 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 otherchannels such as health food stores, direct mail and direct sales, our productsmay face competition from such alternative channels if more customers utilizethese channels of distribution to obtain VMS products. We have evaluated, andwill continue to evaluate, the products and product categories in which we dobusiness. Future product line extensions, or deletions, could have a material adverseeffect on our financial position, results of operations or cash flows.

 

*Our inability to continue to execute ourbusiness plan could adversely affect our business*.

 

Our competitive strengths include our reputation for supplying qualityproducts, low-cost focus, sales and marketing strategies (including the widerange of products offered), and our customer service commitment (includingadaptability to customer needs and speed of delivery). If we are unable, forany reason, to continue to control manufacturing costs or maintain our othercompetitive strengths, we may not be able to continue to execute our businessplan, 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 fornew products could adversely affect our financial position, results ofoperations or cash flows.*

 

The industry we serve is characterized by rapid and frequent changes indemand for products and new product introductions. Some of our competitors mayinvest more heavily in research and/or product development than we do. Thesuccess 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 insufficient 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 thechanging needs of our customers in a timely manner, some of our products couldbecome obsolete, our sales could suffer, and we could lose market share, whichcould have a material adverse effect on our financial position, results ofoperations or cash flows.

 

*We rely on third-party suppliers for someimportant ingredients and products that we cannot manufacture.*

 

We purchase from third-party suppliers some important ingredients andproducts that we cannot manufacture. We currently have supply agreements withseveral suppliers of most of these ingredients and products, and our purchasedmaterials are generally available from numerous sources. However, in someinstances, including for one of our top 10 raw materials, we purchase only froma single source. Furthermore, our suppliers and vendors may not provide theseingredients and products in the quantities requested, in a timely manner or ata price we are willing to pay. An unexpected interruption of supply couldmaterially adversely affect our financial position, results of operations orcash flows. One supplier provided approximately 11.4% of the materialspurchased during fiscal 2005, and a loss of this supplier or any of our keysingle source suppliers could have a material adverse effect on our financialposition, results of operations or cash flows.

 

Increased demand for some of our products can occasionally exceed theexisting supply of some important ingredients and components that we do notmanufacture. We generally receive adequate notice of any potential disruptionin the supply of such ingredients and components to ensure sufficient time toprocure alternative sources. An interruption in supply of such ingredients andcomponents that we are unable to remedy could result in our inability todeliver our products on a timely basis, which, in turn, could have a materialadverse effect on our financial position, results of operations or cash flows.

 

In addition, we expect that the FDA may soon adopt its proposed rules ongood manufacturing practices in manufacturing, packaging or holding dietaryingredients and dietary supplements. Our suppliers and vendors may be subjectto, and may not

 

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be able to comply with, these regulations. Even if our suppliers andvendors are able to comply with these regulations, their compliance mayincrease the cost of some ingredients and products.

 

**A rise in raw material prices could increase ourproduct costs and dilute our margins.**

 

Raw materials account for a significant portion of our manufacturingcosts.  We are exposed to risks in theraw materials market, which include limited supply of key rawmaterials and material fluctuations in pricing.  We have encountered material fluctuations inthe pricing of key raw materials in the past such as glucosamine andchondroitin.  Consequently, the price ofkey raw materials may not remain relatively constant and product costscould increase significantly if raw material prices increase by amountssubstantially above current prices, which would dilute our margins andadversely affect our profitability.  Wehave not always in the past been, and may not in the future always be, able toraise customer prices quickly enough to fully offset the effects of anyincrease in raw material prices.

 

*If we are unable to protect our intellectualproperty rights, our ability to compete could be negatively impacted*.

 

Our  ability to competeeffectively depends in part upon our rights in the trademarks, designs,processes, technologies and materials owned by, used by or licensed to us. Themarket for our products depends to some extent upon the goodwill associatedwith our trademarks and trade names.

 

Although we attempt to protect our trademarks and other intellectualproperty in the United States and in the foreign countries in which we operatethrough a combination of trademark, patent and trade secret laws andnondisclosure agreements, these protections may be insufficient. In addition, becauseof the differences in foreign trademark, patent and other intellectual propertylaws, our intellectual property rights may not receive the same protection inforeign countries as they would in the United States.

 

Other parties may infringe our intellectual property rights and maythereby dilute our brands in the marketplace. We may not always be successfulin protecting or enforcing our intellectual property rights against competitorsor other challenges. Litigation may be required to protect our intellectualproperty rights; the accompanying costs of time and money may be substantial. Asuccessful claim of trademark, patent or other intellectual propertyinfringement against us could prevent us from manufacturing or sellingproducts, 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 nationallybranded products with which our products are comparable. In addition, theformulations for our store brand products are comparable to the national brandswith which they compete. We have received letters from other companies allegingthat our trademarks, trade dress and/or patents have infringed theirintellectual property. Although we are not currently involved in litigation ofsuch matters, we could be subject to legal actions in the future.

 

*The unfavorable resolution of pending productliability claims or of any additional product liability claims brought in thefuture could have a material adverse effect on our financial position, resultsof operations or cash flows.*

 

As a manufacturer of products designed for human consumption, we aresubject to product liability claims if the use of our VMS products is allegedto have resulted in injury. Our VMS products consist of vitamins, minerals,herbs and other ingredients that are classified as foods or dietary supplementsand are not subject to pre-market regulatory approval in the United States. OurOTC products are subject to strict FDA regulations. We have in the past beenand are currently subject to various product liability claims and may besubject to additional claims in the future.

 

There are currently seven pending individual product liabilitycomplaints filed against us and other defendants regarding allegations ofdamages sustained from ingestion of products containing phenylpropanolamine (“PPA”). Prior to the FDA revising its opinionregarding PPA in November 2000, we manufactured cold remedy products anddiet aids that contained PPA. One of the seven PPA claims involve products thatwere neither manufactured nor distributed by us.

 

A supplier of chocolate laxatives to us, which also manufactures itsown national brand laxatives, has been served with many complaints regardingproduct liability. The complaints allege a variety of injuries including bowelimpaction, dependence and colon issues. Pursuant to our supply agreement, thesupplier has asked us for indemnification regarding 46 of the individualcomplaints 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 distributeproducts containing kava kava.

 

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In addition, on February 6, 2004, the FDA issued a regulationprohibiting the sale of dietary supplements containing ephedrine alkaloids (“ephedra”).We and some of our predecessors have sold products containing ephedra. Althoughseveral claims have been filed against other manufacturers and distributors ofproducts containing ephedra, the only complaint against us concerns a productthat was not manufactured by us. Other claims may be filed against us in the future.In addition, we briefly manufactured products containing bitter orange, anephedra alternative.

 

Two other product liability complaints have been filed against us. Thefirst involves women’s laxative tablets allegedly to have been expired and thesecond claim alleges the erroneous dispensation of acetylsalicylic acid(aspirin) in lieu of acetaminophen with codeine.

 

The unfavorable resolution of any of these pending product liabilityclaims or of any additional product liability claims brought in the futurecould have a material adverse effect on our financial position, results ofoperations or cash flows if the judgments awarded in such cases exceed ourinsurance coverage. Since June 2004, we no longer have product liabilitycoverage for new claims related to the use of PPA. Product liability insurancemay not continue to be available to us at an economically reasonable cost andthe coverage of these policies may not be adequate to cover liability incurredby us in respect of product liability claims. If we do not have adequateinsurance, product liabilities relating to our products could have a materialadverse effect on our financial position, results of operations or cash flows.For more information regarding our product liability claims, see “Item 3— LegalProceedings.”

 

*Product recalls costs could hurt ourbusiness.*

 

The FDA or Health Canada may take action with respect to any of ourproducts that it deems fall within its jurisdiction. These actions couldrequire us to change our product labeling or remove a particular product fromthe market. Any future recall or removal would result in additional costs tous, and could give rise to product liability litigation, either of which couldbe material. We cannot predict whether the FDA or Health Canada will takeaction with respect to any of our products and any such product recalls orremovals could have a material adverse effect on our financial position,results of operations or cash flows.

 

*We have limited long-term human consumptionexperience for some products; if adverse reactions from long-term consumptionof these products occur, we could be subject to product liability claims.*

 

Some of our products contain ingredients which do not have longhistories of human consumption, and our products may not have the effectsintended. Previously unknown adverse reactions resulting from the long-termhuman consumption of these ingredients could occur. If our products are allegedto have resulted in injury or death, we could be subject to product liabilityclaims, which could have a material adverse effect on our financial position,results of operations or cash flows. We are currently party to several productliability claims alleging injury or death from the use of our products. See “—Theunfavorable resolution of pending product liability claims or of any additionalproduct liability claims brought in the future could have a material adverseeffect on our financial position, results of operations or cash flows.”

 

*We depend on key personnel for our currentand future performance.*

 

The operation of our business requires managerial and operationalexpertise. Our future success depends to a significant degree upon thecontinued contributions of our senior management, many of whom would bedifficult to replace. We do not have employment contracts with several of ourexecutive officers, including our Chief Executive Officer and our President.If, for any reason, key personnel do not continue to be active in ourmanagement, such loss could have a material adverse effect on our financialposition, results of operations or cash flows.

 

*Rising insurance costs and changes in theavailability of insurance could have a material adverse effect on our financialposition, results of operations or cash flows.*

 

We maintain insurance, includingproperty, 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 onour financial position, results of operations or cash flows depending on thenature of the loss and the level of insurance coverage. We cannot predictwhether deductible or retention amounts will increase or whether coverages willbe reduced in the future. For example, since June 2004, we no longer haveproduct liability coverage for new claims related to the use of PPA.

 

15

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Our operating cash flow has been impacted by rising insurance costs.The cost to obtain all types of insurance continues to increase throughout thenation due to circumstances beyond our control. A continued trend of risinginsurance costs could have a material adverse effect on our financial position,results of operations or cash flows.

 

*Our 2002 restructuring could result insignificant tax exposures.*

 

In April 2002, we underwent a restructuring under Chapter 11 ofthe Bankruptcy Code. As part of the restructuring, we and our affiliatesundertook some transactions which we believe should qualify as tax-free andshould not have resulted in recognition of any gain or loss by us or ouraffiliates. If, however, such transactions were ultimately determined not to betax-free, we could be required to pay a substantial amount of U.S. federalincome tax and interest, which could have a material adverse effect on ourfinancial position, results of operations or cash flows.

 

*Our substantial level of indebtedness couldadversely affect our financial condition and prevent us from fulfilling ourobligations on the Notes.*

 

We have substantial indebtedness. As ofMarch 26, 2005, we had approximately $396.5 million of total indebtedness.In addition, subject to restrictions in the indenture and our New CreditFacility, we may incur additional indebtedness. In particular, as of March 26,2005, we have $38.0 million of additional borrowing capacity under therevolving portion of our New Credit Facility, net of $12.0 million ofoutstanding letters of credit.

 

Our high level of indebtedness could haveimportant 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 substantialportion of our cash flow from operations to interest and principal payments onour indebtedness, thereby reducing the availability of our cash flow for otherpurposes, 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 theinterest rate environment because the New Credit Facility is at a variable rateof interest; and

•limit our ability to borrow additional funds.

 

We expect to obtain the money to pay our expenses and to pay theprincipal and interest on the Notes, our New Credit Facility and other debtfrom cash flow from our operations and from additional loans under our NewCredit Facility. Our ability to meet our expenses thus depends on our futureperformance, which will be affected by financial, business, economic and otherfactors. We will not be able to control many of these factors, such as economicconditions in the markets where we operate and pressure from competitors. Wecannot be certain that our cash flow will be sufficient to allow us to payprincipal and interest on our debt (including the Notes) and meet our otherobligations. If we do not have enough money, we may be required to refinanceall or part of our existing debt (including the Notes), sell assets or borrowmore 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 CreditFacility and the indenture, may restrict us from adopting any of thesealternatives. The failure to generate sufficient cash flow or to achieve suchalternatives could significantly adversely affect the value of the Notes andour ability to pay principal of and interest on the Notes.

 

*The right of holders of Notes to receivepayments 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 paymentto all of our and the guarantors’ senior debt, including our New CreditFacility. As a result, upon any distribution to our creditors or the creditorsof the guarantors in a bankruptcy, liquidation or reorganization or similarproceeding relating to us or the guarantors or our or their property, theholders of senior debt will be entitled to be paid in full in cash before anypayment may be made on these Notes or the subsidiary guarantees. In thesecases, we and the subsidiary guarantors may not have sufficient funds to payall of our creditors, and holders of Notes may receive less, ratably, than theholders of senior debt and, due to the turnover provisions in the indenture,less, ratably, than the holders of unsubordinated obligations, including tradepayables. In addition, all payments on the Notes and the guarantees will beblocked in the event of a payment default on designated senior debt and may beblocked for up to 179 consecutive days in the event of specified non-paymentdefaults on designated senior debt.

 

As of March 26, 2005, the Notes and the guarantees aresubordinated to $246.5 million of senior debt, and $38.0 million is availablefor borrowing as additional senior debt under the revolving portion of our NewCredit Facility, net of $12.0 million

 

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of outstanding letters of credit. We are permitted to incur substantialadditional indebtedness, including senior debt, in the future under the termsof the indenture.

 

*The indenture for the Notes and our NewCredit Facility impose significant operating and financial restrictions, whichmay prevent us from capitalizing on business opportunities and taking someactions.*

 

The indenture for the Notes and our New Credit Facility imposesignificant operating and financial restrictions on us. These restrictionslimit the ability of us and our subsidiaries to, among other things, incuradditional indebtedness, make investments, sell assets, incur liens, enter intoagreements restricting our subsidiaries’ ability to pay dividends, or merge orconsolidate. In addition, our New Credit Facility requires us to maintainspecified financial ratios. These covenants may adversely affect our ability tofinance our future operations or capital needs or to pursue available businessopportunities. A breach of any of these covenants or our inability to maintainthe required financial ratios could result in a default under the relatedindebtedness. If a default occurs, the relevant lenders could elect to declarethe indebtedness, together with accrued interest and other fees, to beimmediately due and payable and proceed against any collateral securing thatindebtedness.

 

*Claims of creditors of our non-guarantorsubsidiaries will generally have priority with respect to the assets andearnings of these subsidiaries over the claims of holders of the Notes.*

 

Our foreign subsidiaries are not guaranteeing the Notes. Claims ofcreditors of the non-guarantor subsidiaries, including trade creditors, securedcreditors and creditors holding indebtedness, and claims of preferredstockholders (if any) of the non-guarantor subsidiaries, will generally havepriority with respect to their assets and earnings over the claims of creditorsof our company, including holders of the Notes, even if the obligations of thesubsidiaries do not constitute senior indebtedness, except to the extent thatthe issuer is itself recognized as a creditor of the subsidiary, in which casethe claims of the issuer would still be subordinate to any security in theassets of the subsidiary and any indebtedness of the subsidiary senior to thatheld by the issuer. As of March 26, 2005, our non-guarantor subsidiarieshad $13.2 million of liabilities (including trade payables) outstanding.

 

*We may not be able to purchase the Notes upona change of control.*

 

Upon the occurrence of a “change of control,” as defined in theindenture, each holder of the Notes will have the right to require us topurchase the Notes at a price equal to 101% of the principal amount, togetherwith any accrued and unpaid interest. Our failure to purchase, or give noticeof 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. Inaddition, a change of control may constitute an event of default under our NewCredit Facility. A default under our New Credit Facility would result in anevent of default under the indenture if the lenders accelerate the debt underour New Credit Facility.

 

If a change of control occurs, we may not have enough assets to satisfyall obligations under our New Credit Facility and the indenture related to theNotes. Upon the occurrence of a change of control, we could seek to refinancethe indebtedness under our New Credit Facility and the Notes or obtain a waiverfrom the lenders or holders of the Notes. We may not be able to obtain a waiveror 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 theNotes.*

 

The Golden Gate Investors and the North Castle Investors each own orcontrol 49.6% (46.7% including our delayed delivery share awards) of the votingpower of the outstanding shares of our new parent company. The Golden GateInvestors and the North Castle Investors effectively control the outcome ofmatters requiring a stockholder vote, including the election of directors.Moreover, under the terms of a stockholders agreement, the Golden GateInvestors and the North Castle Investors possess approval rights over somesignificant transactions that may be pursued by us, including mergers or sales.

 

The interests of the Golden Gate Investors or the North CastleInvestors could conflict with the interests of holders of the Notes. Forexample, if we encounter financial difficulties or are unable to pay our debtsas they mature, the interests of the Golden Gate Investors or the North CastleInvestors might conflict with the interests of holders of the Notes. The GoldenGate Investors or the North Castle Investors may also have an interest inpursuing acquisitions, divestitures, financings or other transactions that, intheir judgment, could enhance their equity investments, even though suchtransactions might involve risks to the holders of the Notes.

 

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*The Notes and guarantees may be voided underspecific legal circumstances.*

 

The Notes are guaranteed by all of our existing and future domesticrestricted subsidiaries. The Notes and guarantees may be subject to reviewunder U.S. federal bankruptcy law and comparable provisions of state fraudulentconveyance laws if a bankruptcy or reorganization case or lawsuit is commencedby or on behalf of our or one of a guarantor’s unpaid creditors. Under theselaws, if a court were to find in such a bankruptcy or reorganization case orlawsuit that, at the time the issuer of Notes incurred the debt evidenced bythe Notes or any guarantor issued a guarantee of the Notes:

 

• it received less than reasonablyequivalent value or fair consideration for issuing the Notes or the guarantee,as applicable, and at the time:

• it was insolvent or rendered insolventby reason of issuing the Notes or the guarantee, as applicable;

• it was engaged, or about to engage, ina business or transaction for which its remaining unencumbered assetsconstituted unreasonably small capital to carry on its business;

• it intended to incur, or believed thatit would incur, debts beyond its ability to pay as they mature;

• it was a defendant in an action formoney damages, or had a judgment for money damages docketed against it if, ineither 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 theguarantee, as applicable, subordinate the Notes or the guarantee of the Notes,as applicable, to other debt or take other action detrimental to the holders ofthe Notes.

 

We cannot be sure as to the standard that a court would use todetermine 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 theNotes or the guarantees would not be voided or the Notes or the guaranteeswould not be subordinated to other debt. If such a case were to occur, theguarantee could also be subject to the claim that, since the guarantee wasincurred for our benefit, and only indirectly for the benefit of the guarantor,the obligations of the applicable guarantor were incurred for less than fairconsideration. A court could thus void the obligations under the guarantee,subordinate the guarantee to the applicable guarantor’s other debt or takeother action detrimental to holders of the Notes.

 

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## **ITEM2.**                             PROPERTIES

 

The following table sets forth the location, type of facility, squarefootage and ownership interest in each of our principal facilities. We alsolease 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               |       | 8/31/2013                      |       |
| Carson, CA          |       | HQ, Sales, Packaging, Distribution        |       | 488,000                   |       | Leased               |       | 3/31/2014                      |       |
| Winnipeg,  Manitoba |       | Manufacturing, Packaging,                 |       | 185,000                   |       | Owned                |       | —                         |       |
|                |       | Distribution                              |       | 34,500                    |       | Leased               |       | 8/31/2006                      |       |
| Garden  Grove, CA   |       | Manufacturing                             |       | 165,000                   |       | Leased               |       | 8/31/2011                      |       |
| Wilson, NC          |       | Manufacturing                             |       | 125,000                   |       | Owned                |       | —                         |       |
| Valencia, CA        |       | Manufacturing                             |       | 52,500                    |       | Leased               |       | 8/31/2012                      |       |

 

We believe that our facilities and equipment are generally wellmaintained and in good operating condition.

 

Our active manufacturing and distribution facilities consist ofapproximately 1.7 million square feet of owned or leased plant and officefacilities in six locations, in three U.S. states and one Canadian Province. Weare one of the largest manufacturers in the North American vitamin productsindustry and are capable of packaging over 37.4 billion doses each year.

 

We have four U.S. manufacturing facilities, which are located in GardenGrove, California, Valencia, California, Wilson, North Carolina and Fort Mill,South Carolina. The primary manufacturing facilities for our vitamin productsand OTC pharmaceuticals are our 165,000 square foot Garden Grove plant, our125,000 square foot Wilson plant and our 680,000 square foot Fort Millfacility. In the event of a catastrophic casualty to one of our primary vitaminor OTC tableting facilities, we have the ability to shift production to otherfacilities. In fiscal 2005, we operated two packaging and distributionfacilities 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 a185,000 square foot facility in Manitoba of which approximately 20,000 squarefeet is office space.

 

## **ITEM 3.**                             LEGALPROCEEDINGS

 

We are from time to time engaged in litigation. We regularly review allpending litigation matters in which we are involved and establish reservesdeemed appropriate by management for these litigation matters. However, some ofthese matters are material and an adverse outcome in these matters could have amaterial adverse effect on our financial condition, results of operations orcash flows. Through our insurers and outside counsel, we are vigorouslydefending each of these claims. We maintain insurance against product liabilityclaims, but it is possible that our insurance coverage will not continue to beavailable on terms acceptable to us or that such coverage will not be adequatefor liability actually incurred.

 

**Product Liability**

 

There are currently seven pending individual product liabilitycomplaints filed against us and/or our customers alleging damages sustainedfrom ingestion of PPA, a substance that previously was an ingredient in some ofour diet aid and cold remedy products. These complaints were filed between August 9,2001 and November 4, 2003 in both state and federal courts inPennsylvania, New York, Arkansas, Texas and Louisiana. The complaints includeallegations such as death, subarachnoid hemorrhage, aneurysm, intracranialhemorrhage, debilitating neurological injuries and headaches. We previouslymanufactured products that contained PPA, but removed that ingredient from allof our product formulations promptly after the FDA revised their opinionregarding PPA in November 2000. One of the seven PPA claims involveproducts that were neither manufactured nor distributed by us.

 

A supplier of chocolate laxatives to us, which also manufactures itsown 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 hasasked us for indemnification for 46 individual complaints and one class actioncomplaint.

 

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On March 11, 2002, Sarah Althoff and other plaintiffs filed acomplaint against 40 defendants, including us, in the Superior Court of theState of California, County of Los Angeles, alleging business practice violationsin connection with the manufacture, labeling and sale of kava kava products. Weare currently in settlement negotiations in this case. We no longer sellproducts containing kava kava.

 

On April 2, 2002, Phyllis DiCenzo filed a complaint against us andone of our customers in the Court of Common Pleas of Trumbull, Ohio, allegingthat she was injured by metal particles that were negligently included in thecontainer of powdered multi-vitamin product she opened. We received thisproduct in individually sealed containers from our indemnifying supplier, whoseinsurer is defending the action.

 

On January 29, 2002, Eiko Winters filed a complaint against sixother defendants, including us, alleging wrongful death of a relative due toingestion of methylsulfonylmethane (“MSM”). Discovery is currently being conducted in this case.

 

In addition, on February 6, 2004, the FDA issued a regulationprohibiting the sale of dietary supplements containing ephedra. We and some ofour predecessors have sold products containing ephedra. Although claims havebeen filed against other manufacturers and distributors of products containingephedra, no claims have been filed against us to date, but such claims may befiled against us in the future. In addition, we briefly manufactured productscontaining bitter orange, an ephedra alternative.

 

On June 17, 2004, Sandra Knight filed a complaint in the Parish ofAvoyelles in the State of Louisiana against one of our suppliers, one of ourcustomers and us regarding women’s laxative tablets. The plaintiff allegesinjury resulting from ingestion of tablets she alleges was expired whenpackaged. We filed discovery requests along with our denial.

 

Paula Malo filed a complaint against a retailer and an entity fromwhich we purchased substantially all of its assets.  The plaintiff alleged injury as a result ofmisdispensation of acetylsalicylic acid(aspirin) instead of acetaminophen with codeine.  The plaintiff moved to add us as a defendant.

 

**Employment Law**

 

On April 18, 2003, John Sullivan filed a complaint allegingretaliatory firing in the California Supreme Court. All claims in this casewere dismissed on March 23, 2004. The plaintiff has announced the intentto appeal, but no appeal has been filed to date.

 

**Breach of Contract**

 

We filed a complaint against AerChem Inc., Weber DistributionWarehouses Inc. and Namar Company, in the Supreme Court of the State ofCalifornia, County of Orange. The complaint involves our former suppliers’breach of contract and negligence in the mislabeling of raw materials that wereshipped to us. Due to the defendants’ mislabeling, we processed bulk tabletscontaining titanium dioxide instead of zinc oxide, resulting in destruction ofsome raw materials. Our testing methods detected the error and shipment wasaverted, but we estimate that we lost potential profits. This matter wassettled on September 8, 2004, and we were paid a settlement amount.

 

**Intellectual Property**

 

The packaging of some of our branded products identifies nationallybranded products with which our products are comparable. In addition, theformulations for our store brand products are comparable to the national brandswith which we compete. We have received letters from other companies allegingthat our trademarks, trade dress and/or patents have infringed theirintellectual property. We design our packaging and manufacture products toavoid infringing the intellectual property rights of other companies.

 

In December 2003, Bausch & Lomb Incorporated filed acomplaint against us in the U.S. District Court, Western District of New York,alleging that our manufacture of *ProtectaVision**TM*productsinfringed Bausch & Lomb’s patent for its *PreserVision**®*products. Weentered into a settlement agreement on February 2004, which provided thatwe will no longer sell *ProtectaVision**TM*products after July 2004.  We have complied fully with the terms of thissettlement.

 

On September 5, 2003, we filed a complaint for declaratoryjudgment against Cytodyne Technologies, Inc. in the U.S. District Court,Central District of California. Our complaint was filed in response to a letterfrom Cytodyne alleging that our manufacture of *Slimadrine**®*infringedCytodyne’s patent, trademark and trade dress regarding their *Xenadrine**®*product. We

 

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have entered into a settlement agreement with one Cytodyne entity, butare awaiting approval of the bankruptcy court regarding settlement with the tworemaining Cytodyne entities that filed for Chapter 11 bankruptcy protection in October 2003.

 

We purchased soy isoflavones from a supplier that is involved inlitigation with a competing soy supplier regarding conflicting method and usepatents owned by or licensed to the two suppliers. One of our competitors hasbeen named as a defendant. We manufacture three (3) products that containsoy isoflavones.

 

From time to time, we are involved in other various legal proceedingsarising in the ordinary course of our business operations, such as personalinjury claims, employment matters, intellectual property and contractualdisputes.

 

## **ITEM 4.**                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

 

There were no matters submitted to a vote of security holders duringthe fourth quarter of fiscal 2005.

 

**PART II**

 

## **ITEM 5.**                             MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

 

There is no trading market for our Common Stock. All of the outstandingshares of our Common Stock are held by Leiner Holdings Corp. We did not pay anydividends in fiscal 2005.

 

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## **ITEM 6.**                             SELECTEDFINANCIAL DATA

 

The following table presents selected historical financial data derivedfrom our consolidated financial statements. This data should be read inconjunction with Item 7. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and Item 8. “Financial Statements andSupplementary Data.”  Effective fiscal2003, 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 yearsended March 29, 2003, March 27, 2004 and March 26, 2005 werecomprised of 52-week periods.

 
| ** **                                                                                        | ** ** | **Year Ended**             | ** **     |
|---------------------------------------------------------------------------------------------------|------------|----------------------------|----------------|
| ** **                                                                                        | ** ** | **March 31,  2001**   | ** **     | **March 31,  2002** | ** ** | **March 29,  2003 (1)** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| ** **                                                                                        | ** ** | **(dollars in thousands)** | ** **     |
| **Consolidated  Statement of Operations Data:**                                                   |       |                       |           |   |   |   |   |   |   |   |   |
| Net sales                                                                                         |       | $                          | 600,616        |   | $ | 585,625 |   | $ | 574,281 |   | $ | 661,045 |   | $ | 684,901 |   |
| Cost of  sales                                                                                    |       | 560,278                    |           | 467,047 |   | 430,090 |   | 486,554 |   | 512,871 |   |
| Gross profit                                                                                      |       | 40,338                     |           | 118,578 |   | 144,191 |   | 174,491 |   | 172,030 |   |
| Marketing,  selling and distribution expenses                                                     |       | 68,985                     |           | 54,110 |   | 48,600 |   | 56,448 |   | 58,532 |   |
| General and  administrative expenses                                                              |       | 48,755                     |           | 59,119 |   | 43,931 |   | 41,041 |   | 34,134 |   |
| Research and  development expenses                                                                |       | 9,382                      |           | 6,223 |   | 5,487 |   | 5,670 |   | 5,299 |   |
| Amortization  of goodwill and other intangibles                                                   |       | 5,610                      |           | 6,682 |   | 1,585 |   | 447 |   | 250 |   |
| Restructuring  charges                                                                            |       | 9,761                      |           | 4,440 |   | (245 | ) | — |   | — |   |
| Recapitalization  expenses.                                                                       |       | —                     |           | — |   | — |   | — |   | 87,982 |   |
| Other  operating expense (income) (2)                                                             |       | (18,426                    | )              | (27,446 | ) | (77,708 | ) | 1,528 |   | 2,386 |   |
| Operating  income (loss)                                                                          |       | (83,729                    | )              | 15,450 |   | 122,541 |   | 69,357 |   | (16,553 | ) |
| Loss from  investment in joint venture                                                            |       | 713                        |           | 274 |   | — |   | — |   | — |   |
| Interest  expense, net                                                                            |       | 35,947                     |           | 34,951 |   | 18,809 |   | 18,954 |   | 32,346 |   |
| Income  (loss) before income taxes                                                                |       | (120,389                   | )              | (19,775 | ) | 103,732 |   | 50,403 |   | (48,899 | ) |
| Provision  for (benefit from) income taxes                                                        |       | (1,487                     | )              | (10,248 | ) | 15,587 |   | 11,347 |   | (987 | ) |
| Income  (loss) before extraordinary item and cumulative effect of change in accounting  principle |       | (118,902                   | )              | (9,527 | ) | 88,145 |   | 39,056 |   | (47,912 | ) |
| Extraordinary  gain, net                                                                          |       | —                     |           | — |   | 68,106 |   | — |   | — |   |
| Cumulative  effect of change in accounting principle, net                                         |       | (3,485                     | )              | — |   | (10,521 | ) | — |   | — |   |
| Net income  (loss)                                                                                |       | (122,387                   | )              | (9,527 | ) | 145,730 |   | 39,056 |   | (47,912 | ) |
| Accretion on  preferred stock                                                                     |       | —                     |           | — |   | (8,083 | ) | (12,105 | ) | (39,212 | ) |
| Net income  (loss) attributable to common shareholders                                            |       | $                          |  (122,387 | ) | $ |  (9,527 | ) | $ |  137,647 |   | $ |  26,951 |   | $ |  (87,124 | ) |
| **Other  Financial Data:**                                                                        |       |                       |           |   |   |   |   |   |   |   |   |
| Cash flow  from (used in) operating activities                                                    |       | $                          | 19,956         |   | $ | 31,348 |   | $ | 88,190 |   | $ | 38,448 |   | $ | (39,230 | ) |
| Cash flow  from (used in) investing activities                                                    |       | (26,600                    | )              | 209 |   | (9,629 | ) | (13,857 | ) | (21,310 | ) |
| Cash flow  from (used in) financing activities                                                    |       | 32,858                     |           | (37,791 | ) | (82,851 | ) | (9,834 | ) | 40,867 |   |
| Capital  expenditures                                                                             |       | 8,083                      |           | 1,325 |   | 5,648 |   | 10,413 |   | 17,991 |   |
| EBITDA (3)                                                                                        |       | (57,645                    | )              | 44,329 |   | 199,777 |   | 84,025 |   | (2,831 | ) |
| **Consolidated  Balance Sheet Data (as of end of period):**                                       |       |                       |           |   |   |   |   |   |   |   |   |
| Cash and  cash equivalents                                                                        |       | $                          | 27,788         |   | $ | 21,236 |   | $ | 17,547 |   | $ | 33,824 |   | $ | 16,951 |   |
| Working  capital (4)                                                                              |       | 84,730                     |           | 70,773 |   | 102,350 |   | 133,791 |   | 133,131 |   |
| Total assets                                                                                      |       | 402,988                    |           | 333,460 |   | 337,529 |   | 387,727 |   | 416,798 |   |
| Total debts                                                                                       |       | 374,382                    |           | 336,287 |   | 174,630 |   | 171,006 |   | 396,526 |   |
| Series A  redeemable preferred stock                                                         |       | —                     |           | — |   | 28,083 |   | 40,188 |   | — |   |
| Shareholders’  equity (deficit)                                                              |       | (117,934                   | )              | (127,649 | ) | 23,183 |   | 51,014 |   | (122,974 | ) |

 

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(1) We consummated a plan of reorganization under Chapter 11 ofthe U.S. Bankruptcy Code and emerged from court protection on April 19,2002.

(2) Other operating expense (income) includes $24,298, $40,778 and$98,380 in fiscal 2001, 2002 and 2003, respectively, representing settlementawards received in connection with an antitrust suit against some of our rawmaterial suppliers, net of legal and consulting fees and other costs ofapproximately $4,300, $9,930 and $19,186, respectively.

 

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(3) EBITDA is defined as income (loss) before income taxes,interest expense, net and depreciation and amortization. EBITDA should not beconsidered as an alternative to, or more meaningful than, amounts determined inaccordance with GAAP including: (a) operating income (loss) as anindicator of operating performance or (b) cash flows from operations as ameasure of liquidity. EBITDA is presented as additional information because webelieve it may be useful to investors as an indicator of our ability to serviceand incur indebtedness and a useful measure of our operating performance. EBITDAis not calculated identically by all companies, and, therefore, thepresentation in this prospectus may not be comparable to similarly titledmeasures of other companies. The following table represents a reconciliation ofEBITDA to net income (loss), a GAAP measure:

 
| ** **                                 | ** ** | **Year Ended**             | ** ** |
|--------------------------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | **March 31,  2001**   | ** ** | **March 31,  2002** | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
|                                       |       |                       |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                         |       | $                          | (122,387   | ) | $ | (9,527 | ) | $ | 145,730 |   | $ | 39,056 |   | $ | (47,912 | ) |
| Interest  expense, net                     |       | 35,947                     |       | 34,951 |   | 18,809 |   | 18,954 |   | 32,346 |   |
| Provision  for (benefit from) income taxes |       | (1,487                     | )          | (10,248 | ) | 15,587 |   | 11,347 |   | (987 | ) |
| Depreciation  and amortization             |       | 30,282                     |       | 29,153 |   | 19,651 |   | 14,668 |   | 13,722 |   |
| EBITDA                                     |       | $                          | (57,645    | ) | $ | 44,329 |   | $ | 199,777 |   | $ | 84,025 |   | $ | (2,831 | ) |

 

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 (4) Fiscal 2001 workingcapital is shown net of $370,705 of debt which was classified as current due toevents of default under the then existing credit agreement.

 

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## **ITEM 7.**                             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

*As used in the management’s discussion andanalysis section of this report, unless the context indicates otherwisethe terms “our company”, “we”, “our”, and “us” refer collectively to LeinerHealth Products Inc. and its subsidiaries (the “Company”); including VitaHealth Products Inc. of Canada (“Vita”), a wholly owned subsidiary. Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our consolidated financialstatements contained elsewhere in this report. Effective fiscal 2003, we changed our reporting period to a 52-week or 53-weekfiscal year, falling on the last Saturday in March each year. Each of thefiscal years ended March 29, 2003, March 27, 2004 and March 26,2005, were comprised of 52-week periods.*

 

**Overview**

 

We are the leading manufacturer of store brand VMS products and thesecond largest supplier of store brand OTC pharmaceuticals in the U.S. FDMCretail market, as measured by U.S. retail sales in 2004. Most of our productsare manufactured for our customers to sell as their own store brands. We havelong-term relationships with leading FDMC retailers and focus on thefastest-growing of these retailers—the mass merchants and warehouse clubs. Inaddition to our primary VMS and OTC products, we provide contract manufacturingservices to consumer products and pharmaceutical companies.

 

We generated 67.0%, 62.7% and 61.2 % of our net sales from VMS productsand 26.0%, 28.9% and 31.2% of our net sales from OTC products in fiscal 2003,2004 and 2005, respectively. Contract manufacturing services accounted for7.0%, 8.3% and 7.6% of our net sales in fiscal 2003, 2004 and 2005,respectively. Our VMS products include multi-vitamins, vitamins C and E, jointcare category, as well as minerals and supplements. Our OTC productsprincipally consist of analgesics, cough, cold and allergy medications anddigestive aids. Most of our products are manufactured for our customers to sellas their own store brands, although we also sell our VMS products under our own*Your Life**®*brand and ourOTC products under our own *PharmacistFormula*® brand.

 

We believe that trends in the VMS and OTC FDMC store brand markets arethe most significant trends impacting our financial performance. We estimatethat over the last 10 years, the VMS FDMC and OTC FDMC markets have grown toapproximately $4.0 billion and $10.7 billion, respectively, as measured by 2004retail sales. Over the same period, we estimate that the VMS FDMC market hasgrown at a compound annual growth rate of approximately 7.9% and the OTC FDMCmarket has grown at a compound annual growth rate of approximately 5.3%. Withinthe VMS FDMC and OTC FDMC markets, store brands have grown faster than nationalbrands. Over the last 10 years, we estimate that the VMS FDMC store brandmarket has grown at a compound annual growth rate of approximately 10.2% andthe OTC FDMC store brand market has grown at a compound annual growth rate ofapproximately 8.0%. This growth in the VMS and OTC FDMC markets is driven by (1) theaging of the U.S. population and the increased life expectancy, (2) theincrease in healthcare costs, which has driven managed care companies andlegislators to seek to enhance the availability of lower cost healthcarealternatives such as OTC drugs and generic drugs, and (3) what we believeis the increasing use by Americans of self-care techniques prior to seeing adoctor. In addition, the growth experienced in the last several years in theVMS FDMC market has also been based on national media attention in regards torecent scientific research suggesting potential health benefits from regularconsumption of some VMS products. However, as has been the case in the past,negative scientific research or publicity concerning the health benefits ofvitamin consumption could adversely impact the growth of the VMS market.

 

We operate under two separate geographical units, one in the UnitedStates and one in Canada. Our U.S. business consists of our U.S. subsidiaries,principally Leiner Health Products, LLC. Our Canadian business consists of VitaHealth Products Inc. (“Vita”).

 

Vita is one of the leading manufacturers of store brand VMS and OTCproducts in Canada. Vita generated 35.7%, 32.2% and 33.4% of its net sales fromVMS products and 62.5%, 66.1% and 65.8% of its net sales from OTC products,respectively, for the fiscal years 2003, 2004 and 2005. Vita’s contractmanufacturing services accounted for 1.8%, 1.7% and 0.8% of its net sales forthe fiscal years 2003, 2004 and 2005, respectively.

 

Vita is located in Winnipeg, Manitoba, where it maintainsmanufacturing, packaging and distribution facilities. For the fiscal years2003, 2004 and 2005, Vita comprised 7.9%, 8.9% and 10.8% of our net sales,respectively.

 

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**General**

 

We generate revenue through the sale of our manufactured products andthe distribution to customers of products manufactured by third parties. Werecognize revenue after all significant obligations have been met,collectibility is probable and when title passes, which is generally uponreceipt of products by the customer. Net sales include provisions for estimateddiscounts, allowances, returns and trade expenses. Consideration paid by us toour customers, such as product placement fees and cooperative advertising, isclassified as a reduction in revenue. Cost of sales includes all directmaterial 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, whichinclude components such as advertising costs, selling costs, warehousing,shipping and handling and (2) general and administrative expenses, whichinclude components such as administrative functions to support manufacturingactivities, 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 the facility consolidation andworkforce reductions described in further detail below under “PrepackagedReorganization in Fiscal Year 2002 and Reengineering.” These charges consistedprincipally of severance costs and lease terminations.

 

**Prepackaged Reorganization in Fiscal Year2002 and Reengineering**

 

In September 1999, raw material suppliers to the vitamin industry,including F. Hoffmann-La Roche Ltd., BASF AG and others, were convicted by theDepartment of Justice for illegally colluding to fix prices. At the time, wehad a high concentration of our sales in vitamins E and C, the raw materialprices of which were illegally inflated by our suppliers. In April 2000, acompetitor drastically lowered prices to gain share from our core customerslargely as a result of the significant reduction in prices for the rawmaterials vitamins E and C. At the same time, we were working our way throughthe higher cartel-priced vitamin C and E inventory on our balance sheet. Thehigher cost of the inventory for the affected products in conjunction witheroding prices drove down sales and profitability. In addition, beginning infiscal 2000, the market for herbal products declined significantly due tonegative publicity that questioned both the efficacy and safety of the productsand entry into the category by many start-up companies that began marketingproducts with questionable quality and advertising claims. As a result ourherbal product sales declined by $46.9 million from fiscal year 2000 to fiscalyear 2001.

 

The difficult operating environment resulted in events of default underour old senior credit facility and our then outstanding senior subordinatednotes, which led us to file a Disclosure Statement and Prepackaged Plan ofReorganization under Chapter 11 of the U.S. Bankruptcy Code on February 28,2002. The Bankruptcy Court confirmed our Plan of Reorganization and we emergedfrom court protection on April 19, 2002. In connection with the financialrestructuring contemplated in the Plan of Reorganization, we received a $20.0million equity infusion and issued Series A redeemable preferred stock.Our old senior credit facility was replaced by a second amended and restatedcredit agreement and our lenders were issued Series B junior convertiblepreferred stock, with a $7.5 million liquidation preference, and our thenoutstanding senior subordinated notes were cancelled in exchange for $15.0million in cash and shares of Series C junior preferred stock, with a $7.0million liquidation preference. As a result of the cancellation of the thenoutstanding senior subordinated notes, an extraordinary gain of $68.1 millionwas recorded in fiscal 2003. In addition, we initiated litigation against theraw material supplier cartel and in fiscal years 2000 through 2003 received anaggregate of $132.3 million in net settlement awards.

 

As a result of the difficult operating environment in fiscal year 2001,we took decisive and significant action to reengineer our business. Weconcentrated our efforts on store brands and providing high quality, low-costmanufacturing and superior service to our largest and fastest-growing FDMCcustomers. In line with this goal, we rationalized more than 80 customers and3,500 SKUs, while redeploying resources to outsource research and developmentand new product development to third parties. While rationalizing lessprofitable SKUs, we diversified our product offering by focusing on corecategories so that today no individual product category represents more than15% of net sales. In an effort to diversify our supplier base, we developed aglobal sourcing initiative that has contributed to purchasing advantages in keyraw materials. By fiscal 2002, we had closed three plants and reduced our staffsize by approximately 24%, eliminating more than 700 positions. Finally, werebuilt our senior management team by adding a new Chief Financial Officer. Theresults of our reengineering efforts are reflected in our record financialperformance in fiscal 2003 and fiscal 2004.

 

**2004 Recapitalization (“Recapitalization”)**

 

On April 15, 2004, Mergeco entered into a recapitalizationagreement 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 newcorporation formed by the Golden Gate Investors and the North Castle Investors,solely for the purpose of completing the Recapitalization. Each share

 

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of the common stock of Mergeco became a share of our common stock. Weare the surviving corporation in the merger. Each holder of our common stockthen exchanged such stock for voting preferred stock of Holdings, a newly formedcompany that became our new parent company. As a result of theRecapitalization, excluding the delayed delivery share awards, the Golden GateInvestors and the North Castle Investors each own or control 49.6% of Holdings.Including delayed delivery share awards made in connection with theRecapitalization, the Golden Gate Investors and the North Castle Investors eachown or control 46.7% of Holdings, and our management and certain formeremployees own equity in Holdings, constituting 6.6% of Holdings. In connectionwith the Recapitalization, Mergeco entered into a new senior credit facility (“NewCredit Facility”), consisting of a $240.0 million term loan, which we refer toas the “new term loan B” and a $50.0 million revolving credit facility (“RevolvingFacility”), under which $5.0 million was borrowed immediately after theRecapitalization by Mergeco. In addition, Mergeco issued $150.0 million of 11%senior subordinated notes due 2012 (“Notes”). Immediately upon consummation ofthe Recapitalization, the obligations of Mergeco under the New Credit Facilityand the Notes were assigned to and assumed by us. The Recapitalization wasaccounted for as a recapitalization of Mergeco which had no impact on thehistorical basis of assets and liabilities as reflected in our condensedconsolidated financial statements.

 

Simultaneously with the initial sale of the 11% senior subordinatednotes due 2012, we entered into a registration rights agreement, under which weagreed to file the Registration Statement with the SEC and to complete anexchange offer.  Under the exchangeoffer, which commenced on September 28, 2004 and expired on October 27,2004, 99.93% of the senior subordinated notes were tendered and exchanged forpublicly registered notes with substantially identical terms.

 

Other operating expense (income) includes settlement awards received inconnection with an antitrust suit against some of our raw material suppliers,net of legal and consulting and other fees. See notes 10 and 14 to our auditedconsolidated financial statements included elsewhere in this report.

 

Results of operations for foreign subsidiaries expressed in functionalcurrencies other than the U.S. dollar are translated using average exchangerates during the year. Assets and liabilities of these foreign subsidiaries aretranslated using the exchange rates in effect at the balance sheet date and theresulting translation adjustments are recognized as a separate component ofshareholders’ equity (deficit). Gains and losses arising from foreign currencytransactions are recognized in the statement of operations as incurred.

 

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**Results of Operations**

 

The following table summarizes our results of operations as apercentage of net sales for the fiscal years 2003, 2004 and 2005.

 
| ** **                                                                                            | ** ** | **Percentage of Net Sales** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                            | ** ** | **Year Ended**              | ** ** |
| ** **                                                                                            | ** ** | **March 29,  2003**    | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Net sales                                                                                             |       | 100.0                       | %          | 100.0 | % | 100.0 | % |
| Cost of  sales                                                                                        |       | 74.9                        |       | 73.6 |   | 74.9 |   |
| Gross profit                                                                                          |       | 25.1                        |       | 26.4 |   | 25.1 |   |
| Marketing,  selling and distribution expenses                                                         |       | 8.5                         |       | 8.5 |   | 8.6 |   |
| General and  administrative expenses                                                                  |       | 7.6                         |       | 6.2 |   | 5.0 |   |
| Research and  development expenses                                                                    |       | 1.0                         |       | 0.9 |   | 0.8 |   |
| Amortization  of other intangibles                                                                    |       | 0.2                         |       | 0.1 |   | — |   |
| Recapitalization  expenses                                                                            |       | —                      |       | — |   | 12.9 |   |
| Other  operating expense (income)                                                                     |       | (13.5                       | )          | 0.2 |   | 0.4 |   |
| Operating  income (loss)                                                                              |       | 21.3                        |       | 10.5 |   | (2.4 | ) |
| Interest  expense, net                                                                                |       | 3.2                         |       | 2.9 |   | 4.7 |   |
| Income  (loss) before income taxes                                                                    |       | 18.1                        |       | 7.6 |   | (7.1 | ) |
| Provision  for (benefit from) income taxes                                                            |       | 2.8                         |       | 1.7 |   | (0.1 | ) |
| Net income  (loss) before extraordinary item and cumulative effect of change in  accounting principle |       | 15.3                        |       | 5.9 |   | (7.0 | ) |
| Extraordinary  gain, net                                                                              |       | 11.9                        |       | — |   | — |   |
| Cumulative  effect of change in accounting principle                                                  |       | (1.8                        | )          | — |   | — |   |
| Net income  (loss)                                                                                    |       | 25.4                        |       | 5.9 |   | (7.0 | ) |
| Accretion on  preferred stock                                                                         |       | (1.4                        | )          | (1.8 | ) | (5.7 | ) |
| Net income  (loss) attributable to common shareholders                                                |       | 24.0                        | %          | 4.1 | % | (12.7 | )% |

 

**Fiscal 2005 Compared to Fiscal 2004**

 

Net Sales were $684.9 million in fiscal 2005, an increase of $23.9million, or 3.6%, from $661.0 million in fiscal 2004.  The increase in net sales for the yearresulted from new product introductions, increases in sales of our joint care productsand strong off-shelf category promotions from our largest customers, partiallyoffset by pronounced product landscape changes caused by product mix within ourVMS category.  The net sales of Vitamin Edecreased by $14.4 million in fiscal 2005 compared to the same period of fiscal2004. Our product mix is moving away from Vitamin E into an increased share ofthe 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 $9.0million, or 1.5% from $602.0 million in fiscal 2004.  The U.S. year-to-year increase for the fiscalyear 2005 was the result of new product sales and promotions, partially offsetby the pronounced product mix changes mentioned above, mainly in the fourthquarter 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.  TheCanadian year-to-year increase for the fiscal year 2005 was the result of newproduct sales of multivitamins as well as improved fulfillment rates on coughand cold products to one of our major customers.

 

Regarding our three principal product categories:

 

•                  Vitamins,minerals and nutritional supplements (“VMS”) products net sales were $419.5million in fiscal 2005, an increase of $5.8 million, or 1.4%, from $413.7million in fiscal 2004.  The VMS categorywas impacted in fiscal 2005 by the launch of new products in the U.S. andCanada as described above, partially offset in the U.S. by the pronouncedproduct mix changes mentioned above.  Weexpect the transition of Vitamin E sales to joint care sales to continue infiscal 2006.

 

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•                  Over-the-counter(“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 wasprimarily attributable to higher sales of analgesic products and the annualizedeffect of the loratadine 10mg launched in fiscal 2004.

 

•                  Contractmanufacturing services net sales were $52.0 million in fiscal 2005, a decreaseof $4.2 million, or 7.4% from $56.2 million in fiscal 2004. The decrease wasprimarily due to a decline in new product sales in fiscal 2005 by our keycontract manufacturing customer.

 

Cost of sales were $512.9 million, or 74.9% of net sales, in fiscal2005, an increase of $26.3 million, or 5.4%, from $486.6 million, or 73.6% ofnet sales, in fiscal 2004. The increase in cost of sales as a percentage of netsales in fiscal 2005 is principally due to the decline in sales of Naproxen andof Vitamin E, a product with an above average margin, the building of marketshare in other key product categories with lower near-term margins, decreasedplant volumes and higher raw material costs in the joint care category. Weexpect continued pressure on margins into fiscal 2006 as those factors continuealong 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. Theimpact of this change resulted in lower cost of sales and higher gross profitof approximately $0.4 million, and the net loss was lower by approximately $0.2million for the period ended March 26, 2005 as a consequence.

 

SG&A, as defined above under “—General,” were $92.7 million, or13.5% 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 drivenby lower compensation, consumer advertising, consultant and outside commissionexpense partly offset by expenditures incurred on management reorganization andfreight expenses. Costs continue to be aggressively controlled by reducing headcount (we eliminated 32 positions in the first quarter and 45 positions in thefourth quarter of fiscal 2005) and monitoring all discretionary costs.  In the second quarter of fiscal 2005, we alsocompleted a number of organizational changes designed to fortify our contractmanufacturing and new product development teams, increase speed to market andreduce costs.

 

R&D expenses were $5.3 million in fiscal 2005, a decrease of $0.4million compared to fiscal 2004 due primarily to lower headcount and temporarylabor expense offset by higher product development and research expenses.

 

Amortization of other intangibles was $0.3 million in fiscal 2005, adecrease of $0.2 million, from $0.4 million in fiscal 2004. The decrease wasprimarily attributable to a lower remaining carrying amount of other intangibleassets in fiscal 2005.

 

The Recapitalization expenses of $88.0 million in fiscal 2005 consistprimarily of compensation expenses related to the in-the-money value of stockoptions and other equity rights issued to certain management personnel of $54.3million, management bonuses of $1.0 million, and expenses incurred inconnection with our capital raising activities of $32.7 million.

 

Other operating expenses were $2.4 million in fiscal 2005, an increaseof $0.8 million compared to fiscal 2004. Other operating expense in fiscal 2005increased primarily due to increase in management fees of $1.7 million offsetby the receipt of $0.8 million from the settlement of a supplier dispute.

 

In fiscal 2005, net interest expense of $32.3 million represents anincrease of $13.4 million, compared to fiscal 2004. The increases in fiscal2005 were primarily due to an increase in our average outstanding indebtednessand the accelerated amortization in the first quarter of fiscal 2005 ofdeferred financing charges related to our old credit facility that were repaidin connection with the Recapitalization.

 

We recorded an income tax benefit for the fiscal year 2005 of $1.0million or a 2.0% effective tax rate compared to a provision of $11.3 millionor a 22.5% effective tax rate in fiscal 2004. The effective tax rate for fiscal 2005 is substantially different fromthe effective tax rate for fiscal 2004 primarily due to certain recapitalizationtransaction costs incurred by us in fiscal 2005.

 

Primarily as a result of factors discussed above, net loss of $47.9million was recorded in fiscal 2005 compared to net income of $39.1 million infiscal 2004. Excluding the Recapitalization expenses of $88.0 million, and therelated 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 tothe Credit Agreement EBITDA of $88.6 million in fiscal 2004. Credit AgreementEBITDA 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) ofmanagement reorganization expenses. Details of the definition 

 

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and calculation of the Credit Agreement EBITDA can be found under “–CovenantRestrictions” and “–Credit Agreement EBITDA” below.

 

**Fiscal 2004 Compared to Fiscal 2003**

 

Net sales were $661.0 million in fiscal 2004, an increase of $86.8million, or 15.1%, from $574.3 million in fiscal 2003. Net sales at Vita were$59.1 million in fiscal 2004, an increase of $13.7 million, or 30.3%, from$45.4 million in fiscal 2003. VMS product net sales were $414.8 million infiscal 2004, an increase of $30.2 million, or 7.8%, from $384.6 million infiscal 2003. The increase was primarily attributable to new product VMS salesand sales growth at core customers, including Wal-Mart, Sam’s Club and Costco,as they continue to grow their share of the VMS FDMC market. OTC product netsales were $191.1 million in fiscal 2004, an increase of $41.7 million, or27.9%, from $149.3 million in fiscal 2003. The increase was primarilyattributable to expansion of the OTC product line, including the successfullaunch of loratadine, and sales growth at core customers, including Wal-Mart,Sam’s Club and Costco. Contract services net sales were $55.2 million in fiscal2004, an increase of $14.9 million, or 36.9%, from $40.3 million in fiscal2003. The increase was primarily attributable to expansion of our key contractmanufacturing customer relationship.

 

Cost of sales were $486.6 million, or 73.6% of net sales, in fiscal2004, an increase of $56.5 million, or 13.1%, from $430.1 million, or 74.9% ofnet sales, in fiscal 2003. This increase is due primarily to the increase innet sales in fiscal 2004. The decrease in cost of sales as a percentage of netsales is principally due to lower production costs resulting from efficienciesachieved in plant operations and lower raw material costs due to leveraging ourpurchasing power and our global sourcing strategy.

 

SG&A, as defined above under “—General,” were $97.5 million infiscal 2004, representing 14.7% of net sales, an increase of $5.0 million, or5.4%, from $92.5 million in fiscal 2003, or 16.1% of net sales. The increase inSG&A in fiscal 2004 was primarily driven by increased expenditures onadvertising of our brands, freight expenses in support of higher sales andconsulting fees related to the Recapitalization. The improvement in SG&A asa percentage of net sales is the result of cost controls implemented during ourreengineering.

 

R&D expenses were $5.7 million in fiscal 2004, an increase of $0.2million, from $5.5 million in fiscal 2003. The increase was primarily relatedto higher expenditures for new product development.

 

Amortization of other intangibles was $0.4 million in fiscal 2004, adecrease of $1.2 million, from $1.6 million in fiscal 2003. The decrease wasprimarily attributable to a lower amount of other intangible assets in fiscal2004.

 

Other operating expense was $1.5 million in fiscal 2004, which includesmanagement fees, offset by other miscellaneous income. Other operating incomewas $77.7 million in fiscal 2003, consisting of antitrust lawsuit settlementsrelated to our claims against the raw material supplier cartel, which wereoffset by legal, consulting fees and other costs, including management fees.See “—Prepackaged Reorganization in Fiscal Year 2002 and Reengineering.”

 

Net interest expense was $19.0 million in fiscal 2004, an increase of$0.1 million, from $18.8 million in fiscal 2003. Borrowings under our termloans and interest rates on the facility were lower in fiscal 2004 compared tofiscal 2003. This decrease was offset by higher interest expense attributableto new capitalized leases entered into in fiscal 2004.

 

The provision for income taxes was $11.3 million in fiscal 2004,compared to $15.6 million in fiscal 2003. Our effective tax rate of 23% forfiscal 2004 was higher than the 15% effective tax rate in fiscal 2003 dueprimarily to the substantial reduction in our valuation allowance in fiscal2003 related to the utilization of net operating loss carryforwards andexclusion from our taxable income of cancellation of indebtedness incomerelated to our reorganization. In fiscal 2004, our effective tax rate was lessthan the statutory tax rate primarily due to the reduction in our valuationallowance related to the tax deductions from compensation expense previouslyrecorded from delayed delivery share awards and due to net operating losscarryovers utilized in Canada.

 

Net income before extraordinary item and cumulative effect of change inaccounting principle was $39.1 million in fiscal 2004, as compared to $88.1million in fiscal 2003. The decrease is primarily as a result of the factorsdiscussed above. Excluding the antitrust settlement of $79.2 million in fiscal2003, net income before extraordinary item and cumulative effect of change inaccounting principle would have been approximately $9.0 million.

 

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**Liquidity and Capital Resources**

 

Our liquidity needs arise primarily from debt service on oursubstantial indebtedness and from the funding of our capital expenditures, ongoingoperating costs and working capital.

 

The following financing transactions (the “Financing Transactions”)were entered into in connection with the Recapitalization:

 

•                  We entered intoour New Credit Facility with several lenders on May 27, 2004. The NewCredit Facility provides for aggregate maximum borrowings of $290.0 millionunder (i) the Term Facility providing for term B loan in an aggregateprincipal amount of $240.0 million and (ii) the Revolving Facilityproviding for up to $50.0 million in revolving loans (including standby andcommercial letters of credit and swingline loans) outstanding at any time.

 

•                  On May 27,2004, after the Recapitalization, we assumed $150.0 million in Notes.

 

•                  The repayment ofall outstanding amounts under our pre-existing senior credit facilities wasmade and commitments under those facilities were terminated.

 

As of March 26, 2005, we had outstanding debt of an aggregateamount of $396.5 million, consisting primarily of $238.8 million in principalamount under the Term Facility, $150.0 million under the Notes and an aggregateamount of $7.7 million under our other debt facilities.

 

Principal and interest payments under the Term Facility and theRevolving Facility, together with principal and interest payments on the Notes,represent significant liquidity requirements for us. We are required to repaythe $238.8 million in term loan outstanding as of March 26, 2005 under theNew Credit Facility by May 27, 2011 with scheduled principal payments of$2.4 million in each of fiscal 2006, fiscal 2009 through fiscal 2011, $3.0million in fiscal 2007, $1.8 million in fiscal 2008 and $224.4 million infiscal 2012. All outstanding revolving credit borrowings under the New CreditFacility will become due on May 27, 2009. We are also required to repaythe $150.0 million of the Notes in fiscal 2013.

 

Borrowings under the New Credit Facility bear interest at a base rateper annum plus an “applicable margin” that is based on our leverage ratio. Wecan choose a base rate of *i)* ABR(Alternate base rate) or *ii)*LIBORfor our Term Facility and Revolving Facility. The ABR rate is determined basedon the higher of federal funds effective rate plus 0.5% or the prime commerciallending rate of UBS AG. The LIBOR rate is determined based on interest periodsof one, two, three or six months. As of March 26, 2005, our averageinterest rates were 5.56% under the New Credit Facility. In addition tospecified agent and up-front fees, the New Credit Facility requires acommitment fee of up to 0.5% per annum of the average daily unused portion ofthe Revolving Facility. The Notes bear interest at a rate of 11% per annum.

 

At March 26, 2005, we had $38.0 million available under ourRevolving Facility. In accordance with our debt agreements, the availabilityunder the Revolving Facility has been reduced by the amount of standby lettersof credit issued of approximately $12.0 million as of March 26, 2005.  These letters of credit are used as securityagainst our lease obligations, inventory purchasing obligations, and anoutstanding note payable.  These lettersof credit expire annually and need extensions each year to various datesthrough 2014.

 

Based upon current levels of operations, anticipated cost-savings andexpectations as to future growth, we believe that cash generated fromoperations, together with amounts available under our Revolving Facility willbe adequate to permit us to meet our debt service obligations, capitalexpenditure program requirements, ongoing operating costs and working capital needs,although no assurance can be given in this regard.  Our future financial and operatingperformance, ability to service or refinance our debt and ability to complywith the covenants and restrictions contained in debt agreements will besubject to future economic conditions and to financial, business and otherfactors, many of which are beyond our control and will be substantiallydependent on the selling prices and demand for our products, raw materialcosts, and our ability to successfully implement our overall business andprofitability strategies.

 

If our future cash flow from operations and other capital resources areinsufficient to pay our obligations as they mature or to fund our liquidityneeds, we may be forced to reduce or delay our business activities and capitalexpenditures, sell assets, obtain additional debt or equity capital orrestructure or refinance all or a portion of our debt, including the Notes, onor before maturity. We cannot assure that we would be able to accomplish any ofthese alternatives on a timely basis or on satisfactory terms, if at all. Inaddition, the terms of our existing and future indebtedness, including theNotes and New Credit Facility, may limit our ability to pursue any of thesealternatives.

 

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**Covenant Restrictions**

 

The New Credit Facility contains various restrictive covenants. Itprohibits us from prepaying other indebtedness, including the Notes, and itrequires us to satisfy financial condition tests and to maintain specifiedfinancial ratios, such as a maximum total leverage ratio, minimum interestcoverage ratio and limitation on capital expenditures. In addition, the NewCredit Facility prohibits us from declaring or paying any dividends andprohibits us from making any payments with respect to the Notes if we fail toperform our obligations under, or fail to meet the conditions of, the NewCredit Facility or if payment creates a default under the New Credit Facility.

 

The indenture governing the Notes, among other things: (1) restrictsour ability and the ability of our subsidiaries to incur additionalindebtedness, issue shares of preferred stock, incur liens, pay dividends ormake other specified restricted payments and enter into some transactions withaffiliates; (2) prohibits specified restrictions on the ability of some ofour subsidiaries to pay dividends or make some payments to us; and (3) placesrestrictions on our ability and the ability of our subsidiaries to merge orconsolidate with any other person or sell, assign, transfer, lease, convey orotherwise dispose of all or substantially all of our assets. The indenturerelated to these Notes and the New Credit Facility also contain variouscovenants that limits our discretion in the operation of our businesses.

 

The financial covenants in the New Credit Facility specify, among otherthings, the following requirements as of the last day of any test period duringany period set forth in the table below:

 
| **Test Period**                                        | ** ** | **Consolidated Indebtedness to  Credit Agreement EBITDA (1)  Leverage Ratio** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| September 25,  2004 – June 25, 2005     |       | 5.25 to 1.00                                                                  |       |
| September 24,  2005 – December 30, 2005 |       | 5.00 to 1.00                                                                  |       |
| March 25,  2006 – June 24, 2006         |       | 4.75 to 1.00                                                                  |       |
| September 30,  2006 – December 30, 2006 |       | 4.50 to 1.00                                                                  |       |
| March 31,  2007                                   |       | 4.25 to 1.00                                                                  |       |
| June 30,  2007 – September 29, 2007     |       | 4.00 to 1.00                                                                  |       |
| December 29,  2007 – March 29, 2008     |       | 3.75 to 1.00                                                                  |       |
| June 28,  2008                                    |       | 3.50 to 1.00                                                                  |       |
| September 27,  2008 – December 27, 2008 |       | 3.25 to 1.00                                                                  |       |
| March 28,  2009 and thereafter                    |       | 3.00 to 1.00                                                                  |       |
|                                                   |       |                                                                          |       |
| ** **                                             | ** ** | **Credit Agreement EBITDA (1)  to Consolidated  Interest Expense Ratio**      | ** ** |
| September 25,  2004 – June 25, 2005     |       | 2.25 to 1.00                                                                  |       |
| September 24,  2005 – December 30, 2006 |       | 2.50 to 1.00                                                                  |       |
| March 31,  2007 – December 29, 2007     |       | 2.75 to 1.00                                                                  |       |
| March 29,  2008 – June 28, 2008         |       | 3.00 to 1.00                                                                  |       |
| September 27,  2008 – December 27, 2008 |       | 3.25 to 1.00                                                                  |       |
| March 28,  2009 and thereafter                    |       | 3.50 to 1.00                                                                  |       |

 

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**Note:**

(1) See “—”Credit Agreement EBITDA” for more information regardingthis term.

 

We are in compliance with all such financial covenants as of March 26,2005.  Our ability to comply in futureperiods with the financial covenants in the New Credit Facility will depend onour ongoing financial and operating performance, which in turn will be subjectto economic conditions and to financial, business and other factors, many ofwhich are beyond our control and will be substantially dependent on the sellingprices and demand for our products, raw material costs, and our ability tosuccessfully implement our overall business and profitability strategies.  If a violation of any of the covenantsoccurred, 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 thisregard.  The New Credit Facility and theindenture governing the Notes have covenants as well as specified cross-defaultor cross-acceleration provisions; failure to comply with these covenants in anyagreement could result in a violation of such agreement which could, in turn,lead to violations of other agreements pursuant to such cross-default orcross-acceleration provisions.

 

31

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The New Credit Facility is collateralized by substantially all of ourassets. Borrowings under the New Credit Facility are a key source of ourliquidity. Our ability to borrow under the New Credit Facility is dependent on,among other things, our compliance with the financial ratio covenants referredto in the preceding paragraphs. Failure to comply with the financial ratiocovenants would result in a violation of the New Credit Facility and, absent awaiver or amendment from the lenders under such agreement, permit theacceleration of all outstanding borrowings under the New Credit Facility.

 

**Credit Agreement EBITDA**

 

The table below sets forth EBITDA as defined in our New CreditFacility, which we refer to as “Credit Agreement EBITDA.” Credit AgreementEBITDA as presented below is a financial measure that is used in our New CreditFacility. Credit Agreement EBITDA is not a defined term under U.S. generallyaccepted accounting principles and should not be considered as an alternativeto income from operations or net income (loss) as a measure of operatingresults or cash flows as a measure of liquidity. Credit Agreement EBITDAdiffers from the term “EBITDA” (earnings before interest expense, income taxexpense, and depreciation and amortization) as it is commonly used.  Credit Agreement EBITDA is calculated byadjusting net income (loss) to exclude interest expense, income tax expense,depreciation and amortization, expenses incurred in connection with theRecapitalization, aggregate amount of all other non-cash items, proceeds frombusiness interruption insurance, management fees, expenses made related to any permittedacquisition, fees and expenses in connection with the exchange of the Notes,expenses incurred to the extent reimbursed by third parties pursuant toindemnification provisions, and non-cash charges that result in an accrual of areserve for cash charges in any future period. In addition, Credit AgreementEBITDA also adjusts net income by all non-cash items increasing consolidatednet income (other than accrual of revenue or recording of receivables). Our NewCredit Facility requires us to comply with a specified debt to Credit AgreementEBITDA leverage ratio and a specified consolidated Credit Agreement EBITDA tointerest expense ratio for specified periods. The specific ratios are set outunder “Liquidity and Capital Resources” above.

 

The calculation of Credit Agreement EBITDA is set forth below (inthousands):

 
| ** **                                 | ** ** | **Year Ended**           | ** ** |
|--------------------------------------------|------------|--------------------------|------------|
| ** **                                 | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Net income  (loss)                         |       | $                        | 39,056     |   | $ | (47,912 | ) |
| Interest  expense, net                     |       | 18,954                   |       | 32,346 |   |
| Provision  for (benefit from) income taxes |       | 11,347                   |       | (987 | ) |
| Depreciation  and amortization             |       | 14,668                   |       | 13,722 |   |
| Recapitalization  expenses (1) (2)    |       | 3,014                    |       | 87,982 |   |
| Non-cash  stock compensation expense (3)   |       | —                   |       | 5 |   |
| Management  fees (4)                       |       | 1,578                    |       | 3,258 |   |
| Credit  Agreement EBITDA (5)               |       | $                        | 88,617     |   | $ | 88,414 |   |

 

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(1)          Representsconsulting, transaction, legal, accounting and other fees associated with the May 2004Recapitalization. Recapitalization expenses for fiscal 2004 were included inthe general and administrative expenses in the consolidated statement ofoperations and in operating activities in the consolidated statement of cashflows. Recapitalization expenses incurred in fiscal 2005 were included as aseparate item in the consolidated statement of operations and in operatingactivities in the consolidated statement of cash flows.

(2)          Recapitalizationexpenses include a correction to increase the previously reported secondquarter amount by $1,186, from $86,170 to $87,356. For the twelve months ended March 26,2005, the $87,982 includes this correction.

(3)          Non-cashcompensation expenses are included in the general and administrative expensesin the consolidated statement of operations and in operating activities in theconsolidated statement of cash flows.

(4)          Managementfees are included in other operating expenses in the consolidated statement ofoperations and in operating activities in the consolidated statement of cashflows.

(5)          CreditAgreement EBITDA is calculated in accordance with the definitions contained inour New Credit Facility as described under “Credit Agreement EBITDA.”

 

32

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**Sources and Uses of Cash**

 

Net cash provided by operating activities totaled $38.4 million and netcash used totaled $39.2 million in fiscal 2004 and fiscal 2005, respectively.The decrease in fiscal 2005 was primarily the result of the Recapitalization inthe first quarter of fiscal 2005.

 

Net cash used in investing activities totaled $13.9 million and $21.3million in fiscal 2004 and fiscal 2005, respectively. The increase was primarilyrelated to an increase in capital expenditures in fiscal 2005 as compared tofiscal 2004.

 

Net cash used in financing activities was $9.8 million and net cashprovided totaled $40.9 million in fiscal 2004 and fiscal 2005, respectively.Net cash used in fiscal 2004 included scheduled repayments and payment ofcontinuation fees under our pre-existing senior credit facilities. Net cashprovided in fiscal 2005 was due primarily to the financing transactions andrelated indebtedness incurred in connection with the Recapitalization, offsetby repayments of existing indebtedness and, to a lesser extent, an increase indeferred financing charges resulting from $15.7 million of deferred financingcharges primarily related to the New Credit Facility and Notes.

 

**Contractual Obligations**

 

We are obligated to make future payments under various contracts suchas debt agreements, capital lease agreements, and operating lease obligations.The following table represents information concerning our contractualobligations and commercial commitments as of March 26, 2005 (inthousands):

 
| ** **                                | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------|------------|
| **Contractual obligations**               | ** ** | **Total**  | ** ** | **Less than  1 year**      | ** ** | **1 to 2  years** | ** ** | **2 to 3  years** | ** ** | **3 to 4  years** | ** ** | **4 to 5  years** | ** ** | **After 5  years** | ** ** |
|                                      |       |       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| New Term B  Loan                          |       | $          | 238,800    |                       | $          | 2,400 |   | $ | 3,000 |   | $ | 1,800 |   | $ | 2,400 |   | $ | 2,400 |   | $ | 226,800 |   |
| Senior  Subordinated Notes                |       | 150,000    |       | —                     |       | — |   | — |   | — |   | — |   | 150,000 |   |
| Industrial  Development Revenue Bond      |       | 4,600      |       | 500                        |       | 500 |   | 500 |   | 500 |   | 500 |   | 2,100 |   |
| Manitoba  Industrial Opportunity Bond     |       | 1,074      |       | 1,074                      |       | — |   | — |   | — |   | — |   | — |   |
| Capitalized  leases                       |       | 2,052      |       | 1,562                      |       | 416 |   | 50 |   | 24 |   | — |   | — |   |
| Operating  lease obligations              |       | 66,179     |       | 12,002                     |       | 9,454 |   | 7,371 |   | 7,085 |   | 7,073 |   | 23,194 |   |
| Consulting  agreement with Mr. Perez |       | 218        |       | 218                        |       | — |   | — |   | — |   | — |   | — |   |
| Total                                     |       | $          | 462,705    |                       | $          | 17,756 |   | $ | 12,770 |   | $ | 10,321 |   | $ | 10,009 |   | $ | 9,973 |   | $ | 402,094 |   |

 

**Critical Accounting Policies and Estimates**

 

*Estimates*

 

Our discussion and analysis of our financial condition and results ofoperations are based on our consolidated financial statements, which have beenprepared in accordance with U.S. generally accepted accounting principles.  The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period.  By their nature, these estimates andjudgments are subject to an inherent degree of uncertainty.  We review our estimates on an on-going basis,including those related to revenue recognition, sales returns and customerallowances, the allowance for doubtful accounts, inventories and relatedreserves, cash flows used to evaluate the recoverability of long-lived assets,certain accrued liabilities, deferred tax assets and litigation.  We base these estimates on historicalexperience and on various other factors that we believe to be reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources.  Theseestimates and assumptions by their nature involve risks and uncertainties, andmay prove to be inaccurate.  In the eventthat any of our estimates or assumptions are inaccurate in any materialrespect, it could have a material effect on our reported amounts of assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the reporting periods.

 

33

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*Revenue Recognition*

 

We record revenue after all significant obligations have been met,collectibility is probable and title has passed, which is generally uponreceipt of products by the customer. Determination of our meeting these criteria is based on our judgmentsregarding collectibility of invoiced amounts and the timing of delivery ofproducts to the customers.  Shouldchanges in conditions cause management to determine that these criteria are notmet for certain future transactions, revenue recognition for any futurereporting periods could be adversely affected. Provisions for sales returns and customer allowances, which are recordedas a reduction to revenues, are based upon historical experience and specificidentification of an event necessitating an allowance and are recorded in theperiod the underlying revenue has been recognized.  Estimates for sales returns and allowancesare highly subjective and require a considerable amount of judgment.

 

*Allowance for Uncollectible Accounts*

 

We maintain reserves for potential credit losses, estimating thecollectibility of customer receivables on an ongoing basis by periodicallyreviewing accounts outstanding over a period of time.  We have recorded reserves for receivablesdeemed to be at risk for collection, as well as a general reserve based onhistorical collections experience.  Aconsiderable amount of judgment is required in assessing the ultimaterealization of these receivables, including the current creditworthiness ofeach customer.  Customer receivables aregenerally unsecured.  If the financialconditions 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 ouroperating results.

 

*Inventories*

 

We state our inventories at the lower of cost or market, with costbeing determined by the first-in, first-out method. We provide reserves forpotentially excess and obsolete inventory and inventory that has aged over aspecified time period based on the difference between the cost of the inventoryand its estimated market value. In estimating the reserve, we consider factorssuch as excess or slow moving inventories, product aging and expiration dating,current and future customer demand and market conditions. During the first quarterended June 26, 2004, we refined our aging based reserve estimation modelby increasing the number of aging categories and revising the reserveestimation percentages applied to the aging categories. We believe that therefined estimation model results in a better estimate of potentially excess andobsolete inventory.

 

*Property, Plant and Equipment*

 

Property, plant and equipment are stated at cost, net of accumulateddepreciation and amortization. Depreciation and amortization are provided using the straight-linemethod, at rates designed to distribute the cost of assets over their estimatedservice lives or for leasehold improvements, the shorter of their estimatedservice lives, or their remaining lease terms. Amortization of assets recorded under capital leases is included indepreciation expense.  Repairs andmaintenance costs are expensed as incurred.

 

*Goodwill*

 

Goodwill represents the excess of the purchase price over the fairvalues of the net assets of acquired entities. On April 1, 2002, we adopted SFAS 142 and we discontinuedamortizing the remaining balances of goodwill as of the beginning of fiscal2003.  All remaining and future acquiredgoodwill 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 fairvalue, most of which are based on projected future cash flows. The estimatesassociated with the goodwill impairment tests are considered critical due tothe judgments required in determining fair value amounts, including projectedfuture cash flows. Changes in these estimates may result in the recognition ofan impairment loss. The required annual testing was performed in the fourthquarter of fiscal 2005 and resulted in no impairment charges for fiscal 2005.

 

*Recoverability of Long-Lived Assets*

 

We review long-lived assets and certain intangibles for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable.  Therecoverability test is performed at the lowest level at which undiscounted netcash flows can be directly attributable to long-lived assets.  The determination of related estimated usefullives and whether or not these assets are impaired involves significantjudgments, related primarily to the future profitability and/or future value ofthe assets.  Changes in our strategicplan and/or market conditions could significantly impact these judgments andcould require adjustments to recorded asset balances.

 

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*Income Taxes*

 

We utilize the liability method of accounting for income taxes as setforth in SFAS No. 109, *Accounting for IncomeTaxes* ("SFAS 109"). Under the liability method, deferredtaxes are determined based on the temporary differences between the financialstatement and tax bases of assets and liabilities using enacted tax rates. Avaluation allowance is recorded when it is more likely than not that some ofthe deferred tax assets will not be realized. We also determine our tax contigenciesin accordance with SFAS No.5, *Accounting forContingencies.* We record estimated tax liabilities to the extent thecontingencies are probable and can be reasonably estimated.

 

**New Accounting Pronouncements**

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts — an amendment of ARB No. 43, Chapter 4” (SFAS 151),which clarifies that abnormal amounts of idle facility expenses, freight,handling costs and wasted materials (spoilage) should be recognized ascurrent period charges. In addition, SFAS 151 requires that allocation offixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. The provisions of SFAS 151 areeffective for inventory costs incurred during fiscal years beginning after June 15,2005. We are reviewing the potential impact of the adoption of SFAS 151 forfiscal 2006.

 

In October 2004, the FASB issued FSP 109-1, “Application of FASBStatement 109, Accounting for Income Taxes, to the Tax Deduction on QualifiedProduction Activities Provided by the American Jobs Creation Act of 2004,”effective tax years beginning after December 31, 2004. The FSP providesguidance on the application of SFAS 109, “Accounting for Income Taxes,” to theprovision within the American Jobs Creation Act of 2004 that provides a taxdeduction on qualified production activities. According to FSP 109-1, thededuction should be accounted for as a special deduction in accordance withStatement 109. We are reviewing the potential impact of the deduction forfiscal 2006.

 

**Forward-looking Statements**

 

This report contains “forward-looking statements” that are subject torisks and uncertainties.  Thesestatements often include words such as “may,” “will,” “should,” “expect,” “plan,”“anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” thenegative of such terms or similar expressions. These statements are only predictions.  In addition to risks and uncertainties noted in this report, there arerisks and uncertainties that could cause our actual operating results to differmaterially from those anticipated by some of the statements made.  Such risks and uncertainties include: (i) slowor negative growth in the vitamin, mineral, supplement or over-the-counterpharmaceutical industry; (ii) adverse publicity regarding the consumptionof vitamins, minerals, supplements or over-the-counter pharmaceuticals; (iii) increasedcompetition; (iv) increased costs; (v) increases in the cost ofborrowings and/or unavailability of additional debt or equity capital; (vi) changesin general worldwide economic and political conditions in the markets in whichwe may compete from time to time; (vii) our inability to gain and/or holdmarket share with our customers; (viii) exposure to and expenses of defendingand resolving product liability claims and other litigation; (ix) ourability to successfully implement our business strategy; (x) our inability tomanage our operations efficiently; (xi) consumer acceptance of our products;(xii) introduction of new federal, state, local or foreign legislation orregulation or adverse determinations by regulators; (xiii) the mix of ourproducts and the profit margins thereon; (xiv) the availability and pricing ofraw materials; and (xv) other factors beyond our control.  We expressly disclaim any obligation toupdate or revise publicly any forward-looking statements, whether as a resultof new information, future events or otherwise.

 

You should carefully consider the risks described above and in Item 1 “Business– Risk Factors”. Any of these risks could materially and adversely affect ourfinancial condition, results of operations or cash flows.

 

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**ITEM 7A.****                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk represents the risk of changes in the value of market risksensitive instruments caused by fluctuations in interest rates and foreignexchange rates. Changes in these factors could cause fluctuations in theresults 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 notuse derivative financial instruments in connection with these market risks.

 

*ForeignExchange Rate Market Risk*

 

We are subject to the risk of foreign currency exchange rate changes inthe conversion from local currencies to the U.S. dollar of the reportedfinancial position and operating results of our non-U.S. based subsidiary. Vitatransacts business in the local currency, thereby creating exposures to changesin exchange rates. We do not currently have hedging or similar foreign currencycontracts. While only a relatively small portion of our business is done inCanada, significant currency fluctuations could adversely impact foreign revenues.However, we do not expect any significant changes in foreign currency exposurein the near future.

 

*InterestRate Market Risk*

 

We are exposed to changes in interest rates on our variable rate debtfacilities. Our New Credit Facility is variable rate debt. On March 26,2005, our total debt was $396.5 million, of which $243.4 million is variablerate debt and $153.1 million is fixed rate debt. Our total annual interestexpense (excluding deferred financing charges), assuming interest rates as theywere at March 26, 2005, would be approximately $30.0 million. A onepercent increase in variable interest rates would increase our total annualinterest expense by $2.4 million. Changes in interest rates do not have adirect impact on the interest expense relating to our remaining fixed ratedebt.

 

**ITEM 8.****                             FINANCIALSTATEMENTS AND SUPPLEMENTAL DATA**

 

The consolidated financial statements, including an index thereto andthe report of Ernst & Young LLP, the Company’s Independent RegisteredPublic Accountants, begin on Page F-1 and are incorporated herein byreference.

 

**ITEM 9.****                             CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None

 

**ITEM 9A.****                    CONTROLSAND PROCEDURES**

 

The Company’s management, with the participation of the Company’s ChiefExecutive Officer and Chief Financial Officer, has evaluated the effectivenessof the Company’s disclosure controls and procedures as of March 26, 2005.Based on that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures were effective as of March 26, 2005. There were no materialchanges in the Company’s internal control over financial reporting during thefourth quarter of fiscal 2005 that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

**ITEM 9B.****       OTHER INFORMATION**

 

None

 

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**PART III**

 

**ITEM 10.****                      DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

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

 

The following is a list of our directors, executive officers and keyemployees as of March 26, 2005.

 
| **Name**                    | ** ** | **Age** | ** ** | **Position**                                                          | ** ** |
|-----------------------------|------------|---------|------------|-----------------------------------------------------------------------|------------|
| Robert M.  Kaminski         |       | 54      |       | Chief  Executive Officer and Vice Chairman of the Board of  Directors |       |
| Gale K.  Bensussen          |       | 58      |       | President  and Director                                               |       |
| Robert K.  Reynolds         |       | 48      |       | Executive  Vice President and Chief Financial Officer                 |       |
| Kevin J.  Lanigan           |       | 58      |       | Executive  Vice President and Corporate General Manager               |       |
| Robert J. La  Ferriere      |       | 55      |       | Executive  Vice President, Sales & Marketing                 |       |
| Charles F.  Baird, Jr. |       | 51      |       | Chairman of  the Board of Directors                                   |       |
| G.V. Prasad                 |       | 44      |       | Director                                                              |       |
| Peter J.  Shabecoff         |       | 42      |       | Director                                                              |       |
| Benjamin B.  James [a]      |       | 47      |       | Director                                                              |       |
| David C.  Dominik           |       | 48      |       | Director                                                              |       |
| Prescott H.  Ashe           |       | 37      |       | Director                                                              |       |
| Jonathan O.  Grad           |       | 31      |       | Director                                                              |       |
| Monty Sharma  *             |       | 40      |       | Director                                                              |       |

 

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* Nominee

 

[a] Effective April 30, 2005, Benjamin James, resigned from theLeiner Board. The Board is expected to approve the nomination of Mr. Sharmaas a new director in their next meeting on June 24, 2005.

 

**Robert M.Kaminski,***Chief Executive Officerand Vice Chairman of the Board of Directors,*has been the ChiefExecutive 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. From1988 to 1992, Mr. Kaminski was Chief Operating Officer of Leiner and from1982 to 1988, he was Vice President–Sales. Mr. Kaminski joined Leiner inJune, 1978 from Procter & Gamble, where he was in Sales Management.

 

**Gale K.Bensussen,***President and Director,*hasbeen a Director of Leiner since June 1992 and President of Leiner since May 1992.Mr. Bensussen was Senior Vice President–Marketing and CorporateDevelopment of Leiner from May 1991 to May 1992. From July 1988to May 1991, Mr. Bensussen was Senior Vice President– Sales andMarketing of Leiner. Mr. Bensussen joined Leiner in 1974.

 

**Robert K.Reynolds,***Executive Vice Presidentand Chief Financial Officer,*has been the Executive Vice Presidentand Chief Financial Officer of Leiner since January 2002. He was ChiefExecutive Officer and Co-Founder of Luxul Corp, a wireless communicationscompany, from 2000 to 2001, Chief Operating Officer and Chief Financial Officerof Weider Nutrition International, Inc., a sports nutrition and VMSmanufacturer, from 1990 to 1999.

 

**Kevin J.Lanigan,***Executive Vice Presidentand Corporate General Manager,*has been Executive Vice President andCorporate General Manager since April 2000. During his 31 years withLeiner, Mr. Lanigan held positions of Executive Vice President and ChiefOperations Officer from 1992 to 2000, Senior Vice President–Operations Planningfrom 1986 to 1992 and Vice President–Operations from 1979 to 1986. Prior tojoining Leiner, Mr. Lanigan held various engineering positions in theaerospace industry.

 

**Robert J.La Ferriere,***Executive Vice President,Sales & Marketing,*has been Executive Vice President, Salesand Marketing since April 2000. He became Senior Vice President–Marketingof Leiner in February 1997 and was a consultant to Leiner from 1996 to1997. Mr. La Ferriere was President and Chief Executive Officer of SlimFast Foods from 1992 to 1996. From 1984 until 1990, Mr. La Ferriere wasfirst Vice President, then Senior Vice President–Purchasing, at Thrifty Drugand Discount Stores.

 

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**Charles F.Baird, Jr.,***Chairman*, hasbeen a Director since October 1997 and Chairman since June 1998. Mr. Bairdis a Managing Director and Founder of North Castle Partners, L.L.C.  He has spent more than 25 years as an investorand partner to CEOs with emphasis on the emerging healthy living and agingmarketplace. Prior to founding North Castle, Mr. Baird served as managingdirector of AEA Investors, Inc. where he was involved in initiating,negotiating, financing, monitoring and exiting principal investments. From 1978to 1989, Mr. Baird worked at Bain & Company, where as anexecutive vice president and North American Management committee member, he wasinvolved in developing strategy and implementing profit improvement initiativesfor companies. From 1975 to 1977, Mr. Baird worked in mergers andacquisitions at the First Boston Corporation. He received an A.B. from HarvardCollege and an M.B.A. from Harvard Business School.

 

**G.V.Prasad,***Director,*hasbeen a Director since June 2003. Since 2001, Mr. Prasad has served asExecutive Vice Chairman and Chief Executive Officer of Dr. Reddy’sLaboratories Limited. From 1990 to 2001, Mr. Prasad was Managing Directorof Cheminor Drugs Ltd., which merged with Dr. Reddy’s LaboratoriesLimited. Prior to that he was the founding director of Benzex Labs, whichmanufactured Active Pharmaceutical Ingredients. He currently serves as memberof the boards of Diana Hotels Limited, Nipuna Services Ltd., Vijaya ProductionsLtd., Diana Projects and Engineers Ltd. and Green Park Hotels and Resorts Ltd. Mr. Prasadhas a bachelors degree in Chemical Engineering from Illinois Institute ofTechnology, Chicago, and a masters degree in Industrial Administration fromPurdue University.

 

**Peter J.Shabecoff**, *Director,*hasbeen a Director since April 2001, and a Managing Director of North CastlePartners, L.L.C. since 1999. Prior to joining North Castle, Mr. Shabecoffwas an attorney in the New York and Paris offices of Debevoise &Plimpton, where he focused on representing financial sponsors. From 1985 to1987, Mr. Shabecoff was a consultant on environmental and resource policyat ICF Incorporated. Mr. Shabecoff also sits on the board of directors ofNaked Juice Company. He received a B.A. from Wesleyan University, a J.D. fromHarvard Law School and a masters degree in public policy from the KennedySchool of Government at Harvard University.

 

**BenjaminB. James**, *Director,*hasbeen a Director of Leiner since April 2001, and a Managing Director ofNorth Castle Partners, L.L.C. since 1998. Mr. James began working withprivate companies when he joined Equitable Capital Management Company in 1987.After four years at Equitable Capital, he and a business associate formed thePrivate Finance Group at PPM America, an investment management company inChicago. Mr. James also sits on the boards of directors of EquinoxHoldings, Inc. and Enzymatic Therapy, Inc. Mr. James received aB.S. in economics from the University of Wisconsin–Madison and an M.B.A. withhonors from the Graduate School of Business at Boston University.

 

**David C.Dominik,***Director*, hasbeen a Director of Leiner since May 2004. Since 2000, he has been aManaging 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 ZeroStage Capital, a venture capital firm focused on early-stage companies.Previously, Mr. Dominik was a venture capital investor and assistant tothe Chairman of Genzyme Corporation, a biotechnology firm, and a consultant atBain & Company. Mr. Dominik received his J.D. from Harvard LawSchool and his Bachelor of Arts from Harvard College. He is currently adirector of Therma-Wave, Inc., Integrated Circuit Systems, Inc. andseveral private companies.

 

**PrescottH. Ashe,***Director,*hasbeen a Director of Leiner since May 2004. Since 2000, he has been aManaging Director of Golden Gate Capital. Prior to joining Golden Gate Capital,Mr. Ashe was an investment professional at Bain Capital, which heinitially joined in 1991. Prior to Bain Capital, Mr. Ashe was a consultantat Bain & Company. Mr. Ashe received his J.D. from Stanford LawSchool and his Bachelor of Science in Business Administration from theUniversity of California at Berkeley. He is currently a director of severalprivate companies.

 

**JonathanO. Grad,***Director*, hasbeen a Director of Leiner since May 2004. Since 2002, he has been aPrincipal at Golden Gate Capital. Prior to joining Golden Gate Capital in 2001,Mr. Grad was a private equity investment professional at both KohlbergKravis Roberts & Co. and Morgan Stanley Capital Partners. Mr. Gradreceived his Bachelor of Arts from Princeton University.

 

**MontySharma**, *Director Nominee,*was recently nominated as a Director of Leiner. The Board is expected to approve his appointment in their next meetingto be held on June 24, 2005. Mr. Sharma has been the Chief ExecutiveOfficer of the Naked Juice Company since May, 2005.  Prior to Naked Juice, he held the positionsof Chief Operating Officer, President and CEO of Experimental and AppliedSciences (“EAS”) from 1999 to 2005.  Mr. Sharmahas also served as the Chief Financial Officer and Senior Vice President ofOperations for Brunswick Corporation from 1996 to 1999.  Mr. Sharma received his Masters ofBusiness Administration from the Southern Illinois University.

 

There are nofamily relationships among any of our executive officers and directors.

 

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**AuditCommittee Financial Expert**

 

The AuditCommittee as of March 26, 2005, consisted of the following members:

 

Benjamin B.James, Director.

Jonathan O.Grad, Director.

 

Mr. James resigned from the Leiner Board effective April 30,2005. The Board will select a substitute member of the Audit Committee toreplace Benjamin James for the coming year. The Board has determined that Mr. Gradhas the requisite attributes of an “audit committee financial expert” under therules of the Securities and Exchange Commission (“SEC”) and that suchattributes were acquired through relevant education and work experience. TheAudit Committee met 4 times during fiscal 2005.

 

**Code ofEthics**

 

The Companyhas adopted a code of ethics that applies to all of its directors, officers(including its chief executive officer, chief financial officers, chiefaccounting officer, controller, and any person performing similar functions)and employees. The Company has filed a copy of this Code of Ethics as Exhibit 14.1to this Form 10-K.

 

39

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## **ITEM 11.**                      EXECUTIVECOMPENSATION

 

The following table sets out the compensation for our Chief ExecutiveOfficer and our other four most highly compensated officers, or the “NamedExecutive 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 (3)** | ** ** | **All Other Compensation (4)** |   |
| Robert M. Kaminski              |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Chief Executive Officer*       |       | $                       | 475,000    |                               | $          | 565,250                            |       | $ | 13,583 |   | 78,270 |   | 9,395,258 |   |
| Gale K. Bensussen               |       |                    |       |                               |       |                               |       |   |   |   |   |
| *President*                     |       | 325,000                 |       | 386,750                            |       | 12,779                             |       | 39,135 |   | 6,615,360 |   |
| Robert K. Reynolds              |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Chief Financial Officer*       |       | 325,000                 |       | 886,750                            |       | 1,920                              |       | 39,135 |   | 2,961,907 |   |
| Kevin J. Lanigan                |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Executive Vice President/*     |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Corporate General Manager*     |       | 265,000                 |       | 551,750                            |       | 6,137                              |       | 19,568 |   | 2,927,697 |   |
| Robert J. La Ferriere           |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Executive Vice President,*     |       |                    |       |                               |       |                               |       |   |   |   |   |
| *Sales & Marketing*    |       | 265,000                 |       | 357,050                            |       | 9,339                              |       | 19,568 |   | 1,775,039 |   |
|                                 |            |                         |            |                                    |            |                                    |            |  |  |  |  |  |  |  |

 

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(1) Bonusamounts include amounts awarded for reaching targeted fiscal 2004 EBITDA goalsas well as special bonuses related to the recapitalization.

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

(3) Alloptions are related to restricted shares of Leiner Holdings Corp. common stockand they have various restrictive Call Rights retained by us after issuance.Although the timing of the removal of the Call Rights is dependant upon thefuture employment status of the employee, generally, the Call Rights areremoved over a pro-rata period of six years from the date of theRecapitalization.

(4) Allother compensation consists of compensation recorded as a result of therecapitalization which occurred on May 27, 2004 as well as compensationrecorded under FAS 123(R) related to the issuance of restricted shares ofLeiner Holdings Corp. common stock. Compensation from the recapitalization was recorded representing the prorata excess value paid for Leiner Health Products Inc. common stock over theexercise prices of the underlying Delayed Delivery Shares and Options held bythe Named Executive Officers. Compensation from the issuance of the restricted shares was recordedbased on the portion of the calculated share based compensation deemed to havebeen earned in the current fiscal year.

 

The following table sets out the options granted in 2004 for the NamedExecutive Officers. All outstanding options were either exchanged for newdelayed delivery share awards or cashed out in connection with therecapitalization.

 

**Restricted Stock Issued in Last Fiscal Year**

 
|                   |   | ** **            |   | ** **              |   | ** **   |   | ** **     |     | **Potential Realizable**   |    |
|------------------------|--------|-----------------------|--------|-------------------------|--------|--------------|--------|----------------|----------|----------------------------|---------|
|                   |   | **Individual Grants** |   | **Value at Assumed**    |   |
|                   |   | **Number of**         |   | **% of Total**          |   | ** **   |   | ** **     |     | **Annual Rates of Stock**  |    |
|                   |   | **Securities**        |   | **Restricted Shares**   |   | **Purchase** |   | ** **     |     | **Price Appreciation for** |    |
|                   |   | **Underlying**        |   | **Issued to Employees** |   | **Price**    |   | **Expiration** |     | **Option Term (2)**        |    |
| **Name**               |   | **Restricted Shares** |   | **in Fiscal Year**      |   | **($/Sh)**   |   | **Date**       |     | **5% ($)**                 |    | **10% ($)** |   |
| Robert M.  Kaminski    |   | 78,270                |   | 100.0                   | %      | $            | 2.37   |           | 12/31/14 |                       | 138,538 |   | 351,432 |   |
| Gale K.  Bensussen     |   | 39,135                |   | 100.0                   | %      | $            | 2.37   |           | 12/31/14 |                       | 69,269  |   | 175,716 |   |
| Robert K.  Reynolds    |   | 39,135                |   | 100.0                   | %      | $            | 2.37   |           | 12/31/14 |                       | 69,269  |   | 175,716 |   |
| Kevin J.  Lanigan      |   | 19,568                |   | 100.0                   | %      | $            | 2.37   |           | 12/31/14 |                       | 34,635  |   | 87,860 |   |
| Robert J. La  Ferriere |   | 19,568                |   | 100.0                   | %      | $            | 2.37   |           | 12/31/14 |                       | 34,635  |   | 87,860 |   |
|                        |        |                       |        |                         |        |              |        |                |          |                            |         |  |  |  |  |

 

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(1) Allrestricted shares are for Leiner Holdings Corp. common stock and they havevarious restrictive Call Rights retained by us after issuance. Although thetiming of the removal of the Call Rights is dependant upon the futureemployment status of the employee, generally, the Call Rights are removed overa pro-rata period of six years from the date of the Recapitalization.

(2) Setsforth potential option gains based on assumed annualized rates of stock priceappreciation from the estimated price at the date of grant of 5% and 10%(compounded annually) over the full term of the grant with appreciationdetermined as of the expiration date. The 5% and 10% assumed rates ofappreciation are mandated by the rules of the Securities and ExchangeCommission, and do not represent our estimate or projection of future commonstock prices.

 

The following table sets forth the restricted stock exercised for thefiscal year ended March 26, 2005 and the stock option values as of March 26,2005, in each case, for each of the Named Executive Officers.

 

**Aggregated RestrictedStock Exercised in Last Fiscal Year**

**and Restricted StockValues as of March 26, 2005 (1)**

 
| ** **             | ** ** | ** **          | ** ** | ** **   | ** ** | **Number of Securities**                 | ** ** | **Value of Unexercised** | ** ** |
|------------------------|------------|---------------------|------------|--------------|------------|------------------------------------------|------------|--------------------------|------------|
| ** **             | ** ** | ** **          | ** ** | ** **   | ** ** | **Underlying Unexercised**               | ** ** | **Restricted Stock at**  | ** ** |
| ** **             | ** ** | **Shares Acquired** | ** ** | **Value**    | ** ** | **Restricted Stock at Fiscal Year  End** | ** ** | **Fiscal Year End (2)**  | ** ** |
| **Name**               | ** ** | **on Exercise**     | ** ** | **Realized** | ** ** | **Exercisable**                          | ** ** | **Unexercisable**        | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Robert M.  Kaminski    |       | —              |       | —       |       | —                                   |       | 78,270                   |       | — |   | 35,222 |   |
| Gale K.  Bensussen.    |       | —              |       | —       |       | —                                   |       | 39,135                   |       | — |   | 17,611 |   |
| Robert K.  Reynolds    |       | —              |       | —       |       | —                                   |       | 39,135                   |       | — |   | 17,611 |   |
| Kevin J.  Lanigan      |       | —              |       | —       |       | —                                   |       | 19,568                   |       | — |   | 8,806 |   |
| Robert J. La  Ferriere |       | —              |       | —       |       | —                                   |       | 19,568                   |       | — |   | 8,806 |   |

 

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(1) All restricted shares are for Leiner Holdings Corp. commonstock and they have various restrictive Call Rights retained by us afterissuance. Although the timing of the removal of the Call Rights is dependantupon the future employment status of the employee, generally, the Call Rightsare removed over a pro-rata period of six years from the date of theRecapitalization.

(2) Sets forth the estimated excess value of the restrictedshares, which is the positive spread between the original purchase prices ofthe restricted shares and the estimated value of Leiner Holdings Corp’s commonstock as of March 26, 2005.

 

**CompensationCommittee Interlocks and Insider Participation**

 

Our Board of Directors had a compensation committee composed of Messrs. Ashe,Baird, Dominik and Shabecoff during fiscal 2005. During fiscal 2005, allmembers of the Board of Directors participated in the deliberations concerningcompensation of our executive officers, except that neither Mr. Kaminskinor Mr. Bensussen participated in any discussions regarding their owncompensation. Mr. Kaminski served in fiscal 2005 as a director ofEnzymatic Therapy, Inc. (“Enzymatic”) and as a member of the compensationcommittee of that board.

 

**EmploymentContracts and Severance Benefit Agreements**

 

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

 

Subsequent tothe Recapitalization, Gerardo. Perez elected to resign from Leiner in his roleas Chief Operating Officer. In connection with Mr. Perez’s resignation, werestructured the responsibilities of some of our senior managers. Mr. Perez’semployment was terminated effective August 6, 2004. Under the terms of hisemployment agreement and his severance release agreement, Mr. Perez isentitled to receive 24 months of salary continuation, a payment equal to his2003 target bonus, is bound by customary restrictive covenants, includingnon-competition, non-solicitation and confidentiality provisions, for the same24 month period, and released Leiner from any and all claims that he may haveagainst us. In connection with his severance, we recorded a charge ofapproximately $1.2 million in the second fiscal quarter 2005. Mr. Perezwill also continue to hold any delayed delivery stock that he held as of August 6,2004 in accordance with the terms of his award agreement. In addition, weentered into a one-year consulting agreement with Mr. Perez (which may beextended for up to two additional years), under which he will provide us adviceand support on strategic and operational matters. Pursuant to the consulting agreement,Mr. Perez will provide consulting services for a minimum of 13 days permonth and earn $1,400 per day.

 

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Pursuant tothe Severance Benefit Agreements with each of Messrs. Kaminski, Bensussen,La Ferriere and Lanigan, if the executive terminates his employment for “goodreason” (as defined in the agreements) or his employment is terminated by uswithout “cause” (as defined in the agreements), each such executive will beentitled to the following severance benefits: (1) the severance paymentset forth opposite to such executive’s name on the table set forth below, (2) outplacement assistance at our expense and (3) such rights under ourapplicable plans or programs (including any stock options or incentive plans),as may be determined pursuant to the terms of such plans or programs. In theevent any such executive is discharged for cause, or if the executivevoluntarily resigns without good reason, all payments of base salary andperformance bonus, as well as all of such executive’s benefits, shallimmediately cease, except for any accrued and unpaid salary, bonuses andbenefits.

 
| **Executive**          | ** ** | **Severance Benefits Payment**                                                                                                                                                                            | ** ** |
|------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Robert M.  Kaminski    |       | $2,000,000  in cash, payable in four equal quarterly installments.                                                                                                                                        |       |
|                   |       |                                                                                                                                                                                                      |       |
| Gale K.  Bensussen     |       | $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’s base salary, plus any  annual individual performance bonus or targeted commission, both as in effect  at the time of the termination. |       |
|                   |       |                                                                                                                                                                                                      |       |
| Robert J. La  Ferriere |       | a lump-sum  payment equal to one year’s base salary, plus any annual individual  performance bonus or targeted commission, both as in effect at the time of  the termination.                        |       |

 

The employmentagreement for Mr. Reynolds sets forth an annual base salary of $325,000,which may be adjusted by the Board of Directors in its sole and absolutediscretion. In addition, Mr. Reynolds may receive an annual bonus of 50%of his base salary, which shall be payable based on the achievement ofspecified performance targets set by the Board of Directors. The employmentagreement for Mr. Reynolds contemplates initial employment terms ending onJanuary 28, 2005 and provides for automatic renewal for periods of oneyear unless either party gives 60-days prior written notice of non-extension.In the event the executive is terminated for any reason, the executive willreceive any accrued and unpaid salary and bonus. In the event the executive isterminated by us without cause (as defined in such executive’s employmentagreement) or if we give the executive a non-extension notice, such executiveshall be entitled to: (1) 24 months of continued regular salary, and (2) aone-time payment in an amount equal to the actual bonus paid to such executivefor the year immediately preceding the date of termination of such executive’semployment. In order to be eligible for such severance payment, the executivemust execute a full release of claims against us. The employment agreement for Mr. Reynoldscontains non-competition, non-solicitation and confidentiality provisions.

 

**Board Compensation Committee Report onExecutive Compensation**

 

*Compensation Policy*

 

The objective of the Company’s executive compensation committee is toreview and monitor compensation arrangements so that the Company continues toretain, attract, and motivate quality management consistent with the annualstrategic plan and budget, and the directions of the Board.

 

During fiscal 2005, the Compensation Committee (“Committee”) of theBoard of Directors was composed of four non-employee directors: Prescott H.Ashe, Charles F. Baird, Jr., David C. Dominik, and Peter J. Shabecoff.  The Board of Directors has adopted aCompensation Committee Charter, which specifies the composition andresponsibilities of the Committee. The Board reviews the charter annually basedon input from the Committee.

 

The charter of the compensation committee gives the Committeeresponsibilities to:

 

•                  reviewthe basic philosophy and policy governing the compensation of the Company’smanagement and other personnel

•                  reviewat least annually the salaries of members of senior management and theirperformance against objectives and potential

•                  reviewand approve the methodology and implementation of an annual incentive bonusprogram. Factors to be considered include the financial and strategicperformance of the Company versus objectives, individual performance andcomparative industry compensation information

 

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•                  reviewand approve salary and incentive programs for all employees

•                  reviewand recommend to the board adoption of, and changes to, stock option and otherincentive programs and plans for key employees

•                  considerand approve, upon recommendation of the chief executive, individuals eligiblefor, and the number, kind and terms of stock options

•                  reviewother employee benefits plans such as pension, 401(k) and other retirementplans

•                  reviewmedical plans and other health plans

•                  considerand approve, upon recommendation of the chief executive, employer contributionsto the 401(k) benefit plan.

 

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

 

*Compensation of the Chief Executive Officer*

 

The Chief Executive Officer’s compensation plan for fiscal 2005consisted of salary at a rate of $475,000 per annum and a bonus of $565,250under the 2004 Management Bonus Plan.  OnDecember 31, 2004, he also purchased under our 2004 Restricted Stock Plan78,270 shares of common stock at $2.37 per share, its estimated fair marketvalue at the time of purchase. The restricted shares have various restrictiveCall Rights retained by us after issuance. Although the timing of the removalof the Call Rights is dependant upon the future employment status of theemployee, generally, the Call Rights are removed over a pro-rata period of sixyears from the date of the Recapitalization.

 

## **ITEM 12.**                      SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF RELATED STOCKHOLDERMATTERS

 

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

 

The following table summarizes shares authorized, issued andoutstanding 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) |
|                           |       |                 |       |   |   |   |   |
| Common Stock                   |       | 6,000,000            |       | 195,676 | (1) | 5,600,000 | (2) |

 

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(1) Restricted stock issued and outstanding under the LHP HoldingsCorp. 2004 Restricted Stock Plan (the “Stock Plan”). The restricted stock hasvarious restrictive Call Rights retained by us after issuance. Although thetiming of the removal of the Call Rights is dependant upon the futureemployment status of the employee, generally, the Call Rights are removed overa pro-rata period of six years from the date of the Recapitalization.

 

43

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(2) 600,000 shares reserved for conversion of delayed deliveryshares (“DDS”) Series B Preferred Stock. 600,000 shares reserved forissuance of DDS Common Stock and 5,000,000 shares reserved for conversion of Series APreferred Stock.

 

The following table sets forth information regarding beneficialownership of common stock of Holdings as of March 26, 2005 by: (i) eachperson 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 ofdirectors, each of our named executive officers and all members of the board ofdirectors and executive officers as a group. To our knowledge, each of suchsecurity holders will have sole voting and investment power as to the sharesshown unless otherwise noted. Beneficial ownership of the securities listed inthe table has been determined in accordance with the applicable rules andregulations promulgated under the Exchange Act.

 
| ** **                                                 | ** ** | **Securities Beneficially Owned  (1)** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                 | ** ** | **Preferred Stock (2)**                | ** ** | **Common Stock (3)** | ** ** |
| **Name**                                                   | ** ** | **Number of  Shares**                  | ** ** | **Percentage of  Class** | ** ** | **Number of  Shares** | ** ** | **Percentage of  Class** | ** ** |
| ** **                                                 | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Principal  Stockholders:**                               | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| GGC  Investment Fund II, L.P. and Related Entities (4)     |       | 1,315,000                              | (11)       | 46.67 | % | — |   | — |   |
| North Castle  Partners III-A, L.P.and Related Entities (5) |       | 1,315,000                              | (10)       | 46.67 | % | — |   | — |   |
|                                                       |       |                                   |       |   |   |   |   |   |   |
| **Directors  and Executive Officers:**                     |       |                                   |       |   |   |   |   |   |   |
| Robert M.  Kaminski (6)                                    |       | 29,320                                 |       | 1.04 | % | 29,320 |   | 17.67 | % |
| Gale K.  Bensussen (6)                                     |       | 27,233                                 |       | 0.97 | % | 27,233 |   | 16.42 | % |
| Robert K.  Reynolds (6)                                    |       | 14,358                                 |       | 0.51 | % | 14,358 |   | 8.65 | % |
| Kevin J.  Lanigan (6)                                      |       | 42,204                                 |       | 1.50 | % | 33,454 |   | 20.16 | % |
| Robert J. La  Ferriere (6)                                 |       | 3,850                                  |       | 0.14 | % | 3,850 |   | 2.32 | % |
| A. Ivette  Santiago (6)                                    |       | 1,450                                  |       | 0.05 | % | 1,450 |   | 0.87 | % |
| Charles F.  Baird, Jr. (7) (8)                   |       | 50,000                                 |       | 1.77 | % | — |   | — |   |
| G.V. Prasad  (6)                                           |       | —                                 |       | — |   | — |   | — |   |
| Peter J.  Shabecoff (7)                                    |       | —                                 |       | — |   | — |   | — |   |
| Benjamin B.  James (7)                                     |       | —                                 |       | — |   | — |   | — |   |
| David C.  Dominik (9)                                      |       | —                                 |       | — |   | — |   | — |   |
| Prescott H.  Ashe (9)                                      |       | —                                 |       | — |   | — |   | — |   |
| Jonathan O.  Grad (9)                                      |       | —                                 |       | — |   | — |   | — |   |
| All  directors and executive officers as a group           |       | —                                 |       | — |   | — |   | — |   |
| (13 persons)                                               |       | 168,415                                |       | 5.98 | % | 109,665 |   | 66.10 | % |

 

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

(2) Preferred Stock includes Series A Preferred Stock, issuedand outstanding, and Series B Preferred Stock, reserved for delayeddelivery.

(3) Common stock includes common stock reserved for delayeddelivery, exercisable Restricted Stock and exercisable Options granted onCommon Stock.

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

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

(6) Theaddress 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., 183Putnam Avenue, Greenwich, Connecticut 06831. Messrs. Baird, Shabecoff andJames are Managing Directors of North Castle Partners, L.L.C., which is themanager of North Castle Partners III-A, L.P. By virtue of their status, Messrs. Baird,Shabecoff and James may be deemed to have or share voting and investment powerwith respect to the shares in which North Castle Partners, L.L.C. and NorthCastle Partners III-A, L.P. have direct or indirect beneficial ownership buteach disclaim the beneficial ownership of the shares held directly orindirectly by such entities except to the extent of his proportionate ownershipinterests therein.

 

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

(9) Theaddress is c/o GGC Investment Fund II, L.P., 1 Embarcadero Center, 33rd Floor,San Francisco, California 94111. Messrs. Dominik and Ashe areManaging Directors and Mr. Grad is a Principal of Golden Gate Capitalwhich is the general partner of the GGC Investment Fund II, L.P. MessrsDominik, Ashe and Grad each disclaim the beneficial ownership of the sharesheld by such entities except to the extent of his proportionate ownershipinterests therein.

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

(11) Consistsof: (i) 361,976.73 shares of series A preferred stock owned by CCGInvestment Fund, L.P., (ii) 18,196.22 shares of series A preferred stockowned by CCG Associates— QP, LLC, (iii) 1,691.94 shares of series Apreferred stock owned by CCG Associates— AI, LLC, (iv) 4,849.27 shares ofseries A preferred stock owned by CCG Investment Fund — AI, L.P., (v) 36694.06shares of series A preferred stock owned by CCG AV, LLC-Series C, (vi) 14,085shares of series A preferred stock owned by CCG AV, LLC-Series F, (vii) 657,433.77shares of series A preferred stock owned by Golden Gate Capital Investment FundII, L.P., (viii) 17,411.28 shares of series A preferred stock owned byGolden Gate Capital Associates II-QP, LLC., (ix) 91,001.64 shares ofseries A preferred stock owned by CCG CI, LLC, (x) 92,678.63 shares of series Apreferred stock owned by Golden Gate Capital Investment Fund II-A, L.P., (xi)16,395 shares of series A preferred stock owned by Golden Gate CapitalInvestment Fund II, (AI) L.P., (xii) 2,311.21 shares of series A preferredstock owned by Golden Gate Capital Investment Fund II-A, (AI) L.P., and (xiii)275.25 shares of series A preferred stock owned by Golden Gate CapitalAssociates II-AI, LLC.

 

## **ITEM 13.**                      CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

 

**StockholdersAgreement**

 

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

 

•*Board of Directors*.The stockholders agreement sets the size of Holdings’ board of directors andour board of directors at nine members each and requires all parties to theagreement to vote their shares and take all steps within their power to electthree nominees selected by the North Castle Investors, three nominees selectedby the Golden Gate Investors and two nominees who are members of management andone nominee that is an outside director, in each case selected jointly by theNorth Castle Investors and the Golden Gate Investors. The North CastleInvestors and the Golden Gate Investors each will have these rights for so longas it meets the definition of a Major Investor. As defined in the stockholdersagreement, a Major Investor (i) owns at least 40% of the shares held as ofthe date of the agreement and (ii) has not transferred to any singleperson more than 50% of the greater of the shares held by it on the date of theagreement or at the time of the transfer, in which case such transferee willsucceed to such rights for so long as it holds 20% of the common stock outstandingon the date of the agreement. As of the date of the stockholders agreement, thedirectors nominated by North Castle will be Messrs. Baird, James andShabecoff and the directors nominated by Golden Gate will be Messrs. Ashe,Dominik and Grad. The management directors will be Mr. Kaminski and Mr. Bensussenfor so long as they serve as Chief Executive Officer and President,respectively. Mr. Prasad will be the outside director.

 

•*Approval of SignificantTransactions.*****The Golden GateInvestors and North Castle Investors, so long as they remain Major Investors,possess approval rights over some significant transactions that may be pursuedby Holdings, including mergers or sales by Holdings or any subsidiary.

 

•*Transfer Restrictions**.***Without the consent of each of the MajorInvestors, until the earlier of the fifth anniversary of the stockholdersagreement and six months after the consummation of a public offering,Stockholders may not transfer shares, other than in transfers permitted by thestockholders agreement. Any such permitted transferees will agree in writing tobe bound by the provisions of the stockholders agreement.

 

•*Participation Rights**.***Pursuant to the stockholders agreement, anyStockholder is granted “tag-along” rights, which entitle them to participate insome sales by the Major Investors.

 

45

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•*Take-Along Sale of CapitalStock**.***Subject to exceptions, ifone or more Major Investors prior to a public offering, approves a sale of morethan 50% of Holdings’ capital stock to an non-affiliated third party and anyMajor Investor that has not initiated such sale approves such transfer, each ofthe 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 thirdanniversary and ending on the fifth anniversary of the stockholders agreement,either Major Investor may effect a take-along sale without obtaining theapproval of the other Major Investor if specified performance criteria are met.After the fifth anniversary of the stockholders agreement, either MajorInvestor may effect a take-along sale without obtaining the approval of theother Major Investor and without meeting any performance criteria.

 

•*Piggyback RegistrationRights.*****The Stockholders areentitled to request the inclusion of their securities in any registrationstatement at Holdings’ expense whenever it proposes to register any equitysecurities.

 

•*Demand Registration.*****Under the stockholders agreement, any MajorInvestor has the right after the first anniversary of the consummation of apublic offering, subject to some exceptions, to require Holdings to registerany or all of their registrable securities under the Securities Act.

 

•*Holdback Agreement for DemandRegistrations**.***Each Stockholder, ifrequired by the managing underwriter in an underwritten offering, agrees not tosell or offer for public sale or distribution, any of such Stockholder’scapital stock within 15 days prior to or 180 days after the effective date ofany demand registration, except as part of such registration.

 

•*Preemptive Rights.*****The Stockholders Agreement contains customarypreemptive rights in favor of each Major Investor.

 

•*Indemnification.*Inconnection with all registrations pursuant to the stockholders agreement,Holdings has agreed to indemnify the Stockholders participating in suchregistrations, the officers and directors of such Stockholders and each personthat controls such Stockholder against liabilities relating to the registration,including liabilities under the Securities Act.

 

•*Affiliate Transactions.*Holdingshas agreed not to engage in any transaction or series of related transactions(other than the consulting agreement and related transactions) with any of theMajor Investors or any of their respective affiliates unless (i) suchtransaction or series of related transactions are on terms and conditions noless favorable than would be obtainable by Holdings in an arm’s-lengthtransaction and its chief financial officer delivers to the Board of Directorsa certificate to such effect and (ii) if the transaction or series ofrelated transactions involve an amount greater than $1 million, a majority ofthe members of the Board of Directors who are not officers, employees ormanaging members of Holdings or the applicable Major Investor of any of itsaffiliates have approved such transactions in writing.

 

**ConsultingAgreement**

 

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

 

Inconsideration for their services in connection with the recapitalization,Holdings, Leiner and Leiner Health Products, LLC paid $6,190,000 to each ofNorth 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 theaggregate by North Castle Partners, L.L.C. and GGC Administration in connectionwith the Recapitalization.

 

Ascompensation for their continuing services, Holdings, Leiner and Leiner HealthProducts, LLC will pay $1,315,000 in arrears annually to each of North CastlePartners and GGC Administration as long as Holdings, Leiner and Leiner HealthProducts, LLC meet a performance target, which we have met in fiscal 2005. Wehave also agreed to reimburse North Castle Partners and GGC Administration fortheir reasonable travel, other out-of-pocket expenses and administrative costsand expenses, including legal and accounting fees, and to pay additional transactionsfees to them in the event Holdings, Leiner or any of its subsidiaries completesany acquisition (whether by merger, consolidation, reorganization,recapitalization, sale of assets, sale of stock or otherwise) financed by newequity or debt, a transaction involving a change of control, as defined in theconsulting agreement, or sale, transfer or other disposition of all orsubstantially all of the assets of Holdings, Leiner or Leiner Health Products,LLC.

 

46

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**RecapitalizationAgreement and Plan of Merger**

 

On April 15,2004, Mergeco entered into a recapitalization agreement and plan of merger withLeiner. The Recapitalization was effected by merging Mergeco with and intoLeiner. In connection with the Recapitalization the Golden Gate Investors madea $131.5 million cash equity investment in Mergeco and the North CastleInvestors made a $131.5 million equity investment in Mergeco, $126.5 million ofwhich was a new cash investment by NCP III-A and $5.0 million of which was arollover of existing Leiner equity by an affiliate of NCP III-A. Immediatelyafter the merger, the holders of Leiner stock exchanged their stock for votingpreferred stock of Holdings. In addition, some members of management exchangedexisting Leiner equity rights for new equity rights in Holdings, which whencombined with the equity rollover, represents an aggregate management rolloverof $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 theirequity interests, approximately $286.4 million of which was paid to otherinvestment funds affiliated with North Castle Partners, L.L.C. Such holders ofLeiner capital stock and equity interests will receive any amounts remaining inthe $6.5 million escrow fund after such escrow is released.

 

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

 

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

 

Upon theclosing of the Recapitalization and the related transactions, all of thecapital stock of Leiner is owned by Holdings, which is owned by the NorthCastle Investors, the Golden Gate Investors and some members of management.

 

**EscrowAgreement**

 

As part of theRecapitalization, the Golden Gate Investors, the North Castle Investors, NorthCastle Partners, L.L.C., Leiner, Mergeco and an escrow agent entered into anescrow agreement. Pursuant to the recapitalization agreement and plan ofmerger, Mergeco deposited $6.5 million in cash in an escrow account to be heldand disposed of as provided in the escrow agreement. The escrow funds will beused to pay specified product liability claims and tax claims as provided forin the escrow agreement. Any amounts remaining in the escrow account will bepaid 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 thecontingent liabilities.

 

**ManagementEquity Arrangements**

 

In connectionwith the Recapitalization, Messrs. Kaminski, Bensussen, Lanigan and LaFerriere 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 Leinercommon stock. Mr. Lanigan also received $0.9 million of voting preferredstock of Holdings in connection with his rollover of existing Leiner commonstock.

 

Each of Messrs. Kaminski,Bensussen, Reynolds, Perez, Lanigan and La Ferriere held options under ourprevious stock incentive plan, which were terminated in connection with theRecapitalization. Some outstanding options to purchase shares of common stockheld by Messrs. Kaminski, Bensussen, Reynolds, Perez, Lanigan and LaFerriere were exchanged for a number of new delayed delivery shares equal tothe quotient determined by dividing (1) the excess of the per share mergerconsideration payable to holders of common stock in the merger over theexercise price per share by (2) the per share cash purchase price paid bythose investors purchasing Leiner common stock in connection with therecapitalization. In connection with the recapitalization, each of Messrs. Kaminski,Bensussen, Reynolds, Perez, Lanigan and La Ferriere received new awards of anaggregate of approximately 29,320, 27,233, 14,358, 710, 19,431 and 3,850 sharesof 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 toapproximately $1.9 million, $0.4 million, $1.5 million, $2.9 million and $1.4million, respectively, in connection with the cash out of their options thatwere not exchanged for new delayed delivery share awards. Messrs. Kaminski,Bensussen and Lanigan held delayed delivery share awards under our former stockincentive plan, which was terminated in connection with the recapitalization.In connection with the recapitalization, each of Messrs. Kaminski andBensussen received an aggregate of approximately $6.9 million and $5.3 million,respectively, in connection with the cash out of his delayed delivery shareawards. Mr. Lanigan rolled over his delayed delivery share awards for anew award of shares of delayed delivery common

 

47

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and preferredstock of Holdings. In connection with the recapitalization, Mr. Laniganreceived an aggregate of approximately 14,023 new delayed delivery shareawards.

 

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

 

**TransactionBonuses**

 

In connectionwith the Recapitalization, we paid Messrs. Reynolds, Lanigan and LaFerriere special one-time bonuses in the amount of $200,000, $200,000 and$50,000, respectively.

 

**CompanyLoans**

 

Some of ourdirectors and executive officers had outstanding loans with the company, withan aggregate outstanding balance of $141,615 as of May 27, 2004. All ofthese loans were repaid by our directors and executive officers at the closingof the Recapitalization.

 

## **ITEM 14.**                      PRINCIPALACCOUNTANT FEES AND SERVICES

 

The following table presents fees for professional services rendered byErnst & Young LLP (“E&Y”) for the audit of the Company’s annualfinancial statements for the fiscal years ended March 27, 2004 and March 26,2005, and fees billed for audit related services, tax services and all otherservices rendered by E&Y during those periods:

 
| ** **              | ** ** | **Year Ended**          | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
| Audit fees  (1)         |       | $                       | 634,000    |   | $ | 1,288,000 |   |
| Audit  related fees (2) |       | 82,000                  |       | 73,000 |   |
| Tax fees (3)            |       | 85,000                  |       | 207,000 |   |
| Total                   |       | $                       | 801,000    |   | $ | 1,568,000 |   |

 

----

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

(2) Audit-related fees consisted primarily of professionalservices rendered in connection with other activities not explicitly related tothe audit of our financial statements, including the consultations concerningfinancial accounting and reporting standards.

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

 

**Audit Committee’s pre-approval policies andprocedures**

 

We have a policy which outlines procedures intended to ensure that ourAudit Committee pre-approves all audit and non-audit services provided to us byE&Y. The policy provides for (a) general pre-approval of certain auditand audit-related services which do not exceed $100,000 and (b) specificpre-approval of all other permitted services and any proposed services exceedingthis pre-approved dollar amount.

 

The term of any general service subject to pre-approval is twelvemonths from the date of pre-approval, unless the Audit Committee considers adifferent period and states otherwise, The Audit Committee will annually reviewand pre-approve the services that may be provided by E&Y without obtainingspecific pre-approval from the Audit Committee. The Audit Committee may modifythe list of general pre-approved services from time to time, based onsubsequent determinations.

 

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

 

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

 

**PART IV**

 

## **ITEM 15.**                      EXHIBITSAND 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 aseparate section of this Annual Report on Form 10-K commencing on thepages referenced below:

 
| Index to Consolidated Financial Statements                                                                                                            |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public  Accounting Firm                                                                                              |   |
| Consolidated Balance Sheets as of March 27, 2004 and March 26,  2005                                                                        |   |
| Consolidated Statements of Operations for  the years ended March 29, 2003, March 27, 2004 and March 26,  2005                          |   |
| Consolidated Statements of Shareholder’s  Equity (Deficit) for the years ended March 29, 2003, March 27, 2004  and March 26, 2005 |   |
| Consolidated Statements of Cash Flows for  the years ended March 29, 2003, March 27, 2004 and March 26,  2005                          |   |
| Notes to Consolidated Financial Statements                                                                                                            |   |

 

**2.****              Financial StatementSchedules.**The following financial statement schedule of the Companyis included in a separate section of this Annual Report on Form 10-Kcommencing on the page referenced below. All other schedules have beenomitted because they are not applicable, not required, or the information isincluded in the Consolidated Financial Statements or notes thereto.

 
| Schedule II—Consolidated Valuation and  Qualifying Accounts |   |
|-----------------------------------------------------------------------|--------|

 

**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. |       |
| 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                                                                                                             |       | Filed as Exhibit 4.1 to the  Registration Statement on                                                     |       |

 

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|   |   | Merger Corporation, the companies named  therein as guarantors, and U.S. Bank National Association, as Trustee.                                                                                                                                                                                                                                                                                                                                                                                    |   | 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.  |   |
| 10.7   |   | Employment Agreement, dated October 15,  2001, between the Issuer and Gerry Perez and Assignment and Assumption  Agreement, dated April 12, 2002 between the Issuer and Leiner Health  Products, LLC.                                                                                                                                                                                                                                                                                    |   | Filed as Exhibit 10.7 to the  Registration Statement on Form S-4 and incorporated herein by reference.  |   |
| 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. |   |
| 12.1   |   | Computation of Ratio of Earnings to Fixed  Charges.                                                                                                                                                                                                                                                                                                                                                                                                                                                |   | Filed as Exhibit 12.1 to the  Registration Statement on Form S-4 and incorporated herein by reference.  |   |
| 14.1   |   | Code of Ethics.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   | Filed herewith.                                                                                                   |   |
| 21.1   |   | Subsidiaries of Issuer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | 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                                                                                                                                                                                                                                                                                                                                                                               |   | Filed herewith.                                                                                                   |   |

 

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|   |   | Sarbanes-Oxley Act of 2002.                                                                                                                       |   |            |   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|--------|
| 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 fiscal2005

 

Incorporated by reference tothe current report on Form 8-K filed by the registrant on June 14,2005.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, Leiner Health ProductsInc. 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 the24th day of June, 2005.

 
|   |   | LEINER HEALTH PRODUCTS INC.                                  |
|--------|--------|--------------------------------------------------------------|
|   | By:    | /S/ ROBERT K. REYNOLDS                                       |   |
|   |   | Name: Robert K. Reynolds                                     |
|   |   | Title: Executive Vice President and Chief  Financial Officer |

 

 

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

 
| **Name**                    | ** ** | **Title**                                                    | ** ** | **Date**           | ** ** |
|-----------------------------|------------|--------------------------------------------------------------|------------|--------------------|------------|
|                        |       |                                                         |       |               |       |
| /s/ CHARLES  F. BAIRD, JR.  |       | Chairman of the Board and Director                           |       | June 24, 2005 |       |
| Charles F.  Baird, Jr. |       |                                                         |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ ROBERT  M. KAMINSKI     |       | Chief Executive Officer, (Principal  Executive Officer) and  |       | June 24, 2005 |       |
| Robert M.  Kaminski         |       | Director                                                     |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ GALE K.  BENSUSSEN      |       | President and Director                                       |       | June 24, 2005 |       |
| Gale K.  Bensussen          |       |                                                         |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ ROBERT  K. REYNOLDS     |       | Chief Financial Officer (principal  financial and accounting |       | June 24, 2005 |       |
| Robert K.  Reynolds         |       | officer)                                                     |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ PETER J.  SHABECOFF     |       | Director                                                     |       | June 24, 2005 |       |
| Peter J.  Shabecoff         |       |                                                         |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ PRESCOTT  H. ASHE       |       | Director                                                     |       | June 24, 2005 |       |
| Prescott H.  Ashe           |       |                                                         |       |               |       |
|                        |       |                                                         |       |               |       |
| /s/ JONATHAN  O. GRAD       |       | Director                                                     |       | June 24, 2005 |       |
| Jonathan O.  Grad           |       |                                                         |       |               |       |

 

52

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**LEINER HEALTH PRODUCTS INC****.****INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| Report of Independent Registered Public  Accounting Firm                                                                                              |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                  |   |
| Consolidated Balance Sheets as of March 27, 2004 and  March 26, 2005                                                                        |   |
|                                                                                                                                                  |   |
| Consolidated Statements of Operations for  the years ended March 29, 2003, March 27, 2004 and March 26,  2005                          |   |
|                                                                                                                                                  |   |
| Consolidated Statements of Shareholder’s  Equity (Deficit) for the years ended March 29, 2003, March 27, 2004  and March 26, 2005 |   |
|                                                                                                                                                  |   |
| Consolidated Statements of Cash Flows for  the years ended March 29, 2003, March 27, 2004 and March 26,  2005                          |   |
|                                                                                                                                                  |   |
| Notes to  Consolidated Financial Statements                                                                                                           |   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

The Board of Directors and ShareholderLeiner Health Products Inc.

 

We have audited the accompanying consolidatedbalance sheets of Leiner Health Products Inc. as of March 27,2004 and March 26, 2005, and the related consolidated statements ofoperations, shareholder’s equity (deficit), and cash flows for each of thethree years in the period ended March 26, 2005. Our audits also includedthe financial statement schedule listed in the Index at Item 15(a). Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Company’s internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly we express no such opinion. An audit also includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements, assessing the accounting principles used and significantestimates made by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Leiner Health Products Inc. at March 27,2004 and March 26, 2005, and the consolidated results of its operationsand its cash flows for each of the three years in the period ended March 26,2005, in conformity with U.S generally accepted accounting principles. Also inour opinion, the related financial statement schedule, when considered inrelation to the basic financial statements taken as a whole, present fairly inall material respect, the information set forthherein.

 

As discussed in Note 2 – Goodwill, theCompany adopted Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangibles Assets*, effective April 1, 2002.

 
|                      | /s/ ERNST & YOUNG LLP |   |
|---------------------------|--------------------------------|--------|
| Orange County, California |
| April 28, 2005       |

 

F-2

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**LEINERHEALTH PRODUCTS INC.CONSOLIDATED BALANCE SHEETS(dollars in thousands, except share data)**

 
| ** **                                                                                                                                                                   | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                   |       |                    |       |                    |       |
| Current assets:                                                                                                                                                              |       |                    |       |                    |       |
| Cash and cash equivalents                                                                                                                                                    |       | $                       | 33,824     |                    | $          | 16,951 |   |
| Accounts receivable, net of allowances of  $2,970 and $3,113 at March 27, 2004 and March 26, 2005,  respectively                                                   |       | 77,984                  |       | 80,250                  |       |
| Inventories                                                                                                                                                                  |       | 144,479                 |       | 164,910                 |       |
| Income tax receivable                                                                                                                                                        |       | 483                     |       | 2,310                   |       |
| Prepaid expenses and other current assets                                                                                                                                    |       | 13,174                  |       | 17,492                  |       |
| Total current assets                                                                                                                                                         |       | 269,944                 |       | 281,913                 |       |
| Property, plant and equipment, net                                                                                                                                           |       | 56,267                  |       | 65,554                  |       |
| Goodwill                                                                                                                                                                     |       | 52,083                  |       | 52,317                  |       |
| Other noncurrent  assets                                                                                                                                                     |       | 9,505                   |       | 17,014                  |       |
| Total assets                                                                                                                                                                 |       | $                       | 387,799    |                    | $          | 416,798 |   |
| **LIABILITIES, REDEEMABLE PREFERRED STOCK AND  SHAREHOLDER’S EQUITY (DEFICIT)**                                                                                         |       |                    |       |                    |       |
| Current liabilities:                                                                                                                                                         |       |                    |       |                    |       |
| Accounts payable                                                                                                                                                             |       | $                       | 91,162     |                    | $          | 101,639 |   |
| Accrued compensation and benefits                                                                                                                                            |       | 14,514                  |       | 9,634                   |       |
| Customer allowances payable                                                                                                                                                  |       | 8,896                   |       | 9,576                   |       |
| Accrued interest                                                                                                                                                             |       | 1,110                   |       | 9,093                   |       |
| Other accrued expenses                                                                                                                                                       |       | 6,185                   |       | 13,304                  |       |
| Current portion of long-term debt                                                                                                                                            |       | 14,286                  |       | 5,536                   |       |
| Total current liabilities                                                                                                                                                    |       | 136,153                 |       | 148,782                 |       |
| Long-term debt                                                                                                                                                               |       | 156,720                 |       | 390,990                 |       |
| Other noncurrent  liabilities                                                                                                                                                |       | 3,724                   |       | —                  |       |
| Total liabilities                                                                                                                                                            |       | 296,597                 |       | 539,772                 |       |
| Commitments and contingencies                                                                                                                                                |       |                    |       |                    |       |
| Series A redeemable preferred stock,  $0.01 par value;  Authorized, issued and outstanding shares-200,000 at March 27, 2004 and zero  at March 26, 2005       |       | 40,188                  |       | —                  |       |
| Shareholder’s equity (deficit):                                                                                                                                         |       |                    |       |                    |       |
| Series B junior convertible preferred  stock, $0.01 par value;  Authorized, issued and outstanding shares-7,500 at March 27, 2004 and zero  at March 26, 2005 |       | 6,616                   |       | —                  |       |
| Series C junior preferred stock, $0.01  par value;  Authorized, issued and outstanding shares-7,000 at March 27, 2004 and zero  at March 26, 2005             |       | 6,178                   |       | —                  |       |
| Common stock, $0.01 par value; 3,000,000  shares authorized, 1,139,394 issued and outstanding at March 27, 2004  and 1,000 at March 26, 2005                       |       | 11                      |       | —                  |       |
| Capital in excess of par value                                                                                                                                               |       | 21,841                  |       | 469                     |       |
| Retained earnings (accumulated deficit)                                                                                                                                      |       | 16,259                  |       | (126,357                | )          |
| Accumulated other comprehensive income                                                                                                                                       |       | 109                     |       | 2,914                   |       |
| Total shareholder’s equity (deficit)                                                                                                                                    |       | 51,014                  |       | (122,974                | )          |
| Total liabilities, redeemable preferred  stock and shareholder’s equity (deficit)                                                                                       |       | $                       | 387,799    |                    | $          | 416,798 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-3

----

 

**LEINERHEALTH PRODUCTS INC.CONSOLIDATED STATEMENTS OFOPERATIONS(dollars in thousands)**

 
| ** **                                                                                           | ** ** | **Year Ended**          | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                           | ** ** | **March 29, 2003** | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
| Net sales                                                                                            |       | $                       | 574,281    |   | $ | 661,045 |   | $ | 684,901 |   |
| Cost of sales                                                                                        |       | 430,090                 |       | 486,554 |   | 512,871 |   |
| Gross profit                                                                                         |       | 144,191                 |       | 174,491 |   | 172,030 |   |
| Marketing, selling and distribution  expenses                                                        |       | 48,600                  |       | 56,448 |   | 58,532 |   |
| General and administrative expenses                                                                  |       | 43,931                  |       | 41,041 |   | 34,134 |   |
| Research and development expenses                                                                    |       | 5,487                   |       | 5,670 |   | 5,299 |   |
| Amortization of other intangibles                                                                    |       | 1,585                   |       | 447 |   | 250 |   |
| Restructuring charges                                                                                |       | (245                    | )          | — |   | — |   |
| Recapitalization expenses                                                                            |       | —                  |       | — |   | 87,982 |   |
| Other operating expense (income)                                                                     |       | (77,708                 | )          | 1,528 |   | 2,386 |   |
| Operating income (loss)                                                                              |       | 122,541                 |       | 69,357 |   | (16,553 | ) |
| Interest expense, net                                                                                |       | 18,809                  |       | 18,954 |   | 32,346 |   |
| Income (loss) before income taxes                                                                    |       | 103,732                 |       | 50,403 |   | (48,899 | ) |
| Provision for (benefit from) income taxes                                                            |       | 15,587                  |       | 11,347 |   | (987 | ) |
| Net income (loss) before extraordinary item  and cumulative effect of change in accounting principle |       | 88,145                  |       | 39,056 |   | (47,912 | ) |
| Extraordinary gain, net                                                                              |       | 68,106                  |       | — |   | — |   |
| Cumulative effect of change in accounting  principle, net                                            |       | (10,521                 | )          | — |   | — |   |
| Net income (loss)                                                                                    |       | 145,730                 |       | 39,056 |   | (47,912 | ) |
| Accretion on preferred stock                                                                         |       | (8,083                  | )          | (12,105 | ) | (39,212 | ) |
| Net income (loss) attributable to common  shareholder                                                |       | $                       | 137,647    |   | $ | 26,951 |   | $ | (87,124 | ) |

 

See accompanying notes toconsolidated financial statements.

 

F-4

----

 

**LEINERHEALTH PRODUCTS INC.CONSOLIDATED STATEMENTS OFSHAREHOLDER’S EQUITY (DEFICIT)**

**(dollars in thousands)**

 
| ** **                                                              | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **                            | ** ** | **Retained**              | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------|------------|------------|------------|---------------------------------------|------------|---------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                              | ** ** | **Preferred  Stock**          | ** ** | ** ** | ** ** | **Capital  in**                       | ** ** | **Earnings**              | ** ** | **Accumulated  Other** | ** ** | **Total**  | ** ** |
| ** **                                                              | ** ** | **Series A  Redeemable** | ** ** | ** ** | ** ** | **Series B  Junior Convertible** | ** ** | **Series C  Junior** | ** ** | **Common  Stock**      | ** ** | **Excess** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Shareholder’s** | ** ** |
| ** **                                                              | ** ** | **Shares**                    | ** ** | **Amount** | ** ** | ** **                            | ** ** | **Shares**                | ** ** | **Amount**             | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **of Par  Value** | ** ** | **Deficit)** | ** ** | **Income  (Loss)** | ** ** | **Equity  (Deficit)** | ** ** |
| Balance at  March 31, 2002                                         |       | —                        |       | $          | —     |                                  |       |                      | —     |                   | $          | —     |       | — |   | $ | — |   | 1,000 |   | $ | 1 |   | $ | 21,851 |   | $ | (148,339 | ) | $ | (1,162 | ) | $ | (127,649 | ) |
|                                                                    |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                              |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | 145,730 |   | — |   | 145,730 |   |
| Translation  adjustment                                                 |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | — |   | 391 |   | 391 |   |
| Comprehensive  income                                                   |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   | 146,121 |   |
| Financial  restructuring                                                |       | —                        |       | —     |       |                                  |       | 7,500                     |       | 6,616                  |       | 7,000      |       | 6,178 |   | 1,138,394 |   | 10 |   | (10 | ) | — |   | — |   | 12,794 |   |
| Issuance of  Series A redeemable preferred stock                   |       | 200,000                       |       | 20,000     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Accretion on  Series A redeemable preferred stock                  |       | —                        |       | 8,083      |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | (8,083 | ) | — |   | (8,083 | ) |
| 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 | ) | 23,183 |   |
|                                                                    |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                              |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | 39,056 |   | — |   | 39,056 |   |
| Translation  adjustment                                                 |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | — |   | 880 |   | 880 |   |
| Comprehensive  income.                                                  |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   | 39,936 |   |
| Accretion 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 |   | 51,014 |   |
|                                                                    |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | (47,912 | ) | — |   | (47,912 | ) |
| Translation  adjustment                                                 |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | — |   | — |   | 2,805 |   | 2,805 |   |
| Comprehensive  loss                                                     |       |                          |       |       |       |                                  |       |                      |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   | (45,107 | ) |
| Accretion on  preferred stock                                           |       | —                        |       | 29,812     |       |                                  |       | —                    |       | 8,578                  |       | —     |       | 822 |   | — |   | — |   | — |   | (39,212 | ) | — |   | (29,812 | ) |
| Repurchase and  retirement of preferred stock                           |       | (200,000                      | )          | (70,000    | )          |                                  |       | (7,500                    | )          | (15,194                | )          | (7,000     | )          | (7,000 | ) | — |   | — |   | — |   |   |   | — |   | (22,194 | ) |
| Recapitalization  (Note 1)                                              |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | (1,138,394 | ) | (11 | ) | (21,841 | ) | (55,492 | ) | — |   | (77,344 | ) |
| Restricted stock  issued in connection with long-term incentive program |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | 464 |   | — |   | — |   | 464 |   |
| Share-based  compensation.                                              |       | —                        |       | —     |       |                                  |       | —                    |       | —                 |       | —     |       | — |   | — |   | — |   | 5 |   | — |   | — |   | 5 |   |
| Balance at  March 26, 2005                                         |       | —                        |       | $          | —     |                                  |       |                      | —     |                   | $          | —     |       | — |   | $ | — |   | 1,000 |   | $ | — |   | $ | 469 |   | $ | (126,357 | ) | $ | 2,914 |   | $ | (122,974 | ) |

 

See accompanying notes to consolidatedfinancial statements

 

F-5

----

 

**LEINERHEALTH PRODUCTS INC.CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

** **
| ** **                                                                                          | ** ** | **Year Ended**          | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                          | ** ** | **March 29, 2003** | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
| **Operating activities**                                                                            |       |                    |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                       | 145,730    |   | $ | 39,056 |   | $ | (47,912 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |                    |       |   |   |   |   |
| Depreciation                                                                                        |       | 13,920                  |       | 12,690 |   | 11,948 |   |
| Amortization                                                                                        |       | 5,731                   |       | 1,978 |   | 1,774 |   |
| Amortization of deferred financing charges                                                          |       | 6,057                   |       | 8,037 |   | 5,445 |   |
| Provision for doubtful accounts                                                                     |       | 2,013                   |       | 4,087 |   | 4,791 |   |
| Provision for excess and obsolete inventory                                                         |       | 11,489                  |       | 5,746 |   | 8,028 |   |
| Cumulative effect of change in accounting  principle                                                |       | 10,521                  |       | — |   | — |   |
| Deferred income taxes                                                                               |       | (5,976                  | )          | (3,488 | ) | (1,176 | ) |
| Extraordinary gain, net                                                                             |       | (68,106                 | )          | — |   | — |   |
| (Gain) loss on disposal of assets                                                                   |       | (105                    | )          | 40 |   | (52 | ) |
| Stock compensation expense                                                                          |       | —                  |       | — |   | 5 |   |
| Translation adjustment                                                                              |       | (280                    | )          | (880 | ) | (2,805 | ) |
| Changes in operating assets and  liabilities:                                                       |       |                    |       |   |   |   |   |
| Accounts receivable                                                                                 |       | (13,596                 | )          | (24,739 | ) | (6,464 | ) |
| Inventories                                                                                         |       | (25,747                 | )          | (15,913 | ) | (26,842 | ) |
| Income tax receivable                                                                               |       | 8,825                   |       | 671 |   | (1,729 | ) |
| Accounts payable                                                                                    |       | (658                    | )          | 16,760 |   | 9,840 |   |
| Accrued compensation and benefits                                                                   |       | 4,607                   |       | (2,865 | ) | (4,992 | ) |
| Customer allowances payable                                                                         |       | (2,135                  | )          | (2,035 | ) | 599 |   |
| Accrued interest                                                                                    |       | (553                    | )          | 781 |   | 7,971 |   |
| Other accrued expenses                                                                              |       | (4,439                  | )          | 1,211 |   | 3,237 |   |
| Other                                                                                               |       | 892                     |       | (2,689 | ) | (896 | ) |
| Net cash provided by (used in) operating activities                                                 |       | 88,190                  |       | 38,448 |   | (39,230 | ) |
| **Investing activities**                                                                            |       |                    |       |   |   |   |   |
| Additions to property, plant and equipment                                                          |       | (5,648                  | )          | (10,413 | ) | (17,991 | ) |
| Increase in other noncurrent  assets                                                                |       | (3,981                  | )          | (3,444 | ) | (3,319 | ) |
| Net cash used in investing activities                                                               |       | (9,629                  | )          | (13,857 | ) | (21,310 | ) |
| **Financing activities**                                                                            |       |                    |       |   |   |   |   |
| Borrowings under bank term credit facility                                                          |       | —                  |       | — |   | 240,000 |   |
| Payments under bank term credit facility                                                            |       | —                  |       | — |   | (1,200 | ) |
| Payments under old credit facility                                                                  |       | (80,528                 | )          | (6,604 | ) | (159,788 | ) |
| Retirement of senior subordinated debt                                                              |       | (17,930                 | )          | — |   | — |   |
| Issuance of senior subordinated debt                                                                |       | —                  |       | — |   | 150,000 |   |
| Increase in deferred financing charges                                                              |       | (3,154                  | )          | (1,774 | ) | (15,753 | ) |
| Issuance of Series A redeemable  preferred stock                                               |       | 20,000                  |       | — |   | — |   |
| Capital contribution from parent                                                                    |       | —                  |       | — |   | 251,500 |   |
| Repurchase 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                                                                |       | (1,239                  | )          | (1,456 | ) | (3,318 | ) |
| Net cash provided by (used in) financing  activities                                                |       | (82,851                 | )          | (9,834 | ) | 40,867 |   |
| Effect of exchange rate changes                                                                     |       | 601                     |       | 1,520 |   | 2,800 |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | (3,689                  | )          | 16,277 |   | (16,873 | ) |
| Cash and cash equivalents at beginning of  period                                                   |       | 21,236                  |       | 17,547 |   | 33,824 |   |
| Cash and cash equivalents at end of period                                                          |       | $                       | 17,547     |   | $ | 33,824 |   | $ | 16,951 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-6

----

 

**LEINERHEALTH PRODUCTS INC.NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS****MARCH 26, 2005**

 

**1.****              Formation andOperations**

 

**General**

 

Leiner HealthProducts Inc. (“Leiner” or the “Company”) isprimarily involved in the manufacture and distribution of vitamins,over-the-counter drugs and other health products to mass market retailers andthrough other channels, primarily in the United States and Canada. Thesefinancial statements include the accounts of the Company and its subsidiary,Vita Health Products Inc. (“Vita”).

 

**Recapitalization**

 

On April 15, 2004, Leiner MergerCorporation (“Mergeco”), entered into arecapitalization agreement and plan of merger (the “Recapitalization”) with Leiner Health Products Inc. (“Leiner”or the “Company”). Mergeco was a new corporationformed 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 thepurpose of completing the Recapitalization. In connection with theRecapitalization, the Golden Gate Investors made a $131,500,000 cash equityinvestment in Mergeco and the North Castle Investorsmade 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 ofwhich was a roll over of existing Leiner equity by anaffiliate of NCP III-A.

 

The Recapitalization was effected by merging Mergecowith and into Leiner on May 27, 2004. Each shareof the common stock of Mergeco became a share ofcommon stock of Leiner, which is the survivingcorporation in the merger. Each holder of Leinercommon stock then exchanged such stock for voting preferred stock of LHPHolding 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 inHoldings, which represent an aggregate management rollover of approximately$18,774,000. Holders of all of Leiner’s other equityand equity rights have received an aggregate of approximately $475,332,000 incash in exchange for their equity interests, approximately $286,351,000 ofwhich 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 escrowfund.  The Company also recordedapproximately $54,294,000 as compensation expense related to the in-the-moneyvalue of stock options, warrants, and delayed delivery shares. The compensationexpense represented the excess of the fair value of the underlying common stockover the exercise price or basis of the options and other equity rightsrepurchased and retired or rolled over in connection with the Recapitalization.

 

As a result of the Recapitalization, the Golden Gate Investors and theNorth Castle Investors each own 46.7% of Holdings equity and Leiner management and certain former employees own 6.6% ofHoldings’ equity including delayed delivery share awards. The Recapitalizationwas accounted for as a recapitalization of the Company which had no impact onthe historical basis of assets and liabilities as reflected in the Company’scondensed consolidated financial statements.

 

In connection with the Recapitalization, Mergecoentered 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 creditfacility (the “Revolving Facility”), under which Leinerborrowed $5,000,000 immediately after the Recapitalization. In addition, Mergeco issued $150,000,000 of 11% senior subordinatednotes due 2012 (the “Notes”). Immediately upon consummation of theRecapitalization, the obligations of Mergeco underthe New Credit Facility and Notes became obligations of the Company. TheCompany repaid approximately $157,788,000 in pre-existing indebtedness and paidapproximately $32,689,000 in fees and expenses related to these transactions.In addition, deferred financing charges of approximately $12,470,000 related tothe New Credit Facility and Notes were recorded under other non-current assetsin the accompanying consolidated balance sheet at March 26, 2005.

 

F-7

----

 

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

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

 

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

 

**2.****              Summary ofSignificant Accounting Policies**

 

*Principles of Consolidation*

 

The accompanying consolidated financial statements include the accountsof the Company and its subsidiaries. All significant intercompanyaccounts and transactions have been eliminated in consolidation.

 

*Fiscal Year*

 

Effective fiscal 2003, the Company changed its reporting period to afifty-two/fifty-three week fiscal year. The Company’s fiscal year end will fallon the last Saturday of March each year. Adoption of the change in fiscalyear 2003 did not have a material impact on the Company’s consolidatedfinancial statements. Fiscal years 2003, 2004 and 2005 are each comprised of 52-weekperiods.

 

*Use of Estimates*

 

The preparation of consolidated financial statements in conformity withU.S. generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of sales and expenses duringthe reporting periods. Actual results could differ from those estimates.Significant estimates made in preparing the consolidated financial statementsinclude valuation allowances for accounts receivable, inventories and deferredtax assets, cash flows used to evaluate the recoverability of long-livedassets, and certain accrued liabilities.

 

*Cash Equivalents*

 

The Company considers all highly liquid investments with a maturity ofthree 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 theshort period of time to maturity. Fair values of the Company’s debt instrumentshave been determined based on borrowing rates currently available to theCompany for loans with similar terms or maturity. The table below providesinformation about the fair value of the Company’s debt obligations under theNew Credit Facility and Notes (in thousands):

 
| ** **            | ** ** | **March 26, 2005** | ** ** |
|-----------------------|------------|-------------------------|------------|
| ** **            | ** ** | **Total**               | ** ** | **Fair Value** | ** ** |
| Variable rate ($US)   |       | $                       | 238,800    |   | $ | 238,800 |   |
| Average interest rate |       | 5.56                    | %          |   |   |
| Fixed rate ($US)      |       | $                       | 150,000    |   | $ | 150,000 |   |
| Average interest rate |       | 11.00                   | %          |   |   |

 

The fair value of the Industrial Development Revenue Bond Loan and theIndustrial Opportunities Program Loan could not be estimated because there isno active market for such debt instruments.

 

F-8

----

 

*Revenue Recognition*

 

Revenue is recognized after all significant obligations have been met, collectibility is probable and title has passed, which isgenerally upon receipt of products by the customer. Provisions are madecurrently for estimated returns and allowances. Consideration paid by theCompany to its customers, such as product placement fees and cooperativeadvertising, is classified as a reduction in revenue.

 

*Allowances for Uncollectible Accounts*

 

The Company maintains reserves for potential credit losses, estimatingthe collectibility of customer receivables on anongoing basis by periodically reviewing accounts outstanding over a certainperiod of time. The Company has recorded reserves for receivables deemed to beat risk for collection, as well as a general reserve based on historicalcollections experience. A considerable amount of judgment is required inassessing the ultimate realization of these receivables, including the currentcredit worthiness of each customer. Customer receivables are generallyunsecured.

 

*Inventories*

 

Inventories are stated at the lower of cost or market, with cost beingdetermined by the first-in, first-out method. Reserves are provided forpotentially excess and obsolete inventory and inventory that has aged over aspecified period of time based on the difference between the cost of theinventory and its estimated market value. In estimating the reserve, managementconsiders factors such as excess or slow moving inventories, product aging andexpiration dating, current and future customer demand and market conditions.During the first quarter ended June 26, 2004, the Company refined itsaging based reserve estimation model by increasing the number of agingcategories and revising the reserve estimation percentages applied to the agingcategories. Management believes that the refined estimation model results in abetter estimate of potentially excess and obsolete inventory. The impact ofthis change resulted in lower cost of sales and higher gross profit ofapproximately $448,000, and the net loss was lower by approximately $260,000for the period ended March 26, 2005.

 

*Property, Plant and Equipment*

 

Property, plant and equipment (including assets recorded under capitalleases) are stated at cost, net of accumulated depreciation and amortization.Depreciation and amortization are provided using the straight-line method, atrates designed to distribute the cost of assets over their estimated servicelives or, for leasehold improvements, the shorter of their estimated servicelives or their remaining lease terms. Amortization of assets recorded undercapital leases is included in depreciation expense. Repairs and maintenancecosts are expensed as incurred.

 

In prior fiscal years, web site development costs incurred by theCompany, which were not material, were expensed as incurred.  During the fourth quarter of fiscal 2005, theCompany changed its accounting policy and capitalized $517,000 of web sitedevelopment costs.

 

*Goodwill*

 

Goodwill is subject to an impairment test in the fourth quarter of eachyear, or earlier if indicators of potential impairment exists, using afair-value-based approach. During the fourth quarter of fiscal 2005, theCompany updated its review, which indicated that there was no impairment. Thegoodwill impairment test is a two-step process that requires goodwill to beallocated to reporting units, which are reviewed by the units’ segmentmanagers. In the first step, the fair value of the reporting unit is comparedwith the carrying value of the reporting unit. If the fair value of thereporting unit is less than the carrying value of the reporting unit, goodwillimpairment exists, and the second step of the test is performed. In the secondstep, the implied fair value of the goodwill is compared with the carryingvalue of the goodwill, and an impairment loss is recognized to the extent thatthe carrying value of the goodwill exceeds the implied fair value of thegoodwill.

 

In fiscal 2003, based on the result of the first step of thetransitional impairment test, the Company identified potential goodwillimpairment in its Canadian reporting unit, and subsequently completed the secondstep of the transitional goodwill impairment test. Because the carrying valueof the Canadian reporting unit’s assets and liabilities (excluding goodwill)exceeded the fair value of the Canadian reporting unit, the Company recorded anet goodwill impairment charge of $10,521,000, net of income tax of $0. Thisnon-cash charge was recorded in fiscal 2003 as a cumulative effect of change inaccounting principle, in the accompanying consolidated statements of operationsas of April 1, 2002.

 

F-9

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*Recoverability of Long-Lived Assets*

 

The Company reviews for impairment of long-lived assets and certainintangibles held and used whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. The recoverabilitytest is performed at the lowest level at which undiscounted net cash flows canbe directly attributable to long-lived assets.

 

*Deferred market development costs*

 

The Company entered into a fifteen-year contract to distribute productsdeveloped by a pharmaceutical company. The Company paid fees for exclusivityrights and such payments were recorded as a deferred asset. Once the productreceives regulatory approval, the deferred amounts made will be amortized overthe expected product life cycle. On an ongoing basis, the Company reviews thebalance remaining in the deferred asset account for impairment. At March 27,2004 and March 26, 2005, the balance of the deferred asset related to thiscontract was approximately $1,245,000 and $2,346,000, respectively.

 

The Company also entered into contracts for supply and distribution ofover-the-counter (“OTC”) products developed by certain pharmaceuticalcompanies.  The payments to thesepharmaceutical companies are recorded as deferred assets.  Amortization of the deferred assets iscalculated using straight line method over the terms of the agreements or asrelated sales is recognized.  The Companyalso reviews for impairment of deferred assets whenever events or changes in circumstancesindicate that the unamortized amount of an asset may not be recoverable.  At March 27, 2004 and March 26,2005, the Company had an unamortized balance of approximately $1,258,000 and$1,044,000, respectively, classified under other non-current assets in theaccompanying consolidated balance sheet. In addition, the Company pays a certain percentage of contractuallycalculated net profit as royalties to these companies and they are expensed asrelated sales are recognized.

 

*Income Taxes*

 

The Company utilizes the liability method of accounting for incometaxes as set forth in SFAS No. 109, *Accounting for IncomeTaxes* (“SFAS 109”).  Under theliability method, deferred taxes are determined based on the temporarydifferences between the financial statement and tax bases of assets andliabilities using enacted tax rates.  Avaluation allowance is recorded when it is more likely than not that some ofthe deferred tax assets will not be realized. The Company also determines its tax contingencies in accordance withSFAS No. 5, *Accounting for Contingencies*.  The Company records estimated tax liabilitiesto the extent the contingencies are probable and can be reasonable estimated.

 

*Foreign Currency Translation*

 

The Company translates the foreign currency financial statements of itsCanadian subsidiary by translating balance sheet accounts at the year-endexchange rate and income statement accounts at the monthly weighted averageexchange rate for the year. Translation gains and losses are recorded in shareholder’sequity (deficit), and realized gains and losses are reflected in results ofoperations. Transaction gains were $280,000, $880,000 and $2,805,000 for theyears ended March 29, 2003, March 27, 2004 and March 26, 2005,respectively.

 

*Stock-Based Compensation*

 

Prior to the current fiscal year, the Company accounted for stock-basedcompensation using the intrinsic value recognition and measurement principlesof APB Opinion No. 25 (“APB 25”), Accounting for Stock Issued toEmployees, and related interpretations. Under the provisions of APB 25, compensation expense is measured at thegrant date for the difference between the estimated fair value of the stock andthe exercise price of the option.  Also,prior to the current fiscal year the Company adopted the disclosure, but notthe accounting, requirements of SFAS No. 123, Accounting for Stock BasedCompensation, (“SFAS 123”,) which established a fair-value based method ofaccounting and disclosure for stock-based employee compensation plans.

 

During the current fiscal year, the Company adopted both the accountingand disclosure requirements of SFAS No. 123R, “Share-Based Payments,” (“SFAS123R”).  SFAS 123R was adopted using theModified Prospective Application Method which requires that the annual financialstatements reflect share-based compensation pursuant to SFAS 123R for thefiscal year 2005.  The annual pro formadisclosure under Modified Prospective Application Method requires the disclosureof compensation cost for the entire annual period.

 

*Shipping and Handling Fees and Costs*

 

The Company classifies shipping and handling costs as marketing,selling and distribution expenses in the accompanying consolidated statementsof operations. Shipping and handling expenses for the years ended March 29,2003, March 27, 2004 and March 26, 2005, were $12,268,000,$14,122,000 and $16,082,000, respectively.

 

*Advertising Costs*

 

Advertising costs are expensed as incurred. Advertising expenses forthe years ended March 29, 2003, March 27, 2004 and March 26,2005, were $1,241,000, $2,689,000 and $1,217,000, respectively.

 

F-10

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*Comprehensive Income (Loss)*

 

The only component of other accumulated comprehensive income (loss) isthe cumulative foreign currency translation adjustment recorded in shareholder’sequity (deficit). The comprehensive income (loss) is as follows (in thousands):

 
| ** **                              | ** ** | **Year Ended**           | ** ** |
|-----------------------------------------|------------|--------------------------|------------|
| ** **                              | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Net income (loss)                       |       | $                        | 145,730    |   | $ | 39,056 |   | $ | (47,912 | ) |
| Foreign currency translation adjustment |       | 280                      |       | 880 |   | 2,805 |   |
| Comprehensive income (loss)             |       | $                        | 146,010    |   | $ | 39,936 |   | $ | (45,107 | ) |

 

*Reclassifications*

 

Certain reclassifications have been made to the fiscal 2003 and 2004consolidated financial statements to conform to the fiscal 2005 presentation.

 

**New Accounting Pronouncements**

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts — an amendment of ARB No. 43, Chapter 4” (SFAS 151),which clarifies that abnormal amounts of idle facility expenses, freight,handling costs and wasted materials (spoilage) should be recognized ascurrent period charges. In addition, SFAS 151 requires that allocation offixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. The provisions of SFAS 151 areeffective for inventory costs incurred during fiscal years beginning after June 15,2005. The Company is reviewing the potential impact of the adoption of SFAS 151for the fiscal 2006.

 

In October 2004, the FASB issued FSP 109-1, “Application of FASBStatement 109, Accounting for Income Taxes, to the Tax Deduction on QualifiedProduction Activities Provided by the American Jobs Creation Act of 2004,”effective tax years beginning after December 31, 2004. The FSP providesguidance on the application of SFAS 109, “Accounting for Income Taxes,” to theprovision within the American Jobs Creation Act of 2004 that provides a taxdeduction on qualified production activities. According to FSP 109-1, thededuction should be accounted for as a special deduction in accordance withStatement 109. The Company is reviewing the potential impact of the deductionfor fiscal 2006.

 

**3.****              RestructuringCharges**

 

In fiscal 2002, the Company reduced its global workforce by 66 fulltime employees. Severance and other costs related to such reductions totaledapproximately $1,875,000, and were charged to operations in the period ended March 31,2002. In addition, the Company established a reserve of $2,565,000 in fiscal2002 related to the cancellation of leases, the majority of which resulted inpayments in fiscal 2003.

 

In fiscal 2003, the Company reduced its global workforce by 38 fulltime employees. Severance and other costs related to such reductions totaledapproximately $650,000, and were charged to operations in the period ended March 29,2003.  Also, in fiscal 2003, excessaccruals aggregating $895,000 related to the fiscal 2002 restructuring werereversed as a reduction to the restructuring charges in fiscal 2003.

 

F-11

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The following table summarizes the activities in the Company’srestructuring reserves (in thousands):

 
| ** **                           | ** ** | **Costs for  Employees  Terminated** | ** ** | **Facilities  Consolidation  and Other** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|-----------|------------|
| Balance at March 31, 2002       |       | $                                    | 2,004      |                                     | $          | 3,068     |       | $ | 5,072 |   |
| Additions to restructuring charges   |       | 650                                  |       | —                                   |       | 650       |       |
| Cash payments                        |       | (1,281                               | )          | (2,048                                   | )          | (3,329    | )          |
| Adjustments to restructuring charges |       | (158                                 | )          | (737                                     | )          | (895      | )          |
| Balance at March 29, 2003       |       | 1,215                                |       | 283                                      |       | 1,498     |       |
| Cash payments                        |       | (1,133                               | )          | (277                                     | )          | (1,410    | )          |
| Balance at March 27, 2004       |       | 82                                   |       | 6                                        |       | 88        |       |
| Cash payments                        |       | (82                                  | )          | (6                                       | )          | (88       | )          |
| Balance at March 26, 2005       |       | $                                    | —     |                                     | $          | —    |       | $ | — |   |

 

**4.****              Debt**

 

Long-term debt consists of (in thousands):

 
| ** **                               | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
|------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
|                                     |       |                    |       |                    |       |
| New Credit Facility:                     |       |                    |       |                    |       |
| Term facility                            |       | $                       | 160,400    |                    | $          | 238,800 |   |
| Senior subordinated notes                |       | —                  |       | 150,000                 |       |
| Capital lease obligations                |       | 3,520                   |       | 2,052                   |       |
| Industrial development revenue bond loan |       | 5,100                   |       | 4,600                   |       |
| Industrial opportunities program loan    |       | 1,986                   |       | 1,074                   |       |
|                                     |       | 171,006                 |       | 396,526                 |       |
| Less current portion                     |       | (14,286                 | )          | (5,536                  | )          |
| Total long-term debt                     |       | $                       | 156,720    |                    | $          | 390,990 |   |

 

*New Credit Facility*

 

The New Credit Facility consists of the $240,000,000 Term Facility andthe $50,000,000 Revolving Facility, made available in U.S. dollars to theCompany. The unpaid principal amount outstanding on the Revolving Facility isdue and payable on May 27, 2009. Commencing on May 27, 2004, the TermFacility required quarterly principal payments of approximately 1% per annumover the next six years and three quarters with the balance due on May 27,2011. Principal payments scheduled during the period March 27, 2005through March 25, 2006 total $2,400,000. Borrowings under the New CreditFacility 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) LIBOR for its Term Facility and RevolvingFacility. The ABR rate is determined based on the higher of federal funds rateplus 0.5% or the prime commercial lending rates of UBS AG.  The LIBOR rate is determined based oninterest periods of one, two, three or six months. The “applicable margin” isbased on the Company’s leverage ratio. The leverage ratio is defined generallyas the ratio of consolidated indebtedness including letters of credit outstandingto the credit agreement EBITDA, as defined, and varies as follows: (a) 1.25%to 1.75% for all ABR based loans and (b) from 2.25% to 2.75% for all LIBORbased loans. As of March 26, 2005, the Company’s interest rates were 5.56%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 ofthe average daily unused portion of the Revolving Facility. In addition, theNew Credit Facility also provides for swingline loans(the “Swingline Loans”) of $5,000,000 due prior tothe Revolving Facility and also permits the Company to issue letters of creditup to an aggregate amount of $20,000,000. However, the Company’s totalborrowings under the Revolving Facility, the SwinglineLoans and letters of credit will not be permitted to exceed the RevolvingFacility of $50,000,000. As of March 26, 2005, the Company had $37,986,000available under its Revolving Facility and had $12,014,000 of letters of creditoutstanding.

 

The New Credit Facility contains certain representations and warrantiesand affirmative and negative covenants which, among other things, limit theincurrence of additional indebtedness, guarantees, investments, distributions,transactions with affiliates, assets sales,

 

F-12

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acquisitions, capital expenditures, mergers and consolidations,prepayment of other indebtedness, liens and encumbrances and other matterscustomarily restricted in such agreements. In addition, the Company must alsocomply, every quarter end and on an annual basis, with certain financial ratiosand tests, including without limitation, a maximum total leverage ratio, aminimum interest coverage ratio and a maximum capital expenditure level. TheCompany was in compliance with all such financial covenants as of March 26,2005.

 

The Company’s ability to comply in future periods with the financialcovenants in the New Credit Facility will depend on its ongoing financial andoperating performance, which in turn will be subject to economic conditions andto financial, business and other factors, many of which are beyond the Company’scontrol and will be substantially dependent on the selling prices and demandfor the Company’s products, raw material costs, and the Company’s ability tosuccessfully implement its overall business and profitability strategies.  If a violation of any of the covenantsoccurred, the Company would attempt to obtain a waiver or an amendment from itslenders, although no assurance can be given that the Company would besuccessful in this regard.  The NewCredit Facility and the indenture governing the Notes have covenants as well ascertain cross-default or cross-acceleration provisions; failure to comply withthe covenants in any applicable agreement could result in a violation of suchagreement which could, in turn, lead to violations of other agreements pursuantto such cross-default or cross-acceleration provisions.

 

The New Credit Facility is collateralized by substantially all of theCompany’s assets. Borrowings under the New Credit Facility are a key source of Leiner’s liquidity. Leiner’sability to borrow under the New Credit Facility is dependent on, among otherthings, its compliance with the financial ratio covenants referred to in thepreceding paragraphs. Failure to comply with these financial ratio covenantswould result in a violation of the New Credit Facility and, absent a waiver oramendment from the lenders under such agreement, permit the acceleration of alloutstanding borrowings under the New Credit Facility.

 

*Senior Subordinated Notes*

 

On May 27, 2004, the Company assumed $150,000,000 of the Notesissued in connection with the Recapitalization. The Notes accrue interest atthe rate of 11% per annum, payable semiannually on June 1 and December 1of each year, commencing on December 1, 2004. The Company may be requiredto purchase the Notes upon a Change in Control (as defined in the indenturegoverning the Notes) and in certain circumstances with the proceeds of assetsales. The Notes are subordinated to the indebtedness under the New CreditFacility. The indenture governing the notes imposes certain restrictions on theCompany and its subsidiaries, including restrictions on its ability to incuradditional debt, make dividends, distributions or investments, sell orotherwise dispose of assets, or engage in certain other activities.

 

*Capital Lease Obligations*

 

The capital lease obligations are payable in variable monthlyinstallments through November 2008, bear interest at effective ratesranging from 1.68% to 14.58%. At March 26, 2005, the weighted averageinterest rate on the capital lease obligations is 5.6%. The capital leases aresecured by equipment with a net book value of approximately $2,019,000 at March 26,2005.

 

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

 

The IRB Loan in the original aggregate principal amount of $8,100,000is an obligation of Leiner Health Products, LLC, asubsidiary 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 (2.32% as of March 26, 2005) isvariable and fluctuates on a weekly basis. At March 26, 2005, $4,600,000aggregate principal amount was outstanding on the IRB Loan. The IRB Loan issecured by a letter of credit under our New Credit Facility. Under certaincircumstances, the interest rate on the bonds may be converted to a fixed ratefor the remainder of the term. On or prior to the date that the bonds areconverted to a fixed rate, bondholders may elect to have their bonds or aportion 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 uponseven days’ notice to the trustee. In the event a portion of the bonds aretendered for purchase, the bondholders must retain bonds in the denomination ofat least $100,000. When any bonds shall have been delivered to the trustee forpurchase, the remarketing agent shall use its best efforts to remarket suchbonds at par plus accrued interest. In the event that sufficient funds are notavailable to the trustee to purchase tendered bonds, the Company is required toprovide funds for such purchase, including funds drawn under the letter ofcredit securing the IRB Loan. Upon conversion to a fixed interest rate, thebondholders’ tender option will terminate.

 

*Industrial Opportunities Program Loan*

 

During fiscal 2000, the Company’s wholly owned subsidiary Vita HealthProducts entered into a loan agreement with the Manitoba IndustrialOpportunities Program to fund the expansion and upgrading of the Company’smanufacturing facility in Canada. The loan is secured principally by a pledgeof certain real property of the Company’s Manitoba manufacturing facility andequipment purchased

 

F-13

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with the proceedsof the loan. Principal repayments were scheduled to be made in two equalpayments of 50% of the final loan amount. The first scheduled payment ofapproximately $1,061,000 was made on September 30, 2004. As of March 26,2005, the Company had the remaining outstanding amount of approximately$1,074,000 in advances on the loan, due on September 30, 2005. Interest onthe loan prior to December 31, 2003, was waived and for the period January 2004thru June 1, 2004, may be waived contingent upon the Company’s compliancewith certain obligations, including meeting certain financial ratios.Thereafter, the Company is required to pay interest on the outstanding loanamount at the rate of 7.125% per annum.

 

*Minimum payments*

 

Principal payments on long-term debt through fiscal 2010 and thereafterare (in thousands):

 
| **Fiscal Year** | ** ** | ** ** | ** ** |
|-----------------|------------|------------|------------|
| 2006            |       | $          | 5,536      |   |
| 2007            |       | 3,916      |       |
| 2008            |       | 2,350      |       |
| 2009            |       | 2,924      |       |
| 2010            |       | 2,900      |       |
| Thereafter      |       | 378,900    |       |
|            |       | $          | 396,526    |   |
|                 |            |            |            |  |  |

 

**5.****              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 ARedeemable Preferred Stock of the Company. The Series A RedeemablePreferred Stock had a liquidation preference equal to the greater of (i) a minimum of three times and a maximum of six timesinvested capital, depending on the date on which the liquidation preferencepayment event occurred and (ii) the amount such stock would receive if,after payment of other outstanding preferred stock of the Company, such stockwere treated ratably on a share for share basis with the common stock of theCompany.

 

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

 

*Series B Junior Convertible PreferredStock*

 

In fiscal 2003, the Company’s then current Senior Lenders were issued7,500 shares of Series B Junior Convertible Preferred Stock of theCompany, which was convertible into an aggregate of 3% of the fully dilutedequity of the Company as of April 15, 2002 (52,620 shares of CommonStock), and paid a fixed liquidation preference of $7,500,000 but nodividend.  The holders of Series BJunior Convertible Preferred Stock were entitled to one vote for each share ofPreferred Stock on all matters submitted for a vote of the holders of shares ofCommon Stock.

 

Pursuant to the Recapitalization, the holders of Series B JuniorConvertible Preferred Stock converted their shares into Common Stock of theCompany and received an aggregate amount of $15,194,000 in cash. The differencebetween the carrying value of the Series B Junior Convertible PreferredStock on the date of the Recapitalization and the aggregate consideration paidwas recorded as accretion on preferred stock in the statement of operations forthe year ended March 26, 2005.

 

*Series C Junior Preferred Stock*

 

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

 

Pursuant to the Recapitalization, the Series C Junior PreferredStock were retired and the holders of Series CJunior Preferred Stock received an aggregate amount of $7,000,000. Thedifference between the carrying value of the Series C Junior PreferredStock on the

 

F-14

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date of theRecapitalization and the aggregate amount paid was recorded as accretion onpreferred stock in the statement of operations for the year ended March 26,2005.

 

**6.****              Income Taxes**

 

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

 
| ** ** | ** ** | **Year Ended**           | ** ** |
|------------|------------|--------------------------|------------|
| ** ** | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| U.S        |       | $                        | 104,162    |   | $ | 46,921 |   | $ | (56,183 | ) |
| Foreign    |       | (430                     | )          | 3,482 |   | 7,284 |   |
|       |       | $                        | 103,732    |   | $ | 50,403 |   | $ | (48,899 | ) |

 

The following is a reconciliation of the statutory federal income taxrate to the Company’s effective income tax rate from continuing operations:

 
| ** **                                           | ** ** | **Year Ended**           | ** ** |
|------------------------------------------------------|------------|--------------------------|------------|
| ** **                                           | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Provision/(benefit) at U.S. statutory rates          |       | 35                       | %          | 35 | % | (35 | )% |
| State income taxes, net of federal tax  benefit      |       | 4                        |       | 3 |   | (2 | ) |
| Non deductible recapitalization expenses             |       | —                   |       | 1 |   | 22 |   |
| Higher/(lower) effective rate of foreign  operations |       | —                   |       | (2 | ) | (5 | ) |
| Imputed interest on foreign intercompany loan        |       | —                   |       | — |   | 1 |   |
| Settlement of IRS examinations                       |       | —                   |       | (2 | ) | — |   |
| Other                                                |       | 4                        |       | (1 | ) | 1 |   |
| Valuation allowances                                 |       | (28                      | )          | (11 | ) | 16 |   |
| Effective income tax rate                            |       | 15                       | %          | 23 | % | (2 | )% |

 

Significant components of the provision (benefit) for income taxes fromcontinuing operations are (in thousands):

 
| ** **                                       | ** ** | **Year Ended**           | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Current:                                         |       |                     |       |   |   |   |   |
| Federal                                          |       | $                        | 17,376     |   | $ | 13,254 |   | $ | (237 | ) |
| State                                            |       | 4,187                    |       | 1,581 |   | 264 |   |
| Foreign                                          |       | —                   |       | — |   | 162 |   |
| Total current                                    |       | 21,563                   |       | 14,835 |   | 189 |   |
| Deferred:                                        |       |                     |       |   |   |   |   |
| Federal                                          |       | (5,976                   | )          | (2,009 | ) | (1,172 | ) |
| State                                            |       | —                   |       | (1,479 | ) | (4 | ) |
| Foreign                                          |       | —                   |       | — |   | — |   |
| Total deferred                                   |       | (5,976                   | )          | (3,488 | ) | (1,176 | ) |
| Total provision for (benefit from) income  taxes |       | $                        | 15,587     |   | $ | 11,347 |   | $ | (987 | ) |

 

Deferred income taxes are computed using the liability method andreflect the effects of temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes.

 

Significant components of the Company’s deferred tax assets andliabilities are (in thousands):

 

F-15

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| ** **                                                     | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| Deferred tax assets:                                           |       |                    |       |                    |       |
| Compensation related accruals                                  |       | $                       | 4,767      |                    | $          | 9,581 |   |
| Net operating loss carry forwards                              |       | 680                     |       | 6,517                   |       |
| Fixed and intangibles assets book versus  tax basis difference |       | 4,017                   |       | 2,714                   |       |
| Inventory obsolescence reserves                                |       | 2,091                   |       | 2,080                   |       |
| Allowances for doubtful accounts and sales  returns            |       | 615                     |       | 1,652                   |       |
| Other                                                          |       | —                  |       | 1,174                   |       |
| Total deferred tax assets                                      |       | 12,170                  |       | 23,718                  |       |
| Valuation allowance                                            |       | (1,801                  | )          | (11,750                 | )          |
| Deferred tax assets                                            |       | 10,369                  |       | 11,968                  |       |
| Deferred tax liabilities:                                      |       |                    |       |                    |       |
| Inventory capitalization                                       |       | (1,037                  | )          | (985                    | )          |
| Fixed and intangibles assets book versus  tax basis difference |       | —                  |       | (510                    | )          |
| Other                                                          |       | (35                     | )          | —                  |       |
| Deferred tax liabilities                                       |       | (1,072                  | )          | (1,495                  | )          |
| Net deferred tax assets                                        |       | $                       | 9,297      |                    | $          | 10,473 |   |

 

AtMarch 26, 2005, the Company has elected to forego its ability to carryback its current year federal net operating loss resultingin federal, state, and foreign net operating loss carryforwardsof $14,135,000, $16,598,000, and $620,000, respectively.  The federal net operating loss carryforward will expire in fiscal year 2026, if notpreviously utilized and state net operating loss carryforwardsbegin to expire in fiscal year 2011.  TheCompany’s foreign net operating loss carryforwardwill expire in fiscal year 2011, if not previously utilized.

 

AtMarch 26, 2005, the Company had federal and state research and developmentcredit carryforwards of approximately $188,000 and$120,000, respectively. These research and development credit carryforwards begin to expire fiscal year 2026, if notpreviously utilized.

 

Dueto the “change of ownership” provision of the Tax Reform Act of 1986,utilization of the Company’s net operating loss carryforwardsmay be subject to an annual limitation against taxable income in futureperiods. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becomingavailable to reduce future income tax liabilities.

 

Inassessing the realizability of deferred tax assets,management considers whether it is “more likely than not” that some portion orall of the deferred tax assets will not be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which those temporary differences becomedeductible. Management considers taxable income in carrybackyears, the scheduled reversal of deferred tax liabilities, tax planningstrategies and projected future taxable income in making this assessment.During fiscal year 2005, a valuation allowance of $7,769,000, related to theportion of domestic deferred tax assets attributable to compensation expenserelated to delayed delivery shares awarded as part of the Recapitalization, hasbeen established to offset the related deferred assets due to the uncertaintyregarding future realization.   Theremaining valuation allowance is attributable to foreign deferred tax assets.

 

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

 

OnOctober 22, 2004, the American Jobs Creation Act of 2004 (AJCA) was signedinto law. The AJCA provides several incentives for U.S. multinationalcorporations and U.S. manufacturers, Subject to certain limitations, theincentives include an 85% dividends received deduction for certain dividendsfrom controlled foreign corporations that repatriate accumulated income abroad,and a deduction for domestic qualified production activities taxable income.The Company does not intend to take advantage of repatriation provisions ofAJCA.

 

As of March 27, 2004 and March 26, 2005, current deferred taxassets of $7,207,000 and $10,629,000 respectively, are classified under prepaidexpenses and other current assets in the accompanying consolidated balancesheet.  Also, as of March 27, 20004and

 

F-16

----

 

March 26, 2005, non current deferred tax assets of $2,090,000 andnon-current deferred tax liabilities of $156,000, respectively are classifiedunder other non-current assets and non-current liabilities, respectively in theaccompanying consolidated balance sheet.

 

**7.****              Employee Benefits**

 

*Stock-Option Plan*

 

During fiscal 2003 and 2004, the Company had one stock-based employeecompensation plan.  During fiscal 2005,the Company had three stock-based employee compensation plans.

 

1997 Option Plan:

 

The Company’s Stock Option Plan, as amended in 1997 (the “1997 OptionPlan”), provided for the issuance of nonqualified stock options to certain keyemployees and directors to purchase up to 252,222 shares of the Company’scommon stock.  Options granted were atexercise prices as determined by the Company’s Board of Directors, but not lessthan $100 per share.  Options generallyvested on a pro rata basis at a rate of 25% per year, with 25% immediatevesting on the date of the grant, and expired no later than ten years from thedate of grant.

 

Activity under the 1997 Option Plan for the years ended March 29,2003, 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 31, 2002  |       | 63,088                           |       | 189,134                 |       | $ | 100-180 |   | $ | 121 |   |
| Options granted                 |       | (26,360                          | )          | 26,360                  |       | 100 |   | 100 |   |
| Options canceled                |       | 550                              |       | (550                    | )          | 140-180 |   | 166 |   |
| Balance at March 29, 2003  |       | 37,278                           |       | 214,944                 |       | 100-180 |   | 118 |   |
| Options granted                 |       | (37,000                          | )          | 37,000                  |       | 225 |   | 225 |   |
| Balance at March 27, 2004  |       | 278                              |       | 251,944                 |       | 100-225 |   | 134 |   |
| Options repurchased and retired |       | (278                             | )          | (251,944                | )          | $ | 100-225 |   | $ | 134 |   |
| Balance 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 byHoldings.  Options with a net value of$13,657,000 were rolled over into new equity rights in Holdings.  The remaining options were purchased forapproximately $25,402,000 representing the difference between the per share Recapitalization purchase price and theexercise price of the stock options.  Thetotal amount of approximately $39,059,000 was incurred in stock-basedcompensation during the fiscal year ended March 26, 2005.   The Company accounted for the 1997 OptionPlan under the principles of APB 25 and no compensation expense was reported inthe financial statements for the options granted in the years ended March 29,2003 and March 27, 2004.  Theweighted-average fair value of options granted during the years ended March 29,2003 and March 27, 2004 were $0 and $167, respectively.

 

2004 Option Plan:

 

The Board of Directors of Holdings approved the LHP Holding Corp. 2004Stock Option Plan (the “2004 Option Plan”) on October 1, 2004.  Under the 2004 Option Plan, common stockreserved up to an aggregate number of shares not to exceed 117,409 may begranted.  Option awards are generallygranted with an exercise price equal to the calculated market value of a shareof Holdings common stock on the date of the grant.  The option awardsgenerally vest based on 4 years of continuous employment service and have tenyear contractual terms to exercise.  Theoption awards provide for accelerated vesting if there is a change in control (asdefined in the 2004 Option Plan).

 

F-17

----

 

Activity under the 2004 Option Plan for the year ended 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 27, 2004 |       | —                           |       | —                  |       | $ | — |   | $ | — |   |
| 2004 option plan approved      |       | 117,409                          |       | —                  |       | — |   | — |   |
| Options granted                |       | (39,138                          | )          | 39,138                  |       | 2.37 |   | 2.37 |   |
| Balance at March 26, 2005 |       | 78,271                           |       | 39,138                  |       | $ | 2.37 |   | $ | 2.37 |   |

 

The following table summarizes the information on the options grantedas of March 26, 2005:

 
| **Outstanding**    | ** ** | **Excercisable**      | ** ** |
|--------------------|------------|-----------------------|------------|
| **Exercise price** | ** ** | **Number of  Shares** | ** ** | **Average  Remaining  Contractual  Life (years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $                  | 2.37       |                  | 39,138     |   | 9.75 |   | $ | 2.37 |   | — |   | $ | 2.37 |   |
|                    |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

The Company accounts for the stock option grants under the 2004 OptionPlan under the principles of SFAS 123R. $1,101 was recorded as share-basedcompensation under General and Administrative expense in the Statement ofOperations for the year ended March 26, 2005.  The weighted-average fair value of optionsgranted during the year ended March 26, 2005 was $0.45.  As of March 26, 2005, there was $16,511of total unrecorded and unrecognized compensation cost related to nonvestedshare based compensation under the 2004 Option Plan.  That cost is expected to be recorded andrecognized over a weighted average period of 3.75 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 reservedup to an aggregate number of shares not to exceed 195,676 may be issued.  Each issuance and purchase of shares underthe Stock Plan will be completed pursuant to a subscription agreement whichwill include such terms and conditions not inconsistent with the Stock Plan asthe Holdings Board of Directors determines. Restricted stock will generally be issued with a purchase price equal tothe calculated market value of a share of Holdings common stock on the date ofthe subscription agreement.  Therestricted stock has various restrictive Call Rights retained by the Companyafter issuance. Although the timing of the removal of the Call Rights isdependant upon the future employment status of the employee, generally, theCall Rights are removed over a pro-rata period of six years from the date ofthe Recapitalization.  The Stock Plan,however, also provides for accelerated removal of the restrictive Call Rightsif there is a change in control (as defined in the Stock Plan).

 

Activity under the Stock Plan for the year ended March 26, 2005 isset 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 |   | 2.37 |   |
| Balance at March 26, 2005      |       | —                              |       | 195,676                           |       | $ | 2.37 |   | $ | 2.37 |   |

 

F-18

----

 

The following table summarizes the information on the options grantedas of March 26, 2005:

 
| **Outstanding**    | ** ** | **Excercisable**      | ** ** |
|--------------------|------------|-----------------------|------------|
| **Purchase price** | ** ** | **Number of  Shares** | ** ** | **Average  Remaining Call  Right Life  (years)** | ** ** | **Weighted  Average  Purchase  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Purchase  Price** | ** ** |
| $                  | 2.37       |                  | 195,676    |   | 5.25 |   | $ | 2.37 |   | — |   | $ | 2.37 |   |
|                    |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

The Company accounts for the restricted stock issued under the StockPlan under the principles of SFAS 123R. $4,002 was recorded as share-basedcompensation under General and Administrative expense in the Statement ofOperations for the year ended March 26, 2005.  The weighted-average fair value of restrictedstock issued during the year ended March 26, 2005 was $0.45.  As of March 26, 2005, there was $84,052of total unrecorded and unrecognized compensation cost related to share basedcompensation under the Stock Plan.  Thatcost is expected to be recorded and recognized over a weighted average periodof 5.25 years.

 

*Pro Forma Disclosures:*

 

Pro forma information regarding net income (loss) is required by SFAS123R.  This information is required to bepresented as if the Company had accounted for stock-based awards to itsemployees under the fair value method pursuant to SFAS 123R, rather than theintrinsic value method pursuant to APB 25. This pro forma requirement covers the fiscal years ended March 29,2003, March 27, 2004 and March 26, 2005.

 

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

 

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

 
| ** **                    | ** ** | **Year Ended**           | ** ** |
|-------------------------------|------------|--------------------------|------------|
| ** **                    | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Risk free interest rate       |       | 4.0                      | %          | 4.0 | % | — |   |
| Expected option life in years |       | 6.25                     |       | 5.60 |   | — |   |

 

The fair value of each option award under the 2004 Option Plan and ofeach restricted stock issued under the Stock Plan was estimated on the date ofgrant or issuance using the Black-Scholes Option Pricing Formula.  The expected terms of the awards willrepresent the period of time that the awards are expected to beoutstanding.  Because the Company’scommon stock is neither publicly nor internally traded, a calculated value torepresent the volatility of the Company’s stock is derived using the historicalvolatility of a representative set of companies in the same industry sector toestablish an appropriate industry sector index. The Black-Scholes Option Pricing Formula used by the Company is adjustedfor the effect of the contractual dividends provided to the preferredshareholders.  In addition, the Companyadjusts the fair value of each option, as derived by the Black-Scholes OptionPricing Formula to consider the effects of non-transferability and the lack ofcontrol inherent in the minority interest that the common stock, which is beingawarded, represents.

 

F-19

----

 

The following weighed average assumptions were used in valuing theshare based awards granted under the 2004 Option Plan and the restricted stockissued under the Stock Plan:

 
| ** **               | ** ** | **Year Ended**           | ** ** |
|--------------------------|------------|--------------------------|------------|
| ** **               | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Risk free interest rate  |       | —                   |       | — |   | 3.73 | % |
| Expected term in years   |       | —                   |       | — |   | 5.00 |   |
| Expected volatility      |       | —                   |       | — |   | 56.34 | % |
| Expected dividend rate   |       | —                   |       | — |   | 13.00 | % |
| Expected forfeiture rate |       | —                   |       | — |   | — | % |

 

*Contributory Retirement Plans*

 

The Company has contributory retirement plans that cover substantiallyall of the Company’s employees who meet minimum service requirements. TheCompany’s contributions to the plans are discretionary and are determined bythe Company’s Board of Directors.  TheCompany changed its current contributory retirement plan documents to shift theplans’ year-ends from a fiscal year to a calendar year on April 1,2002.  Thus the last three completed planyears were from April 1, 2002 to December 31, 2002; from January 1,2003 to December 31, 2003, and from January 1, 2004 to December 31,2004.  The Company did not contribute forthe plan years ended December 31, 2003 and 2004. Also, as of March 26,2005, the Company has not contributed for the current plan year which began January 1,2005.

 

**8.****              Related PartyTransactions**

 

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 administrativeentities affiliated with the Golden Gate Investors (“GGC Administration”) toprovide the Company with certain financial, investment banking, managementadvisory and other services performed in connection with the Recapitalizationand for future financial, investment banking, management advisory and otherservices performed on the Company’s behalf.  In exchange for suchservices in connection with the Recapitalization, the Company has paid$6,190,000 to each of North Castle Partners, L.L.C. and GGC Administration. TheCompany has also paid $175,000 in certain fees, costs and out-of-pocketexpenses incurred in the aggregate by North Castle Partners, L.L.C. and GGCAdministration in connection with the Recapitalization. As compensation fortheir continuing services, the Company will pay a $1,315,000 management fee inarrears annually plus reasonable out of pocket expenses to each of North CastlePartners, L.L.C. and GGC Administration as long as the Company meets aperformance target, which the Company met in fiscal 2005. Other operatingexpenses in the accompanying statement of operations for the years ended March 29,2003, March 27, 2004 and March 26, 2005 included $1,579,000,$1,578,000 and $3,258,000, respectively, of management fees and out-of-pocketexpenses.

 

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

 

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

 

**9.****              Commitments**

 

The Company leases certain real estate for its manufacturingfacilities, warehouses, corporate and sales offices, as well as certainequipment under operating leases (non-cancelable) that expire at various datesthrough March 2014 and contain renewal options. Total rents charged tooperations for the years ended March 29, 2003, March 27, 2004 and March 26,2005 were $13,715,000, $13,876,000 and $13,955,000, respectively.

 

F-20

----

 

Minimum future obligations on non-cancelable operating leases in effectat March 26, 2005 are (in thousands):

 
| **Fiscal year**              | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| 2006                         |       | $          | 12,002     |   |
| 2007                         |       | 9,454      |       |
| 2008                         |       | 7,371      |       |
| 2009                         |       | 7,085      |       |
| 2010                         |       | 7,073      |       |
| Thereafter                   |       | 23,194     |       |
| Total minimum lease payments |       | $          | 66,179     |   |

 

The Company has certain operating leases that have escalating paymentclauses. The Company recognizes expenses on a straight-line basis over the termof the respective leases. At March 27, 2004 and March 26, 2005, theCompany had recorded deferred rent liabilities of $2,137,000 and $2,512,000,respectively.

 

**10.****       Contingencies**

 

*Antitrust Lawsuit*

 

On September 27, 1999, the Company filed a civil antitrust lawsuit(the “Antitrust Lawsuit”) against certain of its raw material suppliers andother alleged co-conspirators. The complaint alleges that the defendantsconspired to fix vitamin prices and allocate vitamin production volume andvitamin customers in the United States. The complaint seeks unspecified damagesand injunctive relief. After the lawsuit was filed, it was consolidated, forpre-trial purposes, with other similar cases.

 

During fiscal 2002, and 2003, the Company entered into settlementagreements with several of its suppliers named in the Antitrust Lawsuit (the “SettlementAgreements”). Pursuant to the terms of the Settlement Agreements, the Companyagreed to release all claims it may have against these suppliers based on theCompany’s purchases of various vitamins from the suppliers and to opt out ofany settlements in connection with the Antitrust Lawsuit insofar as it pertainsto these suppliers. In exchange for the Company’s release and agreement to optout of the settlement in connection with the Antitrust Lawsuit, the Company hasbeen awarded net settlements in the aggregate amount of approximately$40,778,000 and $98,380,000, in the years ended March 31, 2002 and March 29,2003, respectively, which were offset by legal, consulting fees and other costsof approximately $9,930,000 and $19,186,000, respectively. Net proceeds wererecorded in other operating expense (income) in the accompanying consolidatedstatements of operations.

 

*Other*

 

The Company has been named in seven cases alleging adverse reactionsassociated with each plaintiff’s ingestion of Phenylpropanolamine containingproducts which the Company allegedly manufactured and sold. Currently, none ofthe cases have proceeded to trial, but the Company intends to vigorously defendthe allegations if trials ensue. These actions have been tendered to theCompany’s insurance carrier and deductible amounts aggregating approximately$2,000,000 have been accrued in the accompanying consolidated financialstatements.

 

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

 

**11.****       Concentration of CreditRisk and Significant Customers, Suppliers and Products**

 

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

 

F-21

----

 

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

 
| ** ** | ** ** | **Year Ended**           | ** ** |
|------------|------------|--------------------------|------------|
| ** ** | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Customer A |       | 40                       | %          | 42 | % | 43 | % |
| Customer B |       | 17                       | %          | 18 | % | 20 | % |

 

Our largest customer has two retail divisions that, if viewed asseparate entities, would constitute the following percentage of gross sales ineach respective period:

 
| ** ** | ** ** | **Year Ended**           | ** ** |
|------------|------------|--------------------------|------------|
| ** ** | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| Division 1 |       | 23                       | %          | 24 | % | 25 | % |
| Division 2 |       | 17                       | %          | 18 | % | 18 | % |

 

The Company’s top ten customers in the aggregate accounted forapproximately 86%, 87% and 85% of the Company’s gross sales for the years endedMarch 29, 2003, March 27, 2004 and March 26, 2005, respectively.

 

At March 27, 2004 and March 26, 2005, the Company hadreceivables from two U.S. customers of approximately 37% and 22% and 41% and28%, respectively, of U.S. gross receivables.

 

For the years ended March 29, 2003, March 27, 2004 and March 26,2005, one supplier, excluding purchases by Vita, provided approximately 13%,12% and 11 %, respectively, of raw materials purchased.  No other supplier accounted for more than 10%of the Company’s purchases.

 

Sales of vitamins C and E, in the aggregate, accounted forapproximately 15%, 14% and 12% of the Company’s gross sales in fiscal 2003,2004 and 2005, respectively. If one or more of the Company’s major customerssubstantially reduced their volume of purchases from the Company, or if salesof vitamin C were substantially reduced, or if sales of Vitamin E were furtherreduced as a result of negative media in the third quarter of fiscal 2005, theCompany’s results of operations could be materially adversely affected.

 

**12.****       Business SegmentInformation**

 

The Company operates in two business segments. One consists of theCompany’s U.S. Operations (“Leiner U.S.”) and the other is the Company’sCanadian operation (“Vita Health”). The Company’s operating segmentsmanufacture a range of vitamins, minerals and nutritional supplements (“VMS”)and over-the-counter (“OTC”) pharmaceuticals and distribute their productsprimarily through FDMC retailers. The accounting policies between the reportablesegments are the same as those described in the summary of significantaccounting policies. The Company evaluates segment performance based onoperating profit, before the effect of non-recurring charges and gains, andinter-segment profit.

 

F-22

----

 

Selected financial information for the Company’s reportable segmentsfor the years ended March 29, 2003, March 27, 2004 and March 26,2005 is as follows (in thousands):

 
| ** **                                                           | ** ** | **Leiner  U.S.** | ** ** | **Vita  Health** | ** ** | **Consolidated  Totals** | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|------------------|------------|--------------------------|------------|
| **Year ended March 29, 2003**                                   |       |             |       |             |       |                     |       |
| Net sales to external customers                                      |       | $                | 528,929    |             | $          | 45,352                   |       | $ | 574,281 |   |
| Intersegment sales                                                   |       | 1,865            |       | 23               |       | —                   |       |
| Depreciation and amortization, excluding  deferred financing charges |       | 17,783           |       | 1,868            |       | 19,651                   |       |
| Segment operating income                                             |       | 121,532          |       | 1,009            |       | 122,541                  |       |
| Interest expense, net (1)                                            |       | 17,370           |       | 1,439            |       | 18,809                   |       |
| Income tax expense                                                   |       | 15,587           |       | —           |       | 15,587                   |       |
| Extraordinary gain, net                                              |       | 68,106           |       | —           |       | 68,106                   |       |
| Cumulative effect of change in accounting  principle                 |       | —           |       | 10,521           |       | 10,521                   |       |
| Segment assets                                                       |       | 301,014          |       | 36,515           |       | 337,529                  |       |
| Additions to property, plant and equipment                           |       | 7,678            |       | 1,243            |       | 8,921                    |       |
| **Year ended March 27, 2004**                                   |       |             |       |             |       |                     |       |
| Net sales to external customers                                      |       | $                | 601,961    |             | $          | 59,084                   |       | $ | 661,045 |   |
| Intersegment sales                                                   |       | 3,644            |       | 30               |       | —                   |       |
| Depreciation and amortization, excluding  deferred financing charges |       | 12,272           |       | 2,396            |       | 14,668                   |       |
| Segment operating income                                             |       | 64,287           |       | 5,070            |       | 69,357                   |       |
| Interest expense, net (1)                                            |       | 17,366           |       | 1,588            |       | 18,954                   |       |
| Income tax expense                                                   |       | 11,347           |       | —           |       | 11,347                   |       |
| Segment assets                                                       |       | 341,866          |       | 45,933           |       | 387,799                  |       |
| Additions 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                   |       | $ | 684,901 |   |
| Intersegment sales                                                   |       | 4,566            |       | 21               |       | —                   |       |
| Depreciation and amortization, excluding  deferred financing charges |       | 11,107           |       | 2,615            |       | 13,722                   |       |
| Segment operating income (loss)                                      |       | (25,485          | )          | 8,932            |       | (16,553                  | )          |
| Interest expense, net (1)                                            |       | 30,698           |       | 1,648            |       | 32,346                   |       |
| Income tax expense (benefit)                                         |       | (1,149           | )          | 162              |       | (987                     | )          |
| Segment assets                                                       |       | 367,036          |       | 49,762           |       | 416,798                  |       |
| Additions to property, plant and equipment                           |       | 16,646           |       | 1,630            |       | 18,276                   |       |

 

----

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

 

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

 
| ** **                            | ** ** | **Year Ended**           | ** ** |
|---------------------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **March 29,  2003** | ** ** | **%** | ** ** | **March 27,  2004** | ** ** | **%** | ** ** | **March 26,  2005** | ** ** | **%** | ** ** |
| VMS products                          |       | $                        | 384,182    |   | 67 | % | $ | 413,679 |   | 63 | % | $ | 419,491 |   | 61 | % |
| OTC products                          |       | 148,983                  |       | 26 | % | 191,196 |   | 29 | % | 213,402 |   | 31 | % |
| Contract manufacturing services/Other |       | 41,116                   |       | 7 | % | 56,170 |   | 8 | % | 52,008 |   | 8 | % |
| Total                                 |       | $                        | 574,281    |   | 100 | % | $ | 661,045 |   | 100 | % | $ | 684,901 |   | 100 | % |

 

F-23

----

 

**13.****       Financial information forsubsidiary guarantor and subsidiary non-guarantor**

 

In connection with the issuance of Notes, the Company’s U.S.-basedsubsidiaries guaranteed the payment of principal, premium and interest on theNotes. Presented below is consolidating financial information for the Companyand its subsidiary guarantors and subsidiary non-guarantors for the periodsindicated.

 

F-24

----

 

**LeinerHealth Products Inc.**

**ConsolidatingBalance Sheets**

**(inthousands)**

 
| ** **                                                                             | ** ** | **March 27, 2004**                        | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                             | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations and  Consolidating  Entries** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                                                             | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                                        |       |                                           |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                              |       | $                                              | 25,601     |   | $ | 8,223 |   | $ | — |   | $ | 33,824 |   |
| Accounts receivable, net of allowances                                                 |       | 71,879                                         |       | 6,105 |   | — |   | 77,984 |   |
| Inventories                                                                            |       | 126,104                                        |       | 18,375 |   | — |   | 144,479 |   |
| Income tax receivable                                                                  |       | 483                                            |       | — |   | — |   | 483 |   |
| Prepaid expenses and other current assets                                              |       | 13,026                                         |       | 148 |   | — |   | 13,174 |   |
| Total current assets                                                                   |       | 237,093                                        |       | 32,851 |   | — |   | 269,944 |   |
| Intercompany receivable                                                                |       | 29,355                                         |       | — |   | (29,355 | ) | — |   |
| Property, plant and equipment, net                                                     |       | 46,060                                         |       | 10,207 |   | — |   | 56,267 |   |
| Goodwill                                                                               |       | 49,224                                         |       | 2,859 |   | — |   | 52,083 |   |
| Other noncurrent assets                                                                |       | 9,489                                          |       | 16 |   | — |   | 9,505 |   |
| Total assets                                                                           |       | $                                              | 371,221    |   | $ | 45,933 |   | $ | (29,355 | ) | $ | 387,799 |   |
| **LIABILITIES, REDEEMABLE PREFERRED STOCK AND  SHAREHOLDERS’ EQUITY (DEFICIT)**   | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                                                   |       |                                           |       |   |   |   |   |   |   |
| Accounts payable                                                                       |       | $                                              | 83,687     |   | $ | 7,475 |   | $ | — |   | $ | 91,162 |   |
| Accrued compensation and benefits                                                      |       | 13,331                                         |       | 1,183 |   | — |   | 14,514 |   |
| Customer allowances payable                                                            |       | 7,899                                          |       | 997 |   | — |   | 8,896 |   |
| Accrued interest                                                                       |       | 841                                            |       | 269 |   | — |   | 1,110 |   |
| Other accrued expenses                                                                 |       | 5,674                                          |       | 511 |   | — |   | 6,185 |   |
| Current portion of long-term debt                                                      |       | 11,988                                         |       | 2,298 |   | — |   | 14,286 |   |
| Total current liabilities                                                              |       | 123,420                                        |       | 12,733 |   | — |   | 136,153 |   |
| Intercompany payable                                                                   |       | —                                         |       | 29,355 |   | (29,355 | ) | — |   |
| Long-term debt                                                                         |       | 137,052                                        |       | 19,668 |   | — |   | 156,720 |   |
| Other noncurrent liabilities                                                           |       | 3,724                                          |       | — |   | — |   | 3,724 |   |
| Total liabilities                                                                      |       | 264,196                                        |       | 61,756 |   | (29,355 | ) | 296,597 |   |
| Series A redeemable preferred stock                                               |       | 40,188                                         |       | — |   | — |   | 40,188 |   |
| Shareholders’ equity (deficit):                                                   |       |                                           |       |   |   |   |   |   |   |
| Series B junior convertible preferred  stock                                      |       | 6,616                                          |       | — |   | — |   | 6,616 |   |
| Series C junior preferred stock                                                   |       | 6,178                                          |       | — |   | — |   | 6,178 |   |
| Common stock                                                                           |       | 11                                             |       | — |   | — |   | 11 |   |
| Capital in excess of par value                                                         |       | 21,841                                         |       | — |   | — |   | 21,841 |   |
| Retained earnings (accumulated deficit)                                                |       | 32,191                                         |       | (15,932 | ) | — |   | 16,259 |   |
| Accumulated other comprehensive income                                                 |       | —                                         |       | 109 |   | — |   | 109 |   |
| Total shareholders’ equity (deficit)                                              |       | 66,837                                         |       | (15,823 | ) | — |   | 51,014 |   |
| Total liabilities, redeemable preferred  stock and shareholders’ equity (deficit) |       | $                                              | 371,221    |   | $ | 45,933 |   | $ | (29,355 | ) | $ | 387,799 |   |

 

F-25

----

** **

**LeinerHealth Products Inc.**

**ConsolidatingBalance Sheets**

**(inthousands)**

 
| ** **                                       | ** ** | **March 26, 2005**                        | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations and  Consolidating  Entries** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                       | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                  |       |                                           |       |   |   |   |   |   |   |
| Cash and cash equivalents                        |       | $                                              | 11,670     |   | $ | 5,281 |   | $ | — |   | $ | 16,951 |   |
| Accounts receivable, net of allowances           |       | 71,518                                         |       | 8,732 |   | — |   | 80,250 |   |
| Inventories                                      |       | 142,493                                        |       | 22,417 |   | — |   | 164,910 |   |
| Income tax receivable                            |       | 2,310                                          |       | — |   | — |   | 2,310 |   |
| Prepaid expenses and other current assets        |       | 17,267                                         |       | 225 |   | — |   | 17,492 |   |
| Total current assets                             |       | 245,258                                        |       | 36,655 |   | — |   | 281,913 |   |
| Intercompany receivable                          |       | 42,240                                         |       | — |   | (42,240 | ) | — |   |
| Property, plant and equipment, net               |       | 55,540                                         |       | 10,014 |   | — |   | 65,554 |   |
| Goodwill                                         |       | 49,224                                         |       | 3,093 |   | — |   | 52,317 |   |
| Other noncurrent assets                          |       | 17,014                                         |       |   |   | — |   | 17,014 |   |
| Total assets                                     |       | $                                              | 409,276    |   | $ | 49,762 |   | $ | (42,240 | ) | $ | 416,798 |   |
| **LIABILITIES AND SHAREHOLDER’S DEFICIT**   | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                             |       |                                           |       |   |   |   |   |   |   |
| Accounts payable                                 |       | $                                              | 92,974     |   | $ | 8,665 |   | $ | — |   | $ | 101,639 |   |
| Accrued compensation and benefits                |       | 8,024                                          |       | 1,610 |   | — |   | 9,634 |   |
| Customer allowances payable                      |       | 8,513                                          |       | 1,063 |   | — |   | 9,576 |   |
| Accrued interest                                 |       | 9,024                                          |       | 69 |   | — |   | 9,093 |   |
| Other accrued expenses                           |       | 12,396                                         |       | 908 |   | — |   | 13,304 |   |
| Current portion of long-term debt                |       | 4,453                                          |       | 1,083 |   | — |   | 5,536 |   |
| Total current liabilities                        |       | 135,384                                        |       | 13,398 |   | — |   | 148,782 |   |
| Intercompany payable                             |       | —                                         |       | 42,240 |   | (42,240 | ) | — |   |
| Long-term debt                                   |       | 390,970                                        |       | 20 |   | — |   | 390,990 |   |
| Other noncurrent liabilities                     |       |                                           |       |   |   | — |   | — |   |
| Total liabilities                                |       | 526,354                                        |       | 55,658 |   | (42,240 | ) | 539,772 |   |
| Shareholder’s deficit:                      |       |                                           |       |   |   |   |   |   |   |
| Capital in excess of par value                   |       | 469                                            |       | — |   | — |   | 469 |   |
| Accumulated deficit                              |       | (117,547                                       | )          | (8,810 | ) | — |   | (126,357 | ) |
| Accumulated other comprehensive income           |       | —                                         |       | 2,914 |   | — |   | 2,914 |   |
| Total shareholder’s deficit                 |       | (117,078                                       | )          | (5,896 | ) | — |   | (122,974 | ) |
| Total liabilities and shareholder’s deficit |       | $                                              | 409,276    |   | $ | 49,762 |   | $ | (42,240 | ) | $ | 416,798 |   |

 

F-26

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Operations**

**(inthousands)**

 
| ** **                                                                                       | ** ** | **Year Ended March 29, 2003**             | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations and  Consolidating  Entries** | ** ** | **Consolidated** | ** ** |
| Net sales                                                                                        |       | $                                              | 530,794    |   | $ | 45,375 |   | $ | (1,888 | ) | $ | 574,281 |   |
| Cost of sales                                                                                    |       | 395,360                                        |       | 36,618 |   | (1,888 | ) | 430,090 |   |
| Gross profit                                                                                     |       | 135,434                                        |       | 8,757 |   | — |   | 144,191 |   |
| Marketing, selling and distribution  expenses                                                    |       | 44,592                                         |       | 4,008 |   | — |   | 48,600 |   |
| General and administrative expenses                                                              |       | 41,014                                         |       | 2,917 |   | — |   | 43,931 |   |
| Research and development expenses                                                                |       | 5,487                                          |       | — |   | — |   | 5,487 |   |
| Amortization of other intangibles                                                                |       | 1,504                                          |       | 81 |   | — |   | 1,585 |   |
| Restructuring charges                                                                            |       | (895                                           | )          | 650 |   | — |   | (245 | ) |
| Other operating expense (income)                                                                 |       | (77,800                                        | )          | 92 |   | — |   | (77,708 | ) |
| Operating income                                                                                 |       | 121,532                                        |       | 1,009 |   | — |   | 122,541 |   |
| Interest expense, net                                                                            |       | 17,370                                         |       | 1,439 |   | — |   | 18,809 |   |
| Income before income taxes                                                                       |       | 104,162                                        |       | (430 | ) | — |   | 103,732 |   |
| Provision for (benefit from) income taxes                                                        |       | 15,587                                         |       | — |   | — |   | 15,587 |   |
| Income (loss) before extraordinary item and  cumulative effect of change in accounting principle |       | 88,575                                         |       | (430 | ) | — |   | 88,145 |   |
| Extraordinary gain, net                                                                          |       | 68,106                                         |       | — |   | — |   | 68,106 |   |
| Cumulative effect of change in accounting principle,  net                                        |       | —                                         |       | (10,521 | ) | — |   | (10,521 | ) |
| Net income (loss)                                                                                |       | 156,681                                        |       | (10,951 | ) | — |   | 145,730 |   |
| Accretion on preferred stock                                                                     |       | (8,083                                         | )          | — |   | — |   | (8,083 | ) |
| Net income attributable to common  shareholders                                                  |       | $                                              | 148,598    |   | $ | (10,951 | ) | $ | — |   | $ | 137,647 |   |

 

F-27

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Operations**

**(inthousands)**

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

 

F-28

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Operations**

**(inthousands)**

 
| ** **                                             | ** ** | **Year Ended March 26, 2005**             | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations and  Consolidating  Entries** | ** ** | **Consolidated** | ** ** |
| Net sales                                              |       | $                                              | 615,481    |   | $ | 74,007 |   | $ | (4,587 | ) | $ | 684,901 |   |
| Cost of sales                                          |       | 461,348                                        |       | 56,110 |   | (4,587 | ) | 512,871 |   |
| Gross profit                                           |       | 154,133                                        |       | 17,897 |   | — |   | 172,030 |   |
| Marketing, selling and distribution  expenses          |       | 53,711                                         |       | 4,821 |   | — |   | 58,532 |   |
| General and administrative expenses                    |       | 30,031                                         |       | 4,103 |   | — |   | 34,134 |   |
| Research and development expenses                      |       | 5,299                                          |       | — |   | — |   | 5,299 |   |
| Amortization of other intangibles                      |       | 250                                            |       | — |   | — |   | 250 |   |
| Recapitalization expenses                              |       | 87,950                                         |       | 32 |   | — |   | 87,982 |   |
| Other operating expense                                |       | 2,377                                          |       | 9 |   | — |   | 2,386 |   |
| Operating income (loss)                                |       | (25,485                                        | )          | 8,932 |   | — |   | (16,553 | ) |
| Interest expense, net                                  |       | 30,698                                         |       | 1,648 |   | — |   | 32,346 |   |
| Income (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-29

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Cash Flows**

**(inthousands)**

 
| ** **                                                                                   | ** ** | **Year Ended March 29, 2003**             | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
| **Operating activities**                                                                     |       |                                           |       |   |   |   |   |
| Net income (loss)                                                                            |       | $                                              | 156,681    |   | $ | (10,951 | ) | $ | 145,730 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                           |       |   |   |   |   |
| Depreciation                                                                                 |       | 12,142                                         |       | 1,778 |   | 13,920 |   |
| Amortization                                                                                 |       | 5,641                                          |       | 90 |   | 5,731 |   |
| Amortization of deferred financing charges                                                   |       | 5,827                                          |       | 230 |   | 6,057 |   |
| Provision for doubtful accounts                                                              |       | 2,013                                          |       | — |   | 2,013 |   |
| Provision for excess and obsolete inventory                                                  |       | 11,489                                         |       | — |   | 11,489 |   |
| Cumulative effect of change in accounting  principle                                         |       | —                                         |       | 10,521 |   | 10,521 |   |
| Deferred income taxes                                                                        |       | (5,976                                         | )          | — |   | (5,976 | ) |
| Extraordinary gain, net                                                                      |       | (68,106                                        | )          | — |   | (68,106 | ) |
| (Gain) loss on disposal of assets                                                            |       | (186                                           | )          | 81 |   | (105 | ) |
| Translation adjustment                                                                       |       | —                                         |       | (280 | ) | (280 | ) |
| Changes in operating assets and  liabilities:                                                |       |                                           |       |   |   |   |   |
| Accounts receivable                                                                          |       | (15,340                                        | )          | 1,744 |   | (13,596 | ) |
| Inventories                                                                                  |       | (27,412                                        | )          | 1,665 |   | (25,747 | ) |
| Income tax receivable                                                                        |       | 8,643                                          |       | 182 |   | 8,825 |   |
| Accounts payable                                                                             |       | 2,510                                          |       | (3,168 | ) | (658 | ) |
| Accrued compensation and benefits                                                            |       | 4,250                                          |       | 357 |   | 4,607 |   |
| Customer allowances payable                                                                  |       | (1,911                                         | )          | (224 | ) | (2,135 | ) |
| Accrued interest                                                                             |       | (782                                           | )          | — |   | (782 | ) |
| Other accrued expenses                                                                       |       | (2,900                                         | )          | (1,310 | ) | (4,210 | ) |
| Other                                                                                        |       | (353                                           | )          | 1,245 |   | 892 |   |
| Net cash provided by (used in) operating  activities                                         |       | 86,230                                         |       | 1,960 |   | 88,190 |   |
| **Investing activities**                                                                     |       |                                           |       |   |   |   |   |
| Additions to property, plant and equipment                                                   |       | (4,444                                         | )          | (1,204 | ) | (5,648 | ) |
| Increase in other noncurrent assets                                                          |       | (3,921                                         | )          | (60 | ) | (3,981 | ) |
| Net cash used in investing activities                                                        |       | (8,365                                         | )          | (1,264 | ) | (9,629 | ) |
| **Financing activities**                                                                     |       |                                           |       |   |   |   |   |
| Payments under bank term credit facility                                                     |       | (72,085                                        | )          | (8,443 | ) | (80,528 | ) |
| Retirement of senior subordinated debt                                                       |       | (17,930                                        | )          | — |   | (17,930 | ) |
| Net payments on other long-term debt                                                         |       | (1,222                                         | )          | (17 | ) | (1,239 | ) |
| Increase in deferred financing charges                                                       |       | (2,895                                         | )          | (259 | ) | (3,154 | ) |
| Issuance of Series A redeemable  preferred stock                                        |       | 20,000                                         |       | — |   | 20,000 |   |
| Net cash used in financing activities                                                        |       | (74,132                                        | )          | (8,719 | ) | (82,851 | ) |
| Intercompany                                                                                 |       | (8,488                                         | )          | 8,488 |   | — |   |
| Effect of exchange rate changes                                                              |       | —                                         |       | 601 |   | 601 |   |
| Net increase (decrease) in cash and cash  equivalents                                        |       | (4,755                                         | )          | 1,066 |   | (3,689 | ) |
| Cash and cash equivalents at beginning of  period                                            |       | 16,510                                         |       | 4,726 |   | 21,236 |   |
| Cash and cash equivalents at end of period                                                   |       | $                                              | 11,755     |   | $ | 5,792 |   | $ | 17,547 |   |

 

F-30

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Cash Flows**

**(inthousands)**

 
| ** **                                                                                   | ** ** | **Year Ended March 27, 2004**             | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **Parent &  Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
| **Operating activities**                                                                     |       |                                           |       |   |   |   |   |
| Net income                                                                                   |       | $                                              | 35,574     |   | $ | 3,482 |   | $ | 39,056 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                           |       |   |   |   |   |
| Depreciation                                                                                 |       | 10,329                                         |       | 2,361 |   | 12,690 |   |
| Amortization                                                                                 |       | 1,943                                          |       | 35 |   | 1,978 |   |
| Amortization of deferred financing charges                                                   |       | 7,666                                          |       | 371 |   | 8,037 |   |
| Provision for doubtful accounts                                                              |       | 4,087                                          |       | — |   | 4,087 |   |
| Provision for excess and obsolete inventory                                                  |       | 5,746                                          |       | — |   | 5,746 |   |
| Deferred income taxes                                                                        |       | (3,488                                         | )          | — |   | (3,488 | ) |
| (Gain) loss on disposal of assets                                                            |       | 74                                             |       | (34 | ) | 40 |   |
| Translation 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 |   | 671 |   |
| Accounts payable                                                                             |       | 15,282                                         |       | 1,478 |   | 16,760 |   |
| Accrued compensation and benefits                                                            |       | (3,012                                         | )          | 147 |   | (2,865 | ) |
| Customer allowances payable                                                                  |       | (1,913                                         | )          | (122 | ) | (2,035 | ) |
| Accrued interest                                                                             |       | 781                                            |       | — |   | 781 |   |
| Other accrued expenses                                                                       |       | 2,887                                          |       | (895 | ) | 1,992 |   |
| Other                                                                                        |       | (3,463                                         | )          | (7 | ) | (3,470 | ) |
| Net cash provided by (used in) operating  activities                                         |       | 36,856                                         |       | 1,592 |   | 38,448 |   |
| **Investing activities**                                                                     |       |                                           |       |   |   |   |   |
| Additions to property, plant and equipment                                                   |       | (8,975                                         | )          | (1,438 | ) | (10,413 | ) |
| Increase in other noncurrent assets                                                          |       | (3,198                                         | )          | (246 | ) | (3,444 | ) |
| Net cash used in investing activities                                                        |       | (12,173                                        | )          | (1,684 | ) | (13,857 | ) |
| **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 |   | 1,520 |   |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 13,846                                         |       | 2,431 |   | 16,277 |   |
| Cash and cash equivalents at beginning of  period                                            |       | 11,755                                         |       | 5,792 |   | 17,547 |   |
| Cash and cash equivalents at end of period                                                   |       | $                                              | 25,601     |   | $ | 8,223 |   | $ | 33,824 |   |

 

F-31

----

 

**LeinerHealth Products Inc.**

**ConsolidatingStatement of Cash Flows**

**(inthousands)**

 
| ** **                                                                                          | ** ** | **Year Ended March 26, 2005**             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Parent &  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 |   | 11,948 |   |
| Amortization                                                                                        |       | 1,774                                          |       | — |   | 1,774 |   |
| Amortization of deferred financing charges                                                          |       | 5,009                                          |       | 436 |   | 5,445 |   |
| Provision for doubtful accounts                                                                     |       | 4,791                                          |       | — |   | 4,791 |   |
| Provision for excess and obsolete inventory                                                         |       | 8,028                                          |       | — |   | 8,028 |   |
| Deferred income taxes                                                                               |       | (1,176                                         | )          | — |   | (1,176 | ) |
| Gain on disposal of assets                                                                          |       | (52                                            | )          | — |   | (52 | ) |
| Stock option compensation expense                                                                   |       | 5                                              |       | — |   | 5 |   |
| Translation 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 |   | 9,840 |   |
| Accrued compensation and benefits                                                                   |       | (5,308                                         | )          | 316 |   | (4,992 | ) |
| Customer allowances payable                                                                         |       | 614                                            |       | (15 | ) | 599 |   |
| Accrued interest                                                                                    |       | 8,184                                          |       | (213 | ) | 7,971 |   |
| Other accrued expenses                                                                              |       | 2,998                                          |       | 239 |   | 3,237 |   |
| Other                                                                                               |       | (817                                           | )          | (79 | ) | (896 | ) |
| Net cash provided by (used in) operating  activities                                                |       | (43,039                                        | )          | 3,809 |   | (39,230 | ) |
| **Investing activities**                                                                            |       |                                           |       |   |   |   |   |
| Additions to property, plant and equipment                                                          |       | (16,361                                        | )          | (1,630 | ) | (17,991 | ) |
| (Increase) decrease in other noncurrent  assets                                                     |       | (3,327                                         | )          | 8 |   | (3,319 | ) |
| Net cash used in investing activities                                                               |       | (19,688                                        | )          | (1,622 | ) | (21,310 | ) |
| **Financing activities**                                                                            |       |                                           |       |   |   |   |   |
| Borrowings under bank term credit facility                                                          |       | 240,000                                        |       | — |   | 240,000 |   |
| Payments 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                                        |       | — |   | 150,000 |   |
| Increase in deferred financing charges                                                              |       | (15,343                                        | )          | (410 | ) | (15,753 | ) |
| Capital contribution from parent                                                                    |       | 251,500                                        |       | — |   | 251,500 |   |
| Repurchase 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 | ) | 40,867 |   |
| Intercompany                                                                                        |       | (12,885                                        | )          | 12,885 |   | — |   |
| Effect of exchange rate changes                                                                     |       | —                                         |       | 2,800 |   | 2,800 |   |
| Net decrease in cash and cash equivalents                                                           |       | (13,931                                        | )          | (2,942 | ) | (16,873 | ) |
| Cash and cash equivalents at beginning of  period                                                   |       | 25,601                                         |       | 8,223 |   | 33,824 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                              | 11,670     |   | $ | 5,281 |   | $ | 16,951 |   |

 

F-32

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**14. Composition of Certain FinancialStatement Items**

 
| ** **                                            | ** ** | ** ** | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
|-------------------------------------------------------|------------|------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                            | ** ** | ** ** | ** ** | **(in thousands)**      | ** ** |
| Inventories:                                          |       |       |       |                    |       | ** **              | ** ** |
| Raw materials, bulk vitamins and packaging  materials |       |       |       | $                       | 39,268     |                    | $          | 52,784 |   |
| Work-in-process                                       |       |       |       | 40,521                  |       | 49,100                  |       |
| Finished products                                     |       |       |       | 64,690                  |       | 63,026                  |       |
|                                                  |       |       |       | $                       | 144,479    |                    | $          | 164,910 |   |

 
| ** **                                      | ** ** | **Depreciable Lives** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
|                                            | ** ** | **(years)**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Property, plant and equipment:                  |       |                  |       |       |       |       |       |
| Land                                            |       | —                |       | $          | 701        |       | $          | 718 |   |
| Buildings and improvements                      |       | 31 - 40               |       | 11,496     |       | 12,025     |       |
| Leasehold improvements                          |       | 7 - 40                |       | 26,528     |       | 27,415     |       |
| Machinery and equipment                         |       | 3 - 20                |       | 101,420    |       | 121,430    |       |
| Furniture and fixtures                          |       | 3 - 10                |       | 3,029      |       | 3,241      |       |
|                                            |       |                  |       | 143,174    |       | 164,829    |       |
| Less accumulated depreciation and  amortization |       |                  |       | (86,907    | )          | (99,275    | )          |
|                                            |       |                  |       | $          | 56,267     |       | $          | 65,554 |   |

 
| ** **                        | ** ** | **Year Ended**          | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **March 29, 2003** | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
|                              |       |                    |       |   |   |   |   |
| Other operating expense (income)  |       |                    |       |   |   |   |   |
| Antitrust settlement (Note 10)    |       | $                       | (79,194    | ) | $ | — |   | $ | — |   |
| (Gain) loss on disposal of assets |       | (105                    | )          | 40 |   | (52 | ) |
| Management fees (Note 8)          |       | 1,579                   |       | 1,578 |   | 3,258 |   |
| Other                             |       | 12                      |       | (90 | ) | (820 | ) |
|                              |       | $                       | (77,708    | ) | $ | 1,528 |   | $ | 2,386 |   |

 

**15. Supplementary Cash Flow Information**

 
| ** **                                                             | ** ** | **Year Ended**           | ** ** |
|------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                             | ** ** | **March 29,  2003** | ** ** | **March 27,  2004** | ** ** | **March 26,  2005** | ** ** |
| ** **                                                             | ** ** | **(in thousands)**       | ** ** |
| Cash paid during the year for:                                         |       |                     |       |   |   |   |   |
| Interest                                                               |       | $                        | 12,751     |   | $ | 10,100 |   | $ | 18,917 |   |
| Income taxes, net of refunds received                                  |       | 10,042                   |       | 14,636 |   | (30 | ) |
| Non cash issuance of Series B Junior  Convertible Preferred Stock |       | 6,616                    |       | — |   | — |   |
| Non cash issuance of Series C Junior  Preferred Stock             |       | 6,178                    |       | — |   | — |   |
| Non cash increase in capital leases                                    |       | 3,273                    |       | 2,071 |   | 285 |   |
|                                                                        |            |                          |            |  |  |  |  |  |  |  |

 

F-33

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**SCHEDULE II**

 

**LEINERHEALTH PRODUCTS INC.**

**VALUATIONAND QUALIFYING ACCOUNTS**

**(Inthousands)**

 
| ** **                      | ** ** | **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      |   | $ | 2,970 |   |
| Inventory valuation reserve     |       | 15,074                   |       | 5,746                              |       | 9,308          |       | 11,512                        |       |
|                            |       |                     |       |                               |       |           |       |                          |       |
| Year ended March 26, 2005: |       |                     |       |                               |       |           |       |                          |       |
| Accounts receivable allowances  |       | $                        | 2,970      |                               | $          | 4,791          |       | $                             | 4,648      |   | $ | 3,113 |   |
| Inventory valuation reserve     |       | 11,512                   |       | 8,028                              |       | 8,550          |       | 10,990                        |       |

 

S-1

----