**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended**

 

**June 30, 2003**

 

**Commission file number 0-19878**

 

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**OPTION CARE, INC.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                    |   | **36-3791193**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |   | (IRS  Employer Identification No.) |
|                                                            |   |                               |
| **485 Half Day  Road, Suite 300  Buffalo Grove, Illinois**      |   | **60089**                          |
| (Address  of principal executive office)                        |   | (zip  code)                        |
|                                                            |
| **(847) 465-2100**                                         |
| (Registrant’s  telephone number, including area code)      |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Class**                     |   | **Issued and Outstanding  as of August 6, 2003** |
|-------------------------------|--------|--------------------------------------------------|
|                          |   |                                             |
| Common  Stock - .01 par value |   | 20,868,724                                       |

 

 

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**INDEX**

 

**OPTION CARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION** |                                                                                                 |
|-----------------|------------------------------------------------------------------------------------------------------|
|            |
| **PART I**      | **FINANCIAL  INFORMATION**                                                                           |
|            |                                                                                                 |
| Item 1.         | Financial Statements (Unaudited)                                                                     |
|            |                                                                                                 |
|            | Condensed  consolidated balance sheets-June 30, 2003 and December 31, 2002                           |
|            |                                                                                                 |
|            | Condensed  consolidated statements of income-Three and six months ended June 30,  2003 and 2002 |
|            |                                                                                                 |
|            | Condensed  consolidated statements of cash flows-Six months ended June 30, 2003 and  2002       |
|            |                                                                                                 |
|            | Notes  to condensed consolidated financial statements-June 30, 2003                                  |
|            |                                                                                                 |
| Item 2.         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations          |
|            |                                                                                                 |
| Item 3.         | Quantitative and Qualitative Disclosures about  Market Risk                                          |
|            |                                                                                                 |
| Item 4.         | Controls and Procedures                                                                              |
|            |                                                                                                 |
| **PART II**     | **OTHER  INFORMATION**                                                                               |
|            |                                                                                                 |
| Item 1.         | Legal Proceedings                                                                                    |
|            |                                                                                                 |
| Item 2.         | Changes in  Securities and Use of Proceeds                                                           |
|            |                                                                                                 |
| Item 3.         | Defaults Upon Senior  Securities                                                                     |
|            |                                                                                                 |
| Item  4.        | Submission  of Matters to a Vote of Security Holders                                                 |
|            |                                                                                                 |
| Item 5.         | Other Information                                                                                    |
|            |                                                                                                 |
| Item 6(a).      | Exhibits                                                                                             |
|            |                                                                                                 |
| Item 6(b).      | Reports on Form 8-K                                                                             |
|            |                                                                                                 |
|            |                                                                                                 |
| **SIGNATURES**  |
|                 |                                                                                                      |  |

 

2

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**PART I****.  FINANCIAL INFORMATION**

 

**Item 1****.  FinancialStatements**

 

**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

(inthousands, except per share amounts)

 
|                                                                                                                                                                     |   | **June 30, 2003** |       | **December 31, 2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|-----------------------|------------|
|                                                                                                                                                                     |   | **(Unaudited)**   |       | **(Note 1)**          |       |
|                                                                                                                                                                     |   |              | ** ** |                  | ** ** |
| Assets                                                                                                                                                                   |   |              |       |                  |       |
| Current assets:                                                                                                                                                          |   |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                |   | $                 | 328        |                  | $          | 488 |   |
| Accounts receivable, net                                                                                                                                                 |   | 65,927            |       | 74,694                |       |
| Inventory                                                                                                                                                                |   | 5,380             |       | 7,538                 |       |
| Deferred tax asset                                                                                                                                                       |   | 3,115             |       | 3,701                 |       |
| Other current assets                                                                                                                                                     |   | 5,880             |       | 2,744                 |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total current assets                                                                                                                                                     |   | 80,630            |       | 89,165                |       |
| Equipment and other fixed assets, net                                                                                                                                    |   | 12,698            |       | 11,898                |       |
| Goodwill, net                                                                                                                                                            |   | 64,998            |       | 55,412                |       |
| Other assets                                                                                                                                                             |   | 2,169             |       | 2,375                 |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total assets                                                                                                                                                             |   | $                 | 160,495    |                  | $          | 158,850 |   |
|                                                                                                                                                                     |   |              |       |                  |       |
| Liabilities and stockholders’ equity                                                                                                                                |   |              |       |                  |       |
| Current liabilities:                                                                                                                                                     |   |              |       |                  |       |
| Trade accounts payable                                                                                                                                                   |   | $                 | 10,494     |                  | $          | 14,559 |   |
| Current portion of long-term debt                                                                                                                                        |   | 1,448             |       | 261                   |       |
| Other current liabilities                                                                                                                                                |   | 9,130             |       | 12,635                |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total current liabilities                                                                                                                                                |   | 21,072            |       | 27,455                |       |
| Long-term debt, less current portion                                                                                                                                     |   | 6,688             |       | 7,314                 |       |
| Deferred tax liability                                                                                                                                                   |   | 4,933             |       | 4,178                 |       |
| Other liabilities                                                                                                                                                        |   | 349               |       | 368                   |       |
| Minority interest                                                                                                                                                        |   | 463               |       | 934                   |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total liabilities                                                                                                                                                        |   | 33,505            |       | 40,249                |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                               |   |              |       |                  |       |
| Common stock,  $.01 par value per share, 60,000 shares authorized, 20,841 and 20,588 shares  issued and outstanding at June 30, 2003 and December 31, 2002, respectively |   | 208               |       | 206                   |       |
| Common stock to be issued, 63 and 167 shares at June 30, 2003 and  December 31, 2002, respectively                                                                       |   | 405               |       | 1,371                 |       |
| Additional paid-in capital                                                                                                                                               |   | 103,353           |       | 101,777               |       |
| Retained earnings                                                                                                                                                        |   | 23,024            |       | 15,247                |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total stockholders’ equity                                                                                                                                          |   | 126,990           |       | 118,601               |       |
|                                                                                                                                                                     |   |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                          |   | $                 | 160,495    |                  | $          | 158,850 |   |

 

*See notes to condensed consolidated financial statements*

 

3

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements ofIncome**

(Unaudited)

(inthousands, except per share amounts)

 
|                                           |   | **Three  Months EndedJune 30,** |   | **Six Months  EndedJune 30,** |   |
|------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                           |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Revenue:                                       |   |                                 |   |                               |   |   |   |   |   |
| Specialty pharmacy services                    |   | $                                    | 48,172 |                               | $      | 42,527 |   | $ | 105,206 |   | $ | 83,077 |   |
| Infusion and related healthcare services       |   | 34,126                               |   | 30,366                             |   | 67,199 |   | 59,886 |   |
| Other                                          |   | 2,484                                |   | 2,632                              |   | 4,939 |   | 5,269 |   |
| Total revenue                                  |   | 84,782                               |   | 75,525                             |   | 177,344 |   | 148,232 |   |
| Cost of revenue:                               |   |                                 |   |                               |   |   |   |   |   |
| Cost of goods sold                             |   | 47,001                               |   | 43,157                             |   | 101,825 |   | 84,520 |   |
| Cost of services provided                      |   | 10,126                               |   | 8,795                              |   | 20,584 |   | 17,476 |   |
| Total cost of revenue                          |   | 57,127                               |   | 51,952                             |   | 122,409 |   | 101,996 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Gross profit                                   |   | 27,655                               |   | 23,573                             |   | 54,935 |   | 46,236 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Selling, general and administrative expenses   |   | 18,861                               |   | 15,981                             |   | 37,560 |   | 31,428 |   |
| Provision for doubtful accounts                |   | 2,330                                |   | 1,426                              |   | 4,208 |   | 2,925 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Total operating expenses                       |   | 21,191                               |   | 17,407                             |   | 41,768 |   | 34,353 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Operating income                               |   | 6,464                                |   | 6,166                              |   | 13,167 |   | 11,883 |   |
| Interest expense                               |   | (6                                   | )      | (33                                | )      | (106 | ) | (16 | ) |
| Other expense, net                             |   | (84                                  | )      | 43                                 |   | (91 | ) | 11 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Income before income taxes                     |   | 6,374                                |   | 6,176                              |   | 12,970 |   | 11,878 |   |
| Income tax provision                           |   | 2,563                                |   | 2,425                              |   | 5,194 |   | 4,665 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Net income                                     |   | $                                    | 3,811  |                               | $      | 3,751 |   | $ | 7,776 |   | $ | 7,213 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Net income per common share:                   |   |                                 |   |                               |   |   |   |   |   |
| Basic                                          |   | $                                    | 0.18   |                               | $      | 0.18 |   | $ | 0.37 |   | $ | 0.35 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Diluted                                        |   | $                                    | 0.18   |                               | $      | 0.18 |   | $ | 0.37 |   | $ | 0.34 |   |
|                                           |   |                                 |   |                               |   |   |   |   |   |
| Shares used in computing net income per share: |   |                                 |   |                               |   |   |   |   |   |
| Basic                                          |   | 20,799                               |   | 20,627                             |   | 20,788 |   | 20,528 |   |
| Diluted                                        |   | 21,222                               |   | 21,243                             |   | 21,175 |   | 21,110 |   |

 

*Seenotes to condensed consolidated financial statements*

 

4

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements ofCash Flows**

(Unaudited)

(inthousands)

 
|                                                                               |   | **Six Months Ended  June 30,** |       |
|------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                               |   | **2003**                            |       | **2002** |   |
|                                                                               |   |                                | ** ** |   | ** ** |
| Cash flows from operating activities:                                              |   |                                |       |   |   |
| Net income                                                                         |   | $                                   | 7,776      |   | $ | 7,213 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |   |                                |       |   |   |
| Depreciation and amortization                                                      |   | 2,263                               |       | 1,853 |   |
| Provision for doubtful accounts                                                    |   | 4,208                               |       | 2,925 |   |
| Income tax benefit from exercise of stock options                                  |   | 336                                 |       | 1,596 |   |
| Changes in assets and liabilities:                                                 |   |                                |       |   |   |
| Accounts receivable                                                                |   | 4,521                               |       | (7,006 | ) |
| Inventory                                                                          |   | 2,287                               |       | 172 |   |
| Accounts payable                                                                   |   | (4,281                              | )          | (2,867 | ) |
| Income taxes receivable/payable                                                    |   | (1,437                              | )          | 426 |   |
| Change in other assets and liabilities                                             |   | (2,924                              | )          | (2,048 | ) |
|                                                                               |   |                                |       |   |   |
| Net cash provided by operating activities                                          |   | 12,749                              |       | 2,264 |   |
|                                                                               |   |                                |       |   |   |
| Cash flows from investing activities:                                              |   |                                |       |   |   |
| Purchases of equipment and other, net                                              |   | (2,639                              | )          | (2,265 | ) |
| Additions to other assets, net                                                     |   | —                              |       | (70 | ) |
| Payments for  acquisitions, net of cash acquired                                   |   | (11,836                             | )          | (9,834 | ) |
| Proceeds from  disposals                                                           |   | 229                                 |       | — |   |
|                                                                               |   |                                |       |   |   |
| Net cash used in investing activities                                              |   | (14,246                             | )          | (12,169 | ) |
|                                                                               |   |                                |       |   |   |
| Cash flows from financing activities:                                              |   |                                |       |   |   |
| Increase in cash overdraft                                                         |   | —                              |       | 350 |   |
| Increase in financing costs                                                        |   | —                              |       | (530 | ) |
| Net borrowing on credit agreements                                                 |   | 858                                 |       | — |   |
| Payments on capital leases and other debt                                          |   | (297                                | )          | (191 | ) |
| Proceeds from issuance of stock                                                    |   | 776                                 |       | 1,765 |   |
|                                                                               |   |                                |       |   |   |
| Net cash provided by financing activities                                          |   | 1,337                               |       | 1,394 |   |
|                                                                               |   |                                |       |   |   |
| Net decrease in cash and cash equivalents                                          |   | (160                                | )          | (8,511 | ) |
| Cash and cash  equivalents, beginning of period                                    |   | 488                                 |       | 8,511 |   |
| Cash and cash equivalents, end of period                                           |   | $                                   | 328        |   | $ | — |   |

 

*See notes to condensed consolidated financial statements*

 

5

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**Option Care, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements**

**June 30, 2003**

(Unaudited)

 

**1.****              Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and six months ended June 30,2003 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2003.

 

The balance sheet at December 31, 2002 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.

 

For further information, refer to theconsolidated financial statements and footnotes thereto included in OptionCare’s Report on Form 10-K for the year ended December 31, 2002.

 

**2.****              Long-Term Debt**

 

On March 29, 2002,we entered into a $60 million revolving Credit and Security Agreement with J.P.Morgan Business Credit Corporation, J.P. Morgan Chase Bank and LaSalle Bank,N.A.  The facility requires us to meetcertain financial covenants.  OptionCare paid a facility fee of approximately $400,000 upon signing theagreement.  The agreement provides for acommitment fee, calculated and paid quarterly on a sliding scale from 0.45% to0.25%, based on the average daily unused portion of the facility.  For a fee, Option Care may secure up to $5million in letters of credit.  Dependingon our level of borrowing under the agreement, Option Care may select interestrates ranging from the Eurodollar Rate plus 2% to 2.75%, or the bank’sreference rate plus 0% to 0.75%.  Theagreement expires on March 29, 2005.

 

Availability under the Credit and Security Agreement is relatedto various percentages of Option Care’s outstanding accounts receivable andinventory balances, less certain capped and ineligible amounts, as defined inthe agreement.  Overall borrowings underthe agreement will be limited to the lesser of the remaining availability underthe agreement and the total allowable collateral borrowing base.  The facility is secured by substantially allcompany assets.  In addition tocustomary events of default, the facility provides that a change in controlwould give rise to an event of default.

 

As of June 30,2003 and December 31, 2002, our outstanding balances under this facility wereapproximately $6.6 million and $7.1 million, respectively.   At June 30, 2003, we had additionalborrowing capacity of $27.8 million based on the accounts receivable andinventory balances as of that date, while at December 31, 2002, we hadadditional borrowing capacity of $32.3 million.

 

Effective June 1,2003, Option Care entered into a Premium Financing Agreement with A.I. CreditCorporation for payment of the total premiums due under our professionalliability, workers compensation and other insurance policies that renewed onJune 1, 2003.  This agreement allows usto pay the total cost of the premiums in nine monthly installments, with thefinal payment due March 1, 2004. The total amount financed was approximately $1.4 million at an interestrate of 3.51%.

 

6

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**3.****              EarningsPer Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated.

 
|                                                                            |   | **Three months ended  June 30,**             |   | **Six months ended  June 30,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------------------|--------|--------------------------------|--------|
|                                                                            |   | **2003**                                     |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                            |   | **(in thousands, except per share amounts)** |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Basic:                                                                          |   |                                         |   |                           |   |   |   |   |   |
| Net income                                                                      |   | $                                            | 3,811  |                           | $      | 3,751 |   | $ | 7,776 |   | $ | 7,213 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Average shares outstanding                                                      |   | 20,799                                       |   | 20,627                         |   | 20,788 |   | 20,528 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Basic earnings per share                                                        |   | $                                            | 0.18   |                           | $      | 0.18 |   | $ | 0.37 |   | $ | 0.35 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Diluted:                                                                        |   |                                         |   |                           |   |   |   |   |   |
| Net income                                                                      |   | $                                            | 3,811  |                           | $      | 3,751 |   | $ | 7,776 |   | $ | 7,213 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Average shares outstanding                                                      |   | 20,799                                       |   | 20,627                         |   | 20,788 |   | 20,528 |   |
| Net effect of dilutive stock options – Based on the treasury stock  method |   | 423                                          |   | 616                            |   | 387 |   | 582 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Total diluted shares                                                            |   | 21,222                                       |   | 21,243                         |   | 21,175 |   | 21,110 |   |
|                                                                            |   |                                         |   |                           |   |   |   |   |   |
| Diluted earnings per share                                                      |   | $                                            | 0.18   |                           | $      | 0.18 |   | $ | 0.37 |   | $ | 0.34 |   |

 

**4.****              Operating Segments**

 

Option Care hasone identifiable business segment, with three service lines: specialty pharmacyservices; infusion and related healthcare services; and other.  Specialty pharmacy services consist ofdelivering specialty pharmaceuticals directly to patients or to theirphysician’s office.  Infusion andrelated services primarily consists of providing infusion therapies to patientsin non-hospital settings, typically the patient’s home.  Infusion therapy consists of providing intravenousdrugs as well as nursing services and patient monitoring.  For some of our company-owned locations,infusion and related healthcare services also includes the provision of homehealth nursing services, hospice services, respiratory therapy services and/ordurable medical equipment sales and rentals. Other revenue consists of all revenue generated from our franchisenetwork, primarily royalties, and the software licensing and support revenuegenerated by our subsidiary, Management by Information, Inc. (MBI).  The following table presents revenues fromexternal customers for each of our major product categories for the periodsindicated (in thousands):

 
|                                                    |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|---------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                    |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                    |   |                             |   |                           |   |   |   |   |   |
| Specialty  pharmacy services revenue                    |   | $                                | 48,172 |                           | $      | 42,527 |   | $ | 105,206 |   | $ | 83,077 |   |
| Infusion and  related healthcare services revenue:      |   |                             |   |                           |   |   |   |   |   |
| Infusion therapy                                        |   | 28,928                           |   | 23,608                         |   | 56,135 |   | 46,342 |   |
| Related  healthcare services                            |   | 5,198                            |   | 6,757                          |   | 11,064 |   | 13,545 |   |
| Total infusion  and related healthcare services revenue |   | 34,126                           |   | 30,366                         |   | 67,199 |   | 59,886 |   |
| Other revenue:                                          |   |                             |   |                           |   |   |   |   |   |
| Franchise-related                                       |   | 2,224                            |   | 2,300                          |   | 4,368 |   | 4,600 |   |
| Software  licensing and support                         |   | 260                              |   | 332                            |   | 571 |   | 669 |   |
| Total other revenue                                     |   | 2,484                            |   | 2,632                          |   | 4,939 |   | 5,269 |   |
|                                                    |   |                             |   |                           |   |   |   |   |   |
| Total revenue                                           |   | $                                | 84,782 |                           | $      | 75,524 |   | $ | 177,344 |   | $ | 148,232 |   |

 

7

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**5.****              Significant Customer**

 

We generate the majority of our revenue from managed care contracts andother agreements with commercial third party payors.  Our principal managed care contract is with Blue Cross and BlueShield of Florida for our provision of home infusion services and specialtypharmacy services to their members. Approximately 17% of our revenue for the three and six months ended June30, 2003 was related to this contract. In the prior year, for the three and six months ended June 30, 2002,approximately 21% and 20% of our revenue, respectively, was related to thiscontract.  As of June 30, 2003 andDecember 31, 2002, approximately 11% and 9% of our accounts receivable,respectively, was due from Blue Cross and Blue Shield of Florida.  The contract is terminable by either partyon 90 days’ notice and, unless terminated, renews annually each September foran additional one-year term.

 

Option Care also generates revenue from governmental healthcare programssuch as Medicare and Medicaid. Approximately 19% of our revenue for the three and six months ended June30, 2003 was from governmental programs. In the prior year, for the three and six months ended June 30, 2002,approximately 15% and 16% of our revenue, respectively, was related togovernmental programs.  Of our totalaccounts receivable as of June 30, 2003 and December 31, 2002, approximately22% and 19%, respectively, was due from government programs.

 

**6.****              Seasonal Revenue Trends**

 

One of thespecialty pharmaceuticals that we provide to patients, Synagis®, isseasonal.  For the three and six monthsended June 30, 2003, approximately 4.7% and 9.0% of our revenue, respectively,was generated from sales of Synagis®, a drug used for the prevention ofrespiratory synctial virus (RSV) in high-risk pediatric patients. RSV infectionis a seasonal condition, with the season generally covering October throughApril.  Accordingly, our Synagis®revenue declined in the second quarter of2003, and is expected to be near zero in the third quarter before increasing inthe fourth quarter as another RSV season begins.  Option Care’s Synagis® revenue, by quarter, for each quarter in2002 and the first two quarters of 2003 was as follows (in thousands):

 
|                                  |   | **2003** |   | **2002** |   |
|---------------------------------------|--------|----------|--------|----------|--------|
|                                  |   |     |   |     |   |
| Quarter ended  March 31               |   | $        | 11,998 |     | $      | 7,013 |   |
| Quarter ended  June 30                |   | 3,958    |   | 2,601    |   |
| Six months ended  June 30             |   | 15,956   |   | 9,614    |   |
|                                  |   |     |   |     |   |
| Quarter ended  September 30           |   |     |   | 362      |   |
| Quarter ended  December 31            |   |     |   | 8,205    |   |
|                                  |   |     |   |     |   |
| Total Synagis® revenue, per year |   |     |   | $        | 18,181 |   |
|                                       |        |          |        |          |        |  |  |

 

**7.****              Acquisitions**

 

During the quarterended March 31, 2003, Option Care paid a total of $3.1 million related toacquisitions, of which approximately $2.8 million was additional considerationon prior years’ acquisitions and approximately $300,000 was for an acquisitioncompleted in the current year.  Thesingle largest acquisition-related payment in the quarter was a scheduledinstallment of $2.6 million paid in January 2003 to Allina Health Systems aspartial consideration for our July 2002 purchase of their home infusionbusiness operating in the Minneapolis/St. Paul metropolitan area.  Our final installment on this acquisitionwas paid in July 2003 in the amount of approximately $2.5 million.

 

During the quarterended June 30, 2003, we paid $8.7 million related to acquisitions.  Of this total, $8.6 million was used toacquire the minority interest of one of our 2002 acquisitions.  Effective April 1, 2003, we exercised ouroption to acquire the remaining 40% interest of Infusion Specialties, Inc., aspecialty pharmacy business in Houston, Texas. We had acquired a 60% interest in this business a year earlier, effectiveApril 1, 2002.  The purchase price forthe remaining 40% interest was calculated on terms agreed to in the initialpurchase agreement. The anticipated total purchase price for the remaining 40%interest is $9.8 million, with $8.6 million paid in cash during the secondquarter and the remaining $1.2 million expected to become payable by the end of2003, subject to certain contingencies related to collection of accountsreceivable.  The expected total purchaseprice of $9.8 million was allocated approximately $9.5 million to goodwill andapproximately $400,000 as a reduction of minority interest liability, offset byreductions to accounts payable and other accrued expenses of approximately$100,000.

 

In addition to ourpurchase of the minority interest of Infusion Specialties, Inc., in the quarterended June 30, 2003 we also used approximately $100,000 in cash to settle ourremaining obligations under one of our 2001 acquisitions.  We agreed with the sellers on a cashsettlement for all amounts owed between the parties.  The cash settlement relieves our obligation to issue to thesellers approximately

 

8

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39,000 shares of OptionCare common stock, then valued at approximately $400,000, and settles amounts owedby the sellers to Option Care related to our collection of their accountsreceivable.

 

**8.****              AssetDisposals**

 

In the fourthquarter of 2002, Option Care decided to dispose of two company-ownedpharmacies, located in Bullhead City, Arizona and Grand Junction,Colorado.  Because of the small size andgeographic locations of these markets, the two pharmacies do not fit into thestrategic geographic profile of markets where we would like to havecompany-owned locations.  In the fourthquarter of 2002, we recorded a pre-tax charge of $1.7 million related to theplanned disposal of these pharmacies. Part of this $1.7 million charge was a$350,000 goodwill impairment charge, which was calculated based on theestimated sale price of these pharmacies compared to the total market value ofthe Company as a whole. In addition to the goodwill write-off, we recordedcharges of $415,000 related to severance and retention bonuses for a total of38 employees from those pharmacies, and $267,000 for building lease terminationcosts.  These two costs were included inselling, general and administrative expenses in the statement of income.  Also included in the charge was anadditional provision for bad debts of $667,000 related to the expected loss ofcollectability of accounts receivable due to our plan to dispose of thepharmacies and all their employees, including billing staff.  During the six months ended June 30, 2003,both pharmacies were sold and re-franchised. The total proceeds from the sale of these pharmacies equaled $229,000.

 

On March 31, 2003, Option Care completed the sale and franchise of ourpharmacy located in Grand Junction, Colorado. The sale price was equal to the net book value of the assets sold andwas paid in cash at closing.  Uponconsummating the asset purchase agreement, the buyers entered into a five-yearfranchise agreement with Option Care. The franchise agreement allows the buyers to use the Option Care nameand participate in our various contracts in exchange for future royaltypayments based on the subsequent cash collections of the business.

 

On May 1, 2003, we completed the sale and franchise of our pharmacy inBullhead City, Arizona to Convention Center Drug, Inc., which owns and operatesan Option Care franchise in Las Vegas, Nevada. The sale price was equal to the net book value of the assets sold andwas paid in cash at closing.  Uponsigning the asset purchase agreement, the parties also executed an amendment tothe existing franchise agreement between Option Care and Convention Center Drugto add the Bullhead City pharmacy and its service territory to the agreement.

 

Upon completion of the sales of these two pharmacies, Option Carerecorded a reversal of approximately $300,000 of the $1.7 million pre-taxcharge recorded in the fourth quarter of 2002. The reversal was primarily related to building lease termination costs,as the new owners of these businesses assumed our remaining lease obligationsat these locations.

 

**9.****              Change in Estimate**

 

Option Carereceives rebates from pharmaceutical manufacturers and vendors.  These rebates are payable pursuant tobinding agreements between Option Care and those drug manufacturers andvendors.  The rebates are recorded asreductions to our cost of goods sold if related to purchases made by our company-ownedpharmacies, and are recorded as other revenue if related to purchases made byour franchisees.  The total annualrebate amount can be reasonably estimated at the beginning of each year basedon the existing agreements we have in place, and is adjusted quarterly asneeded.

 

We have signed anew agreement with our principal pharmaceutical vendor which has increased ourestimate of the rebates to be received for the year 2003.  This agreement applies only to purchasesmade by our company-owned pharmacies. We recorded a cumulative, year-to-date adjustment of $1.0 million tocost of goods sold in the quarter ended June 30, 2003 to reflect our change inestimate.  Of this adjustment,approximately $500,000 applies to purchases made during the prior quarter endedMarch 31, 2003.

 

**10.****       Stock-Based Compensation**

 

Statement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation*, as amended by Statement of FinancialAccounting Standards No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*, encourages, but does not require, companies torecord compensation cost for stock-based compensation plans at fair value.  Option Care has chosen to account forstock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense for stock options is measured as theexcess, if any, of the quoted market price of Option Care stock at the date ofgrant over the amount an employee must pay to acquire the stock.  Option Care grants options at fair marketvalue and therefore recognizes no compensation expense when options aregranted.  Likewise,

 

9

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OptionCare’s Employee Stock Purchase Plan was structured to qualify under Section 423of the Internal Revenue Code. Therefore, no compensation expense is recognized from employees’purchase of shares under our Employee Stock Purchase Plan.

 

Had compensation cost for Option Care’s stock-based compensation planbeen determined based on FASB Statement No. 123, Option Care’s net incomeand income per common share for the three and six months ended June 30, 2003and 2002 on a pro-forma basis would have been (in thousands, except per shareamounts):

 
|                                                                                                                                                         |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                                                                         |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net income:                                                                                                                                                  |   |                             |   |                           |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                | 3,811  |                           | $      | 3,751 |   | $ | 7,776 |   | $ | 7,213 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                                 |   | 6                                |   | —                         |   | 6 |   | 99 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for the following awards, net of related tax effects: |   |                             |   |                           |   |   |   |   |   |
| Stock option  grants                                                                                                                                         |   | (580                             | )      | (368                           | )      | (1,153 | ) | (858 | ) |
| Employee stock  purchase plan withholdings                                                                                                                   |   | (64                              | )      | (73                            | )      | (118 | ) | (146 | ) |
|                                                                                                                                                         |   |                             |   |                           |   |   |   |   |   |
| Pro forma                                                                                                                                                    |   | $                                | 3,173  |                           | $      | 3,310 |   | $ | 6,511 |   | $ | 6,308 |   |
|                                                                                                                                                         |   |                             |   |                           |   |   |   |   |   |
| Net income per  common share—basic:                                                                                                                     |   |                             |   |                           |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                | 0.18   |                           | $      | 0.18 |   | $ | 0.37 |   | $ | 0.35 |   |
| Pro forma                                                                                                                                                    |   | $                                | 0.15   |                           | $      | 0.16 |   | $ | 0.31 |   | $ | 0.31 |   |
|                                                                                                                                                         |   |                             |   |                           |   |   |   |   |   |
| Net income per common share—diluted:                                                                                                                    |   |                             |   |                           |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                | 0.18   |                           | $      | 0.18 |   | $ | 0.37 |   | $ | 0.34 |   |
| Pro forma                                                                                                                                                    |   | $                                | 0.15   |                           | $      | 0.16 |   | $ | 0.31 |   | $ | 0.30 |   |

 

**11.****       Recent Accounting Pronouncements**

 

EITF 00-21: *Revenue Arrangements with Multiple Deliverables**.*

 

EITF 00-21, which becomes effective for fiscal periods beginning afterJune 15, 2003, addresses situations in which multiple products and/or servicesare delivered at different times under one arrangement with a customer, andprovides guidance in determining whether multiple deliverables should beconsidered as separate units of accounting. We provide a variety of infusion therapies to patients.  A majority of the therapies have multipledeliverables, such as the delivery of drugs and supplies and the provision ofrelated nursing services to train and monitor patient administration of thedrugs.  After applying the criteria fromthe final model in EITF 00-21 to our business, we concluded that separate unitsof accounting do exist in our revenue arrangements with multiple deliverables.

 

In our current revenue recognition policy for infusion therapiesregarding arrangements with multiple deliverables, revenue is recognized wheneach deliverable is provided to the patient. For example, revenue from drug and supplies sales is recognized uponconfirmation of delivery of the products, and revenue from nursing services isrecognized upon receipt of nursing notes confirming that the service wasprovided.  In instances in which theamount allocable to the delivered items is limited to the amount that iscontingent on delivery of additional items, we recognize revenue after all thedeliverables in the arrangement have been provided.  For infusion therapies, we believe that the impact from adoptionof EITF 00-21 will not be material to our statements of income or financialposition.

 

Our specialty pharmacy services often involve only delivery of drugs tothe patient and no ancillary services, such as nursing.  In these cases, since there are no multipledeliverables EITF 00-21 does not apply. For certain specialty drugs and therapies, we do provide some nursingservices to the patient.  In these caseswhen we do have multiple deliverables, we recognize revenue in the same manneras for our infusion therapies, as described above.

 

10

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Our subsidiary, Mangement by Information, Inc. (“MBI”), sells pharmacymanagement software products and provides installation, training and support tocustomers, and therefore would be considered to provide multiple deliverablesunder a single arrangement.  However, weaccount for MBI’s revenue in accordance with SOP 97-2: *Software Revenue Recognition*.  Since this statement of opinion provideshigher-level authoritative guidance than EITF 00-21, adoption of EITF 00-21will have no impact to our accounting policies for MBI.

 

EITF 01-09:  *Accountingfor Consideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products.*

EITF 01-09 addresses the accounting forconsideration given by a vendor or reseller to a customer.  This consideration includes prompt paymentand other discounts.  Our primaryservice lines involve the provision of healthcare services directly topatients, who are the end users of the products and end recipients of theservices.  We do not offer rebates orprompt payment discounts for any of the healthcare services we bill.  Most of our bills are paid based oncontracted fee schedules, none of which allows for prompt payment or otherdiscounts or rebates.  Therefore, EITF01-09 does not apply to these service lines.

 

Under the classification of Other revenue, a portion of this revenue isgenerated from the sale of pharmacy management software products by oursubsidiary, Management by Information, Inc. (MBI), and we would therefore beclassified as a software vendor. However, total MBI revenue has been insignificant in recent periods,representing 0.4%, 0.7% and 1.7% of our total revenue, respectively, for theyears ended December 31, 2002, 2001 and 2000. The amount of discounts and rebates offered on new software sales inthese periods is immaterial to our overall financial results.  Therefore, application of EITF 01-09 to MBIrevenue recognition is not expected to have a significant effect on our resultsof operations in the foreseeable future.

 

EITF 02-16: *Accounting by a Customer (Including a Reseller) forCertain Consideration Received from a Vendor*

EITF 02-16 addresses the accounting for the consideration we receivefrom vendors, primarily drug and medical supply vendors, in the form ofdiscounts and rebates.  The consensus ondiscounts and rebates is effective for new arrangements entered into after December31, 2002 and November 21, 2002, respectively. Our discounts received from vendors are typically in the form of promptpayment discounts.  We recognize thesediscounts as reductions to the associated costs when the discounts are takenupon payment of the invoice.  Ourrebates, which are typically received from drug and medical supplymanufacturers and vendors, are usually calculated as a percentage of ouroverall dollar volume of purchases over a specified period.  Whereas discounts are earned purely on theCompany’s own purchases, a portion of our rebates are earned from the purchasevolume of our franchises.  The portionof our discounts that is earned based on our drug and medical supply purchasevolume is recorded as a reduction of cost of goods, and is recognized ratablyover the applicable period.  The portionof our discounts that is earned from the purchasing activity of our franchisesis recorded as other revenue, and is also recognized ratably over theapplicable period.  Our current accountingpractices are in compliance with EITF 02-16. Therefore, adoption of EITF 02-16 will have no effect on our results ofoperations.

 

FIN 46: *Consolidation: Variable InterestEntities*

FIN 46 addresses the accounting for variableinterest entities in which the parent entity lacks ownership of a majorityvoting interest in another entity, but controls its operations and finances tosuch extent that consolidated financial statements are necessary for a fairpresentation of the financial position and results of operations of the parententity.  Option Care operatesapproximately 40 company-owned pharmacies, while franchisees operateapproximately 80 franchised Option Care pharmacies throughout the UnitedStates.  We own a majority votinginterest in each of our company-owned pharmacies and present consolidatedfinancial statements that include their results of operations.  We do not posses any ownership interest,direct or indirect, in any of our franchised pharmacies and do not controltheir operations or finances.  For thisreason, our franchised pharmacies do not qualify as variable interest entities,and we do not consolidate their financial results with our own.  There are no other entities in existencethat qualify as variable interest entities or special purpose entities ofOption Care.  Therefore, adoption of FIN46 will have no effect on our financial position or results of operations.

 

11

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**Item 2.**                                        **Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**FORWARDLOOKING STATEMENTS**

 

The following discussion should be read in conjunction with our AnnualReport on Form 10-K for the year ended December 31, 2002. The PrivateSecurities Litigation Reform Act of 1995 provides a “safe harbor” forforward-looking statements. Certain information included in this QuarterlyReport on Form 10-Q and other materials filed or to be filed by us withthe Securities and Exchange Commission (as well as information included in oralstatements or other written statements made or to be made by us) containstatements that are or will be forward-looking, such as statements relating toacquisitions and other business development activities, future capitalexpenditures and the effects of future regulation and competition. Suchforward-looking information involves important risks and uncertainties thatcould significantly affect anticipated results in the future and, accordingly,such results may differ from those expressed in any forward-looking statements madeby us, or on our behalf. These risks and uncertainties include, but are notlimited to, uncertainties affecting our businesses and our franchisees relatingto acquisitions and divestitures (including continuing obligations with respectto completed transactions), sales and renewals of franchises, government andregulatory policies (including federal, state and local efforts to reform thedelivery of and payment for healthcare services), general economic conditions(including economic conditions affecting the healthcare industry inparticular), the pricing and availability of equipment and services,technological developments and changes in the competitive environment in whichwe operate.

 

**OVERVIEW**

 

Option Care provides pharmacy services to patients on behalf of managedcare organizations and other third party payors.  We contract with payors to provide specialty pharmacy services,home infusion therapy and other related healthcare services to patients at homeor at other alternate-site settings, such as physicians’ offices.  Our services are provided through ournational network of approximately 120 company-owned and franchise-ownedpharmacies.

 

We have three service lines: specialty pharmacy services, infusion andrelated healthcare services, and other. Specialty pharmacy services consist of delivering specialtypharmaceuticals directly to patients or to their physician’s office.  Infusion and related services primarilyconsists of providing infusion therapies to patients in non-hospital settings,typically the patient’s home.  Infusiontherapy consists of providing intravenous drugs as well as nursing services andpatient monitoring.  For some of ourcompany-owned locations, infusion and related healthcare services also includesthe provision of home health nursing services, hospice services, respiratorytherapy services and/or durable medical equipment sales and rentals.  Specialty pharmacy revenue and infusion andrelated healthcare services revenue relates only to our company-ownedpharmacies.  Other revenue consists ofall revenue generated from our franchise network, primarily royalties, and thesoftware licensing and support revenue generated by our subsidiary, MBI.  Summarized information about revenues andgross profit for each service line is provided in the following table (amountsin thousands):

 
|                                     |   | **Three months ended June 30,** |   | **Six months  ended June 30,** |   |
|------------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                     |   | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                     |   | **Amount**                      |   | **%****of total**              |   | **Amount** |   | **% of total** |   | **Amount** |   | **%****of total** |   | **Amount** |   | **% of total** |   |
| Revenue:                                 |   |                            |   |                           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services             |   | $                               | 48,172 |                           | 56.8   | % | $ | 42,527 |   | 56.3 | % | $ | 105,206 |   | 59.3 | % | $ | 83,077 |   | 56.0 | % |
| Infusion and related healthcare services |   | 34,126                          |   | 40.3                           | %      | 30,366 |   | 40.2 | % | 67,199 |   | 37.9 | % | 59,886 |   | 40.4 | % |
| Other                                    |   | 2,484                           |   | 2.9                            | %      | 2,632 |   | 3.5 | % | 4,939 |   | 2.8 | % | 5,269 |   | 3.6 | % |
|                                     |   |                            |   |                           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenue                            |   | $                               | 84,782 |                           | 100.0  | % | $ | 75,525 |   | 100.0 | % | $ | 177,344 |   | 100.0 | % | $ | 148,232 |   | 100.0 | % |

 
|                                     |   | **Three months ended June 30,** |   | **Six months  ended June 30,** |   |
|------------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                     |   | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                     |   | **Amount**                      |   | **%****margin**                |   | **Amount** |   | **%****margin** |   | **Amount** |   | **%****margin** |   | **Amount** |   | **%****margin** |   |
| Gross Profit:                            |   |                            |   |                           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services             |   | $                               | 10,533 |                           | 21.9   | % | $ | 8,137 |   | 19.1 | % | $ | 21,567 |   | 20.5 | % | $ | 15,096 |   | 18.2 | % |
| Infusion and related healthcare services |   | 14,814                          |   | 43.4                           | %      | 12,828 |   | 42.2 | % | 28,693 |   | 42.7 | % | 25,917 |   | 43.3 | % |
| Other                                    |   | 2,308                           |   | 92.9                           | %      | 2,608 |   | 99.1 | % | 4,675 |   | 94.7 | % | 5,223 |   | 99.1 | % |
|                                     |   |                            |   |                           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total gross  profit                      |   | $                               | 27,655 |                           | 32.6   | % | $ | 23,573 |   | 31.2 | % | $ | 54,935 |   | 31.0 | % | $ | 46,236 |   | 31.2 | % |

 

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Most of our revenue is generated from managed care contracts and otheragreements with commercial third party payors. Our principal managed care contract is with Blue Cross Blue Shield ofFlorida which contracts with us for our provision of home infusion services andspecialty pharmacy services to their members. For both the three months and six months ended June 30, 2003,approximately 17% of our revenue was generated from this contract.  In the prior year, for the three months and sixmonths ended June 30, 2002, approximately 21% and 20% of our revenue,respectively, was related to this contract. As of June 30, 2003 and December 31, 2002, respectively, approximately11% and 9% of our accounts receivable was due from Blue Cross Blue Shield ofFlorida. The contract is terminable by either party on 90 days’ notice and,unless terminated, renews annually each September for an additional one-yearterm.

 

Option Care also generates revenue through governmental healthcareprograms such as Medicare and Medicaid. For the three months and six months ended June 30, 2003, approximately19% of our revenue was generated from governmental programs.  In the prior year, for the three months andsix months ended June 30, 2002, approximately 15% and 16% of our revenue,respectively, came from governmental programs. Approximately 22% and 19% of our total accounts receivable as of June30, 2003 and December 31, 2002, respectively, was due from these governmental programs.

 

Many governmental payors reimburse us for some pharmaceuticals based onthat pharmaceutical’s average wholesale price (AWP).  AWP for most pharmaceuticals is compiled and published by privatecompanies, including First DataBank, Inc. There has been an increase in thenumber of lawsuits and government investigations against pharmaceuticalmanufacturers regarding prescription drug pricing and AWP, alleging thatmanufactuers have misrepresented to First DataBank the actual selling price ofcertain pharmaceuticals.  First DataBankhas announced that it will now base AWP on market prices rather than on pricessubmitted by the manufacturer.  As aresult of this change, First DataBank has published a Market Price Survey thatreduces the AWP significantly for a number of the products we currently supplyto patients.  If the average wholesaleprices on the products we provide are reduced, our gross profit margins coulddecline.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Management’s discussion and analysis of ourfinancial condition and results of operations are based upon our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesestatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses and their relateddisclosures. On an ongoing basis, Option Care evaluates its estimates andjudgments based on historical experience and various other factors that arebelieved to be reasonable. Actual results may vary from these estimates underdifferent assumptions or conditions. We annually review our financial reportingand disclosure practices and accounting policies to ensure that our financialreporting and disclosures provide accurate and transparent information relativeto our financial condition and results of operations, as well as our currentbusiness environment. Option Care management believes that of our significantaccounting policies, the following policies involve a higher degree of judgmentand/or complexity.

 

*Revenue recognition and contractual adjustments*

* *

Our revenue is primarily derived from the sale ofpharmaceuticals and medical supplies and the provision of related nursingservices to patients at alternate-site settings. Most of this revenue is billedunder managed care or other contracts, with a smaller amount billed undergovernment programs, such as Medicare and Medicaid. Billed and unbilled revenueis recorded net of contractual adjustments based on our interpretation of theterms of each managed care contract or government contract or pricing schedule,as loaded into our computerized billing and pharmacy management softwaresystems.  Contractual adjustments arecalculated automatically by our billing systems when the claim is billed.  The contractual adjustments on unbilledamounts must be estimated manually through claim-by-claim analysis of theunbilled claims, by applying historical contractual adjustment percentages tothe gross unbilled amounts, or a combination of the two.  The accuracy of our recorded net revenue issubject to the accuracy of payor information on file for each patient, and isalso subject to our correct interpretation of each underlying contract withrespect to reimbursement rates for the drugs and services we provided. Ifchanges or corrections to our estimates of net revenue prove to be necessary,we adjust net revenue in the period that such changes or corrections areidentified. Such adjustments may have a positive or negative impact on therevenues and results of operations reported for those subsequent periods.Historically, such adjustments have not been significant to our statements ofincome.

 

*Accounts receivable and allowances for doubtful accounts*

* *

We record our accounts receivable net ofcontractual adjustments (as described in the preceding paragraph) and net ofallowances for

 

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doubtful accounts. Our procedure for estimatingthe allowance for doubtful accounts requires significant judgment andassumptions.  The allowance for doubtfulaccounts is estimated based on several factors, including our past accountsreceivable collection history, the age of our accounts receivable at the end ofeach period, and detailed analysis of the expected collectability of amountsreceivable from each significant payor based on a number of factors.  Although we believe that our estimation ofthe net value of our accounts receivable is reasonable, we continually monitorour accounts receivable and our methods for calculating the appropriateallowance for doubtful accounts.  Ouractual collections of accounts receivable may differ from our estimates ofcollectability, affecting our future financial condition and results ofoperations.

 

*Goodwilland other intangible assets*

* *

We record goodwill from our acquisitions equal to the excess of thetotal cost of the acquisitions over the fair value of all identified tangibleand intangible assets acquired. In accordance with Statements of FinancialAccounting Standards (SFAS) No. 141, *Business Combinations* and SFASNo. 142, *Goodwill and Intangible Assets*, effective January 1, 2002 weno longer amortize goodwill but instead test our goodwill annually forimpairment.  Our method of impairmenttesting consists of comparing the market value of our company to its bookvalue. The market value is equal to the current value per share of our commonstock, times the total number of shares outstanding.  We test goodwill for impairment annually each October 1st,or whenever we identify events or conditions that could potentially result inimpairment of our goodwill.

 

Other intangible assets primarily consist of non-compete agreements,payor contracts and patient records. These intangible assets are amortized straight-line over periods rangingfrom two to five years.  Theiramortization period equals their estimated useful lives, or in the case ofnon-compete agreements, the amortization period equals their contractual term.

 

**RESULTSOF OPERATIONS**

 

The following table shows the results of our operations for the threeand six months ended June 30, 2003 and 2002, expressed as percentages ofrevenue:

 
|                                         |   | **Three  Months EndedJune 30,** |       | **Six Months  EndedJune 30,** |       |
|----------------------------------------------|--------|--------------------------------------|------------|------------------------------------|------------|
|                                         |   | **2003**                             |       | **2002**                           |       | **2003** |   | **2002** |   |
|                                         |   |                                 | ** ** |                               | ** ** |   | ** ** |   | ** ** |
| Revenue                                      |   | 100.0                                | %          | 100.0                              | %          | 100.0 | % | 100.0 | % |
| Cost of revenue:                             |   |                                 |       |                               |       |   |   |   |   |
| Cost of goods sold                           |   | 55.4                                 | %          | 57.1                               | %          | 57.4 | % | 57.0 | % |
| Cost of services provided                    |   | 12.0                                 | %          | 11.7                               | %          | 11.6 | % | 11.8 | % |
| Total cost of revenue                        |   | 67.4                                 | %          | 68.8                               | %          | 69.0 | % | 68.8 | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Gross profit                                 |   | 32.6                                 | %          | 31.2                               | %          | 31.0 | % | 31.2 | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Selling, general and administrative expenses |   | 22.3                                 | %          | 21.1                               | %          | 21.2 | % | 21.2 | % |
| Provision for doubtful accounts              |   | 2.7                                  | %          | 1.9                                | %          | 2.4 | % | 2.0 | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Total operating expenses                     |   | 25.0                                 | %          | 23.0                               | %          | 23.6 | % | 23.2 | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Operating income                             |   | 7.6                                  | %          | 8.2                                | %          | 7.4 | % | 8.0 | % |
| Interest expense                             |   | —                               | %          | (0.1                               | )%         | (0.1 | )% | — | % |
| Other expense, net                           |   | (0.1                                 | )%         | 0.1                                | %          | — | % | — | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Income before income taxes                   |   | 7.5                                  | %          | 8.2                                | %          | 7.3 | % | 8.0 | % |
| Income tax provision                         |   | 3.0                                  | %          | 3.2                                | %          | 2.9 | % | 3.1 | % |
|                                         |   |                                 |       |                               |       |   |   |   |   |
| Net income                                   |   | 4.5                                  | %          | 5.0                                | %          | 4.4 | % | 4.9 | % |

 

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**Threeand Six Months Ended June 30, 2003 and 2002**

 

**Revenue.**  Revenue for the quarter ended June 30, 2003was $84.8 million, which represents an increase of $9.3 million, or 12.3%, overthe revenue of $75.5 million for the prior year quarter.  Revenue for the six months ended June 30,2003 was $177.3 million, representing an increase of $29.1 million, or 19.6%,over the six months ended June 30, 2002. The revenue increases are attributable to both acquisitions andsame-store increases in infusion therapy revenue and specialty pharmacyservices revenue.  Same store sales ofspecialty pharmacy services and infusion therapy services increased 10.1% and11.1%, respectively, in the three and six months ended June 30, 2003 comparedto the corresponding prior year periods. We report our operating results in one segment, consisting of threeservice lines: specialty pharmacy services; infusion and related healthcareservices; and other.

 

**Specialtypharmacy services revenue.** For the quarter ended June 30, 2003, specialty pharmacy servicesrevenue increased to $48.2 million, which is an increase of $5.7 million, or13.3%, over the revenue in the prior year quarter.  For the six months ended June 30, 2003, specialty pharmacyservices revenue was $105.2 million, compared to $83.1 million for the sixmonths ended June 30, 2002.  Thisrepresents an increase of $22.1 million, or 26.6%, over the prior year.  The increases in specialty pharmacy servicesrevenue were due to acquisitions completed in 2002 and due to increases in samestore sales.  Specialty pharmaceuticalproducts that produced higher revenue in the current year than the prior yearincluded Synagis®, human growth hormone and factor products.

 

**Infusionand related healthcare services revenue.**  For the quarter ended June 30, 2003,infusion and related healthcare services revenue equaled $34.1 million,representing an increase of $3.8 million, or 12.4%, over the prior yearquarter.  For the six-month period endedJune 30, 2003, infusion and related healthcare services revenue equaled $67.2million, representing an increase of $7.3 million, or 12.2%, over the six-monthperiod ended June 30, 2002.  Theseincreases were primarily due to acquisitions completed in 2002, as well asincreased same store revenue from home infusion therapy services.  Overall, revenue from home infusion therapyservices increased 22.5% and 21.1%, respectively, in the three and six monthsended June 30, 2003 compared to the prior year due to acquisitions and samestore sales growth.  Revenue from otherrelated healthcare services declined as we scaled back operations in theseareas and focused on increasing revenue from home infusion therapy services.

 

**OtherRevenue.** Otherrevenue consists primarily of revenue generated from our franchise network,consisting of royalties, franchise fees and vendor rebates earned from ourfranchises’ purchases, and software sales and rentals by our wholly-ownedsubsidiary, Management by Information, Inc. Other revenue was $2.5 million forthe quarter ended June 30, 2003 compared to $2.6 million for the quarter endedJune 30, 2002, a decline of $100,000, or 5.6%. For the six months ended June 30, 2003, other revenue was $4.9 million,which is $300,000, or 6.3% lower than the other revenue of $5.3 million for thecorresponding prior year period. Declines in software sales revenue and vendor rebate revenue frompharmaceutical purchases by our franchisees were the causes of the declines inother revenue in the current year compared to the prior year.

 

**Cost ofRevenue. **Cost ofrevenue consists of the cost of goods sold and the cost of servicesprovided.  For the quarter ended June30, 2003, cost of revenue increased by $5.2 million, or 10.0%, over thecorresponding quarter of the prior year. For the six months ended June 30,2003, cost of revenue increased by $20.4 million, or 20.0%, compared to the sixmonths ended June 30, 2002. These 10.0% and 20.0% increases in cost of revenuewere related to the corresponding 12.3% and 19.6% increases in revenue due toacquisitions and internal growth.

 

Cost of goods sold for the quarter ended June 30, 2003 was $47.0million, or 55.4% of revenue.  In theprior year quarter, cost of goods sold was $43.2 million, or 57.1% ofrevenue.  The primary cause of thisdecline in cost of goods sold as a percentage of revenue was the signing of anew agreement with our principal pharmaceutical supplier which has increasedour estimate of the total rebates to be received for the calendar year2003.  The new agreement is retroactiveto January 1, 2003.  We recorded a $1.0million reduction to cost of goods sold in the quarter ended June 30, 2003 toreflect the increase in rebates, of which approximately half applies to purchasesduring the quarter ended June 30, 2003 and half applies to purchases during theprior quarter ended March 31, 2003.  Forthe six months ended June 30, 2003, cost of goods sold was $101.8 million, or57.4% of revenue, compared to $84.5 million, or 57.0% of revenue for thecorresponding prior year period.  Theslight increase in percentage, year over year, was due to higher rate of growthin specialty pharmacy services revenue than in infusion and related healthcareservices revenue.  Specialty drugs arehigher in cost and produce a lower gross margin than infusion therapydrugs.  In addition, we have begundepreciating the software development costs incurred in the development ofEmphsys, our new pharmacy management software produced by our subsidiary,MBI.  This depreciation expense resultedin a decline in the gross profit margin on other revenue (see Gross ProfitMargin table, below).

 

Cost of service consists of salaries and related costs for employeesdirectly involved in patient care, including pharmacists, nurses, therapistsand delivery drivers.  Cost of servicealso includes all costs of delivering products and services to thepatient.  The cost of services providedin the quarter ended June 30, 2003 was $10.1 million, or 11.9% of revenue, comparedto a cost of $8.8 million, or 11.6% of revenue, for services provided in thequarter ended June 30, 2002.  The costof services provided during the six-month period ended June 30, 2003 was $20.6million, or 11.6% of revenue.  In theprior year period ended June 30, 2002, cost of service was $17.5 million, or11.8% of revenue.  The minor changes incost of service as a percentage of revenue are attributable to variations inour mix of services provided through our specialty pharmacy and infusion andrelated healthcare service lines.

 

15

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**GrossProfit Margin.**  Thefollowing table shows the gross profit margin for each of our three servicelines: specialty pharmacy services; infusion and related healthcare services;and other:

 
|                                      |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|-------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                      |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                      |   |                             |   |                           |   |   |   |   |   |
| Gross profit  margin:                     |   |                             |   |                           |   |   |   |   |   |
| Specialty  pharmacy services              |   | 21.9                             | %      | 19.1                           | %      | 20.5 | % | 18.2 | % |
| Infusion and  related healthcare services |   | 43.4                             | %      | 42.2                           | %      | 42.7 | % | 43.3 | % |
| Other                                     |   | 92.9                             | %      | 99.1                           | %      | 94.7 | % | 99.1 | % |
| Total gross  profit margin                |   | 32.6                             | %      | 31.2                           | %      | 31.0 | % | 31.2 | % |

 

The gross profit margin for the quarter ended June 30, 2003 was 32.6%compared to 31.2% for the quarter ended June 30, 2002. This overall increase inmargin was primarily due to an increase in rebates, which reduced cost of goodsin the current year quarter, and due to shifts in product mix for our specialtypharmacy service line toward products with higher gross margins.  For the six months ended June 30, 2003, theoverall gross profit margin was 31.0%, which is slightly lower than the grossprofit margin of 31.2% in the prior year period.  Comparing these six-month periods, specialty pharmacy servicesrevenue grew at a faster pace than infusion and related healthcare servicesrevenue.  Because specialty pharmacyservices generate a lower margin, the increase in specialty pharmacy revenuereduced our overall gross profit margin slightly. The gross profit margins onspecialty pharmacy services were 21.9% and 20.5% for the three and six monthsended June 30, 2003.  These marginsincreased by 2.8% and 2.3%, respectively, compared to the corresponding threeand six months ended June 30, 2002. This gross profit margin improvement is due to an increase in sales ofhigher-margin products, such as blood clotting factor products, throughout ournetwork of company-owned pharmacies in the current year.  The increase in our estimated rebatesrecorded during the quarter ended June 30, 2003 was also a contributingfactor.  Infusion and related healthcareservices generated a gross profit margin of 43.4% for the quarter ended June30, 2003, which is 1.2% higher than the margin in the prior year quarter.  This improvement was primarily due to anincrease in vendor rebates in the current year quarter, which decreased theoverall cost of goods for infusion and related healthcare services.  The gross profit margin for the six monthsended June 30, 2003 was 42.7%, which is slightly below the gross profit marginof 43.3% in the prior year period.  Thedecrease in margin was primarily related to variations in our mix of healthcareservices provided within this service line.

 

**Selling,general and administrative expenses. **Selling,general and administrative expenses were $18.9 million for the quarter endedJune 30, 2003, an increase of $2.9 million, or 18.0%, over the correspondingquarter of the prior year.  For the sixmonths ended June 30, 2003, selling, general and administrative expenses were$37.6 million, an increase of $6.1 million, or 19.5%, over the six-month periodended June 30, 2002.  Of the $2.9million quarterly increase and $6.1 million year-to-date increase, $1.8 millionand $3.8 million, respectively, was related to increased labor costs.  A portion of this increase was directly dueto acquisitions, which added their own layer of administrative salaries.  In addition, we increased staff as we beganthe rollout of our new pharmacy management software, Emphsys, to our network ofcompany-owned offices.  Much of theremainder was due to increased corporate staffing of various functions such asbilling and reimbursement management. Another factor contributing to the increase in labor costs wascontinuing market-based increases in employee health insurance and otheremployee benefit costs.

 

As a percentage of revenue, selling, general and administrativeexpenses were 22.2% in the quarter ended June 30, 2003, which is 1.0% higherthan in the prior year quarter.  For thesix months ended June 30, 2003, selling, general and administrative expenseswere 21.2% of revenue, unchanged from the corresponding prior year period.  The slight increase in percentage in thequarter ended June 30, 2003 versus the corresponding prior year quarterwas due to increased labor costs, as described above, and due to various otherfactors, such as increases in business insurance costs and in phone and dataline communications costs.

 

**Provisionfor doubtful accounts.** The provision for doubtful accounts was $2.3 million for the quarterended June 30, 2003.  This represents anincrease of approximately $900,000, or 63.4%, over the $1.4 million provisionfor doubtful accounts in the quarter ended June 30, 2002.  For the six months ended June 30, 2003, theprovision for doubtful accounts was $4.2 million, representing a $1.3 million,or 43.9%, increase over the $2.9 million provision taken in the six monthsended June 30, 2002.  Expressed as apercentage of revenue, the provision for doubtful accounts was 2.7% of revenuein the quarter ended June 30, 2003 compared to 1.9% in the quarter ended June30, 2002.  For the six months periodsended June 30 of each year, the provision taken in 2003 equaled 2.4% of revenuecompared to a provision equal to 2.0% of revenue in 2002.  The current year increase in provision fordoubtful accounts can be directly attributed to accounts receivable in ourTexas offices.  In 2000 and 2001, wecompleted multiple acquisitions in Texas, causing us to have multiple operatinglocations in the Dallas and Houston markets. As part of the integration process for these new businesses, weconsolidated pharmacy locations into one location in each market, consolidatedcomputerized billing systems and sought to retain the appropriate staff tooperate these businesses.  We encountereddifficulties in various aspects of this integration process, leading to anincrease in the incidence of bad debt write-offs and an increase in the age ofour accounts receivable in these offices. We have made regional and local management changes and implemented aplan designed to stabilize and improve the

 

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operations in these offices and to reduce the incidence of bad debtwrite-offs in future periods.  However,additional provisions for doubtful accounts, over and above our normalprovision, may be necessary in the quarter ended September 30, 2003 as wecontinue to evaluate the collectability of our accounts receivable in Texas.

 

**OperatingIncome. **Operatingincome was $6.5 million, or 7.6% of revenue, for the quarter ended June 30,2003.  This represents an increase of$300,000, or 4.8%, over the quarter ended June 30, 2002, in which our operatingincome was $6.2 million, or 8.2% of revenue. For the six months ended June 30, 2003, operating income was $13.2million, or 7.4% of revenue, which is $1.3 million, or 10.8%, higher thanoperating income of $11.9 million, or 8.0% of revenue, for the six months endedJune 30, 2002.  The increases inoperating income over both periods are directly attributed to the revenueincreases driven from acquisitions and same store sales growth. The decline inoperating income as a percentage in revenue was primarily due to the increasesin the provision for bad debts in the current year periods and to increasedsoftware implementation costs, partially offset by increased vendor rebates, asdetailed above.

 

Interest expense for the quarter ended June 30, 2003 was $6,000,compared to $33,000 in the prior year period. For the six months ended June 30, 2003, interest expense was $106,000compared to $16,000 in the corresponding period of the prior year.  Our interest expense is primarily fromborrowings on our revolving credit facility with JP Morgan.

 

**IncomeTaxes. **Income taxprovision for the quarter ended June 30, 2003 was $2.6 million, which isapproximately $200,000, or 5.7%, higher than the $2.4 million income taxprovision the prior year quarter.  Forthe six months ended June 30, 2003, the income tax provision was $5.2 million,an increase of $500,000, or 11.3%, over the corresponding prior yearperiod.  Our income tax provision as apercentage of income before income taxes was 40.2% for the quarter and 40.0%for the six months ended June 30, 2003, compared to 39.3% for the both thequarter and six months ended June 30, 2002. The slight increase in provision rate is due to an increase in businessin higher-taxed states, primarily due to acquisitions completed in 2002.

 

**NetIncome.**  Net incomewas $3.8 million, or $0.18 per diluted share, for the quarter ended June 30,2003.  This represents an increase of1.6% over net income from the prior year quarter, which also rounded to $3.8million and $0.18 per diluted share. For the six months ended June 30, 2003, net income was $7.8 million, or$0.37 per diluted share, which was an increase of $600,000, or 7.8%, over thenet income of $7.2 million, or $0.34 per diluted share, for the six monthsended June 30, 2002.  These increases innet income were primarily due to revenue increases generated by acquisitionsand same store sales growth, but were limited by offsetting increases in laborand other selling, general and administrative expenses, and in the provisionfor bad debts in the current year periods.

 

**Dilutedshares. **Total dilutedshares remained nearly unchanged in the current year periods versus the prioryear periods.  For the quarters endedJune 30, 2003 and June 30, 2002, diluted shares were 21.2 million.  For the six months ended June 30, 2003,diluted shares were 21.2 million, which is just slightly higher than the 21.1million diluted shares for the six months ended June 30, 2002.  Increases in the actual number ofoutstanding shares due to issuance of shares from our stock incentive plan andemployee stock purchase plan were largely offset by reductions in the dilutiveeffect of stock options and by our cash payment in lieu of issuing stock undera prior year acquisition agreement.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

For the six-month period ended June 30, 2003, we financed ouroperations and acquisition activities through operating cash flows, the use ofcash reserves and borrowings under our credit facility.  In previous periods, we have also financedour operations and acquisitions through underwritten public offerings of commonstock.

 

**Operating Cash Flows.** Operations provided $12.7 million of positive cash flow for the sixmonths ended June 30, 2003, compared to $2.3 million provided by operationsduring the six months ended June 30, 2002. The primary cause of the large positive operating cash flow for thecurrent year is our net income during the period and improved collection ofaccounts receivable.  We have focused agreat deal of attention on improving cash collections, and this has helped usimprove operating cash flows significantly over the same period in the prioryear.

 

**Investing Cash Flows.**  We used$14.2 million in investing activities during the six months ended June 30,2003, compared to $12.2 million used in the corresponding prior yearperiod.   In each period, the largestcomponent use of cash was to fund acquisition activities.  In the six months ended June 30, 2003, $11.8million was used for acquisitions.  Weused $8.6 million to acquire the remaining 40% interest in InfusionSpecialties, Inc., a specialty pharmacy business for which we acquired amajority interest in the prior year period. We also made a $2.6 million installment related to our 2002 acquisitionof a home infusion pharmacy business in the Minneapolis/St.Paul area.  The remaining $600,000 was spent for otheracquisition activities.  In the prioryear, during the six months ended June 30, 2002, Option Care invested $9.8million in acquisitions, consisting of $6.9 million paid at closing foracquisitions completed in 2002 and $2.9 million paid as additionalconsideration on prior years’ acquisitions. Payments for purchase of equipment equaled $2.7 million for the sixmonths

 

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ended June 30, 2003, compared to $2.3 million inthe prior year period. Of the $2.6 million used for purchase of equipment inthe current year, approximately $1.0 million was spent on infrastructureimprovements, mostly related to office furniture and related equipment andleasehold improvements for company-owned pharmacies that moved to new leasedfacilities.  Additionally, $700,000 wasused to purchase computer and other technology equipment, $600,000 was used toacquire revenue-producing medical equipment such as infusion pumps and homemedical equipment, and $300,000 was used for software development projects.During the six months ended June 30, 2003, we disposed of our pharmacies inBullhead City, Arizona and Grand Junction, Colorado.  We received approximately $200,000 in proceeds from thesedisposals.

 

**FinancingCash Flows.**  Net cashflow provided by financing activities equaled $1.3 million for the six monthsended June 30, 2003, compared to $1.4 million provided by financing activitiesin the corresponding period of the prior year. Of the $1.3 million provided in the current year, new financing ofbusiness insurance premiums provided approximately $1.3 million in cash flow,while issuance of stock from options exercises and employee withholding underour stock purchase plan generated approximately $800,000 in cash flow.  We used $500,000 to reduce the balance onour credit facility, and used $300,000 to make scheduled installments oncapital leases and other debts.  In theprior year period ended June 30, 2002, the largest component of our $1.4million in cash provided by financing activities was $1.8 million generatedfrom issuance of stock and withholdings under our employee stock purchaseplan.  Another $300,000 was generated byan increase the cash overdraft on our books. Scheduled debt payments used $200,000, while financing costs to obtainour credit facility used $500,000 of cash.

 

As of March 29, 2002, Option Care signed a new senior secured creditfacility with JP Morgan Commercial Finance Corp. Availability under thisrevolving credit facility is related to percentages of our outstanding accountsreceivable and inventory balances, less certain ineligible amounts, as definedin the facility. Overall borrowings allowable under the revolving creditfacility are limited to the lesser of $60 million or the total allowablecollateral base. The agreement requires us to comply with various financialcovenants. The JP Morgan credit facility expires on March 29, 2005.

 

As of June 30, 2003, our outstanding debt balance under this facilitywas approximately $6.6 million, while as of December 31, 2002, our outstandingbalance was approximately $7.1 million. We had additional borrowing availability of approximately $27.8 millionas of June 30, 2003 and $32.3 million as of December 31, 2002 based on ouraccounts receivable and inventory balances on those dates.

 

Effective June 1, 2003, Option Care entered into a Premium FinancingAgreement with A.I. Credit Corporation for payment of the total premiums dueunder our professional liability, workers compensation and other insurancepolicies that renewed on June 1, 2003. This agreement allows us to pay the total cost of the premiums in ninemonthly installments, with the final payment due March 1, 2004.  The total amount financed was approximately$1.4 million at an interest rate of 3.51%.

 

Our accounts receivable, net of bad debt reserves, was $65.9 million asof June 30, 2003 compared to $74.7 million as of December 31, 2002.  This decline in accounts receivable ispartly attributable to strong cash collections during this six-monthperiod.  Another factor was the seasonaldecline in Synagis® revenue in the quarter ended June 30, 2003.  Our days sales outstanding was 75 as ofJune 30, 2003, which equals the days sales outstanding as of December 31,2002.  We calculated days salesoutstanding based on accounts receivable net of contractual reserves and baddebt reserves, and using the exhaustion method whereby we exhaust our accountsreceivable against each preceding month’s, or partial month’s, revenue.

 

As of June 30, 2003, we had cash and cash equivalents of approximately$300,000, compared to $500,000 in cash and cash equivalents as of December 31,2002.  During times when we have anoutstanding balance under our credit facility with JP Morgan, we maintain alow, or zero, cash balance.  Cashcollections are automatically swept against our credit facility balance as theybecome available, and we borrow only as much cash each day as necessary tocover operational needs.

 

We believe that cash flow from operations and amounts available underour revolving credit facility will be sufficient to meet our operating cashneeds for the immediate future, including any interest due on our creditfacility or other debts.  In the eventthat additional capital is required, management cannot assure that such capitalcan be obtained from other sources on terms acceptable to us, if at all.

 

Our business strategy includes the selective acquisition of additionallocal pharmacy facilities and specialty pharmacy operations.  Accordingly, we may require additionalcapital in order to complete these acquisitions.  It is impossible to predict the amount of capital that may berequired for acquisitions, and there is no assurance that sufficient financingfor these activities will be available on terms acceptable to us, if at all.

 

**Goodwilland Other Intangible Assets**

 

As of June 30, 2003, net goodwill and otherintangible assets equaled $66.4 million, consisting of $65.0 million ofgoodwill and $1.4 million of other intangible assets such as non-competeagreements, patient records, and managed care contracts.  As of December 31, 2002,

 

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net goodwill and other intangible assets equaled$57.1 million, consisting of $55.4 million of goodwill and $1.7 million ofother intangible assets.  The $9.6million increase in goodwill is primarily related to our acquisition in thequarter ended June 30, 2003 of the 40% minority interest in InfusionSpecialties, Inc., a Houston-based specialty pharmacy business.  The decline in other intangible assets is primarilydue to amortization of intangible assets relating to prior years’ acquisitions.

 

As required by Statements of Financial AccountingStandards No. 142, *Goodwill and Other Intangible Assets (SFAS No. 142)*,we do not amortize goodwill, but test our goodwill for impairment annually eachOctober 1st, or whenever we identify events or conditions that couldpotentially result in impairment of our goodwill.  During the quarter and six months ended June 30, 2003, noimpairment of goodwill was identified.

 

**Regulatory and Other Developments**

 

Many governmental payors reimburse us for some pharmaceuticals based onthe pharmaceutical’s average wholesale price (AWP). In many cases, we purchasepharmaceuticals at less than AWP. AWP for most pharmaceuticals is compiled andpublished by private companies, including First DataBank, Inc. It has beenreported that there are currently several lawsuits pending againstmanufacturers of certain pharmaceuticals. These government investigations andlawsuits involve allegations that manufacturers have misrepresented to FirstDataBank the actual selling price of certain pharmaceuticals. First DataBankhas announced that it will now base AWP on market prices certified by themanufacturer. As a result of this change, First DataBank has published a MarketPrice Survey that reduces the AWP significantly for a number of the products wecurrently supply to patients. We cannot predict the eventual results of theseinvestigations, nor the changes made in AWP by First DataBank. If AWP’s on theproducts we purchase were reduced, or if the AWP system was replaced with adifferent reimbursement system, our gross profit margins could be narrowed.

 

**ITEM 3.****               Quantitative and Qualitative Disclosures AboutMarket Risk**

 

We are subject to market risk from exposure to changes in interestrates based on our financing and cash management activities. We utilize a mixof debt maturities along with both fixed-rate and variable-rate debt to manageour exposure to changes in interest rates. Although there can be no assurancesthat interest rates will not change significantly, we do not expect changes ininterest rates to have a material effect on income or cash flows in 2003. As ofJune 30, 2003, our fixed-rate debt was $1.5 million and our corresponding variable-ratedebt was $6.6 million.  Based on ourvariable-rate debt as of June 30, 2003, a one-percent increase in interestrates would increase our annual interest expense by $66,000.

 

**ITEM 4.****               Controls and Procedures**

 

**(a)  Evaluation of disclosure controls andprocedures.**

 

We maintain disclosure controls and procedures which have been designedto ensure that information related to Option Care is recorded, processed,summarized and reported by Option Care on a timely basis.  As of the end of the period covered by thisQuarterly Report on Form 10-Q, our Chief Executive Officer, Rajat Rai, andChief Financial Officer, Paul Mastrapa, carried out an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures.  Based upon this evaluation,Mr. Rai and Mr. Mastrapa concluded that our disclosure controls and proceduresare effective in causing material information to be recorded, processed,summarized and reported by management on a timely basis and ensuring that thequality and timeliness of our public disclosures comply with our disclosureobligations under the Securities Exchange Act of 1934.

 

**(b)  Changes in internal controls.**

** **

There were no significant changes in the internal controls overfinancial reporting of the Company during the period covered by this QuarterlyReport on Form 10-Q or in other factors that could materially affect, or arereasonably likely to materially affect, these internal controls over financialreporting.

 

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**PART II****.  OTHER INFORMATION**

 

**ITEM 1.****               Legal Proceedings**

** **

Option Care is subject to claims and legal actions that may arise inthe ordinary course of business.  Asidefrom the two lawsuits previously disclosed in our Annual Report on Form 10-Kfor the year ended December 31, 2002, we are not aware of any claims,investigations or proceedings against us or any of our franchisees that webelieve are likely to have a material financial impact on us.

 

The Company currently maintains insurance for general and professionalliability claims in an aggregate amount of $8 million.  The Company also requires each franchisee tomaintain general liability and professional liability insurance covering boththe franchise and us, at coverage levels that we believed to besufficient.  These insurance policiesprovide coverage on a claims-made or occurrence basis and have certainexclusions from coverage.  There can beno assurance that insurance coverage will be adequate to cover liability claimsthat may be asserted against the Company or that adequate insurance will beavailable in the future at acceptable cost, if at all.  To the extent that liability insurance isnot adequate to cover liability claims against us, we will be responsible forthe excess.

 

**ITEM 2.****               Changes in Securities and Use ofProceeds**

** **

None.

 

**ITEM 3.****               DefaultsUpon Senior Securities**

** **

None.

 

**ITEM 4.****               Submissionof Matters to a Vote of Securities Holders**

** **

Option Care’s annual meeting of stockholders was held on May 9,2003.  The following matters were votedupon at the meeting:

 

1.             Election of threemembers to the Board of Directors, each being elected to hold office for athree-year term or until his respective successor is duly elected andqualified.  Each of management’snominees for election to our Board of Directors as listed in our proxystatement was elected to a three-year term, with the results of the voting asfollows:
|                  |   | **VOTES FOR** |   | **VOTES****AGAINST** |   | **ABSTAIN** |   |
|-----------------------|--------|---------------|--------|----------------------|--------|-------------|--------|
| Kenneth S. Abramowitz |   | 18,514,921    |   | —               |   | 92,810      |   |
| John N. Kapoor, Ph.D. |   | 17,264,638    |   | —               |   | 1,343,093   |   |
| Rajat Rai             |   | 17,273,809    |   | —               |   | 1,333,922   |   |

 

The term of office ofeach of the following directors continued after the meeting: James M. Hussey,Leo Henikoff, M.D. and Jerome F. Sheldon. At the conclusion of the meeting, James G. Andress retired as a directorof the Company.

 

2.             Ratification of theappointment of Ernst & Young, LLP as independent auditors of the Companyfor the fiscal year 2003.  The proxyvoting results were as follows:
| **VOTES FOR** |   | **VOTES****AGAINST** |   | **ABSTAIN** |   |
|---------------|--------|----------------------|--------|-------------|--------|
| 18,523,603    |   | 74,418               |   | 9,710       |   |

 

At the annual meeting, Option Care’s stockholdersvoted to elect the three nominees for director as identified in Matter Number 1above and ratified the appointment of Ernst & Young, LLP to as independentauditors for the Company for the fiscal year 2003 as identified in MatterNumber 2.

 

**ITEM 5.****               Other Information**

** **

None.

 

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**ITEM 6(a).****                    Exhibits**

** **

See Exhibit Index.

 

**ITEM 6(b).****                    Reports on Form 8-K**

** **

On May 13, 2003, Option Care filed a report onForm 8-K containing our earnings press release for the quarter ended March 31,2003, which was released on May 13, 2003.

 

On May 20, 2003, Option Care filed a report onForm 8-K containing the transcript of our conference call with investors toannounce and discuss Option Care’s results of operations for the quarter endedMarch 31, 2003.  The conference calltook place on May 13, 2003 at 9:00 a.m., Central Daylight Time.

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, theCompany has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                       | OPTION  CARE, INC. |
|----------------------------|-------------------------|
| Date: August 14, 2003 | By:                     | /s/ Paul Mastrapa |   |
|                       |                    | *Chief Financial Officer* |
|                       |                    | *(Principal Accounting Officer and**Principal Financial Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** |   |                                                                                                                                                                                                                                                                                         |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.1                 |   | Certificate of Incorporation of  the Registrant, together with Certificate of Amendment thereto filed February 18,  1992. Filed as Exhibit 3(a) to Option Care’s Registration Statement  (No. 33-45836) dated April 15, 1992 and incorporated by reference  herein. |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.2                 |   | Certificate of Amendment to  Certificate of Incorporation of the Registrant filed March 25, 1992.  Filed as Exhibit 3(c) to Option Care’s Registration Statement  (No. 33-45836) dated April 15, 1992 and incorporated by reference  herein.                        |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.3                 |   | Certificate of Amendment to  Certificate of Incorporation of the Registrant filed with the Delaware  Secretary of State on June 18, 2002 and incorporated by reference  herein.                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.4                 |   | Restated By-laws of the  Registrant dated June 1, 1994. Filed as Exhibit 10.5 to Option  Care’s Annual Report on Form 10-K for the year ending December 31,  1994 and incorporated by reference herein.                                                             |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.1                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.2                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.3                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.4                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.5                |   | Option Care, Inc. 401(k)  Profit Sharing Plan. Filed as Exhibit 10(b) to Option Care’s Registration  Statement (No. 33-45836) dated April 15, 1992 and incorporated by  reference herein.                                                                                |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.6                |   | Amendment to the 1992 401(k)  Profit Sharing Plan of the Registrant dated January 1, 1996. Filed as  Exhibit 10.3(a) to Option Care’s Annual Report on Form 10-K for the  year ending December 31, 1997 and incorporated by reference herein.                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.7                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.8                |   | Form of Franchise Agreement.  Filed as Exhibit 10.5 to Option Care’s Annual Report on Form 10-K  for the year ending December 31, 1996 and incorporated by reference  herein.                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.9                |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.10               |   | Consulting Agreement between  the Registrant and EJ Financial Enterprises, Inc. Filed as Exhibit 10(o)  to Option Care’s Registration Statement (No. 33-45836) dated April 15,  1992 and incorporated by reference herein.                                                    |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.11               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.12               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.13               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.14               |   | Executive Severance Agreement  between Cathy Bellehumeur and Option Care, Inc., dated November 12,  1997. Filed as Exhibit 10.18 to Option Care’s Annual Report for the year  ending December 31, 1997 and incorporated by reference herein. *                      |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.15               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.16               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.17               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.18               |   | Intentionally omitted.                                                                                                                                                                                                                                                                       |

 

23

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|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.20  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.21  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.22  |   | Amendment No. 1 to the  Consulting Agreement By and Between EJ Financial Enterprises, Inc.  and Option Care, Inc., dated October 1, 1999. Filed as  Exhibit 10.30 to Option Care’s Annual Report for the year ended  December 31, 1999 and incorporated by reference herein.                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.23  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.24  |   | 2001 Employee Stock Purchase  Plan. Filed as Exhibit A to the registrants definitive proxy statement  for the 2000 Annual Shareholders Meeting and incorporated by reference  herein. *                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.25  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.26  |   | Participation Agreement between  Health Options, Inc. and Option Care, Inc. effective as of June 1,  1997. 2001. Filed as Exhibit 10.26 to Option Care’s Amendment No. 1  to its Annual Report on Form 10-K/A filed September 10, 2001 and  incorporated by reference herein.                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.27  |   | Prescription Drug Agreement  among Blue Cross and Blue Shield of Florida, Inc., Health  Options, Inc. and Option Care, Inc. dated March 8, 2000. Filed  as Exhibit 10.27 to Option Care’s Amendment No. 1 to its Annual  Report on Form 10-K/A filed September 10, 2001 and incorporated by  reference herein.                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.28  |   | Amendment to Participation  Agreement between Health Options, Inc. and Option Care, Inc. dated April 1,  2001. **                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.29  |   | Deferred Compensation Plan for  certain Executives, effective as of January 1, 2001. **                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.30  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.31  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.32  |   | Injectable Drugs Agreement  effective as of September 5, 2001 between Health Option, Inc. and OptionMed,  Inc.  Filed on October 10, 2001 as  Exhibit 10.1 to Form 8-K/A and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.33  |   | Credit and Security Agreement,  dated March 29, 2002, by and among Option Care, Inc. and the domestic  subsidiaries of Option Care party thereto, as Borrowers, the Lending  Institutions party thereto, as Lenders, J.P. Morgan Business Credit Corp., as  Advisor, and JPMorgan Chase Bank, as Administrative and Collateral Agent and  Arranger, and LaSalle Bank National Association, as Co-Agent.  Filed as Exhibit 10.21 to Option Care’s  Current Report on Form 8-K filed May 15, 2002 and incorporated by reference  herein. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.34  |   | Employment Agreement between  Richard M. Smith and Option Care, Inc., dated May 7, 2003.  Filed herewith. *                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.35  |   | Employment Offer Letter between  Option Care, Inc. and Paul Mastrapa, dated January 18, 2002.  Filed herewith. *                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.36  |   | Employment Offer Letter between  Option Care, Inc. and Joe Bonaccorsi, dated December 31, 2001.  Filed herewith. *                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1   |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2   |   | Certification of Senior Vice  President and Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1   |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.2   |   | Certification of Senior Vice  President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                   |

 

----

| *      | Management contracts and compensatory plans and  arrangements.                                                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                 |
| **     | Portions of this Exhibit are subject to a  Confidential Treatment Request pursuant to Rule 24b-2 under the Securities  and Exchange Act of 1934, as amended, filed with the SEC on September 10,  2001 and amended October 10, 2001. |

 

24

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