**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**Forthe quarterly period ended September 30, 2005**

 

**OR**

 

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

 

**Forthe transition period from                          to                          **

 

**Commissionfile number 0-19878**

 
| **OPTION  CARE, INC.**                                     |
|-----------------------------------------------------------------|
| (Exact name 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 markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes ý  No o

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| **Class**                       | ** ** | **Issued  and Outstanding  as of November 1, 2005** |
|---------------------------------|------------|----------------------------------------------------------|
|                            |       |                                                     |
| Common Stock -  $0.01 par value |       | 32,765,262                                               |

 

 

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**INDEX**

 

**OPTIONCARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION**  |
|------------------|
| ** **       | ** ** |
| **PART I**  | **FINANCIAL INFORMATION** |
| ** **       | ** ** |
| Item  1.         | Financial  Statements (Unaudited) |
|             |   |
|             | Condensed consolidated  balance sheets—September 30, 2005 and December 31, 2004 |
|             |   |
|             | Condensed consolidated  statements of income—Three and nine months ended September 30, 2005 and  2004 |
|             |   |
|             | Condensed consolidated  statements of cash flows—Nine months ended September 30, 2005 and 2004 |
|             |   |
|             | Notes to condensed  consolidated financial statements—September 30, 2005 |
|             |   |
| 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.          | Unregistered Sales of Equity  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.          | Exhibits |
|             |   |
| **SIGNATURES**   |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Balance Sheets**

(in thousands,except per share amounts)

 
| ** **                                                                                                                                                                                    | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**             | ** ** | **(Note 1)**               | ** ** |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Assets                                                                                                                                                                                        |       |                        |       |                       |       |
| Current  assets:                                                                                                                                                                              |       |                        |       |                       |       |
| Cash  and cash equivalents                                                                                                                                                                    |       | $                           | 10,107     |                       | $          | 19,816 |   |
| Short-term  investments                                                                                                                                                                       |       | 53,644                      |       | 75,370                     |       |
| Accounts  receivable, net                                                                                                                                                                     |       | 73,744                      |       | 69,930                     |       |
| Inventory                                                                                                                                                                                     |       | 11,917                      |       | 13,191                     |       |
| Deferred  income tax benefit                                                                                                                                                                  |       | 2,894                       |       | 3,098                      |       |
| Other  current assets                                                                                                                                                                         |       | 8,995                       |       | 5,459                      |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  current assets                                                                                                                                                                         |       | 161,301                     |       | 186,864                    |       |
| Equipment  and other fixed assets, net                                                                                                                                                        |       | 18,677                      |       | 13,709                     |       |
| Goodwill,  net                                                                                                                                                                                |       | 106,507                     |       | 65,356                     |       |
| Other  assets                                                                                                                                                                                 |       | 5,401                       |       | 3,918                      |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  assets                                                                                                                                                                                 |       | $                           | 291,886    |                       | $          | 269,847 |   |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Liabilities  and stockholders’ equity                                                                                                                                                    |       |                        |       |                       |       |
| Current  liabilities:                                                                                                                                                                         |       |                        |       |                       |       |
| Trade  accounts payable                                                                                                                                                                       |       | $                           | 18,204     |                       | $          | 21,819 |   |
| Current  portion of long-term debt                                                                                                                                                            |       | 47                          |       | 19                         |       |
| Other  current liabilities                                                                                                                                                                    |       | 7,015                       |       | 6,573                      |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  current liabilities                                                                                                                                                                    |       | 25,266                      |       | 28,411                     |       |
| Long-term  debt, less current portion                                                                                                                                                         |       | 86,319                      |       | 86,306                     |       |
| Deferred  income tax liability                                                                                                                                                                |       | 8,645                       |       | 7,468                      |       |
| Other  liabilities                                                                                                                                                                            |       | 600                         |       | 551                        |       |
| Minority  interest                                                                                                                                                                            |       | 634                         |       | 548                        |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  liabilities                                                                                                                                                                            |       | 121,464                     |       | 123,284                    |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Stockholders’  equity:                                                                                                                                                                   |       |                        |       |                       |       |
| Common  stock, $.01 par value per share, 60,000 shares authorized, 32,708 and  32,183 shares issued and outstanding at September 30, 2005 and December 31,  2004, respectively |       | 327                         |       | 322                        |       |
| Common  stock to be issued, 228 and 171 shares at September 30, 2005 and December 31,  2004, respectively                                                                           |       | 1,831                       |       | 1,085                      |       |
| Additional  paid-in capital                                                                                                                                                                   |       | 112,326                     |       | 108,062                    |       |
| Retained  earnings                                                                                                                                                                            |       | 55,938                      |       | 41,612                     |       |
| Less  treasury stock, at cost, 474 shares at December 31, 2004                                                                                                                           |       | —                      |       | (4,518                     | )          |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  stockholders’ equity                                                                                                                                                              |       | 170,422                     |       | 146,563                    |       |
|                                                                                                                                                                                          |       |                        |       |                       |       |
| Total  liabilities and stockholders’ equity                                                                                                                                              |       | $                           | 291,886    |                       | $          | 269,847 |   |

 

*Seenotes to condensed consolidated financial statements*

 

3

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**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Statements of Income**

(Unaudited)

(in thousands,except per share amounts)

 
| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Revenue:                                        |       |                                       |       |                                      |       |   |   |   |   |
| Specialty  pharmacy services                    |       | $                                          | 67,239     |                                      | $          | 57,752 |   | $ | 209,736 |   | $ | 181,091 |   |
| Infusion  and related healthcare services       |       | 51,178                                     |       | 39,405                                    |       | 141,716 |   | 111,801 |   |
| Other                                           |       | 3,476                                      |       | 2,794                                     |       | 10,687 |   | 8,859 |   |
| Total  revenue                                  |       | 121,893                                    |       | 99,951                                    |       | 362,139 |   | 301,751 |   |
| Cost  of revenue:                               |       |                                       |       |                                      |       |   |   |   |   |
| Cost  of goods sold                             |       | 71,680                                     |       | 59,153                                    |       | 219,122 |   | 181,958 |   |
| Cost  of services provided                      |       | 13,688                                     |       | 10,870                                    |       | 38,269 |   | 32,130 |   |
| Total  cost of revenue                          |       | 85,368                                     |       | 70,023                                    |       | 257,391 |   | 214,088 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Gross  profit                                   |       | 36,525                                     |       | 29,928                                    |       | 104,748 |   | 87,663 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Selling,  general and administrative expenses   |       | 24,689                                     |       | 19,787                                    |       | 69,739 |   | 58,236 |   |
| Provision  for doubtful accounts                |       | 2,248                                      |       | 1,601                                     |       | 6,727 |   | 4,622 |   |
| Depreciation  and amortization                  |       | 915                                        |       | 724                                       |       | 2,668 |   | 1,974 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Total  operating expenses                       |       | 27,852                                     |       | 22,112                                    |       | 79,134 |   | 64,832 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Operating  income                               |       | 8,673                                      |       | 7,816                                     |       | 25,614 |   | 22,831 |   |
| Interest  income, net                           |       | 108                                        |       | 54                                        |       | 258 |   | 89 |   |
| Other  income (expense), net                    |       | (73                                        | )          | (154                                      | )          | (20 | ) | (233 | ) |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Income  before income taxes                     |       | 8,708                                      |       | 7,716                                     |       | 25,852 |   | 22,687 |   |
| Income  tax provision                           |       | 3,348                                      |       | 3,086                                     |       | 9,798 |   | 9,071 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Net  income                                     |       | $                                          | 5,360      |                                      | $          | 4,630 |   | $ | 16,054 |   | $ | 13,616 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Net  income per common share:                   |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                           |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.49 |   | $ | 0.43 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Diluted                                         |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.47 |   | $ | 0.42 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Shares  used in computing net income per share: |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                           |       | 32,771                                     |       | 32,187                                    |       | 32,496 |   | 31,920 |   |
| Diluted                                         |       | 34,566                                     |       | 33,075                                    |       | 34,163 |   | 32,667 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Cash  dividends per share                       |       | $                                          | 0.0200     |                                      | $          | 0.0133 |   | $ | 0.0533 |   | $ | 0.0267 |   |

 

*Seenotes to condensed consolidated financial statements*

 

4

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**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Statements of Cash Flows**

(Unaudited)

(in thousands)

 
| ** **                                                                         | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Cash  flows from operating activities:                                             |       |                                      |       |   |   |
| Net  income                                                                        |       | $                                         | 16,054     |   | $ | 13,616 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                      |       |   |   |
| Depreciation  and amortization                                                     |       | 4,607                                     |       | 3,542 |   |
| Provision  for doubtful accounts                                                   |       | 6,727                                     |       | 4,622 |   |
| Deferred  income taxes                                                             |       | 1,244                                     |       | 1,719 |   |
| Income  tax benefit from exercise of stock options                                 |       | 1,973                                     |       | 1,318 |   |
| Changes  in assets and liabilities, net of acquisitions:                           |       |                                      |       |   |   |
| Accounts  and notes receivable                                                     |       | (8,450                                    | )          | (3,746 | ) |
| Inventory                                                                          |       | 2,974                                     |       | 1,860 |   |
| Accounts  payable                                                                  |       | (4,971                                    | )          | (2,414 | ) |
| Income  taxes receivable/payable                                                   |       | (273                                      | )          | 3,243 |   |
| Change  in other assets and liabilities                                            |       | (1,995                                    | )          | (3,640 | ) |
|                                                                               |       |                                      |       |   |   |
| Net  cash provided by operating activities                                         |       | 17,890                                    |       | 20,120 |   |
|                                                                               |       |                                      |       |   |   |
| Cash  flows from investing activities:                                             |       |                                      |       |   |   |
| Purchases  of short-term investments                                               |       | (170,840                                  | )          | — |   |
| Sales  of short-term investments                                                   |       | 192,566                                   |       | — |   |
| Purchases  of equipment and other, net                                             |       | (7,094                                    | )          | (4,147 | ) |
| Payments  for acquisitions, net of cash acquired                                   |       | (46,367                                   | )          | (3,130 | ) |
|                                                                               |       |                                      |       |   |   |
| Net  cash used in investing activities                                             |       | (31,735                                   | )          | (7,277 | ) |
|                                                                               |       |                                      |       |   |   |
| Cash  flows from financing activities:                                             |       |                                      |       |   |   |
| Increase  in financing costs                                                       |       | (166                                      | )          | — |   |
| Payments  on capital leases and other debt                                         |       | (30                                       | )          | (393 | ) |
| Proceeds  from issuance of stock                                                   |       | 6,060                                     |       | 3,088 |   |
| Payments  of cash dividends to common shareholders                                 |       | (1,728                                    | )          | (855 | ) |
| Payments  for purchase of treasury stock                                           |       | —                                    |       | (944 | ) |
|                                                                               |       |                                      |       |   |   |
| Net  cash provided by financing activities                                         |       | 4,136                                     |       | 896 |   |
|                                                                               |       |                                      |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                              |       | (9,709                                    | )          | 13,739 |   |
| Cash  and cash equivalents, beginning of period                                    |       | 19,816                                    |       | 3,961 |   |
| Cash  and cash equivalents, end of period                                          |       | $                                         | 10,107     |   | $ | 17,700 |   |

 

*Seenotes to condensed consolidated financial statements*

 

5

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**OptionCare, Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements**

**September 30,2005**

(Unaudited)

 

**1.****              Basis ofPresentation**

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Inthe opinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.Operating results for the three and nine months ended September 30, 2005are not necessarily indicative of the results that may be expected for the yearending December 31, 2005.

 

The balance sheet at December 31,2004 has been derived from the audited financial statements at that date butdoes not include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.

 

We completed a 3-for-2split of our common stock on March 31, 2005 for shareholders of record asof March 17, 2005.  All share and per share amounts in this QuarterlyReport on Form 10-Q have been adjusted to reflect the pro forma effects ofthis stock split.

 

For further information,refer to the consolidated financial statements and footnotes thereto includedin Option Care’s Annual Report on Form 10-K for the year ended December 31,2004.

 

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

 

On November 2, 2004,we completed a $75 million offering of 2.25% convertible senior notes due 2024in a private placement to qualified institutional buyers.  The initialpurchasers were granted the option to purchase up to an additional $11.3million principal amount of notes and exercised this option in full on November 9,2004.  We filed a Registration Statement on Form S-3 with theSecurities and Exchange Commission on January 24, 2005 registering thenotes and the common stock issuable upon conversion of the notes for resale tothe public.

 

The convertible notes aresenior unsecured obligations of Option Care and will be convertible into cashand, if applicable, shares of our common stock based on an initial conversionrate of 55.5278 shares per $1,000 principal amount of notes, which representsan initial conversion price of $18.01 per share, subject to adjustment incertain circumstances.  The conversion rate and conversion price weresubsequently adjusted to 83.3763 and $11.99 per share, respectively, pursuantto the terms of the notes as a result of our 3-for-2 common stock split on March 31,2005 and $0.02 per share dividends paid on June 10, 2005 and September 2,2005.  Note holders may convert their notes into cash and, if applicable,shares of our common stock prior to the stated maturity only under thefollowing circumstances: (1) during any calendar quarter beginning after December 31,2004, if the closing sale price of our common stock for each of 20 or moreconsecutive trading days in a period of 30 consecutive trading days ending onthe last trading day of the immediately preceding calendar quarter exceeds 120%of the conversion price in effect on the last trading day of the immediatelypreceding calendar quarter; (2) during the five business day period afterany five consecutive trading day period in which the average trading price per$1,000 principal amount of notes was equal to or less than 97% of the averageconversion value of the notes during the note measurement period; (3) uponthe occurrence of specified corporate transactions; or (4) if we havecalled the notes for redemption.  As of September 30, 2005, notriggering event has occurred that would result in the potential conversion ofour notes.   In general, upon conversion,the holder of each note will receive the conversion value of the note payablein cash, up to the principal amount of the note, and common stock for the notes’conversion value in excess of such principal amount (plus an additional cashpayout in lieu of fractional shares).  If the notes are surrendered forconversion in connection with certain fundamental changes that occur before November 1,2009, holders will in certain circumstances also receive a make-whole premiumin addition to the cash and shares that holders are otherwise entitled toreceive upon conversion.  The convertible senior notes will mature on November 1,2024 and will not be redeemable by us prior to November 1, 2009. Holders of the convertible notes may require us to repurchase all or a portionof the convertible notes for cash on November 1, 2009, 2014 and2019.  Interest will be paid at 2.25% per annum, payable semi-annually inarrears on May 1 and November 1 of each year to the holders of recordat the close of business on the preceding April 15 and October 15,respectively.  The notes are senior unsecured obligations and will rankequally with all of our existing and future senior unsecured indebtedness.

 

6

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**3.****              Earnings Per ShareData**

 

The following table setsforth the computation of basic and diluted earnings per share for the periodsindicated.  All share and per share amounts reflect the 3-for-2 stocksplit effective March 31, 2005 for shareholders of record on March 17,2005. (in thousands, except per share amounts):

 
| ** **                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic:                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Net  income                                                                     |       | $                                          | 5,360      |                                      | $          | 4,630 |   | $ | 16,054 |   | $ | 13,616 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Average  shares outstanding                                                     |       | 32,771                                     |       | 32,187                                    |       | 32,496 |   | 31,920 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Basic  earnings per share                                                       |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.49 |   | $ | 0.43 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Diluted:                                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Net  income                                                                     |       | $                                          | 5,360      |                                      | $          | 4,630 |   | $ | 16,054 |   | $ | 13,616 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Average  shares outstanding                                                     |       | 32,771                                     |       | 32,187                                    |       | 32,496 |   | 31,920 |   |
| Net  effect of dilutive stock options – Based on the treasury stock method |       | 960                                        |       | 888                                       |       | 1,002 |   | 747 |   |
| Net  dilutive effect of contingently convertible debt                           |       | 835                                        |       | —                                    |       | 665 |   | — |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Total  diluted shares                                                           |       | 34,566                                     |       | 33,075                                    |       | 34,163 |   | 32,667 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Diluted  earnings per share                                                     |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.47 |   | $ | 0.42 |   |

 

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

 

We have one identifiablebusiness segment, with three service lines: specialty pharmacy services;infusion and related healthcare services; and other.

 

**•****                  Specialty pharmacy services**involve the distribution of injectible and infused pharmaceuticals to treat awide range of chronic health conditions.  The pharmaceuticals can bedirectly distributed to the patient’s home or to their physician’s office forin-office administration.  These pharmaceuticals may require refrigerationduring shipping as well as special handling to prevent potencydegradation.  Patients receiving treatment usually require specialcounseling and education regarding their condition and treatment program.

 

**•****                  Infusion and related healthcareservices** primarily involve the intravenous administration of medications atthe patient’s home or other non-hospital sites such as one of our infusionsuites.  Infusion pharmacy services treat a wide range of acute andchronic health conditions, including infections, dehydration, cancer, pain andnutritional deficiencies.  All of our company-owned pharmacies provideinfusion pharmacy services.  Some of these pharmacies also provide relatedhealthcare services, such as home health nursing, home hospice services,respiratory therapy services and durable medical equipment.

 

**•****                  Other revenue** consists of royaltiesand other fees generated from our franchised pharmacy network, softwarelicensing and support revenue generated by our subsidiary, Management byInformation, Inc. (“MBI”) and other miscellaneous revenue.

 

**5.****              SignificantCustomers and Concentration of Credit Risk**

 

We generate the majorityof our revenue from managed care contracts and other agreements with commercialthird party payors by providing health care services to their members. Our principal managed care contract is with Blue Cross and Blue Shield ofFlorida, to whose members we provide infusion pharmacy services and specialtypharmacy services.  The contract may be terminated by either party on 90days’ notice and, unless terminated, renews annually each September for anadditional one-year term.  We also generate revenue from governmenthealthcare programs such as Medicare and Medicaid.

 

7

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The following table setsforth information regarding revenue and accounts receivable related to our mostsignificant payors as of the dates and for the periods presented:

 
| ** **                             | ** ** | **Revenue**             | ** ** | ** **             | ** ** | ** **               | ** ** |
|----------------------------------------|------------|-------------------------|------------|------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | **Three  months ended** | ** ** | **Nine  months ended** | ** ** | **Accounts  Receivable** | ** ** |
| ** **                             | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** | **September 30,**   | ** ** | **December 31,** | ** ** |
| ** **                             | ** ** | **2005**                | ** ** | **2004**               | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                   |       |                    |       |                   |       |                     |       |   |   |   |   |   |   |
| Blue  Cross and Blue Shield of Florida |       | 14                      | %          | 17                     | %          | 14                       | %          | 16 | % | 8 | % | 7 | % |
| Medicare &  Medicaid          |       | 15                      | %          | 17                     | %          | 17                       | %          | 19 | % | 21 | % | 18 | % |
| All  other payors (1)                  |       | 71                      | %          | 66                     | %          | 69                       | %          | 65 | % | 71 | % | 75 | % |
|                                   |       |                    |       |                   |       |                     |       |   |   |   |   |   |   |
| Total                                  |       | 100                     | %          | 100                    | %          | 100                      | %          | 100 | % | 100 | % | 100 | % |

 

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(1)          Noother payor represents 10% or more of our revenue or accounts receivable as ofthe dates and for the periods presented.

 

**6.****              Seasonal RevenueTrends**

 

Synagis®, one of thespecialty pharmaceuticals that we provide to patients, is seasonal. Synagis® is a drug used for the prevention of respiratory synctial virus (RSV)in high-risk pediatric patients. RSV infection is a seasonal condition, withthe season generally lasting from October through April.

 

Option Care’s quarterlySynagis® revenue for the year 2004 and the first three quarters of 2005 was asfollows (amounts in thousands):

 
| ** **                             | ** ** | **Synagis® revenue** | ** ** | **% of Total  Revenue** | ** ** |
|----------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** **                | ** ** | ** **              | ** ** |
| Quarter  ended March 31, 2004     |       | $                         | 14,251     |                    | 13.8       | % |
| Quarter  ended June 30, 2004      |       | 3,955                     |       | 4.0                     | %          |
| Quarter  ended September 30, 2004 |       | 571                       |       | 0.6                     | %          |
| Quarter  ended December 31, 2004  |       | 9,455                     |       | 8.4                     | %          |
| Fiscal  year 2004                      |       | $                         | 28,232     |                    | 6.8        | % |
|                                   |       |                      |       |                    |       |
| Quarter  ended March 31, 2005     |       | $                         | 15,536     |                    | 12.9       | % |
| Quarter  ended June 30, 2005      |       | 4,492                     |       | 3.8                     | %          |
| Quarter  ended September 30, 2005 |       | 862                       |       | 0.7                     | %          |

 

**7.****              Acquisitions**

 

During the quarter ended September 30,2005, we completed two acquisitions of home infusion pharmacy businesses.  We acquired the assets of the home infusionbusiness of Northwestern Memorial Hospital in Chicago and the assets of ourfranchise operating in Las Vegas and surrounding areas.  These acquisitions further our goal ofexpanding our national presence of company-owned infusion pharmacies.  We used $20.2 million in cash upon closingthese transactions and may owe up to $7.4 million in additional considerationin 2006, contingent upon the financial performance of the acquiredbusinesses.  We anticipate that anyadditional consideration will be recorded as goodwill.  Concurrent with our payment of the purchaseprice for the Las Vegas franchise, we recorded a gain of approximately $500,000on the early termination and settlement of their pre-existing franchiseagreement.  The results of operations ofthese businesses have been consolidated as of their acquisition dates.  We recorded $18.5 million in goodwill fromthese transactions, all of which we anticipate will be deductible for incometax purposes.  In addition to the twoacquisitions completed in the quarter ended September 30, 2005, we paidadditional consideration of $300,000 related to one of our 2004 acquisitions.

 

We completed twoacquisitions of home infusion pharmacies in the quarter ended March 31,2005 and three during the quarter ended June 30, 2005.  Of these five acquisitions, two were ofcurrent franchisees, one was a former franchisee and the other two wereindependent home infusion providers. Each acquisition was in support of our goal of expanding the size andgeographical coverage of our business, and the results of operations of eachwas consolidated as of the effect date of its acquisition.  We used cash of $7.1 million in the quarterended March 31, 2005 and $18.7 million in the quarter ended June 30,2005 to complete these acquisitions and recorded goodwill of $6.6 million and$13.3 million in each respective quarter, all of which is expected to bedeductible for income tax purposes.

 

8

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The following table setsforth the allocation of purchase price, in aggregate, for the acquisitions wecompleted in the quarter and nine months ended September 30, 2005.  Thisallocation includes approximately $300,000 in additional consideration paidduring the quarter and nine months ended September 30, 2005 related toprior year acquisitions.  For certain of ouracquisitions, the allocation of purchase price is tentative and subject toadjustment based on final valuation of the acquired assets (amounts inthousands):

 
| ** **                                     | ** ** | **Three months ended  September 30, 2005** | ** ** | **Nine months ended  September 30, 2005** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
|                                           |       |                                            |       |                                           |       |
| **Purchase Price:**                            |       |                                            |       |                                           |       |
| Paid  in cash at closing (1)                   |       | $                                               | 20,199     |                                           | $          | 46,367 |   |
| Payable  in shares of Option Care common stock |       | —                                          |       | 1,500                                          |       |
| Liabilities  assumed (2)                       |       | —                                          |       | 1,913                                          |       |
|                                           |       |                                            |       |                                           |       |
|                                           |       | $                                               | 20,199     |                                           | $          | 49,780 |   |
|                                           |       |                                            |       |                                           |       |
| **Allocation of Purchase Price:**              |       |                                            |       |                                           |       |
| Goodwill                                       |       | $                                               | 18,496     |                                           | $          | 41,152 |   |
| Accounts  receivable                           |       | —                                          |       | 4,604                                          |       |
| Inventory                                      |       | 741                                             |       | 1,700                                          |       |
| Other  tangible assets                         |       | 841                                             |       | 1,729                                          |       |
| Other  intangible assets                       |       | 121                                             |       | 595                                            |       |
|                                           |       |                                            |       |                                           |       |
| Total  purchase price                          |       | $                                               | 20,199     |                                           | $          | 49,780 |   |

 

----

(1)   Theactual cash paid at closing for acquisitions completed in the quarter ended September 30,2005 was $19,693, which was net of franchise termination fees valued at $506.

(2)   Liabilitiesassumed includes estimated additional consideration payable in future periods.

 

**8.****              Franchise-related Revenue**

 

Our franchise-related revenueincludes: (1) royalties; (2) vendor rebates and administration fees;and (3) franchise settlements and related fees.  Our franchise-related revenue has fluctuatedand may continue to fluctuate over time, primarily as a result offranchise acquisitions and terminations. During the quarter and nine months ended September 30, 2005, werecorded $500,000 and $3.0 million in franchise settlement revenue,respectively, compared to $100,000 and $1.1 million in the corresponding prioryear periods.  The current yearsettlement revenue primarily related to settling the future royalty obligationsof franchisees we acquired during the year, with the settlement gain equalingthe present value of the excess of the estimated future royalties receivableunder the terminated franchise agreement over current market rates.  The prior year settlement revenue wasprimarily related to our settlement with a franchisee that terminated itsfranchise agreement early and left our network.

 

The following table setsforth our franchise-related revenue for the periods indicated (amounts inthousands):

 
| ** **                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Franchise-related  Revenue:             |       |                                       |       |                                      |       |   |   |   |   |
| Royalties                               |       | $                                          | 1,775      |                                      | $          | 2,121 |   | $ | 5,690 |   | $ | 6,198 |   |
| Vendor  rebates and administration fees |       | 113                                        |       | 249                                       |       | 302 |   | 536 |   |
| Franchise  settlements and related fees |       | 506                                        |       | 100                                       |       | 2,997 |   | 1,136 |   |
| Total franchise-related  revenue        |       | $                                          | 2,393      |                                      | $          | 2,470 |   | $ | 8,989 |   | $ | 7,870 |   |

 

**9.****              Stock-basedCompensation**

 

Statement of FinancialAccounting Standards No. 123,*Accounting for Stock-Based Compensation*, as amended by Statement ofFinancial Accounting Standards No. 148,*Accounting for Stock-Based Compensation—Transition and Disclosure*,encouraged, but did not require, companies to record compensation cost forstock-based compensation plans at fair value.  We have chosen to accountfor stock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*, and relatedinterpretations.  Accordingly, compensation expense for stock options ismeasured as the excess, if any, of the quoted market price of our common stockat the date of grant over the amount an employee must pay to acquire thestock.  We grant options at fair market value and therefore recognize nocompensation expense when options are granted.  Likewise, our Employee StockPurchase Plan was structured to qualify under Section 423 of the InternalRevenue Code. Therefore, no compensation expense is recognized from employees’purchase of shares under this plan.

 

9

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The following table setsforth our net income and net income per common share for the three and ninemonths ended September 30, 2005 and 2004, had compensation cost for ourstock-based compensation plan been determined based on FASB Statement No. 123. All share and per share amounts in the following table have been adjusted toreflect the pro forma effects of the 3-for-2 split of our common stock thatbecame effective March 31, 2005 for shareholders of record on March 17,2005 (in thousands, except per share amounts):

 
| ** **                                                                                                                                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  income:                                                                                                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| As  reported                                                                                                                                                 |       | $                                          | 5,360      |                                      | $          | 4,630 |   | $ | 16,054 |   | $ | 13,616 |   |
| 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                                                                                                                                         |       | (191                                       | )          | (350                                      | )          | (653 | ) | (1,049 | ) |
| Employee  stock purchase plan withholdings                                                                                                                   |       | (65                                        | )          | (42                                       | )          | (174 | ) | (110 | ) |
| Pro  forma                                                                                                                                                   |       | $                                          | 5,105      |                                      | $          | 4,238 |   | $ | 15,228 |   | $ | 12,457 |   |
|                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Net  income per common share—basic:                                                                                                                     |       |                                       |       |                                      |       |   |   |   |   |
| As  reported                                                                                                                                                 |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.49 |   | $ | 0.43 |   |
| Pro  forma                                                                                                                                                   |       | $                                          | 0.16       |                                      | $          | 0.13 |   | $ | 0.47 |   | $ | 0.39 |   |
|                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Net  income per common share—diluted:                                                                                                                   |       |                                       |       |                                      |       |   |   |   |   |
| As  reported                                                                                                                                                 |       | $                                          | 0.16       |                                      | $          | 0.14 |   | $ | 0.47 |   | $ | 0.42 |   |
| Pro  forma                                                                                                                                                   |       | $                                          | 0.15       |                                      | $          | 0.13 |   | $ | 0.45 |   | $ | 0.38 |   |

 

The fair value of optionsgranted under our stock option plan during the three and nine months ended September 30,2005 and 2004 was estimated on the date of grant using the Black-Scholes optionpricing model with the following assumptions (as pro forma adjusted for our 3-for2stock split on March 31, 2005):

 
| ** **                                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Annual  dividend yield per share                          |       | $                                          | 0.08       |                                      | $          | 0.05 |   | $ | 0.08 |   | $ | 0.05 |   |
| Expected  volatility                                      |       | 30                                         | %          | 40                                        | %          | 32 | % | 40 | % |
| Weighted  average risk-free interest rate                 |       | 4.08                                       | %          | 3.05                                      | %          | 3.77 | % | 2.88 | % |
| Expected  grant life (years)                              |       | 4.0                                        |       | 4.0                                       |       | 4.0 |   | 4.0 |   |
| Weighted  average per share fair value of options granted |       | $                                          | 3.77       |                                      | $          | 5.80 |   | $ | 3.93 |   | $ | 4.43 |   |

 

**10.****       Recently Issued AccountingPronouncement**

 

On December 16,2004, the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards (SFAS) No. 123(R),*Share-Based Payment*, which will change the way we account foremployee stock options in future periods.  SFAS No. 123(R), which isa revision to SFAS No. 123,*Accountingfor Stock-Based Compensation*, supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees,*and amends SFAS No. 95,*Statement ofCash Flows*.  Generally, the approach in SFAS No. 123(R) issimilar to the approach described in SFAS No. 123, but with certainenhancements to improve the accuracy of fair value estimates.  However,SFAS 123(R) requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the income statement based on theirfair values.  Pro forma disclosure is no longer an alternative.

 

SFAS No. 123(R)permits public companies to adopt its requirements using one of two methods:

 

•                  A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of Statement 123(R) for allshare-based payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of Statement 123(R) that remain unvested on the effectivedate.

 

•                  A “modifiedretrospective” method which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under SFAS No. 123 for purposes ofpro forma disclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

 

Initially, the SECannounced that SFAS No. 123(R) must be adopted in the first interim orannual period beginning after June 15, 2005.  Subsequently, on April 14,2005, the SEC announced that calendar year-end companies will be allowed todelay implementation of the new standard until their first interim periodbeginning after December 15, 2005.  Wewill adopt SFAS No. 123(R) in our fiscal quarter ending March 31,2006.  Adoption of SFAS No. 123(R)may materially affect our results of operations for periods following adoption,but will have no effect on our financial condition.

 

10

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**11.****       Quarterly Dividends**

 

Our Board of Directorsinitiated a quarterly dividend policy on May 11, 2004.  During thequarter ended September 30, 2005, our Board of Directors declared a $0.02per share cash dividend paid on September 2, 2005 to shareholders ofrecord as of August 19, 2005.  During the nine months ended September 30,2005, we have paid cash dividends totaling $0.0533 per share.  During the corresponding period in 2004, wepaid cash dividends totaling $0.0267 per share.

 

**12.****       Subsequent Events**

 

EffectiveOctober 1, 2005, we entered into a joint venture with Legacy HealthSystems to operate an infusion pharmacy business in the Portland, Oregon market.  Concurrent with our entry into this jointventure, we also acquired the assets and ongoing operations of Legacy VNA’shome health agency business.  Our initialcombined cash investment in these businesses was $1.5 million.  This joint venture and acquisition expand ournational presence to include the Portland, Oregon market.

 

EffectiveNovember 1, 2005, we entered into a joint venture with The University HomeCare Services Corporation to operate an infusion pharmacy business in Columbus,Ohio.  Our existing infusion pharmacybusiness in that market is being merged into the joint venture.  Our initial investment into the joint venturewas $1.3 million in cash, plus the inventory and other assets of our existingColumbus, Ohio pharmacy.   The objectiveof this joint venture is the expansion of revenue and improvement of ourposition in the Columbus, Ohio market.

 

EffectiveNovember 3, 2005, we sold the assets of our wholly-owned subsidiary,Management by Information, Inc. (“MBI”) to Definitive Homecare Solutions,Ltd., which is the largest software provider in the home infusionindustry.  The sale price was $1.9million.

 

**13.****       Comprehensive Income**

 

Net income was our onlycomponent of comprehensive income for the three and nine months ended September 30,2005 and 2004.

 

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**FORWARDLOOKING STATEMENTS**

 

The following discussionshould be read in conjunction with our Annual Report on Form 10-K for theyear ended December 31, 2004. The Private Securities Litigation Reform Actof 1995 provides a “safe harbor” for forward-looking statements. Certaininformation included in this Quarterly Report on Form 10-Q and othermaterials filed or to be filed by us with the Securities and ExchangeCommission (as well as information included in oral statements or other writtenstatements made or to be made by us) contain statements that are or will beforward-looking, such as statements relating to acquisitions and other businessdevelopment activities, future capital expenditures and the effects of futureregulation and competition. Such forward-looking information involves importantrisks and uncertainties that could significantly affect anticipated results inthe future and, accordingly, such results may differ from those expressed in anyforward-looking statements made by us, or on our behalf. These risks anduncertainties include, but are not limited to, uncertainties affecting ourbusinesses and our franchisees relating to acquisitions and divestitures(including continuing obligations with respect to completed transactions),sales and renewals of franchises, government and regulatory policies (includingfederal, state and local efforts to reform the delivery of and payment forhealthcare services), general economic conditions (including economicconditions affecting the healthcare industry in particular), the pricing andavailability of equipment and services, technological developments and changesin the competitive environment in which we operate.  For a morecomprehensive description of risks applicable to our business, see Risk Factorsin our Annual Report on Form 10-K for the year ended December 31,2004.

 

**OVERVIEW**

 

We provide specialtypharmacy services and infusion pharmacy and other related healthcare servicesto patients at home or at other alternate sites such as infusion suites andphysician’s offices.  We contract with managed care organizations andother third party payors who reimburse us for the services we provide to theirsubscriber members.  Our services are provided through our nationalnetwork of company-owned and independently-owned franchised pharmacies and ourtwo central, high-volume drug distribution facilities.

 

We have three servicelines: specialty pharmacy services, infusion and related healthcare services,and other. Specialty pharmacy services involve the distribution of injectibleand infused pharmaceuticals to treat a wide range of chronic healthconditions.  The pharmaceuticals can be directly distributed to thepatient’s home or to their physician’s office for in-officeadministration.  Depending on therapy type, we may also administerspecialty pharmaceuticals to patients at our ambulatory infusion centers. Thesepharmaceuticals may require refrigeration during shipping as well as specialhandling to prevent potency degradation.  Patients receiving treatmentusually require special counseling and education regarding their condition andtreatment program.  Infusion and related services primarily involves theintravenous administration of medications at the patient’s home or othernon-hospital site such as one of our infusion suites.  Infusion pharmacyservices treat a wide range of acute and chronic health conditions, including

 

11

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infections, dehydration,cancer, pain and nutritional deficiencies.  All of our company-ownedpharmacies provide infusion therapies. Some of these pharmacies also providerelated healthcare services, such as home health nursing, home hospiceservices, respiratory therapy services and durable medical equipment. Other revenue consists primarily of royalties and other fees generated from ourfranchised pharmacy network and the software licensing and support revenuegenerated by our subsidiary, MBI, the assets of which were sold effective November 3,2005.

 

Summarized informationabout revenues and gross profit for each of our service lines is provided inthe following table (amounts in thousands):

 

**REVENUE**

 
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **Revenue**                               | ** ** | **% of  total**                          | ** ** | **Revenue** | ** ** | **% of  total** | ** ** | **Revenue** | ** ** | **% of  total** | ** ** | **Revenue** | ** ** | **% of  total** | ** ** |
|                                      |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services              |       | $                                         | 67,239     |                                     | 55.2       | % | $ | 57,752 |   | 57.8 | % | $ | 209,736 |   | 57.9 | % | $ | 181,091 |   | 60.0 | % |
| Infusion  and related healthcare services |       | 51,178                                    |       | 42.0                                     | %          | 39,405 |   | 39.4 | % | 141,716 |   | 39.1 | % | 111,801 |   | 37.1 | % |
| Other                                     |       | 3,476                                     |       | 2.8                                      | %          | 2,794 |   | 2.8 | % | 10,687 |   | 3.0 | % | 8,859 |   | 2.9 | % |
| Total  revenue                            |       | $                                         | 121,893    |                                     | 100.0      | % | $ | 99,951 |   | 100.0 | % | $ | 362,139 |   | 100.0 | % | $ | 301,751 |   | 100.0 | % |

 

**GROSS PROFIT**

 
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **Gross  Profit**                         | ** ** | **Gross  profit  margin**                | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** |
|                                      |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services              |       | $                                         | 11,507     |                                     | 17.1       | % | $ | 10,092 |   | 17.5 | % | $ | 33,367 |   | 15.9 | % | $ | 30,676 |   | 16.9 | % |
| Infusion  and related healthcare services |       | 21,653                                    |       | 42.3                                     | %          | 17,176 |   | 43.6 | % | 61,006 |   | 43.0 | % | 48,540 |   | 43.4 | % |
| Other                                     |       | 3,365                                     |       | 96.8                                     | %          | 2,660 |   | 95.2 | % | 10,375 |   | 97.1 | % | 8,447 |   | 95.4 | % |
| Total  gross profit                       |       | $                                         | 36,525     |                                     | 30.0       | % | $ | 29,928 |   | 29.9 | % | $ | 104,748 |   | 28.9 | % | $ | 87,663 |   | 29.1 | % |

 

The majority of ourrevenue is generated from managed care contracts and other agreements withcommercial third party payors.  Our principal managed care contract iswith Blue Cross/Blue Shield of Florida. For the three and nine months ended September 30,2005, approximately 14% of our revenue was generated from this contractcompared to 17% and 16%, respectively, for the corresponding prior year periods. As of September 30, 2005 and December 31, 2004, respectively, 8% and7% of our accounts receivable were due from Blue Cross Blue Shield of Florida.The contract may be terminated by either party on 90 days’ notice and, unlessterminated, renews annually each September for an additional one-yearterm.

 

We also generate revenuefrom government healthcare programs such as Medicare and Medicaid.  Forthe three and nine months ended September 30, 2005, approximately 15% and17% of our revenue, respectively, was generated from government healthcareprograms compared to 17% and 19% for the corresponding prior year periods. As of September 30, 2005 and December 31, 2004, respectively, 21% and18% of our total accounts receivable were due from government healthcareprograms.

 

12

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**RESULTSOF OPERATIONS**

 

The following table showsthe results of our operations for the three and nine months ended September 30,2005 and 2004, expressed in amounts and percentages of revenue (amounts inthousands):

 
| ** **                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **Amount**                                | ** ** | **% of  Revenue**                        | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** |
| Revenue:                                      |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services                  |       | $                                         | 67,239     |                                     | 55.2       | % | $ | 57,752 |   | 57.8 | % | $ | 209,736 |   | 57.9 | % | $ | 181,091 |   | 60.0 | % |
| Infusion  and related healthcare services     |       | 51,178                                    |       | 42.0                                     | %          | 39,405 |   | 39.4 | % | 141,716 |   | 39.1 | % | 111,801 |   | 37.1 | % |
| Other                                         |       | 3,476                                     |       | 2.8                                      | %          | 2,794 |   | 2.8 | % | 10,687 |   | 3.0 | % | 8,859 |   | 2.9 | % |
| Total  revenue                                |       | 121,893                                   |       | 100.0                                    | %          | 99,951 |   | 100.0 | % | 362,139 |   | 100.0 | % | 301,751 |   | 100.0 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of revenue:                             |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of goods sold                           |       | 71,680                                    |       | 58.8                                     | %          | 59,153 |   | 59.2 | % | 219,122 |   | 60.5 | % | 181,958 |   | 60.3 | % |
| Cost  of services provided                    |       | 13,688                                    |       | 11.2                                     | %          | 10,870 |   | 10.9 | % | 38,269 |   | 10.6 | % | 32,130 |   | 10.6 | % |
| Total  cost of revenue                        |       | 85,368                                    |       | 70.0                                     | %          | 70,023 |   | 70.1 | % | 257,391 |   | 71.1 | % | 214,088 |   | 70.9 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross  profit                                 |       | 36,525                                    |       | 30.0                                     | %          | 29,928 |   | 29.9 | % | 104,748 |   | 28.9 | % | 87,663 |   | 29.1 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses |       | 24,689                                    |       | 20.3                                     | %          | 19,787 |   | 19.8 | % | 69,739 |   | 19.2 | % | 58,236 |   | 19.3 | % |
| Provision  for doubtful accounts              |       | 2,248                                     |       | 1.8                                      | %          | 1,601 |   | 1.6 | % | 6,727 |   | 1.9 | % | 4,622 |   | 1.5 | % |
| Depreciation  and amortization                |       | 915                                       |       | 0.8                                      | %          | 724 |   | 0.7 | % | 2,668 |   | 0.7 | % | 1,974 |   | 0.7 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  operating expenses                     |       | 27,852                                    |       | 22.9                                     | %          | 22,112 |   | 22.1 | % | 79,134 |   | 21.8 | % | 64,832 |   | 21.5 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating  income                             |       | 8,673                                     |       | 7.1                                      | %          | 7,816 |   | 7.8 | % | 25,614 |   | 7.1 | % | 22,831 |   | 7.6 | % |
| Interest  income, net                         |       | 108                                       |       | 0.1                                      | %          | 54 |   | 0.1 | % | 258 |   | — | % | 89 |   | — | % |
| Other  expense, net                           |       | (73                                       | )          | (0.1                                     | )%         | (154 | ) | (0.2 | )% | (20 | ) | — | % | (233 | ) | (0.1 | )% |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income  before income taxes                   |       | 8,708                                     |       | 7.1                                      | %          | 7,716 |   | 7.7 | % | 25,852 |   | 7.1 | % | 22,687 |   | 7.5 | % |
| Income  tax provision                         |       | 3,348                                     |       | 2.7                                      | %          | 3,086 |   | 3.1 | % | 9,798 |   | 2.7 | % | 9,071 |   | 3.0 | % |
|                                          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  income                                   |       | $                                         | 5,360      |                                     | 4.4        | % | $ | 4,630 |   | 4.6 | % | $ | 16,054 |   | 4.4 | % | $ | 13,616 |   | 4.5 | % |

 

**Threeand Nine Months Ended September 30, 2005 and 2004**

 

For the quarter ended September 30,2005, we generated revenue of $121.9 million, an increase of 22.0% over thecorresponding prior year quarter.  For the nine months ended September 30,2005, our revenue was $362.1 million, an increase of 20.0% over the correspondingprior year period.  This revenue growth was the result of acquisitions,start-ups and increased same store sales.  Gross profit margins remained fairlyconsistent in total and across our three service lines.  Within ourspecialty pharmacy service line, supply shortages of IVIG throughout 2005 reducedour margin on this therapy, but margin gains in other specialty therapiespartially offset this decline.  Our net income for the quarter ended September 30,2005 was $5.4 million, an increase of $700,000, or 15.8%, over thecorresponding prior year quarter.  Netincome per diluted share was $0.16 for the quarter and $0.47 for the ninemonths ended September 30, 2005, compared to $0.14 and $0.42 for the correspondingperiods in the prior year.  We paid a cash dividend of $0.02 per shareduring the quarter ended September 30, 2005, an increase of 50% over the $0.0133per share dividend paid in the corresponding prior year quarter.

 

During the quarter ended September 30,2005, we completed two acquisitions.  Wepurchased a home infusion pharmacy business in the Chicago area to expand ourpresence in this market and we acquired our largest franchise to establish ourpresence in the Las Vegas market.  Weused $20.2 million in cash to complete these acquisitions.  We generated positive operating cash flow of$5.9 million for the quarter and $17.9 million for the nine months ended September 30,2005.  We ended the period with $63.8 million in cash and short-terminvestments, while our long-term debt primarily consisted of $86.3 million of2.25% convertible senior notes issued in November 2004 and due November 2024.

 

13

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Option Care will continueevaluating potential acquisitions that we believe will add to shareholdersvalue, as well as pursuing start-ups and strategic joint ventures.  We will also continue to pursue opportunitiesto expand our business through increased market penetration and by partneringwith biotech manufacturers on the release of new specialty drugs.

 

**Revenue:**

We report our operatingresults in one segment, consisting of three service lines: specialty pharmacyservices; infusion and related healthcare services; and other.  For the quarterended September 30, 2005, our revenue was $121.9 million, an increase of$21.9 million, or 22.0% over the quarter ended September 30, 2004.  For the nine months ended September 30,2005, our revenue was $362.1 million, an increase of $60.4 million, or 20.0%,over the corresponding prior year period. These increases in revenue were primarily due to same store sales growth,business acquisitions and new pharmacy start-ups.

 

**Specialtypharmacy services revenue:**

Our specialty pharmacyservices revenue for the quarter ended September 30, 2005 was $67.2million, an increase of $9.5 million, or 16.4%, over the corresponding prioryear quarter.  For the nine months ended September 30, 2005, our specialtyrevenue was $209.7 million, an increase of $28.6 million, or 15.8%, over thecorresponding prior year period.  Two main factors contributed to thisgrowth:  acquisitions and startups; and increased market penetration forvarious specialty drugs and therapies.  The two acquisitions we completed duringthe quarter ended September 30, 2005 and seven overall in the nine monthsended September 30, 2005 accounted for approximately one third of ourtotal specialty pharmacy revenue growth.    Sales of many specialty pharmacy productsincreased on a same store basis during the current year periods as a result offocused marketing efforts.  We anticipate an increase in specialtypharmacy services revenue in the upcoming quarter ending December 31, 2005as a result of the seasonal increase in sales of Synagis, a drug used for theprevention of respiratory synctial virus in premature and other high riskinfants.

 

**Infusionand related healthcare services revenue:**

Our infusion and relatedhealthcare services revenue for the quarter ended September 30, 2005 was $51.2million, an increase of $11.8 million, or 29.9%, over the corresponding prioryear quarter.  For the nine months ended September 30, 2005, infusionand related healthcare services revenue was $141.7 million, an increase of $29.9million, or 26.8%, over the corresponding prior year quarter.  Acquisitions,growth in same store sales and pharmacy start-ups all played a role in thisincrease.    Acquisitions andstart-ups have accounted for approximately two-thirds of our quarterly revenuegrowth and approximately one-half of our growth in the nine months ended September 30,2005 over the corresponding prior year periods.  Same store sales increases of approximately 10%for the quarter and 13% for the nine months ended September 30, 2005accounted for the remaining increase in revenue from infusion and relatedhealthcare services.

 

**Otherrevenue:**

Other revenue consists oftwo primary elements: (1) revenue generated from our franchise network,consisting of royalties, franchise fees and vendor rebates earned through ourfranchises’ purchases under our contracts, and; (2) software licensing andsupport services provided by our wholly-owned subsidiary, MBI, and othermiscellaneous revenue. Other revenue was $3.5 million for the quarter ended September 30,2005 compared to $2.8 million in the corresponding prior year quarter. For the nine months ended September 30, 2005, other revenue was $10.7million compared to $8.9 million in the prior year period.  Theseincreases in other revenue in the current year periods were primarily due tofranchise settlements and audits and an increase in other miscellaneous revenue.  Franchise-related revenue may continue tofluctuate significantly in future periods due to our potential acquisition,audit or termination of various franchises.

 

Effective November 3,2005, we sold the assets of our software subsidiary, MBI.  The sale of MBI is not expected to have amaterial impact on our overall revenue or net income in future periods.  During the nine months ended September 30,2005, MBI generated software license and support revenue to external customers of$1.0 million.

 

**Cost ofrevenue:**

Cost of revenue consistsof the cost of goods and the cost of service provided. Cost of goods includesthe cost of drugs and medical supplies used to provide services to ourpatients, as well as depreciation expense for medical equipment rented topatients.  Cost of service consists of salaries and related costs foremployees directly involved in patient care, including pharmacists, nurses,therapists and delivery drivers.  Cost of service also includes the costof delivering or shipping products and services to the patient, includingdepreciation expense for our delivery vehicles.

 

14

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The following table presentsour cost of revenue for the quarter and nine months ended September 30,2005 and 2004 (in thousands):

 
| ** **                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **Dollar  Change** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Dollar  Change** | ** ** | **Percent  Change** | ** ** |
| Cost  of revenue:          |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of goods sold        |       | $                                         | 71,680     |                                     | $          | 59,153 |   | $ | 12,527 |   | 21.2 | % | $ | 219,122 |   | $ | 181,958 |   | $ | 37,164 |   | 20.4 | % |
| Cost  of services provided |       | 13,688                                    |       | 10,870                                   |       | 2,818 |   | 25.9 | % | 38,269 |   | 32,130 |   | 6,139 |   | 19.1 | % |
| Total  cost of revenue     |       | $                                         | 85,368     |                                     | $          | 70,023 |   | $ | 15,345 |   | 21.9 | % | $ | 257,391 |   | $ | 214,088 |   | $ | 43,303 |   | 20.2 | % |

 

The increases in cost ofrevenue of 21.9% and 20.2% for the quarter and nine months ended September 30,2005 over the respective prior year periods were primarily due to our 22.0% and20.0% increases in revenue over the same periods.

 

**Grossprofit margin.**  The following table sets forth the grossprofit margin for each of our three service lines: specialty pharmacy services;infusion and related healthcare services; and other:

 
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross  profit margin:                     |       |                                       |       |                                      |       |   |   |   |   |
| Specialty  pharmacy services              |       | 17.1                                       | %          | 17.5                                      | %          | 15.9 | % | 16.9 | % |
| Infusion  and related healthcare services |       | 42.3                                       | %          | 43.6                                      | %          | 43.0 | % | 43.4 | % |
| Other                                     |       | 96.8                                       | %          | 95.2                                      | %          | 97.1 | % | 95.4 | % |
| Overall  gross profit margin              |       | 30.0                                       | %          | 29.9                                      | %          | 28.9 | % | 29.1 | % |

 

Our overall gross profitmargins in the current year have remained fairly consistent with the prior yearperiods.  Within our service lines, the gross profit margin on ourspecialty pharmacy services has decreased slightly due to supply shortages ofIVIG, which has driven up the cost of this product and reduced our margin on thistherapy.  However, increased sales volumeof IVIG partially offset the margin decline, as did improvements in margin forvarious other therapies.  The grossprofit margin on our infusion and related healthcare services is slightly lowerin the current year periods than the prior year periods.  This decline is primarily due to fluctuationsin our mix of infusion therapies.  Otherrevenue, which primarily consists of franchise-related revenues and softwaresales and support, has minimal direct costs and therefore produces a high grossprofit margin.

 

**Selling,general and administrative expenses:**

For the quarter ended September 30,2005, selling, general and administrative expenses were $24.7 million, anincrease of $4.9 million, or 24.8% over the corresponding prior yearquarter.  For the nine months ended September 30, 2005, selling,general and administrative expenses were $69.7 million, an increase of $11.5million, or 19.8%, over the corresponding prior year period.  Wages andrelated costs increased by $3.9 million and $8.9 million in the quarter and ninemonths ended September 30, 2005 over the corresponding prior year periodsas a result of business acquisitions, salary adjustments and increased staffingof various corporate departments and field management and support staff. Travel-related expenses, professional services and building rent alsoincreased, in part due to acquisitions and acquisition-relatedactivities.  The increase in professional services was also due in part tothe incremental costs of complying with Section 404 of the Sarbanes-OxleyAct of 2002.

 

**Provisionfor doubtful accounts:**

Our provision fordoubtful accounts for the quarter ended September 30, 2005 was $2.2million, or 1.8% of revenue, compared to $1.6 million, or 1.6% of revenue, inthe prior year quarter.  For the nine months ended September 30,2005, our provision for doubtful accounts was $6.7 million, or 1.9% of revenue,compared to $4.6 million, or 1.5% of revenue, in the corresponding prior yearperiod.  The slight increase in our provision for doubtful accounts, inboth dollar amount and percentage of revenue, was due to the effects of ouracquisitions, which resulted in a higher rate of revenue growth in our localpharmacies than in our two high-volume specialty drug distribution pharmacies. We provide for doubtful accounts at a higher rate at our local pharmacies thanat our high-volume distribution pharmacies.

 

**Depreciationand amortization:**

The depreciation expensecontained within operating expenses on our statements of income relates tonon-revenue producing assets only, such as furniture and fixtures and leaseholdimprovements.  Depreciation for revenue-producing equipment such as rentalmedical equipment and delivery vehicles in included in cost of revenue.

 

For the quarter ended September 30,2005, depreciation and amortization expense was $900,000, an increase of $200,000,or 26.4%, over the corresponding prior year quarter.  For the nine monthsended September 30, 2005, our depreciation and amortization expense was $2.7million, an increase of $700,000, or 35.2%, over the corresponding prior yearperiod.  These increases were primarily due to the depreciation ofinternally-developed software products in the current year periods.

 

15

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**Operatingincome:**

For the quarter ended September 30,2005, operating income was $8.7 million, an increase of $900,000, or 11.0%,over the corresponding prior year quarter.  For the nine months ended September 30,2005, our operating income was $25.6 million, representing an increase of $2.8million, or 12.2%, over the corresponding prior year period.  Theseincreases in operating income were primarily the result of same store salesgrowth, acquisition activities and an increase in franchise-related revenue. As a percentage of revenue, our operating income was 7.1% for the quarter and ninemonths ended September 30, 2005 compared to 7.8% and 7.6% for therespective quarter and nine months ended September 30, 2004.  Thesedeclines were primarily due to supply shortages of IVIG which reduced our grossprofit margin on this product, as well as increases in operating expenses dueto staffing increases and the effect of acquisition activities.

 

**InterestIncome/(Expense):**

Our interest income, netof interest expense, was $108,000 for the quarter and $258,000 for the ninemonths ended September 30, 2005.  Our interest income was $54,000 and$89,000 for the respective quarter and nine months ended September 30,2004.  We raised $86.3 million in cash through an offering of 2.25%convertible senior notes in November 2004.  In the current yearperiods, our interest income earned from the proceeds of this offering hasexceeded our interest expense on the notes. Before our convertible debt offering in November 2004, we hadvirtually no debt and our interest income was generated from our cash reserves.

 

**Incometaxes:**

Our income tax provisionwas $3.3 million for the quarter and $9.8 million for the nine months ended September 30,2005.  In the prior year, our income tax provision was $3.1 million forthe quarter and $9.1 million for the nine months ended September 30,2004.  As a percentage of pre-tax income, our provision for income taxeswas 38.4% for the quarter and 37.9% for the nine months ended September 30,2005 compared to 40.0% for the corresponding prior year periods.  Thedecline in income tax provision as a percentage of pre-tax income in thecurrent year periods was primarily due to two factors:  re-evaluation ofour effective state income tax rate based on our reduced state tax exposurereserve; and an increase in tax-exempt interest income earned from ourshort-term investments.

 

**Netincome:**

Our net income was $5.4million for the quarter and $16.1 million for the nine months ended September 30,2005 compared to $4.6 million for the quarter and $13.6 million for the ninemonths ended September 30, 2004.  Our growth in revenue from samestore sales increases, acquisitions and start-ups and an increase in franchise-relatedrevenue were the primary causes of our increase in net income over the correspondingprior year periods.  As a percentage of revenue, our net income was equalto 4.4% for the quarter and nine month months ended September 30, 2005compared to 4.6% for the quarter and 4.5% for the nine months ended September 30,2004.

 

**Dilutedshares & earnings per share:**

We completed a 3-for-2stock split on March 31, 2005.  All share and per share amounts inthis quarterly report reflect the pro forma effects of this split.  Ourearnings per diluted share were $0.16 for the quarter and $0.47 for the ninemonths ended September 30, 2005, representing increases of 14.3% and 11.9%over the corresponding periods in the prior year.  Total diluted shareswere 34.6 million for the quarter and 34.2 million for the nine months ended September 30,2005 compared to diluted shares of 33.1 million for the quarter and 32.7million for the nine months ended September 30, 2004.  The increasein diluted shares was due to a number of factors, including (1) anincrease in the dilutive effect of our contingently convertible debt, (2) thedilutive effect of employee stock options and shares issued and issuable underour employee stock purchase plan and stock incentive plan, and (3) newshares issued and to be issued as partial payment for acquisitions completed in2005.  The increases from these factors was partially offset by ourpurchase and subsequent retirement of 474,000 shares of treasury stock in thequarter ended December 31, 2004.  Our contingently convertible debtaccounted for 800,000 shares of the total 1.5 million share increase in dilutedshares for the quarter ended September 30, 2005 and 700,000 shares of thetotal 1.5 million share increase in diluted shares for the nine months ended September 30,2005.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

During the nine monthsended September 30, 2005, we financed our operations and businessacquisitions through operating cash flows and the use of cash reserves andproceeds generated from our $86.3 million offering of 2.25% convertible seniornotes, completed in November 2004.  During the three and nine monthsended September 30, 2005, we generated positive operating cash flow of$5.9 million and $17.9 million, respectively.  We also used $20.6 millionand $46.4 million in cash for business acquisitions during the respectivequarter and nine months ended September 30, 2005. We continue to evaluateopportunities for potential strategic business acquisitions, start-ups andjoint ventures.  Accordingly, we may need to seek additional sources ofcapital in the future to fund these activities.  As of September 30,2005, we had cash and short-term investments totaling $63.8 million and totallong-term debt of $86.3 million.

 

**OperatingCash Flows:**

We generated $17.9million in positive cash flow from operations in the nine months ended September 30,2005.  This positive cash flow was primarily the result of our positive netincome of $16.1 million during the period, affected by non-cash expenses.   Wealso benefited by $1.2 million from tax versus book timing differences, primarilyrelated to the amortization of intangible assets such as goodwill.

 

16

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For the nine months endedSeptember 30, 2004, we generated $20.1 million of positive operating cashflow.  The positive cash flow was primarily due to our net income duringthe period and our accounts receivable collection performance.  During the nine months ended September 30,2004, our DSO declined from 61 days to 58 days, providing a major part of thereason why our operating cash flow of $20.1 million exceeded our net income of $13.6million during the period.  Tax versusbook timing differences related to income taxes were also a factor, resultingin $1.7 million of positive operating cash flow during the period.

 

**InvestingCash Flows:**

We used $31.7 million incash in investing activities during the nine months ended September 30,2005.  We used $46.4 million in cash to complete seven businessacquisitions of which two were completed in the quarter ended September 30,2005 for a cost of $20.2 million in cash. During the nine months ended September 30, 2005, we generated $21.7million in cash from the liquidation of short-term investments in order to fundour acquisition activities.  We also used$7.1 million in cash to acquire equipment and other fixed assets of which $2.5million was used to purchase revenue-producing medical equipment such asinfusion pumps and other durable medical equipment, $2.2 million was used forinfrastructure items such as furniture, fixtures and computer hardware, $1.6million was used to purchase computer software and $800,000 was used forinternal software development projects.

 

In the prior year periodending September 30, 2004, we used $7.3 million in investingactivities.  Of this total, we used $3.1 million for business acquisitionsand $4.2 million to acquire equipment and other fixed assets.  Of thetotal cash used for equipment purchases, $1.9 million was used to acquireinfusion pumps and other revenue-generating medical equipment, $1.6 million wasused for infrastructure improvements and $700,000 was used on internally andexternally developed software products.

 

**FinancingCash Flows:**

Financing activitiesgenerated a net $4.1 million in positive cash flow for the nine months ended September 30,2005.  We generated $6.0 million in cash from the issuance of shares ofcommon stock through our employee stock purchase and stock option plans, and weused $1.7 million to pay cash dividends to our shareholders.  We also used$200,000 to pay trailing debt issuance costs related to our convertible debtoffering completed in November 2004.

 

In the nine months ended September 30,2004, financing activities generated $900,000 in cash flow.  We generated$3.1 million from the issuance of common stock, which was offset by our use of$900,000 to pay dividends to our shareholders, $900,000 to purchase treasurystock and $400,000 to make scheduled debt repayments.

 

**ConvertibleSenior Notes:**

In November 1, 2004,we completed an $86.3 million offering of 2.25% convertible senior notes, due2024.  The purpose of the offering was to finance our future growthinitiatives.  The funds have been and may continue to be used foracquisitions, stock repurchases, operating cash needs and other generalcorporate purposes.  The initial offering was completed on November 2,2004 for $75.0 million, with an option for an additional $11.3 million. This option was exercised in full on November 9, 2004.  Theconvertible notes pay interest at 2.25% interest per annum on the principal amountof the notes, payable semi-annually in arrears on May 1 and November 1of each year, with the first payment paid on May 1, 2005.  Theholders may convert the notes into cash and, if applicable, shares of ourcommon stock if certain conversion criteria are met, such as our stock reachinga threshold market price or various other criteria.  As of September 30,2005, no triggering event has occurred that could lead to the potentialconversion of the notes.  The notescannot be redeemed by us prior to November 1, 2009.  On each of November 1,2009, November 1, 2014 and November 1, 2019, the holders can requireus to purchase all or a portion of the outstanding notes for their principalamount plus accrued interest.  At any time on or after November 1,2009, we may redeem the notes, in whole or in part, at a redemption price equalto 100% of the principal amount, plus any accrued and unpaid interest.  Wehave incurred deferred financing costs of $3.2 million related to thisoffering, consisting of underwriting, legal and other related costs. These costs are being amortized straight-line over a five-year period.

 

17

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**AccountsReceivable:**

The following table setsforth information regarding our accounts receivable as of the dates indicated(dollar amounts in thousands):

 
| ** **                                                   | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                         |       |                         |       |                    |       |                     |       |                        |       |
| Accounts  receivable                                         |       | $                            | 79,702     |                    | $          | 78,614                   |       | $                           | 80,029     |   | $ | 76,809 |   |
| Less  allowance for doubtful accounts                        |       | (5,958                       | )          | (6,039                  | )          | (5,948                   | )          | (6,879                      | )          |
|                                                         |       |                         |       |                    |       |                     |       |                        |       |
| Accounts  receivable, net of allowance for doubtful accounts |       | $                            | 73,744     |                    | $          | 72,575                   |       | $                           | 74,081     |   | $ | 69,930 |   |
|                                                         |       |                         |       |                    |       |                     |       |                        |       |
| Days  sales outstanding (DSO)(1)                             |       | 55 days                      |       | 57 days                 |       | 54 days                  |       | 55 days                     |       |
|                                                              |            |                              |            |                         |            |                          |            |                             |            |  |  |  |  |  |

 

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 (1)            DSO is based on tradeaccounts receivable, net of allowance for doubtful accounts, and is calculatedusing the exhaustion method whereby the net accounts receivable balance isexhausted against each preceding month’s or partial month’s net revenue. The DSO calculated above includes only our specialty pharmacy service line andinfusion and related healthcare service line.

 

Our accounts receivable,net of bad debt reserves, was $73.7 million as of September 30, 2005, anincrease of $1.2 million, or 1.6%, since June 30, 2005 and $3.8 million,or 5.5%, since December 31, 2004.  The increases in net accountsreceivable are primarily due to increases in revenue, particularly infusion andrelated healthcare services revenue, over the periods indicated.  These increases were due to the impact ofacquisitions, same store sales increases and new pharmacy start-ups.  Our DSO, which was 55 days as of September 30,2005, has remained consistent throughout 2005 as a result of consistent andeffective billing and collection efforts.

 

The following table setsforth the percentage breakdown of our trade accounts receivable by agingcategory and by major payor as of the dates indicated:

 
| ** **                     | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **By Aging Category (1):**     |       |                         |       |                    |       |                     |       |                        |       |
| 0-90  days                     |       | 73                           | %          | 72                      | %          | 74                       | %          | 72                          | %          |
| 91-180  days                   |       | 13                           | %          | 15                      | %          | 13                       | %          | 13                          | %          |
| 181-365  days                  |       | 9                            | %          | 8                       | %          | 8                        | %          | 9                           | %          |
| Over  365 days                 |       | 5                            | %          | 5                       | %          | 5                        | %          | 6                           | %          |
| Total                          |       | 100                          | %          | 100                     | %          | 100                      | %          | 100                         | %          |
|                           |       |                         |       |                    |       |                     |       |                        |       |
| **By Major Payor:**            |       |                         |       |                    |       |                     |       |                        |       |
| Managed  care and other payors |       | 79                           | %          | 80                      | %          | 83                       | %          | 82                          | %          |
| Medicare  and Medicaid         |       | 21                           | %          | 20                      | %          | 17                       | %          | 18                          | %          |
| Total                          |       | 100                          | %          | 100                     | %          | 100                      | %          | 100                         | %          |

 

----

(1)          Accounts receivable byaging category considers only accounts of our specialty pharmacy service lineand infusion and related healthcare service line.

 

**Capital Resources:**

As of September 30,2005, we had cash and cash equivalents of $10.1 million and short-terminvestments of $53.7 million for a combined total of $63.8 million availablefor operations, acquisitions and other cash requirements.  As of December 31,2004, we had cash and cash equivalents of $19.8 million and short-terminvestments of $75.4 million for a combined total of $95.2 million.  The $31.4million decline in cash, cash equivalents and short-term investments wasprimarily due to our payment of $46.4 million in cash for business acquisitionscompleted during the nine months ended September 30, 2005.  Wegenerated positive cash flow from operations of $17.9 million during the period,partially offsetting our use of cash for acquisitions.  We believe thatcash flow from operations and our current reserves of cash and short-terminvestments will be sufficient to meet our operating cash needs for theimmediate future, including any interest due on our $86.3 million of 2.25%convertible senior notes.  In the event that additional capital isrequired, there can be no assurance that such capital can be obtained on termsacceptable to us, if at all.

 

Our business strategyincludes the selective acquisition of additional local pharmacy facilities andspecialty pharmacy operations.  Accordingly, we may require additionalcapital in order to complete these acquisitions.  It is impossible topredict the amount of capital that may be required for acquisitions, and thereis no assurance that sufficient financing for these activities will beavailable on terms acceptable to us, if at all.

 

18

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**Goodwilland Other Intangible Assets**

 

As of September 30,2005, we had net goodwill and other intangible assets of $107.4 million,consisting of $106.5 million of goodwill and $900,000 of other intangibleassets such as non-competition agreements and managed care contracts.  Asof December 31, 2004, net goodwill and other intangible assets equaled$65.9 million, consisting of $65.4 million of goodwill and $500,000 of otherintangible assets.  During the nine months ended September 30, 2005,goodwill increased $41.1 million as a result of the seven business acquisitionswe completed during the period.  Other intangible assets increased by approximately$700,000 as a result of these acquisitions, offset by amortization of $300,000during the period.

 

As required by Statementsof Financial Accounting Standards No. 142,*Goodwill and Other Intangible Assets (SFAS No. 142)*, we do notamortize goodwill, but test our goodwill for impairment annually each October 1,or whenever we identify events or conditions that could potentially result inimpairment of our goodwill.  During the quarter ended September 30,2005, no impairment of goodwill was identified.

 

**Regulatoryand Other Developments**

 

***Health Insurance Portability and Accountability Act of 1996(HIPAA)****.* To improve the efficiency and effectiveness of the health care system, theHealth Insurance Portability and Accountability Act (HIPAA) of 1996, Public Law104-191, included “Administrative Simplification” provisions that required theDepartment of Health and Human Services (HHS) to adopt national standards forelectronic health care transactions.  The Administrative Simplificationprovisions address electronic health care transactions and the security ofelectronic health information systems.  Providers are required to complywith the standards by specific compliance dates established by HHS.  Forstandards relating to electronic health care transactions, the compliance datewas originally set for October 16, 2002.  If the covered entity filedfor an extension, the compliance date was postponed until October 16,2003.  The security standards applicable to individually identifiablehealth information maintained electronically were required to be implemented byApril 21, 2005.  We were materially compliant with these standards bythe applicable compliance dates.  The standards for a unique nationalhealth identifier for providers used in connection with electronic healthcaretransactions must be implemented by May 23, 2007.  We expect to beable to materially comply with this regulation by its applicable compliancedate.

 

Penalties fornon-compliance with the HIPAA Administrative Simplification provisions rangefrom a civil penalty of $100 for each violation (which can total up to $25,000per person per year), to criminal penalties, including up to $50,000 and/or oneyear imprisonment, up to $100,000 and/or five years imprisonment if the offenseis committed under false pretenses and up to $250,000 and/or ten yearsimprisonment for violating a standard with the intent to sell, transfer or useindividually identifiable health information for commercial advantage, personalgain or malicious harm.

 

In addition to regulatingprivacy of individual health information and other provisions relating toAdministrative Simplification, HIPAA includes several anti-fraud and abuselaws, extends criminal penalties to private health care benefit programs and, inaddition to Medicare and Medicaid, to other federal health care programs, andexpands the Office of Inspector General’s authority to exclude persons andentities from participating in the Medicare and Medicaid programs.

 

***Medicare Prescription Drug, Improvement and ModernizationAct of 2003. *** The Medicare Prescription Drug,Improvement and Modernization Act of 2003 changed the way in which coveredoutpatient drugs are reimbursed by the Medicare program.  In January 2004,payment for most drugs covered by Medicare decreased to 85% of the AWP forthose drugs, determined as of April 1, 2003.  Beginning in 2005,reimbursement for most Medicare Part B drugs not paid on a cost orprospective payment basis was to be set at either 106% of the average salesprice (ASP) or through a competitive acquisition program to be phased inbeginning in 2006.  The competitive acquisition program will beestablished by the Centers for Medicare and Medicaid Services (CMS) and willenable physicians in designated competitive acquisition areas to purchase drugsthrough contractors that have successfully bid for that right.  Eachphysician will elect annually whether to obtain drugs through the competitiveacquisition program.  CMS will re-bid the contracts at least every threeyears.  A significant portion of the infusion drugs provided by us areadministered in connection with covered durable medical equipment (DME). The payment rate for drugs administered in this manner generally will continueto be 95% of the AWP in effect as of October 1, 2003.

 

While the majority of ourrevenue is reimbursed by managed care organizations and other non-governmentpayors, these changes to the way Medicare pays for outpatient drugs andbiologicals may reduce our revenue and gross margins on services provided toMedicare patients.  Further, adoption of ASP as the standard measure fordetermining reimbursement by state Medicaid programs or managed care companiesfor the drugs we provide may reduce our revenue and gross margins.

 

**ITEM 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

We are subject to marketrisk primarily in relation to our cash and cash equivalents and short-terminvestments.  As of September 30, 2005, we had no variable-ratedebt.  In November 2004, we completed an $86.3 million offering of2.25% convertible senior notes due 2024.  The interest rate on this debtis fixed.  However, the interest rate we may earn on the cash generatedfrom this offering, as well as cash generated by our operations, is subject tomarket fluctuations.  We utilize a mix of investment maturities based onour anticipated cash needs and evaluation of existing interest rates and marketconditions.

 

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The following table setsforth our cash and cash equivalents and short-term investments as of the datesindicated (in thousands):

 
| ** **                     | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Cash  and cash equivalents (1) |       | $                            | 10,107     |                    | $          | 8,860                    |       | $                           | 11,604     |   | $ | 19,816 |   |
| Short-term  investments (2)    |       | 53,644                       |       | 71,598                  |       | 85,814                   |       | 75,370                      |       |
| Total                          |       | $                            | 63,751     |                    | $          | 80,458                   |       | $                           | 97,418     |   | 95,186 |   |
|                                |            |                              |            |                         |            |                          |            |                             |            |  |  |  |  |

 

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(1)          Cash equivalentsincludes highly-liquid investments having a maturity of three months or less attime of purchase.

(2)          Short-term investmentsconsist of commercial paper with maturities of three months or more at time ofacquisition, as well as variable-rate municipal demand notes, preferred stocksand similar instruments that are either perpetual in nature or have finalmaturities greater than three months.

 

While we attempt tominimize market risk and maximize return, changes in market conditions maysignificantly affect the income we earn on our cash and cash equivalents andshort-term investments.  Based on our actual cash and cash equivalents andshort-term investment balances at September 30, 2005, a 100 basis pointdecline in interest rates would reduce our interest income by $638,000 on anannualized basis.

 

**ITEM 4.  Controls and Procedures**

 

We carried out anevaluation, under the supervision and with the participation of our management,including our chief executive officer and chief financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) under the SecuritiesExchange Act of 1934 (the Exchange Act)) as of September 30, 2005. Basedupon that evaluation, the chief executive officer and chief financial officerconcluded that our disclosure controls and procedures are effective as of September 30,2005. Disclosure controls and procedures are controls and procedures that aredesigned to ensure that information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

In addition, no change inour internal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) occurred during our fiscal quarter ended September 30,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

We are subject to claimsand legal actions that may arise in the ordinary course of business. However,we maintain insurance to protect against such claims or legal actions. We arenot aware of any litigation, either pending or filed, that we believe is likelyto have a material adverse effect on our results of operation or financialcondition.

 

**ITEM2.  Unregistered Sales of Equity Securities and Use of Proceeds**

 

None.

 

**ITEM 3. Defaults Upon Senior Securities**

 

None.

 

**ITEM4.  Submission of Matters to a Vote of Securities Holders**

 

None.

 

**ITEM 5.  Other Information**

 

None.

 

**ITEM 6.  Exhibits**

 

See Exhibit Index.

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Company has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                         | OPTION CARE, INC. |
|------------------------------|------------------------|
| Date: November 9,  2005 | 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. Filed as Exhibit 3.3  to Option Care’s Quarterly Report on Form 10-Q for the quarter ended June 30,  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.                                                                                  |
|                      |       |                                                                                                                                                                                                                                                                                                               |
| 4.1                       |       | Indenture Agreement by  and among Option Care, Inc. and LaSalle Bank National Association,  including the Form of our 2.25% Convertible Senior Notes due 2024. Filed  as Exhibit 4.1 to our Current Report on Form 8-K filed on November 11,  2004 and incorporated by reference herein.  |
|                      |       |                                                                                                                                                                                                                                                                                                               |
| 4.2                       |       | Registration Rights  Agreement dated as of November 2, 2004 by and among Option Care, UBS  Securities LLC and Piper Jaffray & Co. Filed as Exhibit 4.2  to our Current Report on Form 8-K filed on November 11, 2004 and  incorporated by reference herein.                      |
|                      |       |                                                                                                                                                                                                                                                                                                               |
| 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                        |       | Certification of Chief  Executive Officer and Senior Vice President and Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, and Rule 13a-14(b) of the  Exchange Act.                                                                                                                       |

 

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