** **

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.20549**

 

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**FORM 10-Q**

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

 

**For the quarterly period ended**

 

**September 30, 2003**

 

**Commission file number 0-19878**

 

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**OPTION CARE, INC.**

(Exact name of registrant asspecified 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)      |

 

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

 

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

 

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

 

| **Class**                    |   | **Issued and Outstanding  as of November 10, 2003** |
|------------------------------|--------|-----------------------------------------------------|
|                         |   |                                                |
| Common Stock - .01 par value |   | 20,905,196                                          |

 

 

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

 

2

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**PART I.****  FINANCIALINFORMATION**

 

**Item 1.****  Financial Statements**

**Option Care, Inc. and SubsidiariesCondensed Consolidated BalanceSheets**(in thousands,except per share amounts)

 
|                                                                                                                                                                          |   | **September 30, 2003** |    | **December 31, 2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|-----------------------|--------|
|                                                                                                                                                                          |   | **(Unaudited)**        |    | **(Note 1)**          |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Assets                                                                                                                                                                        |   |                   |    |                  |   |
| Current assets:                                                                                                                                                               |   |                   |    |                  |   |
| Cash and cash equivalents                                                                                                                                                     |   | $                      | 3,567   |                  | $      | 488 |   |
| Accounts receivable, net                                                                                                                                                      |   | 55,997                 |    | 74,694                |   |
| Inventory                                                                                                                                                                     |   | 6,387                  |    | 7,538                 |   |
| Deferred tax asset                                                                                                                                                            |   | 3,729                  |    | 3,701                 |   |
| Other current assets                                                                                                                                                          |   | 7,727                  |    | 2,744                 |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total current assets                                                                                                                                                          |   | 77,407                 |    | 89,165                |   |
| Equipment and other fixed  assets, net                                                                                                                                        |   | 12,046                 |    | 11,898                |   |
| Goodwill, net                                                                                                                                                                 |   | 64,932                 |    | 55,412                |   |
| Other assets                                                                                                                                                                  |   | 2,136                  |    | 2,375                 |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total assets                                                                                                                                                                  |   | $                      | 156,521 |                  | $      | 158,850 |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Liabilities and stockholders’  equity                                                                                                                                    |   |                   |    |                  |   |
| Current liabilities:                                                                                                                                                          |   |                   |    |                  |   |
| Trade accounts payable                                                                                                                                                        |   | $                      | 13,379  |                  | $      | 14,559 |   |
| Current portion of long-term  debt                                                                                                                                            |   | 986                    |    | 261                   |   |
| Other current liabilities                                                                                                                                                     |   | 8,199                  |    | 12,635                |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total current liabilities                                                                                                                                                     |   | 22,564                 |    | 27,455                |   |
| Long-term debt, less current  portion                                                                                                                                         |   | 2,874                  |    | 7,314                 |   |
| Deferred tax liability                                                                                                                                                        |   | 5,400                  |    | 4,178                 |   |
| Other liabilities                                                                                                                                                             |   | 634                    |    | 368                   |   |
| Minority interest                                                                                                                                                             |   | 382                    |    | 934                   |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total liabilities                                                                                                                                                             |   | 31,854                 |    | 40,249                |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Stockholders’ equity:                                                                                                                                                    |   |                   |    |                  |   |
| Common stock, $.01 par value per share,  60,000 shares authorized, 20,898 and 20,588 shares issued and outstanding at  September 30, 2003 and December 31, 2002, respectively |   | 209                    |    | 206                   |   |
| Common stock to be issued, 94  and 167 shares at September 30, 2003 and December 31, 2002, respectively                                                                       |   | 624                    |    | 1,371                 |   |
| Additional paid-in capital                                                                                                                                                    |   | 103,839                |    | 101,777               |   |
| Retained earnings                                                                                                                                                             |   | 19,995                 |    | 15,247                |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total stockholders’ equity                                                                                                                                               |   | 124,667                |    | 118,601               |   |
|                                                                                                                                                                          |   |                   |    |                  |   |
| Total liabilities and  stockholders’ equity                                                                                                                              |   | $                      | 156,521 |                  | $      | 158,850 |   |

 

*Seenotes to condensed consolidated financial statements*

 

3

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**Option Care, Inc. and SubsidiariesCondensed Consolidated Statementsof Operations**(Unaudited)(in thousands, except per share amounts)

 
|                                                   |   | **Three Months  Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                   |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Revenue:                                               |   |                                        |   |                                       |   |   |   |   |   |
| Specialty pharmacy services                            |   | $                                           | 46,047 |                                       | $      | 43,623 |   | $ | 151,253 |   | $ | 126,700 |   |
| Infusion and related  healthcare services              |   | 33,969                                      |   | 34,818                                     |   | 101,169 |   | 94,704 |   |
| Other                                                  |   | 2,374                                       |   | 2,432                                      |   | 7,312 |   | 7,701 |   |
| Total revenue                                          |   | 82,390                                      |   | 80,873                                     |   | 259,734 |   | 229,105 |   |
| Cost of revenue:                                       |   |                                        |   |                                       |   |   |   |   |   |
| Cost of goods sold                                     |   | 47,248                                      |   | 45,630                                     |   | 149,073 |   | 130,151 |   |
| Cost of services provided                              |   | 10,432                                      |   | 9,873                                      |   | 31,016 |   | 27,348 |   |
| Total cost of revenue                                  |   | 57,680                                      |   | 55,503                                     |   | 180,089 |   | 157,499 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Gross profit                                           |   | 24,710                                      |   | 25,370                                     |   | 79,645 |   | 71,606 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Selling, general and  administrative expenses          |   | 21,564                                      |   | 17,246                                     |   | 59,124 |   | 48,674 |   |
| Provision for doubtful  accounts                       |   | 8,097                                       |   | 1,502                                      |   | 12,305 |   | 4,427 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Total operating expenses                               |   | 29,661                                      |   | 18,748                                     |   | 71,429 |   | 53,101 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Operating income (loss)                                |   | (4,951                                      | )      | 6,622                                      |   | 8,216 |   | 18,505 |   |
| Interest expense                                       |   | (176                                        | )      | (63                                        | )      | (282 | ) | (79 | ) |
| Other expense, net                                     |   | (16                                         | )      | (113                                       | )      | (107 | ) | (102 | ) |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Income (loss) before income  taxes                     |   | (5,143                                      | )      | 6,446                                      |   | 7,827 |   | 18,324 |   |
| Income tax provision (benefit)                         |   | (2,114                                      | )      | 2,530                                      |   | 3,079 |   | 7,195 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Net income (loss)                                      |   | $                                           | (3,029 | )                                          | $      | 3,916 |   | $ | 4,748 |   | $ | 11,129 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Net income (loss) per common  share:                   |   |                                        |   |                                       |   |   |   |   |   |
| Basic                                                  |   | $                                           | (0.14  | )                                          | $      | 0.19 |   | $ | 0.23 |   | $ | 0.54 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Diluted                                                |   | $                                           | (0.14  | )                                          | $      | 0.19 |   | $ | 0.22 |   | $ | 0.53 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Shares used in computing net  income (loss) per share: |   |                                        |   |                                       |   |   |   |   |   |
| Basic                                                  |   | 20,945                                      |   | 20,672                                     |   | 20,840 |   | 20,577 |   |
| Diluted                                                |   | 20,945                                      |   | 21,148                                     |   | 21,256 |   | 21,100 |   |

 

*See notes tocondensed consolidated financial statements*

 

4

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**Option Care, Inc. and SubsidiariesCondensed Consolidated Statementsof Cash Flows**(Unaudited)(in thousands)

 
|                                                                               |   | **Nine Months Ended  September 30,** |       |
|------------------------------------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                                               |   | **2003**                                  |       | **2002** |   |
|                                                                               |   |                                      | ** ** |   | ** ** |
| Cash flows from operating  activities:                                             |   |                                      |       |   |   |
| Net income                                                                         |   | $                                         | 4,748      |   | $ | 11,129 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |                                      |       |   |   |
| Depreciation and amortization                                                      |   | 4,172                                     |       | 2,791 |   |
| Provision for doubtful  accounts                                                   |   | 12,305                                    |       | 4,427 |   |
| Income tax benefit from  exercise of stock options                                 |   | 462                                       |       | 1,642 |   |
| Changes in assets and  liabilities:                                                |   |                                      |       |   |   |
| Accounts receivable                                                                |   | 6,354                                     |       | (10,625 | ) |
| Inventory                                                                          |   | 1,347                                     |       | 896 |   |
| Accounts payable                                                                   |   | (1,396                                    | )          | (1,321 | ) |
| Income taxes receivable/payable                                                    |   | (4,613                                    | )          | (235 | ) |
| Change in other assets and  liabilities                                            |   | (185                                      | )          | (762 | ) |
|                                                                               |   |                                      |       |   |   |
| Net cash provided by operating  activities                                         |   | 23,194                                    |       | 7,942 |   |
|                                                                               |   |                                      |       |   |   |
| Cash flows from investing  activities:                                             |   |                                      |       |   |   |
| Purchases of equipment and  other, net                                             |   | (3,649                                    | )          | (5,425 | ) |
| Additions to other assets, net                                                     |   | —                                    |       | (67 | ) |
| Payments for  acquisitions, net of cash acquired                                   |   | (14,336                                   | )          | (20,342 | ) |
| Proceeds from  disposals                                                           |   | 229                                       |       | — |   |
|                                                                               |   |                                      |       |   |   |
| Net cash used in investing  activities                                             |   | (17,756                                   | )          | (25,834 | ) |
|                                                                               |   |                                      |       |   |   |
| Cash flows from financing activities:                                              |   |                                      |       |   |   |
| Increase in financing costs                                                        |   | —                                    |       | (601 | ) |
| Net borrowing (repayments) on credit agreements                                    |   | (3,500                                    | )          | 8,447 |   |
| Payments on capital leases and  other debt                                         |   | (215                                      | )          | (252 | ) |
| Proceeds from issuance of stock                                                    |   | 1,356                                     |       | 2,090 |   |
|                                                                               |   |                                      |       |   |   |
| Net cash provided by (used in)  financing activities                               |   | (2,359                                    | )          | 9,684 |   |
|                                                                               |   |                                      |       |   |   |
| Net increase (decrease) in  cash and cash equivalents                              |   | 3,079                                     |       | (8,208 | ) |
| Cash and cash equivalents, beginning of  period                                    |   | 488                                       |       | 8,511 |   |
| Cash and cash equivalents, end  of period                                          |   | $                                         | 3,567      |   | $ | 303 |   |

 

*Seenotes to condensed consolidated financial statements*

 

5

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**Option Care, Inc. and SubsidiariesNotes to CondensedConsolidated Financial StatementsSeptember 30, 2003**(Unaudited)

 

**1.   Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and nine months ended September30, 2003 are not necessarily indicative of the results that may be expected forthe year ending December 31, 2003.

 

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

 

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

 

**2.   Long-TermDebt**

 

Option Careentered into a $60 million revolving Credit and Security Agreement on March 29,2002 with J.P. Morgan Business Credit Corporation, J.P. Morgan Chase Bank andLaSalle Bank, N.A. (the “Lenders”).  Availability under the Credit and SecurityAgreement is related to various percentages of Option Care’s outstandingaccounts receivable and inventory balances, less certain capped and ineligibleamounts, as defined in the agreement. Overall borrowings under the agreement will be limited to the lesser ofthe remaining availability and the total allowable collateral borrowing base.  The facility is secured by substantially allcompany assets.  In addition tocustomary events of default, the facility provides that a change in controlwould give rise to an event of default. The facility requires us to meetcertain financial covenants.  OptionCare paid a facility fee of approximately $400,000 upon signing theagreement.  The agreement provides for acommitment fee, calculated and paid quarterly on a sliding scale from 0.45% to0.25%, based on the average daily unused portion of the facility.  For a fee, Option Care may secure up to $5million in letters of credit.  Dependingon our level of borrowing under the agreement, Option Care may select interestrates ranging from the Eurodollar Rate plus 2% to 2.75%, or the bank’sreference rate plus 0% to 0.75%.  Theagreement expires on March 29, 2005.

 

As ofSeptember 30, 2003, our outstanding balance under this facility wasapproximately $2.8 million, while as of December 31, 2002, our outstandingbalance was approximately $7.1 million.  At September 30, 2003, we had additional borrowing capacity of $29.2million based on the accounts receivable and inventory balances as of thatdate, while at December 31, 2002, we had additional borrowing capacity of $32.3million.

 

On October 23,2003, the Lenders and Option Care signed an amendment to the Credit andSecurity Agreement to address the $6.8 million special provision for doubtfulaccounts recorded in the quarter ended September 30, 2003 related to our Texasaccounts receivable.  The amendmentallows Option Care to exclude the $6.8 million charge when calculating ourfixed charge coverage ratio in the current and subsequent quarters.  This change in calculation method hasallowed Option Care to remain in compliance with our financial covenants forthe quarter ended September 30, 2003.

 

Effective June1, 2003, Option Care entered into a Premium Financing Agreement with A.I.Credit Corporation for payment of the total premiums due under our professionalliability, workers compensation and other insurance policies that renewed onJune 1, 2003.  This agreement allows usto pay the total cost of the premiums in nine monthly installments, with thefinal payment due March 1, 2004.  Thetotal amount financed was approximately $1.4 million at an interest rate of3.51%.  As of September 30, 2003, theremaining outstanding principal balance was approximately $800,000.

 

6

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**3.   Earnings Per Share Data**

 

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

 
|                                                                            |   | **Three months ended  September 30,**        |   | **Nine months ended  September 30,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------------------|--------|--------------------------------------|--------|
|                                                                            |   | **2003**                                     |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                                            |   | **(in thousands, except per share amounts)** |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Basic:                                                                          |   |                                         |   |                                 |   |   |   |   |   |
| Net income (loss)                                                               |   | $                                            | (3,029 | )                                    | $      | 3,916 |   | $ | 4,748 |   | $ | 11,129 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Average shares outstanding                                                      |   | 20,945                                       |   | 20,672                               |   | 20,840 |   | 20,577 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Basic earnings (loss) per  share                                                |   | $                                            | (0.14  | )                                    | $      | 0.19 |   | $ | 0.23 |   | $ | 0.54 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Diluted:                                                                        |   |                                         |   |                                 |   |   |   |   |   |
| Net income (loss)                                                               |   | $                                            | (3,029 | )                                    | $      | 3,916 |   | $ | 4,748 |   | $ | 11,129 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Average shares outstanding                                                      |   | 20,945                                       |   | 20,672                               |   | 20,840 |   | 20,577 |   |
| Net effect of dilutive stock  options – Based on the treasury stock method |   | —                                       |   | 476                                  |   | 416 |   | 523 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Total diluted shares                                                            |   | 20,945                                       |   | 21,148                               |   | 21,256 |   | 21,100 |   |
|                                                                            |   |                                         |   |                                 |   |   |   |   |   |
| Diluted earnings (loss) per  share                                              |   | $                                            | (0.14  | )                                    | $      | 0.19 |   | $ | 0.22 |   | $ | 0.53 |   |

 

**4.   Operating Segments**

 

Option Care has oneidentifiable business segment, with three service lines: specialty pharmacyservices; infusion and related healthcare services; and other.  Specialty pharmacy services consist ofdelivering specialty pharmaceuticals directly to patients or to theirphysician’s office.  Infusion andrelated services consists of providing infusion therapies and relatedhealthcare products and services to patients in non-hospital settings,typically the patient’s home.  Infusiontherapy consists of providing intravenous drugs as well as nursing services andpatient monitoring.  Related healthcareservices are provided by some of our company-owned locations, and may includehome health nursing services, hospice services, respiratory therapy servicesand/or durable medical equipment sales and rentals.  Other revenue consists of all revenue generated from our franchisenetwork, primarily royalties, and the software licensing and support revenuegenerated by our subsidiary, Management by Information, Inc. (“MBI”).

 

The following tablepresents revenues from external customers for each service line, broken down bymajor product category, for the periods indicated (in thousands):

 

7

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|                                                    |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|---------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                    |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
|                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Specialty pharmacy services                             |   | $                                      | 46,047 |                                  | $      | 43,623 |   | $ | 151,253 |   | $ | 126,700 |   |
| Infusion and related healthcare services:               |   |                                   |   |                                  |   |   |   |   |   |
| Infusion therapy                                        |   | 29,021                                 |   | 28,575                                |   | 85,155 |   | 74,916 |   |
| Related healthcare services                             |   | 4,948                                  |   | 6,243                                 |   | 16,014 |   | 19,788 |   |
| Total infusion and related healthcare  services revenue |   | 33,969                                 |   | 34,818                                |   | 101,169 |   | 94,704 |   |
| Other revenue:                                          |   |                                   |   |                                  |   |   |   |   |   |
| Franchise-related                                       |   | 2,144                                  |   | 2,111                                 |   | 6,512 |   | 6,711 |   |
| Software licensing and support                          |   | 230                                    |   | 321                                   |   | 800 |   | 990 |   |
| Total other revenue                                     |   | 2,374                                  |   | 2,432                                 |   | 7,312 |   | 7,701 |   |
|                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Total revenue                                           |   | $                                      | 82,390 |                                  | $      | 80,873 |   | $ | 259,734 |   | $ | 229,105 |   |

 

**5.   Significant Customer**

 

We generate the majority of our revenue from managed care contracts andother agreements with commercial third party payors.  Our principal managed care contract is with Blue Cross and BlueShield of Florida for the provision of home infusion services and specialtypharmacy services to their members. Approximately 18% of our revenue for the three months ended September30, 2003 and 17% of our revenue for the nine months ended September 30, 2003was related to this contract.  In theprior year, for the three and nine months ended September 30, 2002,approximately 20% of our revenue was related to this contract.  As of September 30, 2003 and December 31,2002, approximately 9% of our accounts receivable was due from Blue Cross andBlue Shield of Florida.  The contract isterminable by either party on 90 days’ notice and, unless terminated, renewsannually each September for an additional one-year term.

 

Option Care also generates revenue from government healthcare programssuch as Medicare and Medicaid.  For thethree and nine months ended September 30, 2003, approximately 17% and 18% ofour revenue, respectively, came from government healthcare programs.  In the prior year, for the three and nine monthsended September 30, 2002, approximately 14% and 15% of our revenue,respectively, was related to government healthcare programs.  Of our total accounts receivable as ofSeptember 30, 2003 and December 31, 2002, approximately 18% and 19%,respectively, was due from government healthcare programs.

 

**6.  Seasonal Revenue Trends**

 

Synagis®, one of the specialty pharmaceuticals that we provide topatients, is seasonal.  Synagis® is adrug used for the prevention of respiratory synctial virus (RSV) in high-riskpediatric patients. RSV infection is a seasonal condition, with the seasongenerally lasting from October through April. OptionCare’s quarterly Synagis® revenue for the first nine months of 2003 and 2002was as follows (in thousands):

 

|                           |   | **2003**                     |   | **2002**                   |   |
|--------------------------------|--------|------------------------------|--------|----------------------------|--------|
|                           |   | **Synagi****s®revenue** |   | **%****of total  revenue** |   | **Synagi****s®****revenue** |   | **% of total  revenue** |   |
|                           |   |                         |   |                       |   |   |   |   |   |
| Quarter ended March 31         |   | $                            | 11,998 |                       | 13.0   | % | $ | 7,013 |   | 9.6 | % |
| Quarter ended June 30          |   | 3,958                        |   | 4.7                        |   | 2,601 |   | 3.4 |   |
| Quarter ended September 30     |   | 435                          |   | 0.5                        |   | 362 |   | 0.4 |   |
|                           |   |                         |   |                       |   |   |   |   |   |
| Nine months ended September 30 |   | $                            | 16,391 |                       | 6.3    | % | $ | 9,976 |   | 4.4 | % |

 

8

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**7.  Acquisitions**

 

During the quarter endedMarch 31, 2003, Option Care paid a total of $3.1 million related toacquisitions, of which approximately $2.8 million was additional considerationon prior years’ acquisitions and approximately $300,000 was for an acquisitioncompleted in the current year.  Thelargest payment during the quarter was a scheduled installment of $2.6 milliontoward the July 2002 purchase of a home infusion business in theMinneapolis/St. Paul metropolitan area.

 

During the quarter ended June 30,2003, we paid $8.7 million related to acquisitions.  Of this total, $8.6 million was used to acquire the minority interestof Infusion Specialties, Inc.  EffectiveApril 1, 2003, we exercised our option to acquire the remaining 40% interest ofInfusion Specialties, Inc., a specialty pharmacy business in Houston, Texas.  We had acquired a 60% interest in thisbusiness a year earlier, effective April 1, 2002.  The purchase price for the remaining 40% interest was calculatedon terms contained in the initial purchase agreement. The estimated totalpurchase price for the remaining 40% interest is $9.8 million, with $8.6 millionpaid in cash during the second quarter and the remaining $1.2 millionpotentially becoming payable in future periods, subject to certaincontingencies related to collection of accounts receivable.  The estimated total purchase price of $9.8million was allocated approximately $9.1 million to goodwill, $400,000 to anon-compete agreement and approximately $400,000 as a reduction of minorityinterest liability, offset by reductions to accounts payable and other accruedexpenses of approximately $100,000.

 

In addition to our purchase of theminority interest of Infusion Specialties, Inc., in the quarter ended June 30,2003 we also used approximately $100,000 in cash to settle our remainingobligations under one of our 2001 acquisitions.  We agreed with the sellers on a cash settlement for all amountsowed between the parties.  The cashsettlement relieves our obligation to issue to the sellers approximately 39,000shares of Option Care common stock, then valued at approximately $400,000, andsettles amounts owed by the sellers to Option Care related to our collection oftheir accounts receivable.

 

During the quarter ended September30, 2003, Option Care paid cash of $2.5 million, plus $135,000 in interest, asthe final installment for our 2002 acquisition of a home infusion business inthe Minneapolis/St. Paul area.  No newacquisitions were completed during this quarter.

 

**8.   Bad Debt Charge**

 

During the quarter ended September 30, 2003, Option Care recorded apre-tax bad debt charge of $6.8 million related to accounts receivable of ourTexas operations.  This charge was theresult of a detailed examination of the accounts receivable at our Texaslocations, which revealed that a significant portion of these accounts may notbe collectable.  We had completed severalacquisitions in Texas during 2001. Issues related to the integration and operational consolidation of theacquired businesses, as well as computer systems conversions and employeeturnover caused the lack of collections of these receivables.  The computer systems conversions have beencompleted, and operational enhancements have been implemented and billings arebeing closely monitored to improve the collectability of future revenue.  We believe that the $6.8 million additionalprovision for doubtful accounts provides an adequate reserve for our Texasaccounts receivable.

 

**9.   Restructuring Charge**

 

During the quarter ended September 30, 2003, Option Care restructuredour operations to improve the efficiency and effectiveness of the organizationand refocus our efforts toward growing sales and improving profitability.  This restructuring resulted in a pre-taxcharge of $1.0 million, which is included in selling, general andadministrative expenses in the accompanying statement of operations for the quarterand nine months ended September 30, 2003. The restructuring was substantiallycomplete by September 30, 2003, and we expect any subsequent costs to beminimal.  The restructuring includedelimination of a middle management level from our field operations, reductionof staff at our company-owned pharmacy locations and various personnel changesand reductions within our corporate office. The largest component of the $1.0 million charge was severance andrelated costs of approximately $800,000. A total of 96 employees were terminated, consisting of 81 employeesterminated from our company-owned pharmacy locations and 15 employeesterminated from field management and corporate office staff.  Another component of the charge wasapproximately $100,000 related to relocation and related costs for newly-hiredcorporate management employees.  Theremainder of the restructuring charge consisted of costs incurred to exit anunprofitable home health nursing business at one of our field locations.  As of September 30, 2003,

 

9

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approximately $400,000 of the$1.0 million restructuring costs had been paid, while the remaining $600,000 isincluded in other current liabilities on the attached balance sheet.  Approximately $500,000 of this liabilityconsists of accrued severance, most of which will be paid in the quarter endingDecember 31, 2003.

 

**10.  Stock-based Compensation**

 

Statement of Financial Accounting StandardsNo. 123, *Accountingfor Stock-Based Compensation*, as amended by Statement of FinancialAccounting Standards No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*, encourages, but does not require, companies torecord compensation cost for stock-based compensation plans at fair value.  Option Care has chosen to account forstock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense for stock options is measured as theexcess, if any, of the quoted market price of Option Care stock at the date ofgrant over the amount an employee must pay to acquire the stock.  Option Care grants options at fair marketvalue and therefore recognizes no compensation expense when options aregranted.  Likewise, Option Care’sEmployee Stock Purchase Plan was structured to qualify under Section 423 of theInternal Revenue Code.  Therefore, nocompensation expense is recognized from employees’ purchase of shares under ourEmployee Stock Purchase Plan.

 

Had compensation cost for Option Care’sstock-based compensation plan been determined based on FASB Statement No. 123,Option Care’s net income (loss) and income (loss) per common share for thethree and nine months ended September 30, 2003 and 2002 on a pro-forma basiswould have been (in thousands, except per share amounts):

 
|                                                                                                                                                         |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                                         |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
| Net income (loss):                                                                                                                                           |   |                                   |   |                                  |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | (3,029 | )                                     | $      | 3,916 |   | $ | 4,748 |   | $ | 11,129 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                                  |   | 6                                      |   | —                                |   | 6 |   | 99 |   |
| Deduct: Total stock-based employee  compensation expense determined under the fair value based method for the  following awards, net of related tax effects: |   |                                   |   |                                  |   |   |   |   |   |
| Stock option grants                                                                                                                                          |   | (505                                   | )      | (701                                  | )      | (1,657 | ) | (1,559 | ) |
| Employee stock purchase plan withholdings                                                                                                                    |   | (39                                    | )      | (90                                   | )      | (157 | ) | (236 | ) |
|                                                                                                                                                         |   |                                   |   |                                  |   |   |   |   |   |
| Pro forma                                                                                                                                                    |   | $                                      | (3,567 | )                                     | $      | 3,125 |   | $ | 2,940 |   | $ | 9,433 |   |
|                                                                                                                                                         |   |                                   |   |                                  |   |   |   |   |   |
| Net income (loss) per common share—basic:                                                                                                               |   |                                   |   |                                  |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | (0.14  | )                                     | $      | 0.19 |   | $ | 0.23 |   | $ | 0.54 |   |
| Pro forma                                                                                                                                                    |   | $                                      | (0.17  | )                                     | $      | 0.15 |   | $ | 0.14 |   | $ | 0.46 |   |
|                                                                                                                                                         |   |                                   |   |                                  |   |   |   |   |   |
| Net income (loss)  per common share—diluted:                                                                                                            |   |                                   |   |                                  |   |   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | (0.14  | )                                     | $      | 0.19 |   | $ | 0.22 |   | $ | 0.53 |   |
| Pro forma                                                                                                                                                    |   | $                                      | (0.17  | )                                     | $      | 0.15 |   | $ | 0.14 |   | $ | 0.45 |   |

 

10

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**11.  Recent Accounting Pronouncements**

 

EmergingIssues Task Force (EITF) 00-21: *RevenueArrangements with Multiple Deliverables*.

EITF 00-21 addresses situationsin which multiple products and/or services are delivered at different timesunder one arrangement with a customer, and provides guidance in determiningwhether multiple deliverables should be considered as separate units ofaccounting.  We provide a variety ofinfusion therapies to patients.  Amajority of the therapies have multiple deliverables, such as the delivery ofdrugs and supplies and the provision of related nursing services to train andmonitor patient administration of the drugs. After applying the criteria from the final model in EITF 00-21 to ourbusiness, we concluded that separate units of accounting do exist in ourrevenue arrangements with multiple deliverables.

 

In our current revenuerecognition policy for infusion therapies regarding arrangements with multipledeliverables, revenue is recognized when each deliverable is provided to thepatient.  For example, revenue from drugand supplies sales is recognized upon confirmation of delivery of the products,and revenue from nursing services is recognized upon receipt of nursing notesconfirming that the service was provided. In instances in which the amount allocable to the delivered items islimited to the amount that is contingent on delivery of additional items, werecognize revenue after all the deliverables in the arrangement have beenprovided.  For infusion therapies, webelieve that the impact from adoption of EITF 00-21 will not be material to ourstatements of operations or financial position.

 

Our specialty pharmacy servicesoften involve only delivery of drugs to the patient and no ancillary services,such as nursing.  In these cases, sincethere are no multiple deliverables EITF 00-21 does not apply.  For certain specialty drugs and therapies,we do provide some nursing services to the patient.  In these cases when we do have multiple deliverables, werecognize revenue in the same manner as for our infusion therapies, asdescribed above.

 

Our subsidiary, MBI, sells pharmacymanagement software products and provides installation, training and support tocustomers, and therefore would be considered to provide multiple deliverablesunder a single arrangement.  However, weaccount for MBI’s revenue in accordance with American Institute of CertifiedPublic Accountants (AICPA) Statement of Position (SOP) 97-2: *SoftwareRevenue Recognition*.  Sincethis statement of opinion provides higher-level authoritative guidance thanEITF 00-21, adoption of EITF 00-21 will have no impact to our accountingpolicies for MBI revenue.

 

EITF01-09:  *Accountingfor Consideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products*.

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

 

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

 

Financial Accounting Standards Board (FASB) Financial Interpretation(FIN) 46: *Consolidation:Variable Interest Entities*

FIN 46addresses the accounting for variable interest entities in which the parententity lacks ownership of a majority voting interest in another entity, butcontrols its operations and finances to such extent that consolidated financialstatements are necessary for a fair presentation of the financial position andresults of operations of the parent entity. Option Care operates approximately 40 company-owned pharmacies, whilefranchisees operate approximately 80 franchised Option Care pharmaciesthroughout the United States.  We own amajority voting interest in each of our company-owned pharmacies and presentconsolidated financial statements that include their results ofoperations.  We do not possess anyownership interest, direct or indirect, in any of our franchised pharmacies anddo not control their operations or finances. For this reason, our franchised pharmacies do not qualify as variableinterest entities, and we do not consolidate their financial results with ourown.  There are no other entities inexistence that qualify as variable interest entities or special purposeentities of Option Care.  Therefore,adoption of FIN 46 will have no affect on our financial position or results ofoperations.

 

11

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**Item 2****.**                                   **Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**FORWARD LOOKING STATEMENTS**

 

The following discussion shouldbe read in conjunction with our Annual Report on Form 10-K for the yearended December 31, 2002. The Private Securities Litigation Reform Act of1995 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 inany forward-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.

 

**OVERVIEW**

 

Option Care provides pharmacyservices to patients on behalf of managed care organizations and other thirdparty payors.  We contract with payorsto provide specialty pharmacy services, home infusion therapy and other relatedhealthcare services to patients at home or at other alternate-site settings,such as physicians’ offices.  Ourservices are provided through our national network of approximately 120company-owned and franchise-owned pharmacies.

 

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

 
|                                      |   | **Three months ended September 30,** |   | **Nine  months ended September 30,** |   |
|-------------------------------------------|--------|--------------------------------------|--------|--------------------------------------|--------|
|                                      |   | **2003**                             |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                      |   | **Amount**                           |   | **%****of  total**                   |   | **Amount** |   | **% of  total** |   | **Amount** |   | **%****of  total** |   | **Amount** |   | **% of  total** |   |
| Revenue:                                  |   |                                 |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services               |   | $                                    | 46,047 |                                 | 55.9   | % | $ | 43,623 |   | 53.9 | % | $ | 151,253 |   | 58.2 | % | $ | 126,700 |   | 55.3 | % |
| Infusion and  related healthcare services |   | 33,969                               |   | 41.2                                 |   | 34,818 |   | 43.1 |   | 101,169 |   | 39.0 |   | 94,704 |   | 41.3 |   |
| Other                                     |   | 2,374                                |   | 2.9                                  |   | 2,432 |   | 3.0 |   | 7,312 |   | 2.8 |   | 7,701 |   | 3.4 |   |
|                                      |   |                                 |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenue                             |   | $                                    | 82,390 |                                 | 100.0  | % | $ | 80,873 |   | 100.0 | % | $ | 259,734 |   | 100.0 | % | $ | 229,105 |   | 100.0 | % |

 

12

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|                                      |   | **Three months  ended September 30,** |   | **Nine months ended September 30,** |   |
|-------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                      |   | **2003**                              |   | **2002**                            |   | **2003** |   | **2002** |   |
|                                      |   | **Amount**                            |   | **Gross  profit****%**              |   | **Amount** |   | **Gross  profit****%** |   | **Amount** |   | **Gross  profit****%** |   | **Amount** |   | **Gross  profit** |   |
| Gross Profit:                             |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services               |   | $                                     | 8,840  |                                | 19.2   | % | $ | 8,321 |   | 19.1 | % | $ | 30,407 |   | 20.1 | % | $ | 23,417 |   | 18.5 | % |
| Infusion and  related healthcare services |   | 13,659                                |   | 40.2                                |   | 14,666 |   | 42.1 |   | 42,352 |   | 41.9 |   | 40,583 |   | 42.9 |   |
| Other                                     |   | 2,211                                 |   | 93.2                                |   | 2,383 |   | 98.0 |   | 6,886 |   | 94.2 |   | 7,606 |   | 98.8 |   |
|                                      |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total gross profit                        |   | $                                     | 24,710 |                                | 30.0   | % | $ | 25,370 |   | 31.4 | % | $ | 79,645 |   | 30.7 | % | $ | 71,606 |   | 31.3 | % |

 

Most of our revenue isgenerated from managed care contracts and other agreements with commercialthird party payors.  Our principalmanaged care contract is with Blue Cross Blue Shield of Florida which contractswith us for the provision of home infusion services and specialty pharmacyservices to their members.  For thethree and nine months ended September 30, 2003, approximately 18% and 17% ofour revenue, respectively, was generated from this contract.  In the prior year, for both the three andnine months ended September 30, 2002, approximately 20% of our revenue wasrelated to this contract.  As of each ofSeptember 30, 2003 and December 31, 2002, approximately 9% of our accounts receivablewas due from Blue Cross Blue Shield of Florida. The contract is terminable byeither party on 90 days’ notice and, unless terminated, renews annually eachSeptember for an additional one-year term.

 

Option Care also generatesrevenue through government healthcare programs such as Medicare andMedicaid.  For the three and nine monthsended September 30, 2003, respectively, approximately 17% and 18% of ourrevenue was generated from government healthcare programs.  In the prior year, for the three and ninemonths ended September 30, 2002, approximately 14% and 15% of our revenue,respectively, was payable from government healthcare programs.  Approximately 18% and 19% of our totalaccounts receivable as of September 30, 2003 and December 31, 2002, respectively,was due from these government healthcare programs.

 

Many of the pharmaceuticals weprovide are reimbursed some percentage of the Average Wholesale Price (AWP) ofthe pharmaceuticals.  AWP for mostpharmaceuticals is compiled and published by private companies, including FirstDataBank, Inc.  On August 20, 2003, TheCenters for Medicare and Medicaid Services (CMS) published a proposed rule torevise the manner by which pharmaceuticals are reimbursed.  CMS proposed adopting one of the followingsystems: (i) limiting Medicare payment for drugs to what contractors pay undercomparable circumstances for drugs administered to their private policyholders; (ii) locking in and reducing the AWPs published in commercialcompendia as of April 1, 2003 by an average discount price; (iii) using existingand additional sources of market-based prices to develop Medicare paymentlimits; or (iv) establishing a competitive acquisition program for covereddrugs in conjunction with establishing a process for determining average saleprice.

 

The adoption of any of theseproposed modifications to the AWP system could have a significant impact on ourfuture results of operations and financial condition.  Reductions in AWP for the products we provide to patients, orreplacement of the AWP system with a different reimbursement system, couldnarrow our gross profit margins.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Management’s discussion and analysis of our financial condition andresults of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these statements requires usto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses and their related disclosures. On an ongoingbasis, Option Care evaluates its estimates and judgments based on historicalexperience and various other factors that are believed to be reasonable. Actualresults may vary from these estimates under different assumptions orconditions. We annually review our financial reporting and disclosure practicesand accounting policies to ensure that our financial reporting and disclosuresprovide accurate and transparent information relative to our financial conditionand results of operations, as well as our current business environment. OptionCare management believes that of our significant accounting policies, thefollowing policies involve a higher degree of judgment and/or complexity.

 

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*Revenuerecognition and contractual adjustments*

 

Our revenue is primarily derived from the sale of pharmaceuticals andmedical supplies and the provision of related nursing services to patients atalternate-site settings. Most of this revenue is billed under managed care orother contracts, with a smaller amount billed under government healthcareprograms, such as Medicare and Medicaid. Billed and unbilled revenue isrecorded net of contractual adjustments based on our interpretation of theterms of each managed care contract or government contract or pricing schedule,as loaded into our computerized billing and pharmacy management softwaresystems.  Contractual adjustments arecalculated automatically by our billing systems when the claim is billed.  The contractual adjustments on unbilledamounts must be estimated manually through claim-by-claim analysis of theunbilled claims, by applying historical contractual adjustment percentages tothe gross unbilled amounts, or a combination of the two.  The accuracy of our recorded net revenue issubject to the accuracy of payor information on file for each patient, and isalso subject to our correct interpretation of each underlying contract with respectto reimbursement rates for the drugs and services we provided. If changes orcorrections to our estimates of net revenue prove to be necessary, we adjustnet revenue in the period that such changes or corrections are identified. Suchadjustments may have a positive or negative impact on the revenues and resultsof operations reported for those subsequent periods. Historically, suchadjustments have not been significant to our statements of operations.

 

*Accountsreceivable and allowances for doubtful accounts*

 

Our accounts receivable are reported net of contractual adjustments andallowances for doubtful accounts.  Themajority of Option Care’s accounts receivable are due from private insurancecarriers and government healthcare programs such as Medicare or Medicaid.  Third party reimbursement is a complicatedprocess, with each payor having its own claim requirements.  The ultimate collection of our accountsreceivable is dependent upon complete and accurate patient intake, timelysubmission of clean claims to payors, and timely and effective follow-up onoutstanding claims.  Our allowance fordoubtful accounts is estimated based on several factors, including our pastaccounts receivable collection history, the aging of our accounts receivable atthe end of each period as reported to us through our computerized billingsystems, our mix of business, and the financial condition of our payors.  We also take into account certain internalfactors, such as computer systems conversions, office acquisitions and consolidations,and operational changes within our billing and reimbursement function.  Although we believe that our estimation ofthe net value of our accounts receivable is reasonable, we continually monitorour accounts receivable and our methods for calculating the appropriateallowance for doubtful accounts, and we adjust our allowances and calculationmethods as needed.  If actualcollections differ from our estimates, we may need to establish an additionalallowance for doubtful accounts, which could materially impact our financialcondition and results of operations in future periods.

 

*Goodwill and other intangible assets*

 

We recordgoodwill from our acquisitions equal to the excess of the total cost of theacquisitions over the fair value of all identified tangible and intangibleassets acquired. In accordance with Statement of Financial Accounting Standards(SFAS) No. 142, *Goodwill and Intangible Assets*, effectiveJanuary 1, 2002 we no longer amortize goodwill but instead test our goodwillannually for impairment.  Our method ofimpairment testing consists of comparing the market value of our company to itsbook value. The market value is equal to the current value per share of ourcommon stock, times the total number of shares outstanding.  We test goodwill for impairment annuallyeach October 1st, or whenever we identify events or conditions thatcould potentially result in impairment of our goodwill.

 

Otherintangible assets primarily consist of non-compete agreements and managed carecontracts.  These intangible assets areamortized straight-line over periods ranging from two to five years.  Their amortization period equals theirestimated useful lives, or in the case of non-compete agreements, theamortization period equals their contractual term.

 

**RESULTS OF OPERATIONS**

 

The following table shows theresults of our operations for the three and nine months ended September 30,2003 and 2002, expressed as percentages of revenue:

 

14

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|                                          |   | **Three  Months EndedSeptember 30,** |       | **Nine  months EndedSeptember 30,** |       |
|-----------------------------------------------|--------|--------------------------------------|------------|-------------------------------------|------------|
|                                          |   | **2003**                             |       | **2002**                            |       | **2003** |   | **2002** |   |
|                                          |   |                                 | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Revenue                                       |   | 100.0                                | %          | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Cost of revenue:                              |   |                                 |       |                                |       |   |   |   |   |
| Cost of goods sold                            |   | 57.3                                 |       | 56.4                                |       | 57.4 |   | 56.8 |   |
| Cost of services provided                     |   | 12.7                                 |       | 12.2                                |       | 11.9 |   | 11.9 |   |
| Total cost of revenue                         |   | 70.0                                 |       | 68.6                                |       | 69.3 |   | 68.7 |   |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Gross profit                                  |   | 30.0                                 |       | 31.4                                |       | 30.7 |   | 31.3 |   |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Selling, general and  administrative expenses |   | 26.2                                 |       | 21.3                                |       | 22.8 |   | 21.3 |   |
| Provision for doubtful  accounts              |   | 9.8                                  |       | 1.9                                 |       | 4.7 |   | 1.9 |   |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Total operating expenses                      |   | 36.0                                 |       | 23.2                                |       | 27.5 |   | 23.2 |   |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Operating income (loss)                       |   | (6.0                                 | )          | 8.2                                 |       | 3.2 |   | 8.1 |   |
| Interest expense                              |   | (0.2                                 | )          | (0.1                                | )          | (0.2 | ) | — |   |
| Other expense, net                            |   | —                               |       | (0.1                                | )          | — |   | (0.1 | ) |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Income (loss) before income  taxes            |   | (6.2                                 | )          | 8.0                                 |       | 3.0 |   | 8.0 |   |
| Income tax provision (benefit)                |   | (2.5                                 | )          | 3.2                                 |       | 1.2 |   | 3.1 |   |
|                                          |   |                                 |       |                                |       |   |   |   |   |
| Net income (loss)                             |   | (3.7                                 | )%         | 4.8                                 | %          | 1.8 | % | 4.9 | % |

 

**Three and Nine Months Ended September 30,2003 and 2002**

 

**Revenue.** We reportour operating results in one segment, consisting of three service lines:specialty pharmacy services; infusion and related healthcare services; andother.  Revenue for the quarter endedSeptember 30, 2003 was $82.4 million, which represents an increase of $1.5million, or 1.9%, over the prior year quarter. This revenue increase is due to a $2.4 million increase in specialtypharmacy services and a $400,000 increase in infusion therapy revenue, offsetby decreases in other related healthcare services such as RT/DME and homehealth nursing.  Revenue for the ninemonths ended September 30, 2003 was $259.7 million, representing an increase of$30.6 million, or 13.4%, over the revenue of $229.1 million for the nine monthsended September 30, 2002.  This revenueincrease is attributable to higher sales of Synagis® and other specialtypharmacy products, increases in infusion therapy revenue and acquisitionscompleted in 2002.

 

**Specialty pharmacy services revenue.** For the quarter ended September 30, 2003,specialty pharmacy services revenue equaled $46.0 million, which represents anincrease of $2.4 million, or 5.6%, over the prior year quarter.  This increase is attributable to increasesin specialty pharmacy sales throughout our network of company-owned pharmacies.  For the nine months ended September 30,2003, specialty pharmacy services revenue was $151.3 million, an increase of$24.6 million, or 19.4%, over the prior year. This increase in specialty pharmacy services revenue was due toacquisitions completed in 2002 and due to same store sales increases in revenuefrom products such as Synagis®.

 

**Infusion and related healthcare servicesrevenue.**  Forthe quarter ended September 30, 2003, infusion and related healthcare servicesrevenue was $34.0 million, representing a decline of $900,000, or 2.4%, comparedto the prior year quarter.  Infusiontherapy revenue increased $400,000 during the current year quarter compared tothe corresponding quarter last year. The slight increase was offset by declinesin other related healthcare services. We have scaled back other healthcare services such as home healthnursing and RT/DME in selected markets with low profitability over the pastyear in an effort to focus more strongly on our core pharmacy services.  Infusion and related healthcare servicesrevenue was essentially unchanged in the quarter ended September 30, 2003 fromthe prior quarter ended June 30, 2003. The pace of hospital discharges slowed during the quarter endedSeptember 30, 2003, accounting for the lack of growth in infusion therapyrevenue compared to the quarter ended June 30, 2003.

 

For the nine months endedSeptember 30, 2003, infusion and related healthcare services revenue equaled$101.2 million, representing an increase of $6.5 million, or 6.8%, over thenine months ended September 30, 2002.  Infusion therapy revenue

 

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increased by 13.7% during thisperiod, primarily due to acquisitions completed in 2002.  Other healthcare services revenue declinedby 19.1% due to scaling back home health nursing and other services offeredfrom our pharmacy locations.

 

**Other revenue.** Other revenue consists primarily of revenuegenerated from our franchise network, consisting of royalties, franchise feesand vendor rebates earned from our franchises’ purchases, and from softwaresales and rentals by our wholly-owned subsidiary, MBI. Other revenue equaled$2.4 million for the quarter ended September 30, 2003, virtually unchanged fromthe quarter ended September 30, 2002. For the nine months ended September 30, 2003, other revenue was $7.3million, which represents a decrease of $400,000, or 5.1%, compared to thecorresponding prior year period. Declines in software sales revenue and vendor rebate revenue frompharmaceutical purchases by our franchisees were the causes of the declines inother revenue.

 

**Cost of revenue. **Cost of revenue consists of the cost ofgoods sold and the cost of service provided. For the quarter ended September 30, 2003, cost of revenue increased by$2.2 million, or 3.9%, over the corresponding quarter of the prior year.  For the nine months ended September 30,2003, cost of revenue increased by $22.6 million, or 14.3%, compared to thenine months ended September 30, 2002. These increases in cost of revenue wereprimarily due to corresponding increases in revenue over the periods.

 

Cost of goods sold for thequarter ended September 30, 2003 was $47.2 million, or 57.3% of revenue.  In the prior year quarter, cost of goodssold equaled $45.6 million, or 56.4% of revenue.  For the nine months ended September 30, 2003, cost of goods soldwas $149.1 million, or 57.4% of revenue, compared to $130.2 million, or 56.8%of revenue for the corresponding prior year period.  The dollar increase and the slight increase in percentage, yearover year, was due to higher rate of growth in specialty pharmacy servicesrevenue than in infusion and related healthcare services revenue.  Specialty drugs are higher in cost andproduce a lower gross margin than infusion therapy drugs.

 

Cost of service consists of salariesand related costs for employees directly involved in patient care, includingpharmacists, nurses, therapists and delivery drivers.  Cost of service also includes the cost of delivering products andservices to the patient.  Cost ofservice in the quarter ended September 30, 2003 was $10.4 million, or 12.7% ofrevenue, compared to $9.9 million, or 12.2% of revenue, for the quarter endedSeptember 30, 2002.  For the nine monthsended September 30, 2003, cost of services equaled $31.0 million, or 11.9% ofrevenue, compared to $27.3 million, or 11.9% of revenue, for the prior yearperiod.  The minor fluctuations in costof service as a percentage of revenue are mostly due to variations in mix ofservices offered by our company-owned pharmacies.

 

**Gross profit margin.**  The following table shows the gross profitmargin 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,** |   |
|-------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                      |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
|                                      |   |                                   |   |                                  |   |   |   |   |   |
| Gross profit margin:                      |   |                                   |   |                                  |   |   |   |   |   |
| Specialty pharmacy services               |   | 19.2                                   | %      | 19.1                                  | %      | 20.1 | % | 18.5 | % |
| Infusion and  related healthcare services |   | 40.2                                   |   | 42.1                                  |   | 41.9 |   | 42.9 |   |
| Other                                     |   | 93.2                                   |   | 98.0                                  |   | 94.2 |   | 98.8 |   |
| Total gross profit margin                 |   | 30.0                                   | %      | 31.4                                  | %      | 30.7 | % | 31.3 | % |

 

Our gross profit margin for thequarter ended September 30, 2003 was 30.0% compared to 31.4% for the quarterended September 30, 2002. For the nine months ended September 30, 2003, theoverall gross profit margin was 30.7%, compared to 31.3% for the nine monthsended September 30, 2002.  Thesedeclines in overall margin were primarily due to a shift in service mix towardspecialty pharmacy services, which produce a lower gross profit margin than ourother services.  Within our servicelines, the overall gross profit margin on specialty pharmacy services hasremained fairly stable.  The grossprofit margin on infusion and related healthcare services has declinedslightly.  The decline is mostly relatedto other related healthcare services, such as RT/DME and home health nursing,which have seen reductions in margin. Also, our infusion therapy gross profit margin declined due to a shifttoward lower margin antibiotic therapies. Other revenue, which consists of franchise-related revenues and softwaresales and support, has minimal direct costs and therefore produces a grossprofit margin near 100%.

 

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**Selling, general and administrativeexpenses. **Selling,general and administrative expenses equaled $21.6 million for the quarter endedSeptember 30, 2003, an increase of $4.3 million, or 25.0%, over thecorresponding prior year quarter.  Forthe nine months ended September 30, 2003, selling, general and administrativeexpenses were $59.1 million, an increase of $10.5 million, or 21.5%, over thenine months ended September 30, 2002. During the quarter ended September 30, 2003, we recognized arestructuring charge which accounted for $1.0 million of the increases inselling, general and administrative expenses in the current year periods. Theremaining $3.3 million and $9.5 million increases in selling, general andadministrative expenses in the current year periods versus the prior yearperiods were due to several factors. Labor costs increased, primarily due to increases in staffing ofadministrative and billing-related functions, and due to increases in employeehealth insurance costs.  Therestructuring effort addressed the increases in labor costs, as we terminated96 employees in total.  Other factorsthat contributed to the current year increases included higher businessinsurance costs, increased building rent due to relocation of our corporateoffice and several pharmacies since the beginning of 2002, and a $400,000 write-downof capitalized costs for an internally-developed software product.  This software product was an electronicpurchase order tracking system, which is currently being re-engineered.  Also, the five acquisitions completed in theperiod from March 19, 2002 through July 1, 2002 contributed incrementally tothe year-to-date increase in selling, general and administrative expenses.

 

**Restructuring charge**.  During the quarter ended September 30, 2003,Option Care restructured its operations to improve the efficiency andeffectiveness of the organization and refocus our efforts toward growing salesand improving profitability.  Thisrestructuring resulted in a pre-tax charge of $1.0 million, which is includedin selling, general and administrative expenses in the accompanying statementof operations for the three and nine months ended September 30, 2003.  Weaccounted for the restructuring charge in accordance with SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities. *Therestructuring was substantially complete by September 30, 2003, and we expectany subsequent costs to be minimal.  Therestructuring included elimination of a middle management level from our fieldoperations, reduction of staff at our company-owned pharmacy locations andvarious personnel changes and reductions within our corporate office.  The primary component of the charge wasseverance and related costs equaling approximately $800,000 for the terminationof 96 employees, consisting of 81 employees from our company-owned pharmacylocations and 15 employees from field management and corporate officestaff.  Approximately $100,000 of thecharge related to relocation and related costs for newly-hired corporatemanagement employees.  The remainderconsisted of costs incurred to exit an unprofitable home health nursingbusiness at one of our field locations.

 

**Provisionfor doubtful accounts.**  Our provision for doubtful accounts for the quarter endedSeptember 30, 2003 included a bad debt charge of $6.8 million related to theaccounts receivable of our Texas operations. This charge resulted from a detailed examination of the collectabilityof these receivables, which revealed that a significant portion might not becollectable.  We had completed severalacquisitions in Texas during 2001. Issues related to the integration and operational consolidation of theacquired businesses, as well as computer systems conversions and employeeturnover caused our lack of collections of these receivables.  The computer systems conversions have beencompleted, and operational enhancements have been implemented and billings arebeing closely monitored to improve the collectability of future revenue.  We believe that the $6.8 million additionalprovision for doubtful accounts provides an adequate reserve for Texas accountsreceivable.

 

Our provision for doubtfulaccounts was $8.1 million for the quarter ended September 30, 2003, whichincludes the bad debt charge of $6.8 million discussed above, compared to $1.5million for the quarter ended September 30, 2002.  For the nine months ended September 30, 2003, the provision fordoubtful accounts was $12.3 million, compared to $4.4 million for the ninemonths ended September 30, 2002.  As apercentage of revenue, the provision for doubtful accounts was 9.8% of revenuefor the quarter ended September 30, 2003, compared to 1.9% of revenue for theprior year quarter ended September 30, 2002. For the nine months periods ended September 30, 2003, the provision takenwas equal to 4.7% of revenue, compared to 1.9% of revenue in the prior yearperiod.  Apart from our Texas locations,which generated the $6.8 million bad debt charge, our provision for doubtfulaccounts remained fairly consistent in the current year compared to the prioryear.

 

**Operating income (loss).** Option Care recognized an operating lossof  $5.0 million, or 6.0% of revenue forthe quarter ended September 30, 2003. For the nine

 

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months ended September 30,2003, our operating income was $8.2 million, or 3.2% of revenue.  In the prior year, our operating income was$6.6 million, or 8.2% of revenue, for the quarter ended September 30, 2002 and$18.5 million, or 8.1% of revenue, for the nine months ended September 30,2002.  The decline in operating incomein dollars and percentage of revenue was primarily due to the bad debt andrestructuring charges of $7.8 million taken in the quarter ended September 30,2003.  Additional factors includedcurrent year increases in various operating expenses such as wages and relatedcosts and business insurance.

 

Interest expense for the quarterended September 30, 2003 was approximately $200,000 compared to $100,000 in theprior year quarter.  For the nine monthsended September 30, 2003, interest expense was $300,000 compared to $100,000 inthe corresponding period of the prior year. In the current year, our interest expense was primarily from borrowingson our revolving credit facility with JP Morgan and interest accrued ondeferred acquisition payments.

 

**Income taxes.** Due to the effects of the bad debt andrestructuring charges recognized in the quarter ended September 30, 2003, werecorded an income tax benefit of $2.1 million in the quarter ended September30, 2003.  For the nine-month periodended September 30, 2003, we recorded an income tax provision of $3.1million.   As a percentage of incomebefore income taxes, our income tax provision was 39.3% for the nine monthsended September 30, 2003, which equals the provision rate in the corresponding periodin the prior year.

 

**Net income (loss).**  Due to the bad debt and restructuringcharges taken in the quarter ended September 30, 2003, we had a net loss of$3.0 million, or $0.14 per diluted share, compared to net income of $3.9million, or $0.19 per diluted share, in the corresponding quarter in 2002.  For the nine months ended September 30,2003, we had net income of $4.7 million, or $0.22 per diluted share, comparedto $11.1 million, or $0.53 per diluted share, in the prior year period.  The current year declines in net income weredirectly attributable to the bad debt and restructuring charges taken in thequarter ended September 30, 2003, and due to increases in operating expensesprior to the restructuring.

 

**Diluted shares.** Due to the net loss in the quarter endedSeptember 30, 2003, total diluted shares for that quarter equaled total basicshares at 20.9 million.  For the ninemonths ended September 30, 2003, total diluted shares equaled 21.3 million.  In the prior year periods, total diluted shareswere 21.1 million for both the quarter and nine months ended September 30,2002.  The increase in diluted sharesfor the nine months ended September 30, 2003 over the nine months endedSeptember 30, 2002 was primarily due to the issuance of new shares from ourstock incentive plan and employee stock purchase plan.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

During the nine months endedSeptember 30, 2003, we financed our operations and acquisition activitiesthrough operating cash flows, the use of cash reserves and borrowings under ourcredit facility.  In previous periods,we have also financed our operations and acquisitions through underwrittenpublic offerings of common stock.

 

**Operating Cash Flows.** Operations provided $23.2 million of positive cash flow for the ninemonths ended September 30, 2003, compared to $7.9 million provided byoperations during the nine months ended September 30, 2002.  The primary cause of the large positiveoperating cash flow for the current year is an overall improvement in our speedof collection of accounts receivable. Throughout 2002, accounts receivable increased, primarily due toincreased revenue from acquisitions and same store sales growth.  In 2003, revenue leveled off and cashcollection efforts have improved overall, despite difficulties in our Texasoffices.   The improved collections haveresulted in greater operating cash flows in the current year compared to theprior year.

 

**Investing Cash Flows.**  During the nine months ended September 30,2003, we used $17.8 million in investing activities compared to $25.8 millionused in the corresponding prior year period. In each period, the primary use of cash was to fund acquisitionactivities.  During the current yearperiod, we used $14.3 million in cash for acquisition, of which $14.0 millionrepresented additional consideration on prior year acquisitions and $300,000was for a small 2003 acquisition.  Ourlargest expenditure was $8.6 million paid to acquire the remaining 40% interestin Infusion Specialties, Inc., a Houston-based specialty pharmacy business ofwhich we acquired a 60% interest effective April 1, 2002.  We estimate the total purchase price forthis 40% interest to equal approximately $9.8 million, with the remaining $1.2million potentially becoming payable in future periods, subject to certaincontingencies related to collection of accounts receivable.  In addition, during the nine months endedSeptember 30, 2003, we made two payments totaling $5.1 million related to ourJuly 2002 purchase of a home infusion pharmacy business in theMinneapolis/St.Paul area.  As ofSeptember 30, 2003, aside from the remaining consideration

 

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expected tobecome payable for Infusion Specialties, our remaining obligations for prioryears’ acquisitions are minimal.

 

We used $3.6million in cash for the purchase of equipment and other long-lived assetsduring the nine months ended September 30, 2003, compared to $5.4 million usedin the prior year period.  Of the $3.6million used in the current year, approximately $1.4 million was spent oninfrastructure improvements, mostly related to office furniture and equipmentand leasehold improvements. Additionally, $1.0 million was used to acquire revenue-producing medicalequipment such as infusion pumps and home medical equipment, $800,000 was usedto purchase computer and other technology equipment, and $400,000 was used forsoftware development projects.

 

During the ninemonths ended September 30, 2003, we disposed of our pharmacies in BullheadCity, Arizona and Grand Junction, Colorado. We received approximately $200,000 in proceeds from thesedisposals.  These pharmacies werere-franchised and therefore continue to be part of the Option Care pharmacynetwork.

 

**Financing Cash Flows.**  Financingactivities used $2.4 million in net cash flows during the nine months endedSeptember 30, 2003, compared to $9.7 million provided by financing activitiesin the corresponding period of the prior year. The primary component of our financing cash flows is borrowings andrepayments on credit agreements.  In thecurrent year period, strong operating cash flows allowed us to repay $3.5million borrowed on credit agreements, principally our credit facility with JPMorgan Commercial Finance.  In the prioryear period, we borrowed $8.4 million on our credit facility in order tofinance acquisitions and their initial operating cash flow needs.  In the current year period, we generatedapproximately $1.3 million from the issuance of stock to employees who participatedin our employee stock purchase plan or exercised stock options, and we used$200,000 for scheduled repayments on capital leases and other debt.

 

Option Care signed a $60 millionsenior secured credit facility with JP Morgan Commercial Finance Corp on March29, 2002.  Borrowing availability underthis revolving credit facility is related to percentages of our outstandingaccounts receivable and inventory balances, less certain ineligible amounts, asdefined in the facility agreement.  Theagreement requires us to comply with various financial covenants. The JP Morgancredit facility expires on March 29, 2005. As of September 30, 2003, our outstanding debt balance under thisfacility was approximately $2.8 million, while as of December 31, 2002 ouroutstanding balance was approximately $7.1 million.  We had additional borrowing availability of approximately $29.2million as of September 30, 2003 and $32.3 million as of December 31, 2002based on our accounts receivable and inventory balances on those dates.

 

On October 23, 2003, OptionCare and JP Morgan Commercial Finance Corp signed an amendment to the Creditand Security Agreement to address the $6.8 million special provision fordoubtful accounts recorded in the quarter ended September 30, 2003 related toour Texas accounts receivable.  Theamendment allows Option Care to exclude the $6.8 million charge whencalculating our fixed charge coverage ratio in the current and subsequentquarters.  This change in calculationmethod has allowed Option Care to remain in compliance with our financialcovenants for the quarter ended September 30, 2003.

 

Effective June 1, 2003, OptionCare entered into a Premium Financing Agreement with A.I. Credit Corporationfor payment of the total premiums due under our professional liability, workerscompensation and other insurance policies that renewed on June 1, 2003.  This agreement allows us to pay the totalcost of the premiums in nine monthly installments, with the final payment dueMarch 1, 2004.  The total amountfinanced was approximately $1.4 million at an interest rate of 3.51%.  As of September 30, 2003, the outstandingbalance on this financing agreement was approximately $800,000.

 

**Accounts Receivable. **Our accounts receivable, net of baddebt reserves, was $56.0 million as of September 30, 2003 compared to $74.7million as of December 31, 2002.  Thisdecline in accounts receivable is primarily due to strong cash collectionsduring the nine months ended September 30, 2003, and due to the bad debt chargeof $6.8 million taken in the quarter ended September 30, 2003.  Another factor was seasonal fluctuations inrevenue and accounts receivable from Synagis®, a specialty drug used during theperiod from October through April for the prevention of respiratory synctialvirus (RSV) in high-risk pediatric patients. As of September 30, 2003, our days sales outstanding (DSO) was 66 dayscompared to 75 days as of December 31, 2002. We calculate our DSO based onaccounts receivable net of contractual reserves and bad debt reserves, and usethe exhaustion method whereby we exhaust our accounts receivable against eachpreceding month’s, or partial month’s, revenue.  The primary reason for the decline in DSO from December 31, 2002to September 30, 2003 was the bad debt charge of $6.8 million for our Texasaccounts receivable taken in the quarter ended September 30, 2003.  However, excluding Texas accounts receivablefrom the calculation, our DSO dropped during this period by approximately threedays due to improved billing and collection performance outside of Texas.

 

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As of September 30, 2003, we had cashand cash equivalents of approximately $3.6 million, compared to $500,000 incash and cash equivalents as of December 31, 2002.  During times when we have an outstanding balance under our creditfacility with JP Morgan, we typically maintain a low cash balance.  Cash collections are automatically sweptagainst our credit facility balance as they become available, and we borrowonly as much cash each day as necessary to cover operational needs.

 

We believe that cash flow fromoperations and amounts available under our revolving credit facility will besufficient to meet our operating cash needs for the immediate future, includingany interest due on our credit facility or other debts.  In the event that additional capital isrequired, management cannot assure that such capital can be obtained from othersources on terms acceptable to us, if at all.

 

Our business strategy includesthe selective acquisition of additional local pharmacy facilities and specialtypharmacy operations.  Accordingly, wemay require additional capital in order to complete these acquisitions.  It is impossible to predict the amount ofcapital that may be required for acquisitions, and there is no assurance thatsufficient financing for these activities will be available on terms acceptableto us, if at all.

 

**Goodwill and Other Intangible Assets**

 

As ofSeptember 30, 2003, net goodwill and other intangible assets equaled $66.2million, consisting of $64.9 million of goodwill and $1.3 million of otherintangible assets such as non-compete agreements and managed carecontracts.  As of December 31, 2002, netgoodwill and other intangible assets equaled $57.1 million, consisting of $55.4million of goodwill and $1.7 million of other intangible assets.  The $7.8 million increase in goodwill isprimarily related to our acquisition of the 40% minority interest in InfusionSpecialties, Inc., a Houston-based specialty pharmacy business, in the quarterended June 30, 2003.  The decline inother intangible assets is primarily due to amortization of intangible assetsfrom prior years’ acquisitions.

 

Asrequired by Statements of Financial Accounting Standards No. 142, *Goodwill andOther Intangible Assets (SFAS No. 142)*, we do not amortize goodwill,but test our goodwill for impairment annually each October 1st, orwhenever we identify events or conditions that could potentially result inimpairment of our goodwill.  During thequarter and nine months ended September 30, 2003, no impairment of goodwill wasidentified.  Subsequently, as of October1, 2003, we completed our annual goodwill impairment test.  No impairment of our goodwill was identifiedfrom this annual test.

 

**Regulatory and OtherDevelopments**

 

***HealthInsurance Portability and Accountability Act of 1996**(HIPAA)***.  To improve the efficiency and effectivenessof the United States health care system, the Health Insurance Portability andAccountability Act of 1996 included “Administrative Simplification” provisionsthat required the Department of Health and Human Servics (HHS) to adoptnational standards for electronic healthcare transactions.  At the same time, Congress recognized thatadvances in electronic technology could erode the privacy of healthinformation.  Consequently, Congressincorporated into HIPAA provisions that mandated the adoption of Federalprivacy protections for individually identifiable health information.

 

In response to the HIPAA mandate, inDecember 2000, HHS published a final regulation in the form of a Privacy Rule,which became effective on April 14, 2001. HHS subsequently adopted a final Rulein August 2002, which incorporated changes to improve workability and avoidunintended consequences that could have impeded patients’ access to delivery ofquality health care.  This Privacy Ruleset national standards for the protection of health information, as applied tohealth plans, health care clearinghouses, and health care providers who conductcertain health care transactions electronically. Pursuant to the final PrivacyRule, as of April 14, 2003, covered entities were required to have standards inplace to protect and guard against misuse of individually identifiable healthinformation.  Failure to timelyimplement these standards may, under certain circumstances, trigger theimposition of civil or criminal penalties.

 

The Privacy Rule establishes, for thefirst time, a foundation of Federal protections for the privacy of protectedhealth information.  The Privacy Ruledoes not replace Federal, State, or other laws that grant individuals evengreater privacy protections, and covered entities are free to retain or adoptmore protective policies or practices. Penalties for no-compliance with the Privacy Rule range from a fine of$100 per person, per incident for unintentional disclosures (which can total upto $25,000 per person per year) up to a fine of $250,000 plus 10 yearsimprisonment for selling protected health information.  In addition to regulating the privacy ofindividual health information, HIPAA includes several anti-fraud and abuselaws, extends

 

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criminal penalties for Medicare andMedicaid fraud to other federal health care programs, and expands the Office ofInspector General’s authority to exclude persons and entities fromparticipating in the Medicare and Medicaid programs.

 

Option Care and each of itsowned offices and franchises have implemented the standards set forth in thePrivacy Rule, and these standards were in place on April 14, 2003.  We believe that Option Care and itsfranchisees are in compliance with the Privacy Rule.

 

***ProposedChanges to the AWP***.  Many of the pharmaceuticals we provide are reimbursed somepercentage of the Average Wholesale Price (AWP) of the pharmaceuticals.  AWP for most pharmaceuticals is compiled andpublished by private companies, Including First DataBank, Inc.  On August 20, 2003, The Centers for Medicareand Medicaid Services (CMS) published a proposed rule to revise the manner bywhich pharmaceuticals are reimbursed. CMS proposed adopting one of the following systems:  (i) limiting Medicare payment for drugs towhat contractors pay under comparable circumstances for drugs administered totheir private policy holders; (ii) locking in and reducing the AWPs published in commercial compendia as ofApril 1, 2003 by an average price discount; (iii) using existing and additionalsources of market-based prices to develop Medicare payment limits; or (iv) establishinga competitive acquisition program for covered drugs in conjunction withestablishing a process for determining average sale price.

 

The adoption of any of theseproposed modifications to the AWP system could have a significant impact on ourfuture results of operations and financial condition.  Reductions in AWP for the products we provide to patients, orreplacement of the AWP system with a different reimbursement system, couldnarrow our gross profit margins.

 

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

 

We are subject to market riskfrom exposure to changes in interest rates based on our financing and cashmanagement activities. We utilize a mix of debt maturities along with bothfixed-rate and variable-rate debt to manage our exposure to changes in interestrates. Although there can be no assurances that interest rates will not changesignificantly, we do not expect changes in interest rates to have a materialeffect on income or cash flows in 2003. As of September 30, 2003, ourfixed-rate debt was $1.0 million and our corresponding variable-rate debt was$2.8 million.  Based on ourvariable-rate debt as of September 30, 2003, a one-percent increase in interestrates would increase our annual interest expense by $28,000.

 

**ITEM4.****  Controls andProcedures**

 

**(a) Evaluation of disclosure controls and procedures.**

 

We maintain disclosure controlsand procedures which have been designed to ensure that information related toOption Care is recorded, processed, summarized and reported by Option Care on atimely basis.  Our Chief ExecutiveOfficer, Rajat Rai, and Chief Financial Officer, Paul Mastrapa, carried out anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures as of September 30, 2003.  Based upon this evaluation, Mr. Rai and Mr. Mastrapa concludedthat our disclosure controls and procedures are effective in causing materialinformation to be recorded, processed, summarized and reported by management ona timely basis and ensuring that the quality and timeliness of our publicdisclosures comply with our disclosure obligations under the SecuritiesExchange Act of 1934.

 

**(b) Changes in internal control over financial reporting.**

 

During the fiscal quarter endedSeptember 30, 2003, there were no changes in our internal control overfinancial reporting identified in our evaluation of that internal control thathave materially affected, or are reasonably likely to materially affect, OptonCare’s internal control over financial reporting.

 

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**PARTII.****  OTHERINFORMATION**

 

**ITEM 1. Legal Proceedings**

 

Option Care is subject toclaims and legal actions that may arise in the ordinary course ofbusiness.  One of the two lawsuitsdisclosed in our Annual Report on Form 10-K for the year ended December 31,2002, *Riosvs. Professional Home Health Services, Inc., et. al*., was settled(subject to a confidential settlement agreement and release) and dismissed onSeptember 15, 2003. We are not aware of any claims, investigations orproceedings against us or any of our franchisees that we believe are likely tohave a material financial impact on us.

 

We currently maintain insurancefor general and professional liability claims in an aggregate amount of $8million.  We also require eachfranchisee to maintain general liability and professional liability insurancecovering both the franchise and us, at coverage levels that we believed to besufficient.  These insurance policiesprovide coverage on a claims-made or occurrence basis and have certainexclusions from coverage.  There can beno assurance that insurance coverage will be adequate to cover liability claimsthat may be asserted against us or that adequate insurance will be available inthe future at acceptable cost, if at all. To the extent that liability insurance is not adequate to coverliability claims against us, we will be responsible for the excess.

 

**ITEM 2. Changes in Securities and Use of Proceeds**

 

None.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

None.

 

**ITEM 4.  Submission of Matters to a Vote ofSecurities Holders**

 

None.

 

**ITEM 5. Other Information**

 

None.

 

**ITEM 6(a). Exhibits**

 

SeeExhibit Index.

 

**ITEM6(b).  Reports on Form 8-K**

 

On August8, 2003, Option Care filed a report on Form 8-K containing our earnings pressrelease for the quarter ended June 30, 2003, which was released on August 5,2003.

 

On August11, 2003, Option Care filed a report on Form 8-K containing the transcript ofour conference call with investors to announce and discuss Option Care’sresults of operations for the quarter ended June 30, 2003.  The conference call took place on August 5,2003 at 9:00 a.m., Central Daylight Time.

 

On October14, 2003, Option Care filed a report on Form 10-Q containing a press release datedOctober 8, 2003 announcing that Option Care will not meet consensus earningsestimates for the quarter ended September 30, 2003 or the year ended December31, 2003.  The press release furtherannounced that Option Care had restructured its operations in the quarter endedSeptember 30, 2003.

 

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**SIGNATURE**

 

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

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

 

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**EXHIBITINDEX**

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

 

24

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| 10.17  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.18  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.19  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.20  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.21  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.22  |   | Amendment No. 1 to the Consulting Agreement By and Between  EJ Financial Enterprises, Inc. and Option Care, Inc., dated  October 1, 1999. Filed as Exhibit 10.30 to Option Care’s Annual  Report for the year ended December 31, 1999 and incorporated by  reference herein.                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.23  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.24  |   | 2001 Employee Stock Purchase Plan. Filed as Exhibit A to the  registrants definitive proxy statement for the 2000 Annual Shareholders  Meeting and incorporated by reference herein. *                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.25  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.26  |   | Participation Agreement between Health Options, Inc. and Option  Care, Inc. effective as of June 1, 1997. 2001. Filed as  Exhibit 10.26 to Option Care’s Amendment No. 1 to its Annual Report  on Form 10-K/A filed September 10, 2001 and incorporated by  reference herein.                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.27  |   | Prescription Drug Agreement among Blue Cross and Blue Shield of  Florida, Inc., Health Options, Inc. and Option Care, Inc.  dated March 8, 2000. Filed as Exhibit 10.27 to Option Care’s  Amendment No. 1 to its Annual Report on Form 10-K/A filed  September 10, 2001 and incorporated by reference herein.                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.28  |   | Amendment to Participation Agreement between Health Options, Inc. and  Option Care, Inc. dated April 1, 2001. **                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.29  |   | Deferred Compensation Plan for certain Executives, effective as of  January 1, 2001. *                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.30  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.31  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.32  |   | Injectable Drugs Agreement effective as of September 5, 2001 between  Health Option, Inc. and OptionMed, Inc.   Filed on October 10, 2001 as Exhibit 10.1 to Form 8-K/A and  incorporated herein by reference.                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.33  |   | Credit and Security Agreement, dated March 29, 2002, by and among  Option Care, Inc. and the domestic subsidiaries of Option Care party thereto,  as Borrowers, the Lending Institutions party thereto, as Lenders, J.P. Morgan  Business Credit Corp., as Advisor, and JPMorgan Chase Bank, as Administrative  and Collateral Agent and Arranger, and LaSalle Bank National Association, as  Co-Agent.  Filed as Exhibit 10.21 to  Option Care’s Current Report on Form 8-K filed May 15, 2002 and incorporated  by reference herein. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.34  |   | Employment Agreement between Richard M. Smith and Option Care, Inc.,  dated May 7, 2003.  Filed as Exhibit  10.34 to our Quarterly Report on Form 10-Q for the quarter ended June 30,  2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.35  |   | Employment Offer Letter between Option Care, Inc. and Paul Mastrapa,  dated January 18, 2002.  Filed as  Exhibit 10.35 to our Quarterly Report on Form 10-Q for the quarter ended June  30, 2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.36  |   | Employment Offer Letter between Option Care, Inc. and Joseph P.  Bonaccorsi, dated December 31, 2001.  Filed as Exhibit 10.36 to our Quarterly Report on Form 10-Q for  the quarter ended June 30, 2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                             |

 

25

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| 10.37  |   | Fourth Amendment to Credit and Security Agreement, dated October 23,  2003, by and among Option Care, Inc. and the domestic subsidiaries party  thereto, as Borrowers, the Lending Institutions party thereto, as Lenders,  J.P. Morgan Business Credit Corp., as Advisor, and JPMorgan Chase Bank, as  Administrative and Collateral Agent and Arranger, and LaSalle Bank National  Association, as Co-Agent.  Filed as  Exhibit 10.37 to this Quarterly Report on Form 10-Q.  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2   |   | Certification of Senior Vice President and Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1   |   | Certifications of Chief Executive Officer and Senior Vice President  and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                               |

 

----

*   Management contracts and compensatory plans and arrangements.

** Portions of this Exhibit are subject to a Confidential TreatmentRequest pursuant to Rule 24b-2 under the Securities and Exchange Act of 1934,as amended, filed with the SEC on September 10, 2001 and amended October 10,2001.

 

26

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