** **

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM10-Q**

 

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

 

**For the quarterly period ended**

 

**June 30, 2004**

 

**Commission file number 00-19878**

 

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**OPTIONCARE, INC.**

(Exact name of registrant as specified in its charter)

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

 

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Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 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 thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 
|   | **Class**                      | ** ** | **Issued and Outstanding  as of  August 5, 2004** | ** ** |
|--------|--------------------------------|------------|--------------------------------------------------------|------------|
|   |                           |       |                                                   |       |
|   | Common Stock - $0.01 par value |       | 21,387,359                                             |       |

 

 

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**INDEX**

 

**OPTION CARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION** |                                                                                                     |
|-----------------|----------------------------------------------------------------------------------------------------------|
|            |                                                                                                     |   |
| **PART I**      | **FINANCIAL INFORMATION**                                                                                |   |
| ** **      | ** **                                                                                               | ** ** |
| Item 1.         | Financial Statements (Unaudited)                                                                         |   |
|            |                                                                                                     |   |
|            | Condensed consolidated balance sheets—June  30, 2004 and December 31, 2003                          |   |
|            |                                                                                                     |   |
|            | Condensed consolidated statements of  income—Three and six months ended June 30, 2004 and 2003 |   |
|            |                                                                                                     |   |
|            | Condensed  consolidated statement of stockholders equity—Six month ended June 30,  2004        |   |
|            |                                                                                                     |   |
|            | Condensed consolidated statements of cash  flows—Six months ended June 30, 2004 and 2003            |   |
|            |                                                                                                     |   |
|            | Notes to condensed consolidated financial  statements—June 30, 2004                                 |   |
|            |                                                                                                     |   |
| 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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**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

** **

**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

(in thousands, except per share amounts)

 
| ** **                                                                                                                                                               | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                                                                                                                                                     |       | **(Unaudited)**   |       | **(Note 1)**          |       |
| Assets                                                                                                                                                                   |       |              |       |                  |       |
| Current assets:                                                                                                                                                          |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                |       | $                 | 12,787     |                  | $          | 3,961 |   |
| Accounts receivable, net                                                                                                                                                 |       | 60,761            |       | 62,190                |       |
| Inventory                                                                                                                                                                |       | 9,095             |       | 11,522                |       |
| Deferred income tax benefit                                                                                                                                              |       | 3,711             |       | 4,442                 |       |
| Other current assets                                                                                                                                                     |       | 5,616             |       | 5,279                 |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total current assets                                                                                                                                                     |       | 91,970            |       | 87,394                |       |
| Equipment and other fixed assets, net                                                                                                                                    |       | 12,680            |       | 12,145                |       |
| Goodwill, net                                                                                                                                                            |       | 65,651            |       | 64,970                |       |
| Other assets                                                                                                                                                             |       | 1,647             |       | 2,025                 |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total assets                                                                                                                                                             |       | $                 | 171,948    |                  | $          | 166,534 |   |
|                                                                                                                                                                     |       |              |       |                  |       |
| Liabilities and stockholders’ equity                                                                                                                                |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                     |       |              |       |                  |       |
| Trade accounts payable                                                                                                                                                   |       | $                 | 16,256     |                  | $          | 19,940 |   |
| Current portion of long-term debt                                                                                                                                        |       | 41                |       | 424                   |       |
| Other current liabilities                                                                                                                                                |       | 7,958             |       | 10,253                |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total current liabilities                                                                                                                                                |       | 24,255            |       | 30,617                |       |
| Long-term debt, less current portion                                                                                                                                     |       | 77                |       | 82                    |       |
| Long-term deferred income tax liability                                                                                                                                  |       | 6,331             |       | 5,677                 |       |
| Other liabilities                                                                                                                                                        |       | 602               |       | 711                   |       |
| Minority interest                                                                                                                                                        |       | 498               |       | 427                   |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total liabilities                                                                                                                                                        |       | 31,763            |       | 37,514                |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                               |       |              |       |                  |       |
| Common stock, $.01 par value per share,  60,000 shares authorized, 21,321 and 20,942 shares issued and outstanding at  June 30, 2004 and December 31, 2003, respectively |       | 213               |       | 209                   |       |
| Common stock to be issued, 91 and 144  shares at June 30, 2004 and  December  31, 2003, respectively                                                                |       | 779               |       | 834                   |       |
| Additional paid-in capital                                                                                                                                               |       | 106,670           |       | 104,173               |       |
| Retained earnings                                                                                                                                                        |       | 32,523            |       | 23,965                |       |
| Less treasury stock, at cost, common shares  — 15 at December 31, 2003                                                                                              |       | —            |       | (161                  | )          |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total stockholders’ equity                                                                                                                                          |       | 140,185           |       | 129,020               |       |
|                                                                                                                                                                     |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                          |       | $                 | 171,948    |                  | $          | 166,534 |   |

 

*See notesto condensed consolidated financial statements*

 

3

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Income**

(Unaudited)

(in thousands, except per share amounts)

 
| ** **                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Revenue:                                       |       |                                  |       |                                |       |   |   |   |   |
| Specialty pharmacy services                    |       | $                                     | 58,407     |                                | $          | 48,172 |   | $ | 123,339 |   | $ | 105,206 |   |
| Infusion and related healthcare services       |       | 37,450                                |       | 34,126                              |       | 72,396 |   | 67,199 |   |
| Other                                          |       | 2,794                                 |       | 2,484                               |       | 6,065 |   | 4,939 |   |
| Total revenue                                  |       | 98,651                                |       | 84,782                              |       | 201,800 |   | 177,344 |   |
| Cost of revenue:                               |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold                             |       | 58,997                                |       | 47,001                              |       | 122,805 |   | 101,825 |   |
| Cost of services provided                      |       | 10,616                                |       | 10,126                              |       | 21,260 |   | 20,584 |   |
| Total cost of revenue                          |       | 69,613                                |       | 57,127                              |       | 144,065 |   | 122,409 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                   |       | 29,038                                |       | 27,655                              |       | 57,735 |   | 54,935 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Selling, general and administrative  expenses  |       | 19,200                                |       | 18,177                              |       | 38,449 |   | 36,208 |   |
| Provision for doubtful accounts                |       | 1,462                                 |       | 2,330                               |       | 3,021 |   | 4,208 |   |
| Depreciation and amortization                  |       | 569                                   |       | 684                                 |       | 1,250 |   | 1,352 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Total operating expenses                       |       | 21,231                                |       | 21,191                              |       | 42,720 |   | 41,768 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Operating income                               |       | 7,807                                 |       | 6,464                               |       | 15,015 |   | 13,167 |   |
| Interest income (expense), net                 |       | 34                                    |       | (6                                  | )          | 35 |   | (106 | ) |
| Other expense, net                             |       | (12                                   | )          | (84                                 | )          | (79 | ) | (91 | ) |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Income before income taxes                     |       | 7,829                                 |       | 6,374                               |       | 14,971 |   | 12,970 |   |
| Income tax provision                           |       | 3,128                                 |       | 2,563                               |       | 5,985 |   | 5,194 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Net income                                     |       | $                                     | 4,701      |                                | $          | 3,811 |   | $ | 8,986 |   | $ | 7,776 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Net income per common share:                   |       |                                  |       |                                |       |   |   |   |   |
| Basic                                          |       | $                                     | 0.22       |                                | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Diluted                                        |       | $                                     | 0.22       |                                | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Shares used in computing net income per share: |       |                                  |       |                                |       |   |   |   |   |
| Basic                                          |       | 21,282                                |       | 20,799                              |       | 21,188 |   | 20,788 |   |
| Diluted                                        |       | 21,742                                |       | 21,222                              |       | 21,644 |   | 21,175 |   |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Cash dividends per share                       |       | $                                     | 0.02       |                                | $          | — |   | $ | 0.02 |   | $ | — |   |

 

*See notesto condensed consolidated financial statements*

 

4

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statement of Stockholders’ Equity**

(Unaudited)

(in thousands, except per share amounts)

 
| ** **                                        | ** ** | **Common Stock** | ** ** | **Common** | ** ** | **Additional **     | ** ** | ** **           | ** ** | ** **             | ** ** | **Stock-**          | ** ** |
|---------------------------------------------------|------------|------------------|------------|------------|------------|--------------------------|------------|----------------------|------------|------------------------|------------|---------------------|------------|
| ** **                                        | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Stock to be   Issued** | ** ** | **Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **holders’  Equity** | ** ** |
|                                              |       |             |       |       |       |                     |       |                 |       |                   |       |                |       |   |   |
| Balance at December 31, 2003                      |       | 20,927           |       | $          | 209        |                     | $          | 834                  |       | $                      | 104,173    |                | $          | 23,965 |   | $ | (161 | ) | $ | 129,020 |   |
| Net income                                        |       | 3⁄4           |       | 3⁄4     |       | 3⁄4                   |       | 3⁄4               |       | 8,986                  |       | 3⁄4              |       | 8,986 |   |
| Shares issued and issuable under stock  plans (1) |       | 480              |       | 5          |       | (55                      | )          | 2,451                |       | 3⁄4                 |       | 2                   |       | 2,403 |   |
| Income tax benefit from stock option  exercises   |       | 3⁄4           |       | 3⁄4     |       | 3⁄4                   |       | 1,148                |       | 3⁄4                 |       | 3⁄4              |       | 1,148 |   |
| Purchase of treasury stock                        |       | (86              | )          |       |       | 3⁄4                   |       | 3⁄4               |       | 3⁄4                 |       | (944                | )          | (944 | ) |
| Retirement of treasury stock                      |       |             |       | (1         | )          | 3⁄4                   |       | (1,102               | )          | 3⁄4                 |       | 1,103               |       | 3⁄4 |   |
| Cash dividends paid ($0.02 per share)             |       | 3⁄4           |       | 3⁄4     |       | 3⁄4                   |       | 3⁄4               |       | (428                   | )          | 3⁄4              |       | (428 | ) |
|                                              |       |             |       |       |       |                     |       |                 |       |                   |       |                |       |   |   |
| Balance at June 30, 2004                          |       | 21,321           |       | $          | 213        |                     | $          | 779                  |       | $                      | 106,670    |                | $          | 32,523 |   | $ | — |   | $ | 140,185 |   |

 

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(1) Amended and Restated StockIncentive Plan and Employee Stock Purchase Plan.

 

*See notesto condensed consolidated financial statements*

 

5

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)

(in thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                       | ** ** | **2003** | ** ** |
|                                                                               |       |                           |       |   |   |
| Cash flows from operating activities:                                              |       |                           |       |   |   |
| Net income                                                                         |       | $                              | 8,986      |   | $ | 7,776 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 2,494                          |       | 2,263 |   |
| Provision for doubtful accounts                                                    |       | 3,021                          |       | 4,208 |   |
| Deferred income taxes                                                              |       | 1,473                          |       | 1,346 |   |
| Income tax benefit from exercise of stock  options                                 |       | 1,148                          |       | 336 |   |
| Changes in assets and liabilities:                                                 |       |                           |       |   |   |
| Accounts receivable                                                                |       | (1,205                         | )          | 4,521 |   |
| Inventory                                                                          |       | 2,495                          |       | 2,287 |   |
| Accounts payable                                                                   |       | (3,685                         | )          | (4,281 | ) |
| Income taxes receivable/payable                                                    |       | 715                            |       | (1,437 | ) |
| Change in other assets and liabilities                                             |       | (3,582                         | )          | (4,270 | ) |
|                                                                               |       |                           |       |   |   |
| Net cash provided by operating activities                                          |       | 11,860                         |       | 12,749 |   |
|                                                                               |       |                           |       |   |   |
| Cash flows from investing activities:                                              |       |                           |       |   |   |
| Purchases of equipment and other, net                                              |       | (2,588                         | )          | (2,639 | ) |
| Payments for acquisitions, net of cash  acquired                                   |       | (1,090                         | )          | (11,836 | ) |
| Proceeds from disposals                                                            |       | —                         |       | 229 |   |
|                                                                               |       |                           |       |   |   |
| Net cash used in investing activities                                              |       | (3,678                         | )          | (14,246 | ) |
|                                                                               |       |                           |       |   |   |
| Cash flows from financing activities:                                              |       |                           |       |   |   |
| Net borrowing on credit agreements                                                 |       | —                         |       | 858 |   |
| Payments on capital leases and other debt                                          |       | (387                           | )          | (297 | ) |
| Proceeds from issuance of stock                                                    |       | 2,403                          |       | 776 |   |
| Payment of cash dividends                                                          |       | (428                           | )          | — |   |
| Payments for purchase of treasury stock                                            |       | (944                           | )          | — |   |
|                                                                               |       |                           |       |   |   |
| Net cash provided by financing activities                                          |       | 644                            |       | 1,337 |   |
|                                                                               |       |                           |       |   |   |
| Net increase in cash and cash equivalents                                          |       | 8,826                          |       | (160 | ) |
| Cash and cash equivalents, beginning of  period                                    |       | 3,961                          |       | 488 |   |
| Cash and cash equivalents, end of period                                           |       | $                              | 12,787     |   | $ | 328 |   |

* *

*See notesto condensed consolidated financial statements*

 

6

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**Option Care, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements**

**June 30, 2004**

(Unaudited)

 

**1.   Basis of Presentation**

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, they donot include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded. Operating results for the three and six months ended June 30, 2004are not necessarily indicative of the results that may be expected for the yearending December 31, 2004.

 

The balancesheet at December 31, 2003 has been derived from the audited financialstatements at that date but does not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements.

 

For furtherinformation, refer to the consolidated financial statements and footnotesthereto included in Option Care’s Annual Report on Form 10-K for the yearended December 31, 2003.

 

**2.  Long-Term Debt**

 

We are partyto a $20 million revolving Credit and Security Agreement with J.P. MorganBusiness Credit Corporation, J.P. Morgan Chase Bank and LaSalle Bank, N.A. (the“Lenders”).  Originally, on March 29,2002, we entered into a three-year, $60 million revolving Credit and SecurityAgreement with the Lenders.  On June 15,2004, we agreed with the Lenders on an amendment (the “Amendment”) to reducethe overall facility to $20 million throughout the remaining term of theagreement, which is scheduled to expire on March 29, 2005.

 

Availabilityunder the Credit and Security Agreement is related to various percentages ofour outstanding accounts receivable and inventory balances, less certain cappedand ineligible amounts, as defined in the agreement.  Overall borrowings will be limited to thelesser of the remaining availability and the total collateral borrowing base.  The facility is secured by substantially allof our assets.  In addition to customaryevents of default, the agreement provides that a change in control would giverise to an event of default. The agreement requires us to maintain quarterlycompliance with certain financial covenants. We paid a facility fee of approximately $400,000 upon signing theagreement.  The agreement provided for acommitment fee, calculated and paid quarterly based on our average daily unusedportion of the facility.  Per theAmendment signed June 15, 2004, the commitment fee rate is 0.375%, effectiveJune 1, 2004.  Previously, the commitmentfee was calculated on a sliding scale ranging from 0.45% to 0.25% based on theaverage unused portion of the facility. The original Credit and SecurityAgreement allowed us, for a fee, to secure up to $5 million in letters ofcredit.  The Amendment reduced the letterof credit sub-limit to $2.5 million.  Ourinterest rate under the agreement varies depending on our level of borrowing.  We may select Eurodollar loans or borrow atrates indexed to the prime rate.  Ourinterest rate on borrowings may range from lows of prime plus 0.25% or theEurodollar rate plus 2.25% to highs of prime plus 0.75% or the Eurodollar rateplus 2.75%.

 

The originalCredit and Security Agreement contained a prohibition against our payment ofcash dividends.  The Amendment dated June15, 2004 removed this prohibition, and now allows us to pay up to $2.5 millionin annual cash dividends to our shareholders. This change was made in response to the approval by our Board of Directors,at their meeting on May 4, 2004, to institute a new quarterly dividend policyand pay an initial dividend of $0.02 per share. This dividend was paid on June 15, 2004 to shareholders of record as ofJune 1, 2004.

 

As of bothJune 30, 2004 and December 31, 2003, we had no balance outstanding under thecredit facility and had one letter of credit in place for $1.0 million.  At June 30, 2004, based on our minimumongoing availability requirements we had borrowing availability of $17.0million.  As of December 31, 2003, we hadadditional borrowing capacity of $37.7 million against the $60 million facilitythen in place, based on our accounts receivable and inventory balances on thatdate.

 

On October 23,2003, the Lenders agreed to amend the Credit and Security Agreement to addressthe $6.8 million special

 

7

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provision for doubtful accounts recorded in the quarter ended September30, 2003 related to our Texas accounts receivable.  The amendment allowed us to exclude the $6.8million charge when calculating our fixed charge coverage ratio for the quarterended September 30, 2003 and the next three quarters.  This change in calculation method allowed usto remain in compliance with our financial covenants for the quarters endedSeptember 30 and December 31, 2003.  Forthe quarters ended March 31 and June 30, 2004, we were in compliance with ourfinancial covenants before consideration of this amendment.

 

**3.    Earnings Per Share Data**

 

The followingtable sets forth the computation of basic and diluted earnings per share forthe periods indicated (in thousands, except per share amounts):

 
| ** **                                                                      | ** ** | **Three months ended  June 30,**             | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                     | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Basic:                                                                          |       |                                         |       |                           |       |   |   |   |   |
| Net income                                                                      |       | $                                            | 4,701      |                           | $          | 3,811 |   | $ | 8,986 |   | $ | 7,776 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Average shares outstanding                                                      |       | 21,282                                       |       | 20,799                         |       | 21,188 |   | 20,788 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Basic earnings per share                                                        |       | $                                            | 0.22       |                           | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Diluted:                                                                        |       |                                         |       |                           |       |   |   |   |   |
| Net income                                                                      |       | $                                            | 4,701      |                           | $          | 3,811 |   | $ | 8,986 |   | $ | 7,776 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Average shares outstanding                                                      |       | 21,282                                       |       | 20,799                         |       | 21,188 |   | 20,788 |   |
| Net effect of dilutive stock options –  Based on the treasury stock method |       | 460                                          |       | 423                            |       | 456 |   | 387 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Total diluted shares                                                            |       | 21,742                                       |       | 21,222                         |       | 21,644 |   | 21,175 |   |
|                                                                            |       |                                         |       |                           |       |   |   |   |   |
| Diluted earnings per share                                                      |       | $                                            | 0.22       |                           | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |

 

**4.   Operating Segments**

 

We have one identifiable business segment, with threeservice lines: specialty pharmacy services; infusion and related healthcareservices; and other.

 

**Specialty pharmacy services**involve the distribution of injectible and infused pharmaceuticals to treat awide range of chronic health conditions. The pharmaceuticals can be directly distributed to the patient’s home orto their physician’s office for in-office administration.  These pharmaceuticals may requirerefrigeration during shipping as well as special handling to prevent potencydegradation.  Patients receiving treatmentusually require special counseling and education regarding their condition andtreatment program.

 

**Infusion and related healthcare services**primarilyinvolves the intravenous administration of medications at the patient’s home orother non-hospital sites such as one of our infusion suites.  Infusion pharmacy services treat a wide rangeof acute and chronic health conditions, including infections, dehydration,cancer, pain and nutritional deficiencies. All of our company-owned pharmacies provide infusion pharmacyservices.  Some of these pharmacies alsoprovide related healthcare services, such as home health nursing, home hospiceservices, respiratory therapy services and durable medical equipment.

 

**Other revenue**consists ofroyalties and other fees generated from our franchised pharmacy network and thesoftware licensing and support revenue generated by our subsidiary, Managementby Information, Inc. (“MBI”). 

 

8

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**5.   Significant Customers and Concentration ofCredit Risk**

 

The followingtable presents information regarding revenue and accounts receivableattributable to our most significant payors as of the dates and for the periodspresented:

 
| ** **                            | ** ** | **NET REVENUE**                  | ** ** | **ACCOUNTS RECEIVABLE**       | ** ** |
|---------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **Three months  ended June 30,** | ** ** | **Six month  ended June 30,** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                             |       |                          |       |   |   |   |   |   |   |   |   |
| Blue Cross and Blue Shield of Florida |       | 16                               | %          | 17                            | %          | 15 | % | 17 | % | 9 | % | 9 | % |
|                                  |       |                             |       |                          |       |   |   |   |   |   |   |   |   |
| Medicare                              |       | 7                                | %          | 9                             | %          | 7 | % | 8 | % | 10 | % | 10 | % |
| Medicaid                              |       | 13                               | %          | 10                            | %          | 13 | % | 11 | % | 7 | % | 10 | % |
| Total – government payors        |       | 20                               | %          | 19                            | %          | 20 | % | 19 | % | 17 | % | 20 | % |
|                                  |       |                             |       |                          |       |   |   |   |   |   |   |   |   |
| All other payors (1)                  |       | 64                               | %          | 64                            | %          | 65 | % | 64 | % | 74 | % | 71 | % |
|                                  |       |                             |       |                          |       |   |   |   |   |   |   |   |   |
| Total                                 |       | 100                              | %          | 100                           | %          | 100 | % | 100 | % | 100 | % | 100 | % |

 

----

(1) No other payor represents10% or more of revenue or accounts receivable as of the dates and for theperiods presented.

 

We generatethe majority of our revenue from managed care contracts and other agreementswith commercial third party payors from our provision of health care servicesto their members.  Our principal managedcare contract is with Blue Cross and Blue Shield of Florida, to whose memberswe provide infusion pharmacy services and specialty pharmacy services.  For the three and six months ended June 30,2004, respectively, 16% and 15% of our revenue was related to thiscontract.  In the prior year, for thethree and six months ended June 30, 2003, 17% of our revenue was related tothis contract. As of June 30, 2004 and December 31, 2003, 9% of our accountsreceivable was due from Blue Cross and Blue Shield of Florida.  The contract is terminable by either party on90 days’ notice and, unless terminated, renews annually each September for anadditional one-year term.  

 

We alsogenerate revenue from government healthcare programs such as Medicare andMedicaid.  For the three and six monthsended June 30, 2004, 20% of our revenue came from government healthcareprograms.  In the prior year, for thethree and six months ended June 30, 2003, 19% of our revenue came from governmenthealthcare programs. Of our accounts receivable, 17% and 20% was attributableto government healthcare programs as of June 30, 2004 and December 31, 2003,respectively.

 

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

** **

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.

 

9

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Option Care’s quarterly Synagis® revenue for 2003 and for the first twoquarters of 2004 was as follows (amounts in thousands):

 
| ** **                       | ** ** | **Synagis®  revenue** | ** ** | **%****of  Specialty  Pharmacy  Revenue** | ** ** | **% of Total  Revenue** | ** ** |
|----------------------------------|------------|----------------------------|------------|-------------------------------------------|------------|-------------------------|------------|
| Quarter ended March 31, 2003     |       | $                          | 11,998     |                                      | 21.0       | %                       | 13.0       | % |
| Quarter ended June 30, 2003      |       | 3,958                      |       | 8.2                                       | %          | 4.7                     | %          |
| Quarter ended September 30, 2003 |       | 435                        |       | 0.9                                       | %          | 0.5                     | %          |
| Quarter ended December 31, 2003  |       | 8,867                      |       | 15.5                                      | %          | 9.3                     | %          |
| Fiscal year 2003                 |       | $                          | 25,258     |                                      | 12.1       | %                       | 7.1        | % |
|                             |       |                       |       |                                      |       |                    |       |
| Quarter ended March 31, 2004     |       | $                          | 14,251     |                                      | 21.9       | %                       | 13.8       | % |
| Quarter ended June 30, 2004      |       | $                          | 3,955      |                                      | 6.8        | %                       | 4.0        | % |

 

**7.****              Acquisitions**

** **

Wecompleted no acquisitions during the quarter ended June 30, 2004.  Subsequently, in July 2004 we completed twosmall acquisitions.  While we anticipatethat these acquisitions will be accretive to earnings, they are not expected tohave a material affect on our revenue or net income.

 

During the quarter ended March 31,2004, we completed two small acquisitions in existing markets that weserve.  These acquisitions are notexpected to have a material affect on our revenue or net income.

 

**8.  Stock-based Compensation**

** **

Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*, as amended byStatement of Financial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure*, encourages,but does not require, companies to record compensation cost for stock-basedcompensation plans at fair value.  OptionCare has chosen to account for stock-based compensation using the intrinsicvalue method prescribed in Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*, and relatedinterpretations.  Accordingly,compensation expense for stock options is measured as the excess, if any, ofthe quoted market price of Option Care stock at the date of grant over theamount 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.

 

10

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Had compensation cost for Option Care’sstock-based compensation plan been determined based on FASB Statement No. 123,Option Care’s net income and income per common share for the three and sixmonths ended June 30, 2004 and 2003 on a pro-forma basis would have been (inthousands, except per share amounts):

 
| ** **                                                                                                                                                   | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income:                                                                                                                                                  |       |                            |       |                          |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                               | 4,701      |                          | $          | 3,811 |   | $ | 8,986 |   | $ | 7,776 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                                  |       | 3⁄4                          |       | 6                             |       | 3⁄4 |   | 6 |   |
| 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                                                                                                                                          |       | (367                            | )          | (580                          | )          | (699 | ) | (1,153 | ) |
| Employee stock purchase plan withholdings                                                                                                                    |       | (33                             | )          | (64                           | )          | (68 | ) | (118 | ) |
|                                                                                                                                                         |       |                            |       |                          |       |   |   |   |   |
| Pro forma                                                                                                                                                    |       | $                               | 4,301      |                          | $          | 3,173 |   | $ | 8,219 |   | $ | 6,511 |   |
|                                                                                                                                                         |       |                            |       |                          |       |   |   |   |   |
| Net income per common share—basic:                                                                                                                      |       |                            |       |                          |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                               | 0.22       |                          | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |
| Pro forma                                                                                                                                                    |       | $                               | 0.20       |                          | $          | 0.15 |   | $ | 0.39 |   | $ | 0.31 |   |
|                                                                                                                                                         |       |                            |       |                          |       |   |   |   |   |
| Net income per  common share—diluted:                                                                                                                   |       |                            |       |                          |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                               | 0.22       |                          | $          | 0.18 |   | $ | 0.42 |   | $ | 0.37 |   |
| Pro forma                                                                                                                                                    |       | $                               | 0.20       |                          | $          | 0.15 |   | $ | 0.38 |   | $ | 0.31 |   |

 

**9.****              Quarterly DividendPolicy**

 

At their meeting on May 11, 2004, our Board of Directors initiated aquarterly cash dividend policy and announced an initial quarterly dividend of$0.02 per share.

 

Each quarter, the Board will decide whether to declare a dividend.  At their meeting on May 11, 2004, the Boardannounced an initial quarterly dividend of $0.02 per share, which was paid onJune 15, 2004 to shareholders of record as of June 1, 2004.  The total amount paid to stockholders was$428,000.  Subsequently, at their nextquarterly meeting on July 29, 2004, our Board of Directors once again declareda cash dividend of $0.02 per share, which will be paid on August 31, 2004 toshareholders of record as of August 16, 2004.

 

Our Credit and Security Agreement with J.P. Morgan Business CreditCorporation contained a prohibition against our payment of cash dividendsthroughout the term of the agreement. However, on June 15, 2004, the parties signed an amendment allowing usto pay up to $2.5 million per year in cash dividends throughout the remainingterm of the agreement.

 

**10.****       Comprehensive Income**

 

Net income was our only component of comprehensive income for the threeand six month periods ended June 30, 2004 and 2003.

 

11

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

 

**FORWARDLOOKING STATEMENTS**

 

The following discussion shouldbe read in conjunction with our Annual Report on Form 10-K for the yearended December 31, 2003. 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**

 

We provide pharmacy services topatients on behalf of managed care organizations and other third partypayors.  We contract with payors to providespecialty pharmacy services, infusion pharmacy and other related healthcareservices to patients at home or at other alternate-site settings, such asphysicians’ offices or infusion suites at our pharmacy locations.  Our services are provided through ournational network of company-owned and franchise-owned pharmacies.

 

We have three service lines:specialty pharmacy services, infusion and related healthcare services, andother. Specialty pharmacy services involve the distribution of injectible and infusedpharmaceuticals to treat a wide range of chronic health conditions.  The pharmaceuticals can be directlydistributed to the patient’s home or to their physician’s office for in-officeadministration.  These pharmaceuticalsmay require refrigeration during shipping as well as special handling toprevent potency degradation.  Patientsreceiving treatment usually require special counseling and education regardingtheir condition and treatment program. Infusion and related services primarily involves the intravenousadministration of medications at the patient’s home or other non-hospital sitesuch as one of our infusion suites. Infusion pharmacy services treat a wide range of acute and chronichealth conditions, including infections, dehydration, cancer, pain andnutritional deficiencies.  All of ourcompany-owned pharmacies provide infusion therapies.  Some of these pharmacies also provide relatedhealthcare services, such as home health nursing, home hospice services,respiratory therapy services and durable medical equipment.  Other revenue consists of royalties and otherfees generated from our franchised pharmacy network and the software licensingand support revenue generated by our subsidiary, MBI.  

 

Summarized information aboutrevenues and gross profit for each service line is provided in the followingtables (amounts in thousands):

 

REVENUE

 
| ** **                                | ** ** | **Three months  ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **Revenue**                      | ** ** | **%****of  total**            | ** ** | **Revenue** | ** ** | **% of  total** | ** ** | **Revenue** | ** ** | **%****of  total** | ** ** | **Revenue** | ** ** | **%****of  total** | ** ** |
|                                      |       |                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services               |       | $                                | 58,407     |                          | 59.2       | % | $ | 48,172 |   | 56.8 | % | $ | 123,339 |   | 61.1 | % | $ | 105,206 |   | 59.3 | % |
| Infusion and  related healthcare services |       | 37,450                           |       | 38.0                          | %          | 34,126 |   | 40.3 | % | 72,396 |   | 35.9 | % | 67,199 |   | 37.9 | % |
| Other                                     |       | 2,794                            |       | 2.8                           | %          | 2,484 |   | 2.9 | % | 6,065 |   | 3.0 | % | 4,939 |   | 2.8 | % |
|                                      |       |                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenue                             |       | $                                | 98,651     |                          | 100.0      | % | $ | 84,782 |   | 100.0 | % | $ | 201,800 |   | 100.0 | % | $ | 177,344 |   | 100.0 | % |

 

12

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GROSS PROFIT

 

| ** **                                | ** ** | **Three months  ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **Gross  profit**                | ** ** | **Gross  profit  margin%**    | ** ** | **Gross  profit** | ** ** | **Gross  profit  margin%** | ** ** | **Gross  profit** | ** ** | **Gross  profit  margin%** | ** ** | **Gross  profit** | ** ** | **Gross  profit  margin%** | ** ** |
|                                      |       |                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services               |       | $                                | 10,059     |                          | 17.2       | % | $ | 10,533 |   | 21.9 | % | $ | 20,585 |   | 16.7 | % | $ | 21,567 |   | 20.5 | % |
| Infusion and related  healthcare services |       | 16,334                           |       | 43.6                          | %          | 14,814 |   | 43.4 | % | 31,363 |   | 43.3 | % | 28,693 |   | 42.7 | % |
| Other                                     |       | 2,645                            |       | 94.7                          | %          | 2,308 |   | 92.9 | % | 5,787 |   | 95.4 | % | 4,675 |   | 94.7 | % |
|                                      |       |                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total gross profit                        |       | $                                | 29,038     |                          | 29.4       | % | $ | 27,655 |   | 32.6 | % | $ | 57,735 |   | 28.6 | % | $ | 54,935 |   | 31.0 | % |

 

The majority 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 for theprovision of specialty pharmacy services and infusion pharmacy services totheir members. For the three and six months ended June 30, 2004, 16% and 15% ofour revenue was generated from this contract. In the prior year, for the three and six months ended June 30, 2003, 17%of our revenue was generated from this contract.  As of June 30, 2004 and December 31, 2003, 9%of our accounts receivable was due from Blue Cross Blue Shield of Florida. Thecontract is terminable by either party on 90 days’ notice and, unlessterminated, renews annually each September for an additional one-year term.

 

We also generate revenue fromgovernment healthcare programs such as Medicare and Medicaid.  For the three and six months ended June 30,2004, 20% of our revenue was generated from these programs.  In the prior year, for the three and sixmonths ended June 30, 2003, 19% of our revenue was generated from governmenthealthcare programs.  As of June 30, 2004and December 31, 2003, respectively, 17% and 20% of our total accountsreceivable was due from these government healthcare programs.  

 

Many of the pharmaceuticals weprovide are reimbursed at some percentage of the Average Wholesale Price (AWP)for those pharmaceuticals.  AWP for mostpharmaceuticals is compiled and published by private companies, including FirstDataBank, Inc.  In recent years, we haveseen reductions to AWP for certain of the pharmaceuticals that we provide topatients in the aftermath of government investigations and other legal andregulatory actions.  Any modifications tothe AWP system or reductions in AWP for the products we provide to patientscould narrow our gross profit margins.

 

The Medicare Prescription Drug,Improvement and Modernization Act of 2003 changed the way in which coveredoutpatient drugs are reimbursed by the Medicare program.  In January 2004, payment for most drugscovered by Medicare decreased to 85% of the AWP, determined as of April 1,2003.  Beginning in 2005, reimbursementfor non-self administered drugs furnished to patients in conjunction with otherMedicare covered services will be set at either 106% of the average sales price(ASP) or through a competitive acquisition program to be phased in beginning in2006.  The competitive acquisitionsprogram will be established by the Center for Medicare and Medicaid Services(CMS) and will enable physicians in designated competitive acquisition areas topurchase drugs through contractors that have successfully bid for thatright.  Each physician will electannually whether to obtain drugs through the competitive acquisitionprogram.  CMS will re-bid the contractsat least every three years.  For infusiondrugs administered in connection with covered durable medical equipment, thepayment rate generally will continue to be 95% of the AWP as of October 1,2003, until such drugs are subject to the implementation of the competitiveacquisition program discussed above. While the majority of our revenue is reimbursed by managed careorganizations and other non-government payors, these changes to the way inwhich Medicare pays for outpatient drugs and biologicals may have some impacton us or our franchisees.  In addition,as CMS implements the ASP reimbursement model, managed care organizations maypush for adoption of ASP as the basis of pharmaceutical reimbursement aswell.  If managed care organizations doadopt the ASP model, our future financial condition and results of operationscould be materially affected based on our ability to renegotiate pricing usingthe ASP methodology.

 

13

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**CRITICALACCOUNTING POLICIES AND ESTIMATES**

** **

Management’s discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these statements requires us to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues and expensesand their related disclosures. On an ongoing basis, we evaluate our estimatesand judgments based on historical experience and various other factors that arebelieved to be reasonable. Actual results may vary from these estimates underdifferent assumptions or conditions. We annually review our financial reportingand disclosure practices and accounting policies to ensure that our financialreporting and disclosures provide accurate and transparent information relativeto our financial condition and results of operations, as well as our currentbusiness environment. Management believes that of our significant accountingpolicies, the following policies involve a higher degree of judgment and/orcomplexity: revenue recognition and contractual adjustments; accountsreceivable and allowances for doubtful accounts; goodwill and other intangibleassets; and computer software development costs.  For a complete discussion of these accountingpolicies, please refer to our Annual Report on Form 10-K for the year endedDecember 31, 2003. 

 

14

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**RESULTS OF OPERATIONS**

 

The following table shows the resultsof our operations for the three and six months ended June 30, 2004 and 2003,expressed in amounts and percentages of revenue (amounts in thousands):

 
| ** **                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **Amount**                      | ** ** | **% of  Revenue**             | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** |
| Revenue:                                      |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services                   |       | $                               | 58,407     |                          | 59.2       | % | $ | 48,172 |   | 56.8 | % | $ | 123,339 |   | 61.1 | % | $ | 105,206 |   | 59.3 | % |
| Infusion and related healthcareservices       |       | 37,450                          |       | 38.0                          | %          | 34,126 |   | 40.3 | % | 72,396 |   | 35.9 | % | 67,199 |   | 37.9 | % |
| Other                                         |       | 2,794                           |       | 2.8                           | %          | 2,484 |   | 2.9 | % | 6,065 |   | 3.0 | % | 4,939 |   | 2.8 | % |
| Total revenue                                 |       | 98,651                          |       | 100.0                         | %          | 84,782 |   | 100.0 | % | 201,800 |   | 100.0 | % | 177,344 |   | 100.0 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue:                              |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                            |       | 58,997                          |       | 59.8                          | %          | 47,001 |   | 55.4 | % | 122,805 |   | 60.9 | % | 101,825 |   | 57.4 | % |
| Cost of services provided                     |       | 10,616                          |       | 10.8                          | %          | 10,126 |   | 12.0 | % | 21,260 |   | 10.5 | % | 20,584 |   | 11.6 | % |
| Total cost of revenue                         |       | 69,613                          |       | 70.6                          | %          | 57,127 |   | 67.4 | % | 144,065 |   | 71.4 | % | 122,409 |   | 69.0 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                  |       | 29,038                          |       | 29.4                          | %          | 27,655 |   | 32.6 | % | 57,735 |   | 28.6 | % | 54,935 |   | 31.0 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative  expenses |       | 19,200                          |       | 19.5                          | %          | 18,177 |   | 21.5 | % | 38,449 |   | 19.1 | % | 36,208 |   | 20.4 | % |
| Provision for doubtful accounts               |       | 1,462                           |       | 1.5                           | %          | 2,330 |   | 2.7 | % | 3,021 |   | 1.5 | % | 4,208 |   | 2.4 | % |
| Depreciation and amortization                 |       | 569                             |       | 0.5                           | %          | 684 |   | 0.8 | % | 1,250 |   | 0.6 | % | 1,352 |   | 0.8 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total operating expenses                      |       | 21,231                          |       | 21.5                          | %          | 21,191 |   | 25.0 | % | 42,720 |   | 21.2 | % | 41,768 |   | 23.6 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income                              |       | 7,807                           |       | 7.9                           | %          | 6,464 |   | 7.6 | % | 15,015 |   | 7.4 | % | 13,167 |   | 7.4 | % |
| Interest income (expense), net                |       | 34                              |       | —                        | %          | (6 | ) | — | % | 35 |   | — | % | (106 | ) | (0.1% | ) |
| Other income (expense), net                   |       | (12                             | )          | —                        | %          | (84 | ) | (0.1% | ) | (79 | ) | — | % | (91 | ) | — | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income before income taxes                    |       | 7,829                           |       | 7.9                           | %          | 6,374 |   | 7.5 | % | 14,971 |   | 7.4 | % | 12,970 |   | 7.3 | % |
| Income tax provision                          |       | 3,128                           |       | 3.1                           | %          | 2,563 |   | 3.0 | % | 5,985 |   | 2.9 | % | 5,194 |   | 2.9 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                    |       | $                               | 4,701      |                          | 4.8        | % | $ | 3,811 |   | 4.5 | % | $ | 8,986 |   | 4.5 | % | $ | 7,776 |   | 4.4 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income per share - diluted                |       | $                               | 0.21       |                          |       |   | $ | 0.18 |   |   |   | $ | 0.41 |   |   |   | $ | 0.37 |   |   |   |

 

15

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**Three andSix Months Ended June 30, 2004 and 2003**

** **

During the quarter ended June 30, 2004, we achievedsignificant revenue growth from both our specialty pharmacy and infusionpharmacy services.  Our increased focuson marketing our core infusion therapies resulted in infusion pharmacy revenueof $32.2 million during the quarter, an increase of 11.3% over thecorresponding prior year quarter and 8.7% above the quarter ended March 31,2004.  For the six months ended June 30,2004, infusion pharmacy services increased 10.1% over the corresponding prioryear period. Specialty pharmacy services revenue increased primarily due toincreased sales of Xolairâ,Synagisâ and human growth hormone. Our specialty pharmacyservices revenue increased by 21.2% and 17.2% in the quarter and six monthsended June 30, 2004, respectively, compared to the corresponding prior yearperiods.  As a result of our growth inrevenue, our net income increased to $0.22 per diluted share in the quarter and$0.42 for the six month period ended June 30, 2004, increases of 22.2% and13.5% over the corresponding prior year periods.

 

Our days sales outstanding (DSO) was 61 days as ofJune 30, 2004, a slight increase compared to our DSO of 57 days as of March 31,2004 but consistent with our DSO at December 31, 2003.  This increase since March 31, 2004 wasprimarily due to routine variations in the payment cycle for a large managedcare customer within our specialty pharmacy business.   In the quarter ended June 30, 2004, wecontinued to generate positive operating cash flow, ending the quarter with$12.8 million in cash reserves compared to $6.6 million at March 31, 2004 and$4.0 million at December 31, 2003.  AtJune 30, 2004, we had no outstanding balance on our credit facility and virtuallyno debt.

 

Throughout the remainder of 2004, we plan to build onour positive operating results for the quarter ending June 30, 2004, continuingto leverage the strengths of our people, processes and delivery model toincrease market penetration for our infusion pharmacy and specialty pharmacyservices.  We will also continue toevaluate strategic acquisition opportunities in order to enhance our growth inrevenue and net income.

 

**Revenue:**

We report our operating resultsin one segment, consisting of three service lines: specialty pharmacy services;infusion and related healthcare services; and other.  Revenue for the quarter ended June 30, 2004was $98.7 million, representing an increase of $13.9 million, or 16.4%, overthe prior year quarter.  Revenue for thesix months ended June 30, 2004 was $201.8 million, exceeding revenue for thecorresponding prior year period by $24.5 million, or 13.8%.  These increases in revenue resulted from twomain factors:  refocused sales effortswhich produced increases in both infusion pharmacy and specialty pharmacyrevenue; and sales of a new specialty drug, Xolair®.

 

**Specialtypharmacy services revenue:**

For the quarter ended June 30, 2004,our specialty pharmacy services revenue was $58.4 million, representing anincrease of $10.2 million, or 21.2%, over the prior year quarter.  For the six months ended June 30, 2004,specialty pharmacy services revenue was $123.3 million, which was $18.1million, or 17.2%, higher than in the corresponding prior year period.  We continued to see increases in sales ofXolair®, a new specialty drug for the treatment of moderate to severe allergicasthma, which we began selling late in 2003. In addition, our Florida specialty pharmacies also produced increasedrevenue compared to the prior year periods, producing increases of $2.4 millionand $3.6 million for the three and six months ended June 30, 2004,respectively, compared to the prior year periods.  Also, our human growth hormone revenue alsoincreased in the quarter and six months ended June 30, 2004 compared to theprior year periods.  Our Synagis® revenuefor the quarter ended June 30, 2004 was consistent with the prior yearquarter.  However, on a year-to-datebasis, Synagis® revenue was $2.3 million higher than the prior yearperiod.  

 

**Infusionand related healthcare services revenue:**

For the quarter ended June 30,2004, infusion and related healthcare services revenue was $37.5 million, anincrease of $3.3

 

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million, or 9.7%, over the corresponding prior year quarter.  For the six months ended June 30, 2004,infusion and related healthcare services revenue was $72.4 million,representing an increase of $5.2 million, or 7.7%, over the prior year period.These increases were primarily related to our increased focus on driving salesof our infusion pharmacy services.  In2004, we increased our focus on marketing our core infusion pharmacy services,resulting in increased revenues across most infusion therapies.  On a sequential quarterly basis, our infusionpharmacy revenue reached $32.2 million, an increased of  8.7% over the quarter ended March 31,2004.  

 

**Other revenue:**

Other revenue consists of two primaryelements: (1) revenue generated from our franchise network, consisting ofroyalties, franchise fees and vendor rebates earned through our franchises’purchases under our contracts, and; (2) software licensing and support servicesprovided by our wholly-owned subsidiary, MBI. Other revenue was $2.8 millionfor the quarter ended June 30, 2004 compared to $2.5 million in thecorresponding prior year quarter.  Thisincrease was primarily due to revenue recognized from amortization of anon-compete agreement with the buyers of a former franchise.  For the six months ended June 30, 2004, otherrevenue was $6.1 million, representing an increase of $1.1 million over theprior year period.  Revenue from theaforementioned non-compete agreement was the largest factor in thisincrease.  Additionally, softwarelicensing and support fees revenue increased as a result of sales of MBI’s newiEmphsys software.

 

**Cost ofrevenue:**

Cost of revenue consists of the costof goods sold and the cost of service provided. For the quarter ended June 30, 2004, our cost of revenue increased by$12.5 million, or 21.9%, over the corresponding quarter of the prior year.   For the six months ended June 30, 2004, costof revenue increased by $21.7 million, or 17.7%, over the prior yearperiod.  These increases were the resultof our increases in revenue in the current year periods.  

 

Cost of goods sold for thequarter ended June 30, 2004 was $59.0 million, or 59.8% of revenue, compared to$47.0 million, or 55.4% of revenue, in the prior year quarter. For the sixmonths ended June 30, 2004, cost of goods sold was $122.8 million, or 60.9% ofrevenue, compared to $101.8 million, or 57.4% of revenue, for the correspondingprior year period.  The increase in costof goods as a percentage of revenue in the current year periods was due to ourincreases sales of specialty pharmaceuticals such as Xolairâand Synagisâ.  Thesehigh-cost specialty drugs tend to increase our overall cost of goods percentageas revenue from their sale increases.

 

Cost of service consists of the wagesand related costs for employees directly involved in patient care, includingpharmacists, nurses, therapists and delivery drivers.  Cost of service also includes the cost ofshipping or delivering products and services to the patient.  Our cost of service for the quarter endedJune 30, 2004 was $10.6 million, or 10.8% of revenue, compared to $10.1million, or 12.0% of revenue, for the quarter ended June 30, 2003.  For the six months ended June 30, 2004, ourcost of service was $21.3 million, or 10.5% of revenue, compared to $20.6million, or 11.6% of revenue, for the prior year period.  The declines in cost of service as apercentage of revenue was anticipated due to our increase in specialty pharmacyrevenue, which has a very small service component, along with the decline inhome health nursing services, which has a much higher service component.

 

**Grossprofit margin.** The following table sets forth the gross profit margin for each of ourthree service lines: specialty pharmacy services; infusion and relatedhealthcare services; and other:

 
| ** **                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                             |       |                           |       |   |   |   |   |
| Gross profit margin:                     |       |                             |       |                           |       |   |   |   |   |
| Specialty pharmacy services              |       | 17.2                             | %          | 21.9                           | %          | 16.7 | % | 20.5 | % |
| Infusion and related healthcare services |       | 43.6                             | %          | 43.4                           | %          | 43.3 | % | 42.7 | % |
| Other                                    |       | 94.7                             | %          | 92.9                           | %          | 95.4 | % | 94.7 | % |
| Overall gross profit margin              |       | 29.4                             | %          | 32.6                           | %          | 28.6 | % | 31.0 | % |

 

Our overall gross profit margin forthe quarter ended June 30, 2004 was 29.4% compared to 32.6% in the prior yearquarter.  For the six months ended June30, 2004, our overall gross profit margin was 28.6% compared to 31.0% for thecorresponding prior year period.  Thesedeclines in overall margin were primarily due to a shift in service mix towardspecialty pharmacy services,

 

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which produce a lower gross profitmargin than our other services, and also due to a shift in mix of productswithin our specialty pharmacy service line. In the current year periods, revenue has increased from the sale ofSynagisâ, Xolairâ and human growth hormone.  These high-cost products produce a lowergross profit margin than most of our other specialty pharmaceutical products,accounting for much of the current year declines in our specialty pharmacygross profit margin, as well as the declines in our overall gross profit margin.  For infusion and related healthcare services,our gross profit margin has remained stable. Other revenue, which consists of franchise-related revenues and softwaresales and support, has minimal direct costs and therefore produces a grossprofit margin near 100%.

 

**Selling,general and administrative expenses:**

For the quarter ended June 30,2004, selling, general and administrative (“SG&A”) expenses were $19.2million, or 19.5% of revenue, compared to $18.2 million, or 21.5% of revenue,for the prior year quarter.  For the sixmonths ended June 30, 2004, SG&A expenses were $38.4 million, or 19.1% ofrevenue, compared to $36.2 million, or 20.4% of revenue for the correspondingprior year period.  Of the $1.0 millionincrease in SG&A expenses in the quarter ended June 30, 2004 over the prioryear quarter, $800,000 was in wages and related costs.  For the six months ended June 30, 2004compared to the prior year period, $1.1 million of the $2.5 million increasewas related to wages and related costs. Other SG&A expense categories that increased in the year-to-dateperiods included building rent and recruiting expenses.   The overall declines in SG&A expenses asa percentage of revenue were due to our increases in revenue in the currentyear periods and our continuing cost containment efforts.

**Provisionfor doubtful accounts:**

For the quarter ended June 30, 2004,our provision for doubtful accounts was $1.5 million, or 1.5% of revenue,compared to $2.3 million, or 2.7% of revenue, for the prior year quarter.  For the six month period ended June 30, 2004,our provision for doubtful accounts was $3.0 million, or 1.5% of revenue,compared to $4.2 million, or 2.4% of revenue, for the corresponding prior yearperiod.  The reduction in expense in thecurrent year was due to two main factors: (1) a shift in our mix of businesstoward products with lower reimbursement risk, and (2) operational improvementsthat have reduced our bad debt provision requirements at our Texas pharmaciesand elsewhere.  Due to the manner of billingand reimbursement for many of the specialty drugs we sell, our risk ofnon-collection of the related accounts receivable is small.  As our mix of business has shifted towardspecialty pharmacy services, our provision for doubtful accounts has decreasedaccordingly.   In addition to thisfactor, we have improved and standardized our billing and collection practicesthroughout our network of company-owned pharmacies, particularly our Texaspharmacies, which has reduced our anticipated incidence of bad debtwrite-offs.  In the prior year periods,we had recorded much higher provisions in these pharmacies than in the currentyear periods.

 

**Depreciationand amortization:**

For the quarter ended June 30, 2004,depreciation and amortization expense was $600,000 compared to $700,000 for thequarter ended June 30, 2003.  For the sixmonths ended June 30, 2004, depreciation and amortization was $1.3 millioncompared to $1.4 million for the prior year period.  The small declines in the current yearperiods are due to a reduction in amortization of intangible assets acquiredthrough prior years’ acquisitions as those assets become fully amortized.  

 

The depreciation expense containedwithin this line item only relates to non-revenue producing assets, such asfurniture and fixtures and leasehold improvements.  Depreciation for revenue-producing equipmentsuch as rental medical equipment and delivery vehicles is included in cost ofgoods sold and cost of services, respectively. 

 

**Operatingincome:**

Our operating income for the quarterended June 30, 2004 was $7.8 million, representing an increase of 20.8% overthe prior year quarter.  Operating incomefor the six months ended June 30, 2004 was $15.0 million, which is an increaseof 14.0% over the corresponding prior year period.  The increases in operating income were theresult of our revenue growth in both infusion pharmacy and specialty pharmacyservices in the current year, compared to the prior year, along with ongoingcost-containment efforts.  

 

**Interest Income/(Expense):**

Throughout the quarter ended June 30,2004 we had a net positive cash balance, did not borrow against our creditfacility, and had minimal total debt. Our interest income in the quarter ended June 30, 2004 was $34,000,compared to net interest expense of $6,000 in the prior year quarter.  For the six months ended June 30, 2004, wehave earned a net $35,000 in interest income compared to $106,000 of interestexpense in the prior year period.  Ourinterest expense in the prior year periods was due to borrowings against ourcredit facility to finance acquisition activities.  Subsequent positive operating cash flows haveallowed us to pay off this debt balance and accumulate cash reserves.

 

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**Income taxes:**

For the quarter ended June 30, 2004,our provision for income taxes was $3.1 million compared to $2.6 million in theprior year quarter.  Our provision forincome taxes for the six months ended June 30, 2004 was $6.0 million, comparedto $5.2 million in the corresponding prior year period.  Our tax provision rate for the quarter andsix months ended June 30, 2004 was 40.0%, which is approximately equal to ourtax provision rate in the prior year periods.

 

**Netincome:**

Our net income for the quarterended June 30, 2004 was $4.7 million, which is 23.4% higher than our net incomeof $3.8 million in the prior year quarter. For the six months ended June 30, 2004, our net income was $9.0 million,which is 15.6% higher than our net income of $7.8 million for the correspondingprior year period.  These increases innet income were the result of our intensified focus on selling our infusionpharmacy and specialty pharmacy services, supported by our clinical expertiseand flexible service distribution model. 

 

**Dilutedshares & earnings per share:**

For the quarter ended June 30, 2004,our diluted earnings were $0.22 per share, an increase of $0.04 per share, or22.2%, over the prior year quarter.  Forthe six months ended June 30, 2004, diluted earnings were $0.42 per share,which is an increase of $0.05 per share, or 13.5%, over the corresponding prioryear period.  Total diluted shares were21.7 million for the quarter ended June 30, 2004 compared to 21.2 million forthe prior year quarter.  For the sixmonths ended June 30, 2004, total diluted shares were 21.6 million, compared to21.2 million in the prior year period. The increases in diluted shares were due to issuance of new shares foremployee stock option exercises and stock purchases under our employee stock purchaseplan, partially offset by our purchase of treasury stock in January 2004.  The 101,000 shares of treasury stock acquiredin December 2003 and January 2004 were retired in the quarter ended June 30,2004.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

During the quarter ended June 30,2004, we financed our operations through current cash flows and the use of cashreserves.  We continue to generatepositive operating cash flows and ended the quarter with $12.8 million in cash.

 

Recognizing our strong cash positionand our reduced need for borrowed capital, on June 15, 2004 we signed anamendment to our Credit and Security Agreement with J.P. Morgan Business CreditCorporation to reduce our overall credit facility from $60 million to $20million.  

 

The amendment to our Credit andSecurity Agreement also removed the prohibition against payment of cashdividends, allowing us to distribute up to $2.5 million in cash per year to ourshareholders in the form of dividends. The change was agreed to in light of our Board of Directors’ approval ofa quarterly dividend policy and their declaration of a $0.02 per sharedividend, which was paid on June 15, 2004 to shareholders of record as of June1, 2004.

 

**OperatingCash Flows:**

Operations provided $11.9million of positive cash flow during the six months ended June 30, 2004compared to $12.7 million provided by operations during the corresponding prioryear period.  The primary causes of ourpositive operating cash flow for the six months ended June 30, 2004 were ournet income during the period and our solid collections of accountsreceivable.  Focused sales and marketingefforts produced higher revenue and net income, and consistent cash collectionsduring the period allowed us to maintain our DSO at 61 days.   Our operating cash flows in the six monthsended June 30, 2004 also benefited from the income tax overpayment we carriedover from the prior year.

 

**Investing Cash Flows.**

During the six months ended June 30,2004, investing activities used $3.7 million in cash compared to $14.2 millionused in the corresponding prior year period. Of the current year expenditure of $3.7 million, $2.6 million was usedto acquire equipment and other fixed assets. Of this total, approximately $1.5 million was spent on infusion pumpsand other revenue-generating medical equipment, $600,000 was spent oninfrastructure items such as furniture, fixtures and computer equipment, and$500,000 was spent on externally-developed and internally-developed softwareprograms.  In addition to the $2.6 millionused to acquire equipment and other fixed assets, we used $1.1 million duringthe period to complete two small business acquisitions, one an Option Carefranchised pharmacy in the Philadelphia area and the other an RT/DME providerin central Missouri.  In the prior year,our primary use of cash for investing activities was to acquire the 40%minority interest of a specialty pharmacy business for which we had acquired a60% interest a year

 

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earlier.

 

**Financing Cash Flows:**

We generated $600,000 in cash fromfinancing activities during the six months ended June 30, 2004, compared to$1.3 million generated in the prior year period.  In the current year, we generated $2.4million from the issuance of stock to employees exercising stock options andfrom employee payroll withholdings for our 2004 employee stock purchaseplan.  We used $900,000 in cash topurchase treasury stock, and used $400,000 for payment of a cash dividend toour stockholders.  We also used $400,000for scheduled payments on capital leases and other fixed-rate debt.  In the current year period, there was no netactivity under our credit facility, as we began and ended the period with nooutstanding balance.

 

**Credit Facility:**

On March 29, 2002, Option Care signeda $60 million revolving Credit and Security Agreement with J.P. Morgan BusinessCredit Corp., JPMorgan Chase Bank and LaSalle Bank N.A.  On June 15, 2004, we signed an amendment tothis agreement to reduce the overall facility from $60 million to $20million.   The agreement has a scheduledexpiration date of March 29, 2005.

 

Availability under this facility isrelated to percentages of our outstanding accounts receivable and inventorybalances, less certain ineligible amounts, as defined in the agreement.  The agreement requires us to comply withvarious financial covenants on a quarterly basis.  As of June 30, 2004 and December 31, 2003, wehad no outstanding balance under this facility. We had borrowing availability of $17.0 million as of June 30, 2004 and$37.7 million as of December 31, 2003 based on our accounts receivable andinventory balances on those dates, and based on the size and terms of theoverall facility at those dates.

 

On October 23, 2003, theparties agreed to an amendment to the Credit and Security Agreement to addressthe $6.8 million special provision for doubtful accounts recorded in thequarter ended September 30, 2003 related to our Texas accounts receivable. Theamendment allowed us to exclude the $6.8 million charge when calculating ourfixed charge coverage ratio the quarter ended September 30, 2003 and thefollowing three quarters.  With thisamendment, we were able to remain in compliance with all our financial covenantsfor the quarters ended September 30, 2003 and December 31, 2003.  For the quarters ended March 31, 2004 andJune 30, 2004, we were in compliance with all financial covenants beforeconsideration of this amendment.

 

**Accounts Receivable:**

The following table sets forthinformation regarding our accounts receivable as of the dates indicated (dollaramounts in thousands):

 
| ** **                                                   | ** ** | **June 30,2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
|                                                         |       |             |       |                  |       |
| Accounts receivable                                          |       | $                | 68,713     |                  | $          | 70,692 |   |
| Less allowance for doubtful accounts                         |       | (7,952           | )          | (8,502                | )          |
|                                                         |       |             |       |                  |       |
| Accounts receivable, net of allowance for  doubtful accounts |       | $                | 60,761     |                  | $          | 62,190 |   |
|                                                         |       |             |       |                  |       |
| Days sales outstanding (DSO)(1)                              |       | 61               |       | 61                    |       |

 

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(1)          DSO is calculated using the exhaustion method based onaccounts receivable net of allowance for doubtful accounts, and considers onlyour specialty pharmacy service line and infusion and related healthcareservices line.

 

Our accounts receivable, net of baddebt reserves, was $60.8 million as of June 30, 2004 compared to $62.2 millionas of December 31, 2003.  This 2.3%decrease in accounts receivable was primarily due to the seasonal reduction inrevenue and accounts receivable from sales of Synagisâ. 

 

The following table sets forth thepercentage breakdown of our trade accounts receivable by aging category and bymajor payor as of the dates indicated:

 
| ** **                            | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------------|------------|-------------------|------------|-----------------------|------------|
| By Aging Category (2):                |       |              |       |                  |       |
| Aged 0-90 days                        |       | 68.4              | %          | 72.4                  | %          |
| Aged 91-180 days                      |       | 15.0              | %          | 12.5                  | %          |
| Aged 181-365 days                     |       | 9.8               | %          | 10.7                  | %          |
| Aged over 365 days                    |       | 6.8               | %          | 4.4                   | %          |
|                                  |       |              |       |                  |       |
| Total                                 |       | 100.0             | %          | 100.0                 | %          |
|                                  |       |              |       |                  |       |
| By Major Payor:                       |       |              |       |                  |       |
| Medicare and Medicaid                 |       | 17                | %          | 20                    | %          |
| Blue Cross and Blue Shield of Florida |       | 9                 | %          | 9                     | %          |
| All other payors                      |       | 74                | %          | 71                    | %          |
|                                  |       |              |       |                  |       |
| Total                                 |       | 100               | %          | 100                   | %          |

 

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(2)          Accounts receivable by aging category considers onlyaccounts of our specialty pharmacy service line and infusion and relatedhealthcare service line.

 

Our days’ sales outstanding (DSO) was61 days as of June 30, 2004 which was equal to our DSO at December 31,2003.  Our billing and collectionsperformance has improved as we re-focused on training and adherence to policieslate in 2003 and throughout the first six months of 2004.  We continue to pursue electronic billing andother methods and practices to shorten our collection cycle.

 

As of June 30, 2004, we had cash andcash equivalents of approximately $12.8 million, an increase of $8.8 millionover the balance at December 31, 2003. Strong net income and operating cash flows allowed us to increase ourcash reserves even though we used $1.1 million in cash for acquisitions andanother $900,000 to buy treasury stock during the period.  We believe that cash flow from operations andamounts available under our revolving credit facility will be sufficient tomeet our operating cash needs for the immediate future, including any interestdue on our credit facility or other debts. In the event that additional capital is required, management cannotassure that such capital can be obtained from other sources on terms acceptableto us, if at all.

 

Our business strategy includesthe selective acquisition of additional local pharmacy facilities and specialtypharmacy operations.  Accordingly, we mayrequire 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.

 

**Goodwilland Other Intangible Assets**

 

As of June 30, 2004, we had netgoodwill and other intangible assets totaling $66.5 million, consisting of$65.7 million of goodwill and $800,000 of other intangible assets such asnon-compete agreements and managed care contracts.  As of December 31, 2003, net goodwill andother intangible assets equaled $66.1 million, consisting of $65.0 million ofgoodwill and $1.1 million of other intangible assets.  During the six months ended June 30, 2004,goodwill increased $700,000 as a result of two acquisitions completed inJanuary 2004.  Other intangible assetsincreased $100,000 as a result of these acquisitions, offset by amortization of$400,000 during the period.

 

As required by Statements ofFinancial Accounting Standards No. 142, *Goodwill and OtherIntangible Assets (SFAS No. 142)*, we do not amortize goodwill, buttest our goodwill for impairment annually each October 1st, orwhenever we identify events or conditions that could potentially result inimpairment of our goodwill.  During thequarter ended June 30, 2004, no impairment of goodwill was identified.

 

**Regulatoryand Other Developments**

 

***Health Insurance Portability andAccountability Act of 1996 (HIPAA)****.*  To improve theefficiency and effectiveness of the health care system, the Health InsurancePortability and Accountability Act (HIPAA) of 1996, Public Law 104-191,included “Administrative Simplification” provisions that required theDepartment of Health and Human Services (HHS) to adopt national standards forelectronic health care transactions. At the same time, Congress recognized thatadvances in electronic technology could erode the privacy of healthinformation. Consequently, Congress incorporated provisions into HIPAA thatmandated the adoption of Federal privacy protections for individuallyidentifiable health information.

 

In response to the HIPAA mandate, in December 2000, HHS publisheda final regulation in the form of the Privacy Rule, which

 

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became effective on April 14, 2001. This Privacy Rule set nationalstandards for the protection of health information, as applied to the threetypes of covered entities: health plans, health care clearinghouses, and healthcare providers who conduct certain health care transactions electronically. InMarch 2002, HHS published proposed modifications to the Privacy Rule, toimprove workability and avoid unintended consequences that could have impededpatient access to delivery of quality health care. Following another round ofpublic comment, in August 2002, HHS adopted final modifications necessaryto ensure that the Privacy Rule worked as intended. Pursuant to the PrivacyRule, as of April 14, 2003, covered entities were required to havestandards in place to protect and guard against the misuse of individuallyidentifiable health information. (Small health plans had until April 14,2004 to implement such standards.) Failure to timely implement these standardsmay, under certain circumstances, trigger the imposition of civil or criminalpenalties.

 

The Privacy Rule establishes a foundation of Federal protections forthe privacy of protected health information. The Privacy Rule does not replaceFederal, State, or other laws that grant individuals even greater privacyprotections, and covered entities are free to retain or adopt more protectivepolicies or practices.  We haveimplemented the standards set forth in the Privacy Rule, and these standardswere in place on April 14, 2003.  Webelieve that we and all of our franchisees are in compliance with the PrivacyRule or any more stringent federal or state laws relating to privacy.

 

Additionally, the Administrative Simplification provisions addresselectronic health care transactions and the security of electronic healthinformation systems.  Providers arerequired to comply with the standards by specific compliance dates establishedby HHS.  For standards relating toelectronic health care transactions, the compliance date was originally set forOctober 16, 2002.  If the covered entityfiled for an extension, the compliance date was postponed until October 16,2003.  We were materially compliant withthese standards by the applicable compliance date.  The security standards applicable toindividually identifiable health information maintained electronically must beimplemented by April 21, 2005.  Thestandards for a unique national health identifier for providers used inconnection with the electronic healthcare transactions must be implemented byMay 23, 2007.  We expect to be able tomaterially comply with these regulations by their applicable compliance dates.

 

Penalties for non-compliance with the Privacy Rule and other HIPAAAdministrative Simplification provisions range from a civil penalty of $100 foreach violation (which can total up to $25,000 per person per year), to criminalpenalties, including up to $50,000 and/or one year imprisonment, up to $100,000and/or five years imprisonment if the offense is committed under falsepretenses and up to $250,000 and/or ten years imprisonment for violating astandard with the intent to sell, transfer or use individually identifiablehealth information for commercial advantage, personal gain or malicious harm. 

 

In addition to regulating privacy of individual health information andother provisions relating to Administrative Simplification, HIPAA includesseveral anti-fraud and abuse laws, extends criminal penalties to private healthcare benefit programs and, in addition to Medicare and Medicaid, to otherfederal health care programs, and expands the Office of Inspector General’sauthority to exclude persons and entities from participating in the Medicareand Medicaid programs.

 

***Medicare Prescription Drug, Improvement andModernization Act of 2003****.*  The Medicare Prescription Drug, Improvementand Modernization Act of 2003 changes the way in which covered outpatient drugsare reimbursed by the Medicare program. In January 2004, payment for mostdrugs covered by Medicare decreased to 85% of the Average Wholesale Price (AWP)determined as of April 1, 2003. Beginning in 2005, reimbursement fornon-self administered drugs furnished to patients in conjunction with otherMedicare covered services will be set at either 106% of the average sales price(ASP) or through a competitive acquisition program to be phased in beginning in2006. The competitive acquisitions program will be established by CMS and willenable physicians in designated competitive acquisition areas to purchase drugsthrough contractors that have successfully bid for that right. Each physicianwill elect annually whether to obtain drugs through the competitive acquisitionprogram. CMS will re-bid the contracts at least every three years. For infusiondrugs administered in connection with covered durable medical equipment (DME),the payment rate generally will continue to be 95% of the AWP as ofOctober 1, 2003, until such drugs are subject to the implementation of thecompetitive acquisition program discussed above.

 

While the majority of our revenue is reimbursed by managed careorganizations and other non-government payors, these changes to the way inwhich Medicare pays for outpatient drugs and biologicals may have some impacton us or our franchisees. In addition, as CMS implements the ASP model ofreimbursement, it may affect our current AWP based reimbursement structure withour managed care customers. If managed care organizations adopt an ASP-basedreimbursement model, our future financial position and results of operationscould be materially affected by our ability to renegotiate pricing based on thenew methodology. 

 

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**ITEM3.  Quantitative and Qualitative Disclosures About Market 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 2004. As of June 30, 2004, our fixed-ratedebt was $100,000 and we had no variable rate debt.

 

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**ITEM4.  Controls and Procedures**

** **

We carried out an evaluation, under the supervision and with theparticipation of our management, including our chief executive officer andchief financial officer, of the effectiveness of the design and operation ofour disclosure controls and procedures, (as defined in Rules 13a-15(e)under the Securities Exchange Act of 1934 (the Exchange Act)) as of June 30,2004. Based upon that evaluation, the chief executive officer and chieffinancial officer concluded that our disclosure controls and procedures areeffective. Disclosure controls and procedures are controls and procedures thatare designed to ensure that information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

In addition, no change in our internal control over financial reporting(as defined in Rule 13a-15(f) under the Exchange Act) occurred during ourfiscal quarter ended June 30, 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting. 

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. Legal Proceedings**

 

We are subject to claims andlegal actions that may arise in the ordinary course of business. However, wemaintain insurance to protect against such claims or legal actions. We are notaware of any litigation either pending or filed that we believe are likely tohave a material adverse effect on our results of operation or financial condition.

 

We were named as a defendant ina lawsuit filed on December 31, 2002 in the District Court, Bexar County,State of Texas under the caption *Candace Booker, et. al.vs. Option Care, Inc. et. al,* No. 2002 CI 18401.Plaintiffs alleged that we negligently prepared a prescription resulting in afatal injury. We recently entered into an agreement with the plaintiffs tosettle this case.  The settlement amountfell within the limits of our general and professional liability insurancecoverage for this claim and will be paid by our insurer.  Our obligation will be limited to the $25,000deductible applicable to this claim.

 

**ITEM2.  Changes in Securities and Use ofProceeds**

 

None.

 

**ITEM3.  Defaults Upon Senior Securities**

 

None.

 

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

 

We held our annual meeting of stockholders on May 11, 2004.  At that meeting, our stockholders were askedto consider and vote upon the following matters:

 

1.               Electionof one member to the Board of Directors to hold office for a three-year term oruntil his successor is duly elected and qualified.  The nominee, who was listed in our proxystatement, was elected for a three-year term, with the results of voting asfollows:

 
| ** **        | ** ** | **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **ABSTAIN** | ** ** |
|-------------------|------------|---------------|------------|-------------------|------------|-------------|------------|
| Jerome F. Sheldon |       | 18,513,188    |       | 3⁄4            |       | 287,487     |       |

 

2.               Ratificationof the appointment of Ernst & Young, LLP as our independent auditors forthe fiscal year 2004.  The proxy votingresults were as follows:

 

| **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **ABSTAIN** | ** ** |
|---------------|------------|-------------------|------------|-------------|------------|
| 18,793,400    |       | 4,150             |       | 3,125       |       |

 

3.               Toconsider and vote upon an amendment to our Amended and Restated Stock IncentivePlan to increase the annual grant of options to eligible non-employee directorsfrom 9,375 to 10,000 options.  The amendmentwas passed, with the results of voting as follows:

 

| **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **ABSTAIN** | ** ** |
|---------------|------------|-------------------|------------|-------------|------------|
| 13,798,409    |       | 1,790,958         |       | 293,337     |       |

 

**ITEM 5. Other Information**

 

None.

 

**ITEM 6(a). Exhibits**

 

See Exhibit Index.

 

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

 

We filed the following Form8-Ks during the quarter ended June 30, 2003 and subsequently through July 30,2004.

 

On April 19, 2004, we filed acurrent report on Form 8-K regarding a press release we issued on April 15,2004 to announce our anticipated operating results for the quarter ended March31, 2004.

 

On May 10, 2004, we filed twocurrent reports on Form 8-K.  The firstcontained the text of our press release, dated May 4, 2004, announcing ourearnings for the quarter ended March 31, 2004. The second contained the transcript of our quarterly conference callwith investors, which took place on May 4, 2004, to announce and discuss ouroperating results for the quarter ended March 31, 2004.

 

On May 19, 2004, we filed acurrent report on Form 8-K regarding a press release we issued on May 13, 2004to announce that our Board of Directors had approved a quarterly dividendpolicy and declared a $0.02 per share dividend payable of June 15, 2004 toshareholders of record on June 1, 2004.

 

On July 14, 2004, we filed acurrent report on Form 8-K regarding a press release we issued on July 13, 2004to announce our

 

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anticipated operating resultsfor the quarter ended June 30, 2004.

 

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**SIGNATURE**

 

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

 
|                       | OPTION  CARE, INC. |
|----------------------------|-------------------------|
| Date:  August 9, 2004 | By:                     | /s/ Paul Mastrapa |   |
| * *                   | * *                | *Chief  Financial Officer* |
| * *                   | * *                | *(Principal  Accounting Officer and*  *Principal  Financial Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                  |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 3.1                 |       | Certificate  of Incorporation of the Registrant, together with Certificate of Amendment  thereto filed February 18, 1992. Filed as Exhibit 3(a) to Option  Care’s Registration Statement (No. 33-45836) dated April 15, 1992  and incorporated by reference herein.                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 3.2                 |       | Certificate  of Amendment to Certificate of Incorporation of the Registrant filed  March 25, 1992. Filed as Exhibit 3(c) to Option Care’s Registration  Statement (No. 33-45836) dated April 15, 1992 and incorporated by  reference herein.                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 3.3                 |       | Certificate  of Amendment to Certificate of Incorporation of the Registrant filed with the  Delaware Secretary of State on June 18, 2002 and incorporated by  reference herein.                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 3.4                 |       | Restated  By-laws of the Registrant dated June 1, 1994. Filed as Exhibit 10.5  to Option Care’s Annual Report on Form 10-K for the year ending  December 31, 1994 and incorporated by reference herein.                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.5                |       | 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.                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.8                |       | 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.                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.10               |       | 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.                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.22               |       | 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.                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.24               |       | 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. *                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.26               |       | 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. **                                                                                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                        |
| 10.32               |       | 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.                                                                                                                                         |

 

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| **Exhibit  Number** |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 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. *                                                                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 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  our Quarterly Report on Form 10-Q for the quarter ended September 30,  2003.               |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.38               |   | Fifth Amendment to Credit and Security Agreement,  dated June 15, 2004, 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 10.38 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, and Exchange Act Rule 13a-14(b).                                                                                                                                                                                                                                                                                                    |

 

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*      Management contracts and compensatoryplans and arrangements.

**          Portions of this Exhibit are subject to aConfidential Treatment Request pursuant to Rule 24b-2 under the Securities andExchange Act of 1934, as amended, filed with the SEC on September 10, 2001 andamended October 10, 2001.

 

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