**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

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

 

**For thequarterly period ended June 30, 2005**

 

**OR**

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

 

**For thetransition period from                           to                           **

 

**Commissionfile number 0-19878**

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

 

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

 

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

 

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

 
| **Class**                       | ** ** | **Issued and Outstanding  as of August 1, 2005** |
|---------------------------------|------------|-------------------------------------------------------|
|                            |       |                                                  |
| Common Stock  - $0.01 par value |       | 32,480,036                                            |

 

 

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**INDEX**

 

**OPTIONCARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION**  |                                                                                                     |
|------------------|----------------------------------------------------------------------------------------------------------|
| ** **       | ** **                                                                                               |   |
| **PART I**  | **FINANCIAL INFORMATION**                                                                                |   |
| ** **       | ** **                                                                                               | ** ** |
| Item 1.          | Financial Statements (Unaudited)                                                                         |   |
|             |                                                                                                     |   |
|             | Condensed consolidated balance sheets—June 30,  2005 and December 31, 2004                |   |
|             |                                                                                                     |   |
|             | Condensed consolidated statements of  income—Three and six months ended June 30, 2005 and 2004 |   |
|             |                                                                                                     |   |
|             | Condensed consolidated statements of cash  flows—Six months ended June 30, 2005 and 2004       |   |
|             |                                                                                                     |   |
|             | Notes to condensed consolidated financial statements—June 30,  2005                            |   |
|             |                                                                                                     |   |
| Item 2.          | Management’s Discussion and Analysis of Financial Condition and  Results of Operations              |   |
|             |                                                                                                     |   |
| Item 3.          | Quantitative and Qualitative Disclosures about Market Risk                                               |   |
|             |                                                                                                     |   |
| Item 4.          | Controls and Procedures                                                                                  |   |
| ** **       | ** **                                                                                               | ** ** |
| **PART II** | **OTHER  INFORMATION**                                                                                   |   |
| ** **       | ** **                                                                                               | ** ** |
| Item  1.         | Legal  Proceedings                                                                                       |   |
|             |                                                                                                     |   |
| Item 2.          | Unregistered Sales of Equity Securities and Use of Proceeds                                              |   |
|             |                                                                                                     |   |
| Item 3.          | Defaults Upon Senior Securities                                                                          |   |
|             |                                                                                                     |   |
| Item 4.          | Submission of Matters to a Vote of Security Holders                                                      |   |
|             |                                                                                                     |   |
| Item  5.         | Other  Information                                                                                       |   |
|             |                                                                                                     |   |
| Item 6.          | Exhibits                                                                                                 |   |
|             |                                                                                                     |   |
| **SIGNATURES**   | ** **                                                                                               |

 

2

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**PART I.  FINANCIALINFORMATION**

 

**Item 1.  Financial Statements**

**OptionCare, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

(in thousands, except per shareamounts)

 
| ** **                                                                                                                                                                               | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **(Unaudited)**        | ** ** | **(Note 1)**               | ** ** |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Assets                                                                                                                                                                                   |       |                   |       |                       |       |
| Current  assets:                                                                                                                                                                         |       |                   |       |                       |       |
| Cash and  cash equivalents                                                                                                                                                               |       | $                      | 8,860      |                       | $          | 19,816 |   |
| Short-term  investments                                                                                                                                                                  |       | 71,598                 |       | 75,370                     |       |
| Accounts  receivable, net                                                                                                                                                                |       | 72,575                 |       | 69,930                     |       |
| Inventory                                                                                                                                                                                |       | 12,615                 |       | 13,191                     |       |
| Deferred  income tax benefit                                                                                                                                                             |       | 2,938                  |       | 3,098                      |       |
| Other  current assets                                                                                                                                                                    |       | 8,259                  |       | 5,459                      |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total  current assets                                                                                                                                                                    |       | 176,845                |       | 186,864                    |       |
| Equipment  and other fixed assets, net                                                                                                                                                   |       | 16,267                 |       | 13,709                     |       |
| Goodwill,  net                                                                                                                                                                           |       | 85,289                 |       | 65,356                     |       |
| Other assets                                                                                                                                                                             |       | 4,973                  |       | 3,918                      |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total assets                                                                                                                                                                             |       | $                      | 283,374    |                       | $          | 269,847 |   |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Liabilities  and stockholders’ equity                                                                                                                                               |       |                   |       |                       |       |
| Current  liabilities:                                                                                                                                                                    |       |                   |       |                       |       |
| Trade  accounts payable                                                                                                                                                                  |       | $                      | 16,786     |                       | $          | 21,819 |   |
| Current  portion of long-term debt                                                                                                                                                       |       | 47                     |       | 19                         |       |
| Other  current liabilities                                                                                                                                                               |       | 7,427                  |       | 6,573                      |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total  current liabilities                                                                                                                                                               |       | 24,260                 |       | 28,411                     |       |
| Long-term  debt, less current portion                                                                                                                                                    |       | 86,335                 |       | 86,306                     |       |
| Deferred  income tax liability                                                                                                                                                           |       | 8,066                  |       | 7,468                      |       |
| Other  liabilities                                                                                                                                                                       |       | 582                    |       | 551                        |       |
| Minority  interest                                                                                                                                                                       |       | 597                    |       | 548                        |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total  liabilities                                                                                                                                                                       |       | 119,840                |       | 123,284                    |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Stockholders’  equity:                                                                                                                                                              |       |                   |       |                       |       |
| Common  stock, $.01 par value per share, 60,000 shares authorized, 32,464 and 32,183 shares  issued and outstanding at June 30, 2005 and December 31, 2004,  respectively |       | 325                    |       | 322                        |       |
| Common stock  to be issued, 189 and 114 shares at June 30, 2005 and December 31,  2004, respectively                                                                           |       | 2,140                  |       | 1,085                      |       |
| Additional  paid-in capital                                                                                                                                                              |       | 109,840                |       | 108,062                    |       |
| Retained  earnings                                                                                                                                                                       |       | 51,229                 |       | 41,612                     |       |
| Less  treasury stock, at cost, 474 shares at December 31, 2004                                                                                                                      |       | —                 |       | (4,518                     | )          |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total  stockholders’ equity                                                                                                                                                         |       | 163,534                |       | 146,563                    |       |
|                                                                                                                                                                                     |       |                   |       |                       |       |
| Total  liabilities and stockholders’ equity                                                                                                                                         |       | $                      | 283,374    |                       | $          | 269,847 |   |

 

*See notes to condensed consolidated financialstatements*

 

3

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**OptionCare, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Income**

(Unaudited)

(in thousands, except per shareamounts)

 
| ** **                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Revenue:                                        |       |                                  |       |                                |       |   |   |   |   |
| Specialty  pharmacy services                    |       | $                                     | 67,600     |                                | $          | 58,407 |   | $ | 142,497 |   | $ | 123,339 |   |
| Infusion and  related healthcare services       |       | 47,690                                |       | 37,450                              |       | 90,538 |   | 72,396 |   |
| Other                                           |       | 4,201                                 |       | 2,794                               |       | 7,211 |   | 6,065 |   |
| Total  revenue                                  |       | 119,491                               |       | 98,651                              |       | 240,246 |   | 201,800 |   |
| Cost of  revenue:                               |       |                                  |       |                                |       |   |   |   |   |
| Cost of  goods sold                             |       | 71,750                                |       | 58,997                              |       | 147,442 |   | 122,805 |   |
| Cost of  services provided                      |       | 12,781                                |       | 10,616                              |       | 24,581 |   | 21,260 |   |
| Total cost  of revenue                          |       | 84,531                                |       | 69,613                              |       | 172,023 |   | 144,065 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                    |       | 34,960                                |       | 29,038                              |       | 68,223 |   | 57,735 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Selling,  general and administrative expenses   |       | 23,509                                |       | 19,200                              |       | 45,050 |   | 38,449 |   |
| Provision  for doubtful accounts                |       | 2,153                                 |       | 1,462                               |       | 4,479 |   | 3,021 |   |
| Depreciation  and amortization                  |       | 849                                   |       | 569                                 |       | 1,753 |   | 1,250 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  operating expenses                       |       | 26,511                                |       | 21,231                              |       | 51,282 |   | 42,720 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Operating  income                               |       | 8,449                                 |       | 7,807                               |       | 16,941 |   | 15,015 |   |
| Interest  income                                |       | 194                                   |       | 34                                  |       | 150 |   | 35 |   |
| Other income  (expense), net                    |       | 100                                   |       | (12                                 | )          | 53 |   | (79 | ) |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Income  before income taxes                     |       | 8,743                                 |       | 7,829                               |       | 17,144 |   | 14,971 |   |
| Income tax  provision                           |       | 3,334                                 |       | 3,128                               |       | 6,450 |   | 5,985 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Net income                                      |       | $                                     | 5,409      |                                | $          | 4,701 |   | $ | 10,694 |   | $ | 8,986 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Net income  per common share:                   |       |                                  |       |                                |       |   |   |   |   |
| Basic                                           |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.28 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Diluted                                         |       | $                                     | 0.16       |                                | $          | 0.14 |   | $ | 0.32 |   | $ | 0.28 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Shares used  in computing net income per share: |       |                                  |       |                                |       |   |   |   |   |
| Basic                                           |       | 32,559                                |       | 31,923                              |       | 32,332 |   | 31,782 |   |
| Diluted                                         |       | 34,519                                |       | 32,613                              |       | 33,930 |   | 32,466 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Cash  dividends per share                       |       | $                                     | 0.0200     |                                | $          | 0.0133 |   | $ | 0.0333 |   | $ | 0.0133 |   |

 

*See notes to condensed consolidated financialstatements*

 

4

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**OptionCare, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)

(in thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Cash flows  from operating activities:                                             |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 10,694     |   | $ | 8,986 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                |       |   |   |
| Depreciation  and amortization                                                     |       | 3,022                               |       | 2,494 |   |
| Provision  for doubtful accounts                                                   |       | 4,479                               |       | 3,021 |   |
| Deferred  income taxes                                                             |       | 663                                 |       | 1,473 |   |
| Income tax  benefit from exercise of stock options                                 |       | 1,388                               |       | 1,148 |   |
| Changes in  assets and liabilities:                                                |       |                                |       |   |   |
| Accounts and  notes receivable                                                     |       | (3,066                              | )          | (1,205 | ) |
| Inventory                                                                          |       | 1,546                               |       | 2,495 |   |
| Accounts  payable                                                                  |       | (5,693                              | )          | (3,685 | ) |
| Income taxes  receivable/payable                                                   |       | 1,639                               |       | 715 |   |
| Change in  other assets and liabilities                                            |       | (2,715                              | )          | (3,582 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash  provided by operating activities                                         |       | 11,957                              |       | 11,860 |   |
|                                                                               |       |                                |       |   |   |
| Cash flows  from investing activities:                                             |       |                                |       |   |   |
| Purchases of  short-term investments                                               |       | (135,288                            | )          | — |   |
| Sales of  short-term investments                                                   |       | 139,060                             |       | — |   |
| Purchases of  equipment and other, net                                             |       | (4,158                              | )          | (2,588 | ) |
| Payments for  acquisitions, net of cash acquired                                   |       | (25,742                             | )          | (1,090 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash  used in investing activities                                             |       | (26,128                             | )          | (3,678 | ) |
|                                                                               |       |                                |       |   |   |
| Cash flows  from financing activities:                                             |       |                                |       |   |   |
| Increase in  financing costs                                                       |       | (161                                | )          | — |   |
| Payments on  capital leases and other debt                                         |       | (13                                 | )          | (387 | ) |
| Proceeds from  issuance of stock                                                   |       | 4,466                               |       | 2,403 |   |
| Payments of  cash dividends to common shareholders                                 |       | (1,077                              | )          | (428 | ) |
| Payments for  purchase of treasury stock                                           |       | —                              |       | (944 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash  provided by financing activities                                         |       | 3,215                               |       | 644 |   |
|                                                                               |       |                                |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (10,956                             | )          | 8,826 |   |
| Cash and  cash equivalents, beginning of period                                    |       | 19,816                              |       | 3,961 |   |
| Cash and  cash equivalents, end of period                                          |       | $                                   | 8,860      |   | $ | 12,787 |   |

 

*See notes to condensed consolidated financialstatements*

 

5

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**OptionCare, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements**

**June 30,2005**

(Unaudited)

 

**1.  Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and six months ended June 30,2005 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2005.

 

The balance sheet at December 31, 2004 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.

 

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

 

For further information, refer to the consolidated financial statementsand footnotes thereto included in Option Care’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

**2.   Long-Term Debt**

 

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

 

The convertible notes are senior unsecured obligations of Option Careand will be convertible into cash and, if applicable, shares of our commonstock based on an initial conversion rate of 55.5278 shares per $1,000principal amount of notes, which represents an initial conversion price of$18.01 per share, subject to adjustment in certain circumstances.  The conversion rate and conversion price weresubsequently adjusted to 83.3338 and $12.00 per share, respectively, pursuantto the terms of the notes as a result of our 3-for-2 common stock split on March 31,2005 and $0.02 per share dividend paid on June 10, 2005.  Note holders may convert their notes intocash and, if applicable, shares of our common stock prior to the statedmaturity only under the following circumstances: (1) during any calendarquarter beginning after December 31, 2004, if the closing sale price ofour common stock for each of 20 or more consecutive trading days in a period of30 consecutive trading days ending on the last trading day of the immediatelypreceding calendar quarter exceeds 120% of the conversion price in effect onthe last trading day of the immediately preceding calendar quarter; (2) duringthe five business day period after any five consecutive trading day period inwhich the average trading price per $1,000 principal amount of notes was equalto or less than 97% of the average conversion value of the notes during thenote measurement period; (3) upon the occurrence of specified corporatetransactions; or (4) if we have called the notes for redemption.  In general, upon conversion, the holder ofeach note will receive the conversion value of the note payable in cash, up tothe principal amount of the note, and common stock for the notes’ conversionvalue in excess of such principal amount (plus an additional cash payout inlieu of fractional shares).  If the notesare surrendered for conversion in connection with certain fundamental changesthat occur before November 1, 2009, holders will in certain circumstancesalso receive a make-whole premium in addition to the cash and shares thatholders are otherwise entitled to receive upon conversion.  The convertible senior notes will mature on November 1,2024 and will not be redeemable by us prior to November 1, 2009.  Holders of the convertible notes may requireus to repurchase all or a portion of the convertible notes for cash on November 1,2009, 2014 and 2019.  Interest will bepaid at 2.25% per annum, payable semi-annually in arrears on May 1 and November 1of each year to the holders of record at the close of business on the precedingApril 15 and October 15, respectively.  The notes are senior unsecured obligationsand will rank equally with all of our existing and future senior unsecuredindebtedness.

 

6

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**3.   Earnings Per Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated. All share and per share amounts reflect the 3-for-2 stock spliteffective March 31, 2005 for shareholders of record on March 17,2005. (in thousands, except per share amounts):

 
| ** **                                                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic:                                                                          |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                      |       | $                                     | 5,409      |                                | $          | 4,701 |   | $ | 10,694 |   | $ | 8,986 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Average  shares outstanding                                                     |       | 32,559                                |       | 31,923                              |       | 32,332 |   | 31,782 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Basic  earnings per share                                                       |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.28 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Diluted:                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                      |       | $                                     | 5,409      |                                | $          | 4,701 |   | $ | 10,694 |   | $ | 8,986 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Average  shares outstanding                                                     |       | 32,559                                |       | 31,923                              |       | 32,332 |   | 31,782 |   |
| Net effect  of dilutive stock options – Based on the treasury stock method |       | 1,025                                 |       | 690                                 |       | 1,023 |   | 684 |   |
| Net effect  of dilutive contingently convertible debt (1)                       |       | 935                                   |       | 3⁄4                              |       | 575 |   | 3⁄4 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  diluted shares                                                           |       | 34,519                                |       | 32,613                              |       | 33,930 |   | 32,466 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Diluted  earnings per share                                                     |       | $                                     | 0.16       |                                | $          | 0.14 |   | $ | 0.32 |   | $ | 0.28 |   |

 

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(1)  Weightedaverage shares issuable upon conversion of all $86.3 million of our 2.25%convertible senior notes due 2024.

 

**4.  Operating Segments**

 

We have one identifiable business segment, with three service lines:specialty pharmacy services; infusion and related healthcare services; andother.

 

•      **Specialty pharmacy services** involve thedistribution of injectible and infused pharmaceuticals to treat a wide range ofchronic health conditions.  The pharmaceuticals can be directlydistributed to the patient’s home or to their physician’s office for in-officeadministration.  These pharmaceuticals may require refrigeration duringshipping as well as special handling to prevent potency degradation. Patients receiving treatment usually require special counseling and educationregarding their condition and treatment program.

 

•      **Infusion and related healthcare services**primarily involve the intravenous administration of medications at the patient’shome or other non-hospital sites such as one of our infusion suites. Infusion pharmacy services treat a wide range of acute and chronic healthconditions, including infections, dehydration, cancer, pain and nutritionaldeficiencies.  All of our company-owned pharmacies provide infusionpharmacy services.  Some of these pharmacies also provide relatedhealthcare services, such as home health nursing, home hospice services,respiratory therapy services and durable medical equipment.

 

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

 

**5.  Significant Customers and Concentration of Credit Risk**

 

We generate the majority of our revenue from managed care contracts andother agreements with commercial third party payors by providing health careservices to their members.  Our principalmanaged care contract is with Blue Cross and Blue Shield of Florida, to whosemembers we provide infusion pharmacy services and specialty pharmacyservices.  The contract may be terminatedby either party on 90 days’ notice and, unless terminated, renews annually eachSeptember for an additional one-year term. We also generate revenue from government healthcare programs such asMedicare and Medicaid.

 

7

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The following table sets forth information regarding revenue and accountsreceivable related to our most significant payors as of the dates and for theperiods presented:

 
| ** **                             | ** ** | **Revenue**                           | ** ** | ** **                          | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** | **Accounts Receivable** | ** ** |
| **June 30,**                      | ** ** | **December 31,**                 |
| ** **                             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                   |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Blue Cross  and Blue Shield of Florida |       | 14                                    | %          | 16                                  | %          | 14 | % | 15 | % | 9 | % | 7 | % |
| Medicare &  Medicaid          |       | 17                                    | %          | 20                                  | %          | 17 | % | 20 | % | 20 | % | 18 | % |
| All other  payors (1)                  |       | 69                                    | %          | 64                                  | %          | 69 | % | 65 | % | 71 | % | 75 | % |
|                                   |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Total                                  |       | 100                                   | %          | 100                                 | %          | 100 | % | 100 | % | 100 | % | 100 | % |

 

----

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

 

**6.****     SeasonalRevenue Trends**

 

Synagis®, one of the specialty pharmaceuticals that we provide topatients, is seasonal.  Synagis® is adrug used for the prevention of respiratory synctial virus (RSV) in high-riskpediatric patients. RSV infection is a seasonal condition, with the seasongenerally lasting from October through April.

 

Option Care’s quarterly Synagis® revenue for the year 2004 and thefirst two quarters of 2005 was as follows (amounts in thousands):

 

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

 

**7.****     Acquisitions**

 

During the quarter ended June 30, 2005, we completed threeacquisitions of home infusion pharmacy businesses.  Two of the acquired businesses were currentor former Option Care franchises, while the third was an independent,non-affiliated home infusion provider. On April 8, 2005, we acquired the assets of our franchisee servingIndianapolis, Indiana and surrounding areas. Effective May 1, 2005, we acquired the outstanding stock of anindependent home infusion pharmacy business operating in Montana.  As of June 1, 2005, we acquired theoutstanding stock of our former franchisee in Bakersfield, California.  These acquisitions continued our objective ofexpanding our overall national presence of company-owned home infusionpharmacies.  We have consolidated theresults of operations of these businesses as of the effective dates of theacquisitions. We used $18.7 million in cash upon closing these transactions andwill also issue 48,315 shares of our common stock, valued at a market price of$13.31 per share, in an unregistered offering. Each acquisition contains a provision for payment of additionalconsideration in future periods if various performance measures areachieved.  We anticipate that any suchadditional consideration would be recorded as goodwill.  From the initial purchase payments, werecorded $12.9 million in goodwill from these transactions and expect theentire amount to be deductible for income tax purposes.

 

The following table sets forth the allocation of purchase price, inaggregate, for the three acquisitions we completed in the quarter ended June 30,2005.  For certain of our acquisitions,the allocation of purchase price is tentative and subject to adjustment basedon final valuation of the acquired assets (amounts in thousands):

 

8

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| **Purchase  Price:**                           |   |   |   |
|------------------------------------------------|--------|--------|--------|
| Paid in cash  at closing                       |   | $      | 18,643 |   |
| Payable in  shares of Option Care common stock |   | 643    |   |
| Liabilities  assumed                           |   | 310    |   |
|                                           |   |   |   |
| Total  purchase price                          |   | $      | 19,596 |   |
|                                           |   |   |   |
| **Allocation  of Purchase Price:**             |   |   |   |
| Accounts receivable                            |   | $      | 5,114  |   |
| Inventory                                      |   | 736    |   |
| Other  tangible assets                         |   | 625    |   |
| Goodwill                                       |   | 12,901 |   |
| Other  intangible assets                       |   | 220    |   |
|                                           |   |   |   |
| Total  purchase price                          |   | $      | 19,596 |   |

 

In addition to our new acquisitions, during the six months ended June 30,2005, we recorded $500,000 in goodwill equal to the additional cashconsideration we expect to pay related to our 2004 acquisitions.  The additional consideration is based uponthe achievement of performance targets contained in the purchase agreements forthe acquired businesses.  This additionalgoodwill is expected to be fully deductible for income tax purposes.

 

**8.****     Franchise-relatedRevenue**

 

We maintain a national franchise network through which we generate aportion of our revenue.  Ourfranchise-related revenues include: (1) royalties; (2) vendor rebatesand administration fees; and (3) franchise settlement and relatedfees.  Each of these types of revenue canfluctuate over time, with the largest potential fluctuations relating tofranchise terminations.

 

During the six months ended June 30, 2005, we recorded franchisesettlement revenue related to two of our former franchisees.  During the quarter ended June 30, 2005,we recorded $2.0 million related to the termination of one of ourfranchisees, of which $1.7 million was related to release of future obligationsunder the franchise agreement and $300,000 represented settlement ofunder-reported royalties from prior periods discovered during our audit oftheir books and records.  During thequarter ended March 31, 2005, we acquired our franchise in St. Cloud,Minnesota.  As part of the transaction,we terminated the franchise agreement early and recorded a settlement gain of$800,000, which was equal to the present value of the excess of the estimatedfuture royalty payments receivable under the franchise agreement over currentmarket rates.

 

During the quarter and six months ended June 30, 2004, we recordedrevenue of $400,000 and $900,000, respectively, related to the termination ofone of our franchisees.  This revenue wasprimarily related to the amortization of a non-competition agreement we signedwith the buyers of the franchisee's business. We also recorded $100,000 in revenue during the quarter endedMarch 31, 2004 related to a settlement reached with a former franchisethat had been terminated in 2003.

 

Our franchise-related revenue is included in our “Other” serviceline.  The following table sets forth ourfranchise-related revenue for the periods indicated (in thousands):

 
| ** **                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                              | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                    |       |                                  |       |                                |       |   |   |   |   |
| Franchise-related  revenue:             |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Royalties                               |       | $                                     | 2,105      |                                | $          | 1,983 |   | $ | 3,915 |   | $ | 4,077 |   |
| Vendor  rebates and administration fees |       |                                  | 95         |                                |       | 125 |   |   | 189 |   |   | 287 |   |
| Franchise  settlements and related fees |       |                                  | 1,700      |                                |       | 392 |   |   | 2,491 |   |   | 1,036 |   |
|                                    |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Total  franchise-related revenue        |       | $                                     | 3,900      |                                | $          | 2,500 |   | $ | 6,595 |   | $ | 5,400 |   |

 

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

 

Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*, as amended by Statementof Financial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure*, encouraged,but did not require, companies to record compensation cost for stock-basedcompensation plans at fair value.  Wehave chosen to account for stock-based compensation using the intrinsic valuemethod 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 common stock at the date of grant overthe amount an employee must pay to acquire the stock.  We grant options at fair market value andtherefore recognize no compensation expense when options are granted.  Likewise, our Employee

 

9

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Stock Purchase Plan was structured to qualify under Section 423 ofthe Internal Revenue Code. Therefore, no compensation expense is recognizedfrom employees’ purchase of shares under this plan.

 

The following table sets forth our net income and net income per commonshare for the three and six months ended June 30, 2005 and 2004, hadcompensation cost for our stock-based compensation plan been determined basedon FASB Statement No. 123.  Allshare and per share amounts in the following table have been adjusted toreflect the pro forma effects of the 3-for-2 split of our common stock thatbecame effective March 31, 2005 for shareholders of record on March 17,2005 (in thousands, except per share amounts):

 
| ** **                                                                                                                                                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income:                                                                                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                                     | 5,409      |                                | $          | 4,701 |   | $ | 10,694 |   | $ | 8,986 |   |
| 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                                                                                                                                         |       | (239                                  | )          | (367                                | )          | (462 | ) | (699 | ) |
| Employee  stock purchase plan withholdings                                                                                                                   |       | (63                                   | )          | (33                                 | )          | (127 | ) | (68 | ) |
| Pro forma                                                                                                                                                    |       | $                                     | 5,107      |                                | $          | 4,301 |   | $ | 10,105 |   | $ | 8,219 |   |
|                                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Net income  per common share—basic:                                                                                                                     |       |                                  |       |                                |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.28 |   |
| Pro forma                                                                                                                                                    |       | $                                     | 0.16       |                                | $          | 0.13 |   | $ | 0.31 |   | $ | 0.26 |   |
|                                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Net income per common share—diluted:                                                                                                                    |       |                                  |       |                                |       |   |   |   |   |
| As reported                                                                                                                                                  |       | $                                     | 0.16       |                                | $          | 0.14 |   | $ | 0.32 |   | $ | 0.28 |   |
| Pro forma                                                                                                                                                    |       | $                                     | 0.15       |                                | $          | 0.13 |   | $ | 0.30 |   | $ | 0.25 |   |

 

The fair value of options granted under our stock option plan duringthe three and six months ended June 30, 2005 and 2004 was estimated on thedate of grant using the Black-Scholes option pricing model with the followingassumptions (as pro forma adjusted for our 3-for2 stock split on March 31,2005):

 
| ** **                                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Annual dividend  yield per share                          |       | $                                     | 0.08       |                                | $          | 0.05 |   | $ | 0.08 |   | $ | 0.05 |   |
| Expected  volatility                                      |       | 30                                    | %          | 40                                  | %          | 33 | % | 40 | % |
| Weighted  average risk-free interest rate                 |       | 3.72                                  | %          | 3.10                                | %          | 3.66 | % | 2.86 | % |
| Expected  grant life (years)                              |       | 4.0                                   |       | 4.0                                 |       | 4.0 |   | 4.0 |   |
| Weighted  average per share fair value of options granted |       | $                                     | 3.92       |                                | $          | 2.93 |   | $ | 3.99 |   | $ | 2.85 |   |

 

**10.****  RecentlyIssued Accounting Pronouncement**

 

On December 16, 2004, the Financial Accounting Standards Boardissued Statement of Financial Accounting Standards (SFAS) No. 123(R), *Share-Based Payment*, which will change the way we accountfor employee stock options in future periods. SFAS No. 123(R), which is a revision to SFAS No. 123, *Accounting for Stock-Based Compensation*, supersedes APBOpinion No. 25, *Accounting for StockIssued to Employees,* and amends SFAS No. 95, *Statement of Cash Flows*. Generally, the approach in SFAS No. 123(R) is similar to theapproach described in SFAS No. 123, but with certain enhancements toimprove the accuracy of fair value estimates. However, SFAS 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. Pro forma disclosure is no longer an alternative.

 

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

 

•      A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of Statement 123(R) for allshare-based payments granted after the effective date and (b) based on the

 

10

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requirements of SFAS No. 123 for allawards granted to employees prior to the effective date of Statement 123(R)that remain unvested on the effective date.

 

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

 

Initially, the SEC announced that SFAS No. 123(R) must be adoptedin the first interim or annual period beginning after June 15, 2005.  Subsequently, on April 14, 2005, the SECannounced that calendar year-end companies will be allowed to delayimplementation of the new standard until their first interim period beginningafter December 15, 2005.

 

We will adopt SFAS No. 123(R) in our fiscal quarter ending March 31,2006 and intend to apply the “modified retrospective” method. Adoption of SFAS No. 123(R)may materially affect our results of operations for periods following adoption,but will have no effect on our financial condition.

 

**11.****  QuarterlyDividends**

 

Our Board of Directors initiated a quarterly dividend policy on May 11,2004 and we paid our first quarterly dividend in the quarter ended June 30,2004.  During the quarter ended June 30,2005, our Board of Directors declared a $0.02 per share dividend paid on June 10,2005 to shareholders of record as of May 27, 2005.  In each of the preceding four quarters, wepaid dividends of $0.0133 per share.

 

**12.****  ComprehensiveIncome**

 

Net income wasour only component of comprehensive income for the three and six months ended June 30,2005 and 2004.

 

11

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

 

**FORWARD LOOKING STATEMENTS**

 

The following discussion should be read in conjunction with our AnnualReport on Form 10-K for the year ended December 31, 2004. The PrivateSecurities Litigation Reform Act of 1995 provides a “safe harbor” forforward-looking statements. Certain information included in this QuarterlyReport on Form 10-Q and other materials filed or to be filed by us withthe Securities and Exchange Commission (as well as information included in oralstatements or other written statements made or to be made by us) containstatements that are or will be forward-looking, such as statements relating toacquisitions and other business development activities, future capitalexpenditures and the effects of future regulation and competition. Suchforward-looking information involves important risks and uncertainties thatcould significantly affect anticipated results in the future and, accordingly,such results may differ from those expressed in any forward-looking statementsmade by us, or on our behalf. These risks and uncertainties include, but arenot limited to, uncertainties affecting our businesses and our franchiseesrelating to acquisitions and divestitures (including continuing obligationswith respect to completed transactions), sales and renewals of franchises,government and regulatory policies (including federal, state and local effortsto reform the delivery of and payment for healthcare services), generaleconomic conditions (including economic conditions affecting the healthcareindustry in particular), the pricing and availability of equipment andservices, technological developments and changes in the competitive environmentin which we operate.  For a morecomprehensive description of risks applicable to our business, see Risk Factorsin our Annual Report on Form 10-K for the year ended December 31,2004.

 

**OVERVIEW**

 

We provide specialty pharmacy services and infusion pharmacy and otherrelated healthcare services to patients at home or at other alternate sitessuch as infusion suites and physician’s offices.  We contract with managed care organizationsand other third party payors who reimburse us for the services we provide totheir subscriber members.  Our servicesare provided through our national network of company-owned and franchise-ownedpharmacies and our two central, high-volume drug distribution facilities.

 

We have three service lines: specialty pharmacy services, infusion andrelated healthcare services, and other. Specialty pharmacy services involve thedistribution of injectible and infused pharmaceuticals to treat a wide range ofchronic health conditions.  The pharmaceuticalscan be directly distributed to the patient’s home or to their physician’soffice for in-office administration. Depending on therapy type, we may also administer specialtypharmaceuticals to patients at our ambulatory infusion centers. Thesepharmaceuticals may require refrigeration during shipping as well as specialhandling to prevent potency degradation. Patients receiving treatment usually require special counseling andeducation regarding their condition and treatment program.  Infusion and related services primarilyinvolves the intravenous administration of medications at the patient’s home orother non-hospital site 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 therapies. Some ofthese pharmacies also provide related healthcare services, such as home healthnursing, home hospice services, respiratory therapy services and durablemedical equipment.  Other revenueconsists of royalties and other fees generated from our franchised pharmacynetwork and the software licensing and support revenue generated by oursubsidiary, MBI.

 

Summarized information about revenues and gross profit for each of ourservice lines is provided in the following table (amounts in thousands):

 

**REVENUE**

 
| ** **                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                               | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Revenue**                          | ** ** | **%****of  total**                 | ** ** | **Revenue** | ** ** | **%****of  total** | ** ** | **Revenue** | ** ** | **%****of  total** | ** ** | **Revenue** | ** ** | **%****of  total** | ** ** |
|                                     |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services             |       | $                                    | 67,600     |                               | 56.6       | % | $ | 58,407 |   | 59.2 | % | $ | 142,497 |   | 59.3 | % | $ | 123,339 |   | 61.1 | % |
| Infusion and related healthcare services |       | 47,690                               |       | 39.9                               | %          | 37,450 |   | 38.0 | % | 90,538 |   | 37.7 | % | 72,396 |   | 35.9 | % |
| Other                                    |       | 4,201                                |       | 3.5                                | %          | 2,794 |   | 2.8 | % | 7,211 |   | 3.0 | % | 6,065 |   | 3.0 | % |
| Total  revenue                           |       | $                                    | 119,491    |                               | 100.0      | % | $ | 98,651 |   | 100.0 | % | $ | 240,246 |   | 100.0 | % | $ | 201,800 |   | 100.0 | % |

 

12

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**GROSS PROFIT**

 
| ** **                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                               | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Gross  Profit**                    | ** ** | **Gross  profit  margin**          | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** | **Gross  Profit** | ** ** | **Gross  profit  margin** | ** ** |
|                                     |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services             |       | $                                    | 10,307     |                               | 15.2       | % | $ | 10,059 |   | 17.2 | % | $ | 21,860 |   | 15.3 | % | $ | 20,585 |   | 16.7 | % |
| Infusion and related healthcare services |       | 20,555                               |       | 43.1                               | %          | 16,334 |   | 43.6 | % | 39,353 |   | 43.5 | % | 31,363 |   | 43.3 | % |
| Other                                    |       | 4,098                                |       | 97.6                               | %          | 2,645 |   | 94.7 | % | 7,010 |   | 97.2 | % | 5,787 |   | 95.4 | % |
| Total gross  profit                      |       | $                                    | 34,960     |                               | 29.3       | % | $ | 29,038 |   | 29.4 | % | $ | 68,223 |   | 28.4 | % | $ | 57,735 |   | 28.6 | % |

 

The majority of our revenue is generated from managed care contractsand other agreements with commercial third party payors.  Our principal managed care contract is withBlue Cross Blue Shield of Florida. For the three and six months ended June 30,2005, approximately 14% of our revenue was generated from this contractcompared to 16% and 15%, respectively, for the corresponding periods in theprior year.  As of June 30, 2005 andDecember 31, 2004, respectively, 9% and 7% of our accounts receivable wasdue from Blue Cross Blue Shield of Florida. The contract may be terminated byeither party on 90 days’ notice and, unless terminated, renews annually each September foran additional one-year term.

 

We also generate revenue from government healthcare programs such asMedicare and Medicaid.  For the three andsix months ended June 30, 2005, approximately 17% of our revenue was generatedfrom government healthcare programs compared to 20% for the corresponding threeand six month periods in the prior year. As of June 30, 2005 and December 31, 2004, respectively, 20%and 18% of our total accounts receivable was due from government healthcareprograms.

 

13

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**RESULTS OF OPERATIONS**

 

The following table shows the results of our operations for the threeand six months ended June 30, 2005 and 2004, expressed in amounts andpercentages of revenue (amounts in thousands):

 
| ** **                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **Amount**                           | ** ** | **% of  Revenue**                  | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** |
| Revenue:                                      |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services                  |       | $                                    | 67,600     |                               | 56.6       | % | $ | 58,407 |   | 59.2 | % | $ | 142,497 |   | 59.3 | % | $ | 123,339 |   | 61.1 | % |
| Infusion and  related healthcare services     |       | 47,690                               |       | 39.9                               | %          | 37,450 |   | 38.0 | % | 90,538 |   | 37.7 | % | 72,396 |   | 35.9 | % |
| Other                                         |       | 4,201                                |       | 3.5                                | %          | 2,794 |   | 2.8 | % | 7,211 |   | 3.0 | % | 6,065 |   | 3.0 | % |
| Total  revenue                                |       | 119,491                              |       | 100.0                              | %          | 98,651 |   | 100.0 | % | 240,246 |   | 100.0 | % | 201,800 |   | 100.0 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of  revenue:                             |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of  goods sold                           |       | 71,750                               |       | 60.0                               | %          | 58,997 |   | 59.8 | % | 147,442 |   | 61.4 | % | 122,805 |   | 60.9 | % |
| Cost of services  provided                    |       | 12,781                               |       | 10.7                               | %          | 10,616 |   | 10.8 | % | 24,581 |   | 10.2 | % | 21,260 |   | 10.5 | % |
| Total cost  of revenue                        |       | 84,531                               |       | 70.7                               | %          | 69,613 |   | 70.6 | % | 172,023 |   | 71.6 | % | 144,065 |   | 71.4 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                  |       | 34,960                               |       | 29.3                               | %          | 29,038 |   | 29.4 | % | 68,223 |   | 28.4 | % | 57,735 |   | 28.6 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses |       | 23,509                               |       | 19.7                               | %          | 19,200 |   | 19.5 | % | 45,050 |   | 18.7 | % | 38,449 |   | 19.1 | % |
| Provision  for doubtful accounts              |       | 2,153                                |       | 1.8                                | %          | 1,462 |   | 1.5 | % | 4,479 |   | 1.9 | % | 3,021 |   | 1.5 | % |
| Depreciation  and amortization                |       | 849                                  |       | 0.7                                | %          | 569 |   | 0.5 | % | 1,753 |   | 0.7 | % | 1,250 |   | 0.6 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  operating expenses                     |       | 26,511                               |       | 22.2                               | %          | 21,231 |   | 21.5 | % | 51,282 |   | 21.3 | % | 42,720 |   | 21.2 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating  income                             |       | 8,449                                |       | 7.1                                | %          | 7,807 |   | 7.9 | % | 16,941 |   | 7.1 | % | 15,015 |   | 7.4 | % |
| Interest  income (expense), net               |       | 194                                  |       | 0.1                                | %          | 34 |   | — | % | 150 |   | — | % | 35 |   | — | % |
| Other  expense, net                           |       | 100                                  |       | 0.1                                | %          | (12 | ) | — | % | 53 |   | — | % | (79 | ) | — | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income  before income taxes                   |       | 8,743                                |       | 7.3                                | %          | 7,829 |   | 7.9 | % | 17,144 |   | 7.1 | % | 14,971 |   | 7.4 | % |
| Income tax  provision                         |       | 3,334                                |       | 2.8                                | %          | 3,128 |   | 3.1 | % | 6,450 |   | 2.6 | % | 5,985 |   | 2.9 | % |
|                                          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                    |       | $                                    | 5,409      |                               | 4.5        | % | $ | 4,701 |   | 4.8 | % | $ | 10,694 |   | 4.5 | % | $ | 8,986 |   | 4.5 | % |

 

**Three and Six Months Ended June 30, 2005and 2004**

 

For the quarter ended June 30, 2005, we generated revenue of$119.5 million, an increase of 21.1% over the corresponding prior yearquarter.  For the six months ended June 30,2005, our revenue was $240.2 million, and increase of 19.1% over the prioryear.  This revenue growth was the resultof acquisitions, start-ups and an increase in same store sales.  Gross profit margins remained steady acrossmost therapies, with the exception of IVIG (immune globulin).  Supply shortages of IVIG throughout 2005 havesignificantly increased its cost, reducing our margin on this therapy.  Our overall specialty pharmacy gross profitmargin declined to 15.2% in the quarter ended June 30, 2005 compared to17.2% in the corresponding prior year quarter, primarily due to the increasedcost of IVIG.  Despite this marginpressure, our net income increased by 15.1% to $5.4 million for the quarterended June 30, 2005 compared to $4.7 million in the prior year quarter asa result of revenue growth through increased same store sales, acquisitions andstart-ups, and an increase in franchise-related revenue.  For the six months ended June 30, 2005,net income was $10.7 million, an increase of 19.0% over the $9.0 million netincome in the prior year period.  Netincome per diluted share was $0.16 for the quarter and $0.32 for the six monthsended June 30, 2005, compared to $0.14 and $0.28 for the respectivequarter and six months in the prior year. We paid a cash dividend of $0.02 per share during the quarter ended June 30,2005 compared to $0.0133 in the prior year quarter.

 

Our operating cash flow has continued to be positive.  We generated $12.0 million in cash from operationsduring the six months ended June 30, 2005 with $4.8 million of this totalgenerated in the quarter ended June 30, 2005.  We used $25.7 million in cash to completefive business acquisitions thus far in 2005, with three of these acquisitionstaking place in the quarter ended June 30,

 

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2005.  We plan to continueevaluating potential acquisitions that we believe will add to shareholdersvalue, as well as pursuing start-ups and strategic joint ventures. We will alsocontinue to pursue opportunities to expand our business through increasedmarket penetration and by partnering with biotech manufacturers on the releaseof new specialty drugs.  As of June 30,2005, we had $8.9 million of cash and cash equivalents and $71.6 million inshort-term investments, while our debt primarily consisted of $86.3 million of2.25% convertible senior notes due 2024.

 

**Revenue:**

We report our operating results in one segment, consisting of threeservice lines: specialty pharmacy services; infusion and related healthcareservices; and other.  For the three andsix months ended June 30, 2005, our revenue was $119.5 million and $240.2million, respectively, representing increases of 21.1% and 19.1% over thecorresponding prior year periods.  Ourincreases in revenue were primarily due to same store sales growth and from theeffects of acquisitions and start-ups.

 

**Specialty pharmacy services revenue:**

Our specialty pharmacy services revenue for the quarter ended June 30,2005 was $67.6 million, an increase of $9.2 million, or 15.7%, over thecorresponding prior year quarter.  For thesix months ended June 30, 2005, specialty revenue was $142.5 million, anincrease of $19.2 million, or 15.5%, over the corresponding period in the prioryear.  Three main factors contributed tothis growth:  acquisitions and startups;increased sales of Xolair; and increased market penetration for various otherspecialty drugs and therapies.  Wecompleted three acquisitions during the quarter ended June 30, 2005 andfive acquisitions overall so far this year. All of the acquired businesses are infusion therapy providers that alsodistribute specialty drugs for various therapies, adding to our revenue basefor both of these service lines.  OurXolair revenue steadily increased throughout 2004 after the drug became availablelate in 2003 for the treatment of moderate to severe allergic asthma.  We continue to see sequential quarterlyincreases in sales of Xolair, but at a more modest rate than during 2004.  In addition, revenue from various otherspecialty products, such as growth hormone and blood clotting factor, increasedon a same store basis during the current year periods as a result of focusedmarketing efforts.  On a sequentialquarterly basis, our specialty pharmacy services revenue decreased due to theseasonal effect of Synagis, a drug used during the colder months to preventrespiratory synctial virus infection in premature and other high-riskinfants.  With the wind-down of thecurrent Synagis season, our Synagis revenue declined to $4.5 million in the quarterended June 30, 2005 compared to $15.5 million in the quarter ended March 31,2005.

 

**Infusion and related healthcare servicesrevenue:**

Our infusion and related healthcare services revenue for the quarterended June 30, 2005 was $47.7 million, an increase of $10.2 million, or27.3%, over the prior year quarter.  Forthe six months ended June 30, 2005, infusion and related healthcareservices revenue was $90.5 million, an increase of $18.1million, or 25.1%, overthe corresponding prior year quarter. Our increases in revenue have been due to same store sales growth,acquisitions, and start-ups.  Same storesales have grown at a rate of 12.2% in the quarter ended June 30, 2005compared to the prior year quarter, and 14.0% in the six months ended June 30,2005 compared to the corresponding prior year period.  Increases have occurred across a wide varietyof therapies.

 

**Other revenue:**

Other revenue consists of two primary elements: (1) revenuegenerated from our franchise network, consisting of royalties, franchise feesand vendor rebates earned through our franchises’ purchases under ourcontracts, and; (2) software licensing and support services provided byour wholly-owned subsidiary, MBI. Other revenue was $4.2 million for thequarter ended June 30, 2005 compared to $2.8 million in the correspondingprior year quarter.  For the six monthsended June 30, 2005, other revenue was $7.2 million compared to $6.1million in the prior year period.  Theseincreases in other revenue in the current year periods were due to franchiseterminations, audits and settlements. Franchise-related revenue may continue to fluctuate significantly infuture periods due to our potential acquisition, audit or termination ofvarious franchises.  Our software revenuein the current periods was immaterial in amount and consistent with the prioryear periods.

 

**Cost of revenue:**

Cost of revenue consists of the cost of goods sold and the cost ofservice provided. Cost of goods primarily consists of the cost of drugs andmedical supplies used in the provision of services to our patients, as well asdepreciation expense for medical equipment rented to patients.  Cost of service consists of salaries andrelated 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, includingdepreciation of delivery vehicles.

 

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The following table presents our cost of revenue for the quarter andsix months ended June 30, 2005 and 2004 (in thousands):

 
| ** **                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **Dollar  Change** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Dollar  Change** | ** ** | **Percent  Change** | ** ** |
| Cost of  revenue:          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of  goods sold        |       | $                                    | 71,750     |                               | $          | 58,997 |   | $ | 12,753 |   | 21.6 | % | $ | 147,442 |   | $ | 122,805 |   | $ | 24,637 |   | 20.1 | % |
| Cost of  services provided |       | 12,781                               |       | 10,616                             |       | 2,165 |   | 20.4 | % | 24,581 |   | 21,260 |   | 3,321 |   | 15.6 | % |
| Total cost  of revenue     |       | $                                    | 84,531     |                               | $          | 69,613 |   | $ | 14,918 |   | 21.4 | % | $ | 172,023 |   | $ | 144,065 |   | $ | 27,958 |   | 19.4 | % |

 

The increases in cost of revenue of 21.4% and 19.4% for the quarter andsix months ended June 30, 2005 over the respective prior year periods wereprimarily due to our 21.1% and 19.1% increases in revenue over the sameperiods.  Cost of goods sold increased ata higher rate than revenue primarily because of supply shortages for IVIG whichresulted in a higher cost of goods and lower gross profit margin for that drug,and due to increased sales of Xolair in the current year periods.

 

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

 
| ** **                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross profit  margin:                     |       |                                  |       |                                |       |   |   |   |   |
| Specialty  pharmacy services              |       | 15.2                                  | %          | 17.2                                | %          | 15.3 | % | 16.7 | % |
| Infusion and  related healthcare services |       | 43.1                                  | %          | 43.6                                | %          | 43.5 | % | 43.3 | % |
| Other                                     |       | 97.6                                  | %          | 94.7                                | %          | 97.2 | % | 95.4 | % |
| Overall  gross profit margin              |       | 29.3                                  | %          | 29.4                                | %          | 28.4 | % | 28.6 | % |

 

Our overall gross profit margins in the current year have remainedconsistent with the prior year.  Withinour services lines, the gross profit margin on our specialty pharmacy services hasdecreased, the margin on infusion and related healthcare services has remainedsteady and the margin on our other revenue has increased.  Our specialty pharmacy services gross profitmargin declined by 200 basis points in the quarter ended June 30, 2005compared to the prior year quarter and 140 basis points in the six months endedJune 30, 2005 compared to the corresponding prior year period.  This decline was primarily due to supplyshortages of IVIG which drove up the cost of that drug and reduced our grossprofit margins.  Our margin on otherrevenue improved in 2005 due to an increase in franchise-related revenuerelated to our acquisition of one franchisee and termination of another.  Other revenue, which consists offranchise-related revenues and software sales and support, has minimal directcosts and therefore produces a high gross profit margin.  Our infusion and related healthcare servicesgross profit margins have remained fairly consistent.  The 50 basis point decline in margin for infusionand related healthcare services in the quarter ended June 30, 2005 was due to aone-time adjustment to depreciation expense for certain respiratory equipmentas a result of a change in our estimate of useful life.

 

**Selling, general and administrative expenses:**

For the quarter ended June 30, 2005, selling, general andadministrative expenses were $23.5 million, an increase of $4.3 million, or22.4% over the prior year quarter.  Forthe six months ended June 30, 2005, selling, general and administrativeexpenses were $45.1 million, an increase of $6.6 million, or 17.2%, over theprior year period.  Wages and relatedcosts increased by $3.2 million and $5.0 million in the quarter and six monthsended June 30, 2005 as a result of business acquisitions, increases incorporate and field staff and merit wage adjustments.  Travel-related expenses, professionalservices and building rent also increased, in part due to acquisitions andacquisition-related activities. Professional services also increased in part due to incremental costs ofcomplying with Section 404 of the Sarbanes-Oxley Act of 2002.

 

**Provision for doubtful accounts:**

Our provision for doubtful accounts for the quarter ended June 30,2005 was $2.2 million, or 1.8% of revenue, compared to $1.5 million, or 1.5% ofrevenue, in the prior year period.  Forthe six months ended June 30, 2005, our provision for doubtful accountswas $4.5 million, or 1.9% of revenue, compared to $3.0 million, or 1.5% ofrevenue, in the corresponding prior year period.  The slight

 

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increase in our provision for doubtful accounts in both dollar amountand percentage of revenue was primarily due to the effects of our acquisitionsand growth in same store sales at our company-owned local pharmacies.  We provide for doubtful accounts at a higherrate at our local pharmacies than at our two high-volume distributionpharmacies.  Therefore, as we acquiredadditional local pharmacies and generated higher revenue at our existing localpharmacies, our blended bad debt provision rate increased slightly in thecurrent year periods as a percentage of revenue.

 

**Depreciation and amortization:**

For the quarter ended June 30, 2005, depreciation and amortizationexpense was $800,000, an increase of $300,000, or 49.2%, over the correspondingprior year quarter.  For the six monthsended June 30, 2005, our depreciation and amortization expense was $1.8million, an increase of $500,000, or 40.2%, over the corresponding prior yearperiod.  The primary causes of theseincreases are the depreciation of internally-developed software products andthe amortization of deferred financing costs generated by our $86.3 millionoffering of 2.25% convertible senior notes, completed in November 2004.  The depreciation expense contained withinthis line item relates to non-revenue producing assets only, such as furnitureand fixtures and leasehold improvements. Depreciation for revenue-producing equipment such as rental medical equipmentand delivery vehicles in included in cost of revenue.

 

**Operating income:**

Our operating income was $8.4 million in the quarter ended June 30,2005, an increase of $600,000, or 8.2%, over the corresponding prior yearquarter.  For the six months ended June 30,2005, our operating income was $16.9 million, which represents an increase of$1.9 million, or 12.8%, over the prior year period.  These increases in operating income wereprimarily the result of same store sales growth, acquisition activities and anincrease in franchise-related revenue. As a percentage of revenue, our operating income was 7.1% for thequarter and six months ended June 30, 2005 compared to 7.9% for thequarter ended June 30, 2004 and 7.4% for the six months ended June 30,2004.  These declines were primarily dueto supply shortages of IVIG, which reduced our gross profit margin on thisproduct and reduced our operating income in the current year periods.

 

**Interest Income/(Expense):**

Our interest income, net of interest expense, was $194,000 and $150,000for the quarter and six months ended June 30, 2005, respectively.  In the prior year periods, our interestincome was $34,000 and $35,000 for the respective quarter and six months ended June 30,2004.  We completed an $86.3 millionoffering of 2.25% convertible senior notes in November 2004.  In the current year periods, our interestexpense was primarily from these convertible notes and our interest income wasearned from investing the proceeds from this debt offering.  The interest earned on our investmentsexceeded the interest expense on the convertible notes, resulting in netinterest income during the current year periods.  In the prior year periods, we had virtuallyno debt and our net interest income was earned from investing our cashreserves.

 

**Income taxes:**

Our income tax provision was $3.3 million for the quarter and $6.5million for the six months ended June 30, 2005.  In the prior year, our income tax provisionwas $3.1 million for the quarter and $6.0 million for the six months ended June 30,2004.  As a percentage of pre-tax income,our provision for income taxes was 38.1% for the quarter and 37.6% for the sixmonths ended June 30, 2005 compared to 40.0% for the corresponding prioryear periods.  The decline in income taxprovision as a percentage of pre-tax income is primarily due to twofactors:  re-evaluation of our effectivestate income tax rate based on our reduced state tax exposure reserve; and anincrease in tax-exempt interest income earned from our short-term investments.

 

**Net income:**

Our net income was $5.4 million for the quarter and $10.7 million forthe six months ended June 30, 2005 compared to $4.7 million for thequarter and $9.0 million for the six months ended June 30, 2004.  Our growth in revenue from same store salesincreases, acquisitions and start-ups and an increase in franchise terminationrevenue were the primary causes of our increase in net income over theperiod.  As a percentage of revenue, ournet income was equal to 4.5% for both the quarter and six months ended June 30,2005 compared to 4.8% for the quarter and 4.5% for the six months ended June 30,2004.

 

**Diluted shares & earnings per share:**

We completed a 3-for-2 stock split on March 31, 2005.  All share and per share amounts in thisquarterly report reflect the pro forma effects of this split.  Our earnings per diluted share were $0.16 forthe quarter and $0.32 for the six months ended June 30, 2005, representingincreases of 14.3% over our earnings per diluted share of $0.14 for the quarterand $0.28 for the six months ended June 30, 2004.  Total diluted shares were 34.5 million forthe quarter and 33.9 million for the six months ended June 30, 2005compared to diluted shares of 32.6 million for the quarter and 32.5 million forthe six months ended June 30, 2004. These increases in diluted shares were due to a number of factors,including (1) an increase in the dilutive effect of our contingentlyconvertible debt, (2) the dilutive effect of employee stock options andshares issued and issuable under our employee stock purchase plan and stockincentive plan, and (3) new shares issued and to be issued as partialpayment for acquisitions.  Theseincreases were partially offset by our purchase and subsequent retirement of474,000 shares of treasury stock in the quarter ended December 31,2004.  Our contingently

 

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convertible debt accounted for 900,000 shares of the total 1.9 millionshare increase in diluted shares for the quarter ended June 30, 2005 overthe corresponding prior year quarter.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

During the six months ended June 30, 2005, we financed ouroperations and business acquisitions through operating cash flows and the useof cash reserves and proceeds generated from our $86.3 million offering of 2.25%convertible senior notes, completed in November 2004.  During the six months ended June 30,2005, we generated $12.0 million in cash flow from operations.  We also used $25.7 million in cash duringthis period for business acquisitions. We continue to evaluate opportunitiesfor potential business acquisitions, start-ups and joint ventures that webelieve will be accretive to future earnings. Accordingly, we may need to seek additional sources of capital in the futureto fund these activities.  As of June 30,2005, we had cash and short-term investments totaling $80.5 million and totallong-term debt of $86.3 million.

 

**Operating Cash Flows:**

We generated $12.0 million in positive cash flow from operations in thesix months ended June 30, 2005. This positive cash flow was primarily the result of our net income of$10.7 million in the current year period, as well as our consistent collectionof accounts receivable.  Also, of thecurrent period $12.0 million of positive operating cash flow, $1.6 million was dueto the timing of our income tax payments and $1.4 million was the result of taxcredits from employee stock option exercises.

 

For the six-month period ended June 30, 2004, we generated $11.9million of positive operating cash flow. The positive cash flow was primarily due to our net income during theperiod and our accounts receivable collection performance.  Additionally, our operating cash flowbenefited during this period from a federal income tax overpayment carried overfrom 2003.

 

**Investing Cash Flows:**

We used $26.1 million in cash in investing activities during the sixmonths ended June 30, 2005.  Of thistotal, $25.7 million was used to complete five business acquisitions during theperiod, with the majority of this expenditure occurring in the quarter ended June 30,2005.  We also used $4.2 million toacquire equipment and other fixed assets, of which $1.2 million was used topurchase a new software system for our specialty drug distribution business,$1.5 million was used for infrastructure items such as furniture, fixtures andcomputer hardware, $1.1 million was used to acquire revenue-generating medicalequipment such as infusion pumps and other durable medical equipment, and$400,000 was used for internally-developed software projects.  During the six months ended June 30,2005, we generated a net $3.8 million in cash from the liquidation ofshort-term investments to help fund our acquisition payments.

 

In the prior year period ending June 30, 2004, we used $3.7million in investing activities.  Of thistotal, we used $1.1 million to acquire two small businesses and used $2.6million for the purchase of equipment and other fixed assets.  Of this total, $1.5 million was used toacquire infusion pumps and other revenue-generating medical equipment, $600,000was used for infrastructure improvement and $500,000 was used on internally andexternally developed software products.

 

**Financing Cash Flows:**

Financing activities generated a net $3.2 million in positive cash flowduring the six months ended June 30, 2005. We generated $4.5 million in cash from issuance of shares of commonstock to employees who exercised stock options or participated in our employeestock purchase plan, and we used $1.1 million to pay cash dividends to ourshareholders.  We also used $200,000 topay trailing debt issuance costs related to our convertible debt offering from November 2004.

 

In the prior year period ending June 30, 2004, financingactivities generated $600,000 in cash flow. We generated $2.4 million from employee stock option exercises andemployee stock purchase plan contributions. This was offset by $900,000 used to purchase treasury stock, $400,000used to pay a cash dividend to our common shareholders and $400,000 used forscheduled debt repayments on capital leases and other fixed-rate debts.

 

**Convertible Senior Notes:**

In November 1, 2004, we completed an $86.3 million offering of2.25% convertible senior notes, due 2024. The purpose of the offering was to finance our future growthinitiatives.  The funds may be used foracquisitions, stock repurchases, operating cash needs and other generalcorporate purposes.  The initial offeringwas completed on November 2, 2004 for $75.0 million, with an option for anadditional $11.3 million.  This optionwas exercised in full on November 9, 2004. We will pay 2.25% interest per annum on the principal amount of thenotes, payable semi-annually in arrears on May 1 and November 1 ofeach year, with the first payment due and paid on May 1, 2005.  The holders may convert the notes into cashand, if applicable, shares of our common stock if certain

 

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conversion criteria are met, such as our stock reaching a thresholdmarket price or various other criteria. The notes cannot be redeemed by us prior to November 1, 2009.  On each of November 1, 2009, November 1,2014 and November 1, 2019, the holders can require us to purchase all or aportion of the outstanding notes for their principal amount plus accruedinterest.  At any time on or after November 1,2009, we may redeem the notes, in whole or in part, at a redemption price equalto 100% of the principal amount, plus any accrued and unpaid interest.  We have incurred deferred financing costs of$3.2 million related to this offering, consisting of underwriting, legal andother related costs.  These costs arebeing amortized straight-line over a five-year period.

 

**Accounts Receivable:**

The following table sets forth information regarding our accountsreceivable as of the dates indicated (dollar amounts in thousands):

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

 

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(1)   DSOis based on trade accounts receivable, net of allowance for doubtful accounts,and is calculated using the exhaustion method whereby the net accountsreceivable balance is exhausted against each preceding month’s or partial month’snet revenue.  The DSO calculated aboveincludes only our specialty pharmacy service line and infusion and related healthcareservice line.

 

Our accounts receivable, net of bad debt reserves, was $72.6 million asof June 30, 2005 compared to $74.1 million at March 31, 2005 and$69.9 million as of December 31, 2004. The quarterly decline in accounts receivable was primarily due to aseasonal decline in Synagis revenue which more than offset the increase relatedto same store sales growth and business acquisitions we completed during thequarter.

 

The following table sets forth the percentage breakdown of our tradeaccounts receivable by aging category and by major payor as of the datesindicated:

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

 

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(1)   Accountsreceivable by aging category considers only accounts of our specialty pharmacyservice line and infusion and related healthcare service line.

 

Our days sales outstanding (DSO) increased to 57 days as of June 30,2005 from 54 days as of March 31, 2005. This increase was due in part to normal fluctuations in the timing ofpayments received under our principal managed care contract with Blue Cross andBlue Shield of Florida.

 

As of June 30, 2005 we had cash and cash equivalents of $8.9million and short-term investments of $71.6 million for a combined

 

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total of $80.5 million available for operations, acquisitions and othercash requirements.  As of December 31,2004, we had cash and cash equivalents of $19.8 million and short-term investmentsof $75.4 million for a combined total of $95.2 million.  The $14.7 million decline in cash, cashequivalents and short-term investments was primarily due to acquisitionactivities, which used $25.7 million in cash during the period.  We generated positive cash flow fromoperations of $12.0 million during the six months ended June 30, 2005,which partially offset our use of cash for acquisitions.  We believe that cash flow from operations andour current reserves of cash and short-term investments will be sufficient tomeet our operating cash needs for the immediate future, including any interestdue on our $86.3 million of 2.25% convertible senior notes.  In the event that additional capital isrequired, there can be no assurance that such capital can be obtained fromother sources on terms acceptable to us, if at all.

 

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

 

**Goodwill and Other Intangible Assets**

 

As of June 30, 2005, we had net goodwill and other intangibleassets of $86.0 million, consisting of $85.3 million of goodwill and $700,000of other intangible assets such as non-competition agreements and managed carecontracts.  As of December 31, 2004,net goodwill and other intangible assets equaled $65.9 million, consisting of$65.4 million of goodwill and $500,000 of other intangible assets.  During the six months ended June 30,2005, goodwill increased $19.9 million as a result of the five businessacquisitions we completed during the period. Other intangible assets increased by $400,000 as a result of theseacquisitions, offset by amortization of $200,000 during the period.

 

As required by Statements of Financial Accounting Standards No. 142,*Goodwill and Other Intangible Assets (SFAS No. 142)*,we do not amortize goodwill, but test our goodwill for impairment annually eachOctober 1, or whenever we identify events or conditions that couldpotentially result in impairment of our goodwill.  During the quarter ended June 30, 2005,no impairment of goodwill was identified.

 

**Regulatory and 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.  TheAdministrative Simplification provisions address electronic health caretransactions and the security of electronic health information systems.  Providers are required to comply with thestandards by specific compliance dates established by HHS.  For standards relating to electronic healthcare transactions, the compliance date was originally set for October 16,2002.  If the covered entity filed for anextension, the compliance date was postponed until October 16, 2003.  The security standards applicable toindividually identifiable health information maintained electronically wererequired to be implemented by April 21, 2005.  We were materially compliant with thesestandards by the applicable compliance dates. The standards for a unique national health identifier for providers usedin connection with electronic healthcare transactions must be implemented by May 23,2007.  We expect to be able to materiallycomply with this regulation by its applicable compliance date.

 

Penalties for non-compliance with the HIPAA AdministrativeSimplification provisions range from a civil penalty of $100 for each violation(which can total up to $25,000 per person per year), to criminal penalties,including up to $50,000 and/or one year imprisonment, up to $100,000 and/orfive years imprisonment if the offense is committed under false pretenses andup to $250,000 and/or ten years imprisonment for violating a standard with theintent to sell, transfer or use individually identifiable health informationfor 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. ***TheMedicare Prescription Drug, Improvement and Modernization Act of 2003 changedthe way in which covered outpatient drugs are reimbursed by the Medicareprogram.  In January 2004, payment formost drugs covered by Medicare decreased to 85% of the AWP for those drugs,determined as of April 1, 2003. Beginning in 2005, reimbursement for most Medicare Part B drugs not paidon a cost or prospective payment basis was to be set at either 106% of theaverage sales price (ASP) or through a competitive acquisition program to bephased in beginning in 2006.  Thecompetitive acquisition program will be established by the Centers for Medicareand Medicaid Services (CMS) and will enable physicians in designatedcompetitive acquisition areas to purchase drugs through contractors that havesuccessfully bid for that right.  Eachphysician will elect annually whether to obtain drugs through the competitiveacquisition program.  CMS will re-bid thecontracts at least every three years.  Asignificant portion of the infusion drugs provided by us are administered in connectionwith covered durable medical equipment (DME). The payment rate for drugs administered in this manner generally willcontinue to be 95% of the AWP in effect as of October 1, 2003.

 

While the majority of our revenue is reimbursed by managed careorganizations and other non-government payors, these changes to the wayMedicare pays for outpatient drugs and biologicals may reduce our revenue andgross margins on services provided to Medicare patients.  Further, adoption of ASP as the standardmeasure for determining reimbursement by state Medicaid programs for the drugswe provide may reduce our revenue and gross margins.

 

**ITEM 3.  Quantitative andQualitative Disclosures About Market Risk**

 

We are subject to market risk primarily in relation to our cash andcash equivalents and short-term investments. As of June 30, 2005, we had no variable-rate debt.  In November 2004, we completed an $86.3million offering of 2.25% convertible senior notes due 2024.  The interest rate on this debt is fixed.  However, the interest rate we may earn on thecash generated from this offering, as well as

 

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cash generated from our operations, is subject to marketfluctuations.  We utilize a mix ofinvestment maturities based on our anticipated cash needs and evaluation ofexisting interest rates and market conditions.

 

The following table sets forth our cash and cash equivalents andshort-term investments as of the dates indicated (in thousands):

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

 

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(1)   Cashequivalents includes highly-liquid investments having a maturity of threemonths or less at time of purchase,

(2)   Short-terminvestments consist of commercial paper with maturities of three months or moreat time of acquisition, as well as variable-rate municipal demand notes,preferred stocks and similar instruments that are either perpetual in nature orhave final maturities greater than three months.

 

While we attempt to minimize market risk and maximize return, changesin market conditions may significantly affect the income we earn on our cashand cash equivalents and short-term investments.  Based on our actual cash and cash equivalentsand short-term investment balances at June 30, 2005, a 100 basis pointdecline in interest rates would reduce our interest income by $805,000 on anannualized basis.

 

**ITEM 4.  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) underthe Securities Exchange Act of 1934 (the Exchange Act)) as of June 30,2005. Based upon that evaluation, the chief executive officer and chieffinancial officer concluded that our disclosure controls and procedures areeffective as of June 30, 2005. Disclosure controls and procedures arecontrols and procedures that are designed to ensure that information requiredto be disclosed in our reports filed or submitted under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’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 duringour fiscal quarter ended June 30, 2005 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 and legal actions that may arise in theordinary course of business. However, we maintain insurance to protect againstsuch claims or legal actions. We are not aware of any litigation, eitherpending or filed, that we believe is likely to have a material adverse effecton our results of operation or financial condition.

 

**ITEM 2. Unregistered Sales of Equity Securities**

 

Effective May 1, 2005, we acquired the outstanding stock of AtHome Solutions, Inc., an independent infusion pharmacy provider operatingin the major population centers of Montana. A portion of the purchase price will be paid in shares of our commonstock.  A total of 48,315 shares will beissued, valued at $13.31 per share, pursuant to the exemption from registrationprovided Rule 506 of Regulation D and/or Section 4(2) of theSecurities Act of 1933.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

None.

 

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

 

We held our annual meeting of stockholders on May 9, 2005.  At that meeting, our stockholders were askedto consider and vote upon the following matters.

 

1.     Election of one member to the Board ofDirectors to hold office for a three-year term or until his successor is dulyelected and qualified.  The nominee, whowas listed in our proxy statement, was elected for a three-year term, with theresults of voting as follows:

 

| ** **          | ** ** | **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **ABSTAIN** | ** ** |
|---------------------|------------|---------------|------------|-------------------|------------|-------------|------------|
| Leo  Henikoff, M.D. |       | 22,886,626    |       | 0                 |       | 1,102,685   |       |

 

2.     Ratification of the appointment ofErnst & Young, LLP as our independent auditors for the fiscal year2005.  The proxy voting results were asfollows:

 

| **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **ABSTAIN** | ** ** |
|---------------|------------|-------------------|------------|-------------|------------|
| 23,941,025    |       | 46,850            |       | 1,436       |       |

 

**ITEM 5.  Other Information**

 

None.

 

**ITEM6.  Exhibits**

 

See Exhibit Index.

 

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**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Company has duly caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 
|                      | OPTION CARE, INC. |
|---------------------------|------------------------|
| Date: August 9, 2005 | By:                    | /s/ Paul Mastrapa |   |
| * *                  | * *               | *Chief Financial Officer* |
| * *                  | * *               | *(Principal Accounting Officer and Principal  Financial Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | ** **                                                                                                                                                                                                                                                                                                         |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                               |
| 3.1                 |       | Certificate of Incorporation of the  Registrant, together with Certificate of Amendment thereto filed February 18,  1992. Filed as Exhibit 3(a) to Option Care’s Registration Statement  (No. 33-45836) dated April 15, 1992 and incorporated by reference  herein.                  |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 3.2                 |       | Certificate of Amendment to Certificate of  Incorporation of the Registrant filed March 25, 1992. Filed as Exhibit 3(c) to  Option Care’s Registration Statement (No. 33-45836) dated April 15,  1992 and incorporated by reference herein.                                          |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 3.3                 |       | Certificate of Amendment to Certificate of  Incorporation of the Registrant filed with the Delaware Secretary of State on  June 18, 2002. Filed as Exhibit 3.3 to Option Care’s Quarterly  Report on Form 10-Q for the quarter ended June 30, 2002 and  incorporated by reference herein. |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 3.4                 |       | Restated By-laws of the Registrant dated June 1,  1994. Filed as Exhibit 10.5 to Option Care’s Annual Report on Form  10-K for the year ending December 31, 1994 and incorporated by reference  herein.                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 4.1                 |       | Indenture Agreement by and among Option  Care, Inc. and LaSalle Bank National Association, including the Form of  our 2.25% Convertible Senior Notes due 2024. Filed as Exhibit 4.1 to our  Current Report on Form 8-K filed on November 11, 2004 and  incorporated by reference herein.  |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 4.2                 |       | Registration Rights Agreement dated as of November 2,  2004 by and among Option Care, UBS Securities LLC and Piper Jaffray &  Co. Filed as Exhibit 4.2 to our Current Report on Form 8-K filed on  November 11, 2004 and incorporated by reference herein.                       |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 31.1                |       | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 31.2                |       | Certification of Senior Vice President and  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                               |
| 32                  |       | Certification of Chief Executive Officer  and Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350,  and Rule 13a-14(b) of the Exchange Act.                                                                                                                        |

 

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