** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

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

 

**For the quarterly period ended**

 

**September 30, 2002**

 

**Commission file number 0-19878**

 

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**option**careâ

| **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)      |

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

 

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

 

| **Class**                    |   | **Issued and Outstanding  as of November 5, 2002** |
|------------------------------|--------|----------------------------------------------------|
|                         |   |                                               |
| Common Stock - .01 par value |   | 20,587,427                                         |

 

 

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**INDEX**

 

**OPTIONCARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION** |                                                                                                            |
|-----------------|-----------------------------------------------------------------------------------------------------------------|
|            |
| **PART I**      | **FINANCIAL INFORMATION**                                                                                       |
|            |                                                                                                            |
| Item 1.         | Financial Statements  (Unaudited)                                                                               |
|            |                                                                                                            |
|            | Condensed  consolidated balance sheets—September 30, 2002 and December 31, 2001                            |
|            |                                                                                                            |
|            | Condensed  consolidated statements of income—Three and nine months ended  September 30, 2002 and 2001 |
|            |                                                                                                            |
|            | Condensed  consolidated statements of cash flows—Nine months ended September 30,  2002 and 2001       |
|            |                                                                                                            |
|            | Notes  to condensed consolidated financial statements—September 30, 2002                                   |
|            |                                                                                                            |
| Item  2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |
|            |                                                                                                            |
| Item  3.        | Quantitative  and Qualitative Disclosures about Market Risk                                                     |
|            |                                                                                                            |
| Item 4.         | Controls and  Procedures                                                                                        |
|            |                                                                                                            |
|            |                                                                                                            |
| **PART II**     | **OTHER INFORMATION**                                                                                           |
|            |                                                                                                            |
| Item 1.         | Legal Proceedings                                                                                               |
|            |                                                                                                            |
| Item  2.        | Changes  in Securities and Use of Proceeds                                                                      |
|            |                                                                                                            |
| Item 3.         | Defaults Upon  Senior Securities                                                                                |
|            |                                                                                                            |
| Item  4.        | Submission  of Matters to a Vote of Security Holders                                                            |
|            |                                                                                                            |
| Item 5.         | Other Information                                                                                               |
|            |                                                                                                            |
| Item 6(a).      | Exhibits                                                                                                        |
|            |                                                                                                            |
| Item 6(b).      | Reports on  Form 8-K                                                                                       |
|            |                                                                                                            |
| **SIGNATURES**  |
|                 |                                                                                                                 |  |

 

2

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

 

**Item 1. Financial Statements**

 

**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

(in thousands, except per share amounts)

 
|                                                                                                                                                            |   | **September 30, 2002** |    | **December 31, 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|-----------------------|--------|
|                                                                                                                                                            |   | **(Unaudited)**        |    | **(Note 1)**          |   |
| Assets                                                                                                                                                          |   |                   |    |                  |   |
| Current  assets:                                                                                                                                                |   |                   |    |                  |   |
| Cash  and cash equivalents                                                                                                                                      |   | $                      | 303     |                  | $      | 8,511 |   |
| Accounts  receivable, net                                                                                                                                       |   | 69,342                 |    | 56,341                |   |
| Inventory                                                                                                                                                       |   | 6,709                  |    | 6,388                 |   |
| Deferred  tax asset                                                                                                                                             |   | 2,940                  |    | 3,038                 |   |
| Other  current assets                                                                                                                                           |   | 3,115                  |    | 3,421                 |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  current assets                                                                                                                                           |   | 82,409                 |    | 77,699                |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Equipment  and other fixed assets, net                                                                                                                          |   | 11,182                 |    | 7,330                 |   |
| Goodwill,  net                                                                                                                                                  |   | 55,731                 |    | 38,384                |   |
| Intangible assets, net                                                                                                                                          |   | 1,905                  |    | 1,555                 |   |
| Other  assets                                                                                                                                                   |   | 546                    |    | 294                   |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  assets                                                                                                                                                   |   | $                      | 151,773 |                  | $      | 125,262 |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Liabilities  and stockholders’ equity                                                                                                                      |   |                   |    |                  |   |
| Current  liabilities:                                                                                                                                           |   |                   |    |                  |   |
| Current  portion of long-term debt                                                                                                                              |   | $                      | 221     |                  | $      | 265 |   |
| Trade  accounts payable                                                                                                                                         |   | 11,489                 |    | 11,117                |   |
| Other  current liabilities                                                                                                                                      |   | 11,464                 |    | 9,960                 |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  current liabilities                                                                                                                                      |   | 23,174                 |    | 21,342                |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Long-term  debt, less current portion                                                                                                                           |   | 8,781                  |    | 353                   |   |
| Other  liabilities                                                                                                                                              |   | 3,149                  |    | 2,333                 |   |
| Minority  interest                                                                                                                                              |   | 1,042                  |    | 468                   |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  liabilities                                                                                                                                              |   | 36,146                 |    | 24,496                |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Stockholders’  equity:                                                                                                                                     |   |                   |    |                  |   |
| Common stock, $.01 par  value per share, 60,000 shares authorized, 20,587 and 20,046 shares issued  and outstanding at September 30, 2002 and December 31, 2001 |   | 206                    |    | 200                   |   |
| Common  stock to be issued, 99 and 191 shares at September 30, 2002 and December 31,  2001                                                                      |   | 1,318                  |    | 1,270                 |   |
| Additional  paid-in capital                                                                                                                                     |   | 101,806                |    | 98,128                |   |
| Retained  earnings                                                                                                                                              |   | 12,297                 |    | 1,168                 |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  stockholders’ equity                                                                                                                                |   | 115,627                |    | 100,766               |   |
|                                                                                                                                                            |   |                   |    |                  |   |
| Total  liabilities and stockholders’ equity                                                                                                                |   | $                      | 151,773 |                  | $      | 125,262 |   |

 

*See notes tocondensed consolidated financial statements*

 

3

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Income**

(Unaudited)

(in thousands, except per share amounts)

 
|                                            |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                            |   | **2002**                                   |   | **2001**                                  |   | **2002** |   | **2001** |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Revenue                                         |   | $                                          | 80,873 |                                      | $      | 56,093 |   | $ | 229,105 |   | $ | 151,901 |   |
| Cost  of revenue                                |   | 55,503                                     |   | 37,333                                    |   | 157,499 |   | 100,178 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Gross  profit                                   |   | 25,370                                     |   | 18,760                                    |   | 71,606 |   | 51,723 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Selling,  general and administrative expenses   |   | 17,246                                     |   | 12,961                                    |   | 48,674 |   | 35,964 |   |
| Provision  for doubtful accounts                |   | 1,502                                      |   | 934                                       |   | 4,427 |   | 2,345 |   |
| Amortization  of goodwill                       |   | —                                     |   | 267                                       |   | — |   | 729 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Total  operating expenses                       |   | 18,748                                     |   | 14,162                                    |   | 53,101 |   | 39,038 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Operating  income                               |   | 6,622                                      |   | 4,598                                     |   | 18,505 |   | 12,685 |   |
| Interest  expense                               |   | (63                                        | )      | (458                                      | )      | (79 | ) | (1,212 | ) |
| Other  expense, net                             |   | (113                                       | )      | (84                                       | )      | (102 | ) | (84 | ) |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Income  before income taxes                     |   | 6,446                                      |   | 4,056                                     |   | 18,324 |   | 11,389 |   |
| Income  tax provision                           |   | 2,530                                      |   | 1,579                                     |   | 7,195 |   | 4,440 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Net  income                                     |   | $                                          | 3,916  |                                      | $      | 2,477 |   | $ | 11,129 |   | $ | 6,949 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Net  income per common share:                   |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                           |   | $                                          | 0.19   |                                      | $      | 0.16 |   | $ | 0.54 |   | $ | 0.45 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Diluted                                         |   | $                                          | 0.19   |                                      | $      | 0.15 |   | $ | 0.53 |   | $ | 0.43 |   |
|                                            |   |                                       |   |                                      |   |   |   |   |   |
| Shares  used in computing net income per share: |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                           |   | 20,672                                     |   | 15,596                                    |   | 20,577 |   | 15,470 |   |
| Diluted                                         |   | 21,148                                     |   | 16,375                                    |   | 21,100 |   | 16,106 |   |

 

*See notes to condensed consolidatedfinancial statements*

 

4

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**Option Care, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)

(in thousands)

 
|                                                                                          |   | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                                                          |   | **2002**                                  |       | **2001** |   |
|                                                                                          |   |                                      | ** ** |   | ** ** |
| Cash  flows from operating activities:                                                        |   |                                      |       |   |   |
| Net  income                                                                                   |   | $                                         | 11,129     |   | $ | 6,949 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities: |   |                                      |       |   |   |
| Depreciation  and amortization                                                                |   | 2,791                                     |       | 2,774 |   |
| Provision  for doubtful accounts                                                              |   | 4,427                                     |       | 2,345 |   |
| Other                                                                                         |   | 1,642                                     |       | 579 |   |
| Changes  in assets and liabilities:                                                           |   |                                      |       |   |   |
| Accounts  receivable                                                                          |   | (10,625                                   | )          | (20,299 | ) |
| Inventory                                                                                     |   | 896                                       |       | (956 | ) |
| Accounts  payable                                                                             |   | (1,321                                    | )          | 1,995 |   |
| Change  in other assets and liabilities                                                       |   | (997                                      | )          | 954 |   |
|                                                                                          |   |                                      |       |   |   |
| Net  cash provided by (used in) operating activities                                          |   | 7,942                                     |       | (5,659 | ) |
|                                                                                          |   |                                      |       |   |   |
| Cash  flows from investing activities:                                                        |   |                                      |       |   |   |
| Purchases  of equipment and other, net                                                        |   | (5,425                                    | )          | (2,218 | ) |
| Additions  to other assets, net                                                               |   | (67                                       | )          | 204 |   |
| Payments for  acquisitions, net of cash acquired                                              |   | (20,342                                   | )          | (10,433 | ) |
|                                                                                          |   |                                      |       |   |   |
| Net  cash used in investing activities                                                        |   | (25,834                                   | )          | (12,447 | ) |
|                                                                                          |   |                                      |       |   |   |
| Cash  flows from financing activities:                                                        |   |                                      |       |   |   |
| Increase  in cash overdraft                                                                   |   | —                                    |       | 1,028 |   |
| Increase  in deferred financing costs                                                         |   | (601                                      | )          | — |   |
| Net  borrowing on credit agreements                                                           |   | 8,447                                     |       | 16,298 |   |
| Payments  on capital leases and other debt                                                    |   | (252                                      | )          | (52 | ) |
| Proceeds  from issuance of stock                                                              |   | 2,090                                     |       | 832 |   |
|                                                                                          |   |                                      |       |   |   |
| Net  cash provided by financing activities                                                    |   | 9,684                                     |       | 18,106 |   |
|                                                                                          |   |                                      |       |   |   |
| Net  decrease in cash and cash equivalents                                                    |   | (8,208                                    | )          | — |   |
| Cash and cash  equivalents, beginning of period                                               |   | 8,511                                     |       | — |   |
| Cash  and cash equivalents, end of period                                                     |   | $                                         | 303        |   | $ | — |   |

 

*See notes tocondensed consolidated financial statements*

 

5

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**Option Care, Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements**

**September 30,2002**

(Unaudited)

 

**1.   Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Inthe opinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation of the results of theinterim periods presented have been included. Operating results for the threeand nine months ended September 30, 2002 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2002.

 

The balance sheet at December 31, 2001 has been derived from the auditedfinancial statements at that date but does not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements.  For further information, refer to theconsolidated financial statements and footnotes thereto included in OptionCare’s Report on Form 10-K for the year ended December 31, 2001.

 

Effective January1, 2002, Option Care is operating in and reporting one segment.  Since there is no longer a clear distinctionbetween the operations of our local pharmacies and our regional specialtypharmacies, the chief decision-maker no longer uses separate financialinformation for those two portions of our business to make decisions. Ouroperations are reflected as one segment and all prior period informationcontained in this Form 10-Q has been reclassified accordingly.

 

**2.  Reclassifications**

 

Certain amounts in the condensed consolidatedfinancial statements have been reclassified to conform to the current yearpresentation.

 

**3.  Long-Term Debt**

 

On March 29, 2002,Option Care entered into a $60 million revolving Credit and Security Agreementwith J.P. Morgan Business Credit Corporation, J.P. Morgan Chase Bank andLaSalle Bank, N.A.  The facilityrequires us to meet certain financial covenants.  Option Care paid a facility fee of approximately $400,000 uponsigning the agreement.  The agreementprovides for a commitment fee, calculated and paid quarterly on a sliding scalefrom 0.45% to 0.25%, based on the average daily unused portion of the facility.  For a fee, Option Care may secure up to $5million in letters of credit.  Dependingon our level of borrowing under the agreement, Option Care may select interestrates ranging from the Eurodollar Rate plus 2% to 2.75%, or the bank’sreference rate plus 0% to 0.75%.  Theagreement expires on March 29, 2005.

 

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

 

As of September30, 2002, our total allowable collateral borrowing base under the facility was $33.6million based on the accounts receivable and inventory balances as of thatdate.  Option Care had an outstandingbalance under the credit facility of $8.4 million as of September 30, 2002,with additional availability of $25.2 million.

 

6

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**4.  Earnings Per Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated. Share and per share amounts for all periods presented reflect the effectsof the 5-for-4 stock split completed on May 1, 2002 for stockholders of recordas of April 10, 2002.

 
|                                  |   | **Three months ended  September 30,**         |   | **Nine months ended  September 30,** |   |
|---------------------------------------|--------|-----------------------------------------------|--------|--------------------------------------|--------|
|                                  |   | **2002**                                      |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                  |   | **(in thousands, except per share  amounts)** |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Basic:                                |   |                                          |   |                                 |   |   |   |   |   |
| Net  income                           |   | $                                             | 3,916  |                                 | $      | 2,477 |   | $ | 11,129 |   | $ | 6,949 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Average  shares outstanding           |   | 20,672                                        |   | 15,596                               |   | 20,577 |   | 15,470 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Basic  earnings per share             |   | $                                             | 0.19   |                                 | $      | 0.16 |   | $ | 0.54 |   | $ | 0.45 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Diluted:                              |   |                                          |   |                                 |   |   |   |   |   |
| Net  income                           |   | $                                             | 3,916  |                                 | $      | 2,477 |   | $ | 11,129 |   | $ | 6,949 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Average  shares outstanding           |   | 20,672                                        |   | 15,596                               |   | 20,577 |   | 15,470 |   |
| Net  effect of dilutive stock options |   | 476                                           |   | 779                                  |   | 523 |   | 636 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Total  diluted shares                 |   | 21,148                                        |   | 16,375                               |   | 21,100 |   | 16,106 |   |
|                                  |   |                                          |   |                                 |   |   |   |   |   |
| Diluted  earnings per share           |   | $                                             | 0.19   |                                 | $      | 0.15 |   | $ | 0.53 |   | $ | 0.43 |   |

 

**5.   Operating Segments**

 

Effective January 1, 2002, Option Care is operating in and reporting onesegment. Previously, Option Care had identified two distinct operatingsegments: the local pharmacy division and the regional specialty pharmacydivision.  Over the past year, OptionCare has expanded the distribution of specialty drugs through its company-ownedlocal pharmacies.  Since there is nolonger a clear distinction between the operations of our local pharmacies andour regional specialty pharmacies, Option Care’s chief decision-makersno longer use separate financial information for those two portions of ourbusiness to make decisions. Our operations are now reflected as one reportingsegment and all prior period informationcontained in this Form 10-Q has been reclassified accordingly.

 

**6.   Significant Customer**

 

We generate revenue from managed care contracts and other agreementswith commercial third party payors.  Ourprincipal managed care contract is with Blue Cross and Blue Shield of Floridawhich contracts with us through our company-owned pharmacy located in Miami,Florida.  Approximately 20% of ourrevenue for the three and nine months ended September 30, 2002 was related tothis contract.  For the three and ninemonths ended September 30, 2001, approximately 20% and 21% of our revenue,respectively, was related to this contract. As of both September 30, 2002 and December 31, 2001, approximately 11%of our accounts receivable was due from Blue Cross and Blue Shield of Florida.The contract is terminable by either party on 90 days’ notice and, unlessterminated, renews annually each September for an additional one-year term.  The contract renewed automatically inSeptember 2002 without modification.

 

Option Care also generates revenue from government programs such asMedicare and Medicaid.  Approximately14% and 15% of our revenue for the three and nine months ended September 30, 2002was related to these government programs. For the three months and nine months ended September 30, 2001,approximately 13% and 14% of our revenue, respectively, was related to theseprograms.  Approximately 20% and 17% ofour accounts receivable as of September 30, 2002 and December 31, 2001,respectively, was due from these government programs.

 

7

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**7.   Acquisitions**

 

On July 29, 2002, Option Care acquired certain assets and the relatedhome infusion operations of Allina Health Systems, which operates a network ofhospitals in Minnesota and Wisconsin. This acquisition provides Option Care with entry to theMinneapolis/St.Paul metropolitan area, expanding Option Care’s presence in theupper Midwest.  The effective date ofthis acquisition was July 1, 2002. The purchase price was $15.1 million,of which $10.0 million was paid in cash at closing and $5.1 million will bepayable in 2003, subject to various offsets. The $5.1 million payable in 2003 is contained within other currentliabilities on the September 30, 2002 balance sheet.  Of the total $15.1 million purchase price, $5.4 million wasallocated to accounts receivable and other tangible assets, $9.6 million was allocatedto goodwill, and $100,000 was allocated to other intangible assets.

 

On May 15, 2002, Option Care acquired100% of the issued and outstanding shares of capital stock of SpringvillePharmacy Infusion Therapy, Inc., an independent provider of home infusiontherapies in Springville, New York, which is a suburb of Buffalo.  This acquisition expands Option Care’scoverage within the state of New York and improves our opportunity to securestatewide contracts.

 

On May 6, 2002, Option Care acquired 60% of the issued and outstandingcapital stock of Infusion Specialties, Inc., a Houston, Texas based independentprovider of specialty pharmaceuticals, primarily focused on treating chronicconditions such as hemophilia and cystic fibrosis. The effective date of thisacquisition was April 1, 2002. This acquisition expands Option Care’s marketshare in Texas and expands our menu of services to include the treatment ofhemophilia.  On April 1, 2003, theCompany has the right to purchase and the seller has the right to sell theremaining 40% interest at a price based on the operation’s earnings.

 

On April 16, 2002, Option Care acquired certain assets and the relatedhome infusion operations of The Mount Sinai Hospital, which is located in NewYork, New York.  This acquisitionprovides us with entrance into the New York City market, and establishes anassociation with a well-established and respected healthcare institution.  This acquisition also furthers our goal ofexpanding our overall presence in the Northeast.

 

On March 19, 2002, Option Careacquired certain assets and the continuing home infusion operations of AmericanHomepatient, Inc. in the Providence, Rhode Island marketplace. This acquisitionfurthers Option Care’s goal of expanding our overall presence in the Northeast.

 

During the three and nine-monthperiods ended September 30, 2002, Option Care also paid additionalconsideration of $500,000 and $3.3 million, respectively, in cash related toacquisitions completed in 2001, 2000 and 1996. The results of operations of each or our 2002 acquisitions are includedin the condensed consolidated statements of income as of the effective date ofeach acquisition, which is the purchase date, except where otherwise noted.

 

The aggregate cost of all acquisitions completed during the nine monthsended September 30, 2002 was as follows:

 

|                              |   | **(in thousands)** |   |
|-----------------------------------|--------|--------------------|--------|
|                              |   |               |   |
| Cash                              |   | $                  | 16,992 |   |
| Deferred  acquisition obligations |   | 5,637              |   |
| Assumption  of liabilities        |   | 1,497              |   |
|                              |   | $                  | 24,126 |   |

 

The aggregatepurchase price was allocated as follows:

 

|                    |   | **(in thousands)** |   |
|-------------------------|--------|--------------------|--------|
|                    |   |               |   |
| Accounts  receivable    |   | $                  | 6,785  |   |
| Inventory               |   | 1,216              |   |
| Property  and equipment |   | 642                |   |
| Other  tangible assets  |   | 8                  |   |
| Intangible  assets      |   | 325                |   |
| Goodwill                |   | 15,657             |   |
| Minority  interest      |   | (507               | )      |
|                    |   | $                  | 24,126 |   |

 

8

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Of the $15.7 millionin aggregate purchase price that was allocated to goodwill, $11.7 million isexpected to be deductible for tax purposes.

 

Our unaudited pro formaresults of operations, presented as if the acquisitions Option Care completedfrom January 1, 2001 through September 30, 2002 had occurred as of January 1,2001, were as follows:

 
|                                                   |   | **Three Months Ended September 30,**          |       | **Nine Months Ended September 30,** |   |
|--------------------------------------------------------|--------|-----------------------------------------------|------------|-------------------------------------|--------|
|                                                   |   | **2002**                                      |       | **2001**                            |   | **2002** |   | **2001** |   |
|                                                   |   | **(in thousands, except per share  amounts)** | ** ** |
|                                                   |   |                                          |       |                                |   |   |   |   |   |
| Revenue                                                |   | $                                             | 80,873     |                                | $      | 73,349 |   | $ | 244,999 |   | $ | 228,609 |   |
|                                                   |   |                                          |       |                                |   |   |   |   |   |
| Net income                                             |   | 3,916                                         |       | 3,307                               |   | 12,151 |   | 9,713 |   |
|                                                   |   |                                          |       |                                |   |   |   |   |   |
| Net income per diluted  share                          |   | $                                             | 0.19       |                                | $      | 0.25 |   | $ | 0.58 |   | $ | 0.60 |   |
|                                                   |   |                                          |       |                                |   |   |   |   |   |
| Shares used in  computing net income per diluted share |   | 21,148                                        |       | 16,375                              |   | 21,100 |   | 16,106 |   |

 

**8.   New Accounting Pronouncements**

 

Option Care adopted the non-amortization provisions of Statement ofFinancial Accounting Standards (SFAS) No. 142, *Goodwill and Other Intangible Assets*,effective January 1, 2002.  This resultedin an increase to net income of approximately $900,000 for the nine monthsended September 30, 2002, and is expected to increase full-year net income byapproximately  $1.3 million. Inaccordance with the requirements of SFAS No. 142, Option Care has testedgoodwill for impairment as of January 1, 2002. No impairment of goodwill was identified.

 

The following table provides comparative netincome and net income per share had the non-amortization provisions of SFAS No.142 been adopted for all periods presented:

 
|                               |   | **Three Months Ended September 30,**     |   | **Nine Months Ended September 30,** |   |
|------------------------------------|--------|-----------------------------------------------|--------|------------------------------------------|--------|
|                               |   | **2002**                                      |   | **2001**                                 |   | **2002** |   | **2001** |   |
|                               |   | **(in thousands, except per share  amounts)** |   |
|                               |   |                                          |   |                                     |   |   |   |   |   |
| Reported  net income               |   | $                                             | 3,916  |                                     | $      | 2,477 |   | $ | 11,129 |   | $ | 6,949 |   |
| Goodwill  amortization, net of tax |   | —                                        |   | 180                                      |   | — |   | 496 |   |
| Adjusted  net income               |   | $                                             | 3,916  |                                     | $      | 2,657 |   | $ | 11,129 |   | $ | 7,445 |   |
|                               |   |                                          |   |                                     |   |   |   |   |   |
| Basic  income per share:           |   |                                          |   |                                     |   |   |   |   |   |
| Reported  basic income per share   |   | $                                             | 0.19   |                                     | $      | 0.16 |   | $ | 0.54 |   | $ | 0.45 |   |
| Goodwill  amortization, net of tax |   | —                                        |   | 0.01                                     |   | — |   | 0.03 |   |
| Adjusted  basic income per share   |   | $                                             | 0.19   |                                     | $      | 0.17 |   | $ | 0.54 |   | $ | 0.48 |   |
|                               |   |                                          |   |                                     |   |   |   |   |   |
| Diluted  income per share:         |   |                                          |   |                                     |   |   |   |   |   |
| Reported  diluted income per share |   | $                                             | 0.19   |                                     | $      | 0.15 |   | $ | 0.53 |   | $ | 0.43 |   |
| Goodwill  amortization, net of tax |   | —                                        |   | 0.01                                     |   | — |   | 0.03 |   |
| Adjusted diluted income  per share |   | $                                             | 0.19   |                                     | $      | 0.16 |   | $ | 0.53 |   | $ | 0.46 |   |

 

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

 

**FORWARD LOOKING STATEMENTS**

 

The following discussionshould be read in conjunction with our Annual Report on Form 10-K for theyear ended December 31, 2001. The Private Securities Litigation Reform Actof 1995 provides a “safe harbor” for forward-looking statements. Certain informationincluded in this Quarterly Report on Form 10-Q and other materials filedor to be filed by us with the Securities and Exchange Commission (as well asinformation included in oral statements or other written statements made or tobe made by us) contain statements that are or will be forward-looking, such asstatements relating to acquisitions and other business development activities,future capital expenditures and the effects of future regulation andcompetition. Such forward-looking information involves important risks anduncertainties that could significantly affect anticipated results in the futureand, accordingly, such results may differ from those expressed in anyforward-looking statements made by us, or on our behalf. These risks and uncertaintiesinclude, but are not limited to, uncertainties affecting our businesses and ourfranchisees relating to acquisitions and divestitures (including continuingobligations with respect to completed transactions), sales and renewals offranchises, government and regulatory policies (including federal, state andlocal efforts to reform the delivery of and payment for healthcare services),general economic conditions (including economic conditions affecting thehealthcare industry in particular), the pricing and availability of equipmentand services, technological developments and changes in the competitiveenvironment in which we operate.

 

**OVERVIEW**

 

Option Care providesalternate site infusion therapy and specialty pharmacy services to patients onbehalf of managed care organizations and other third party payors.  We contract with payors to provide infusiontherapy, specialty pharmaceuticals and other related healthcare services topatients at home or at other alternate-site settings, such as physicians’offices.  As of September 30, 2002, ourservices are provided locally through our nationwide network of 40 owned and 86franchised pharmacy locations, operating under the name Option Care®.  Four of the company-owned pharmacies alsoserve as OptionMed® distribution points for the sale of specialtypharmaceuticals under managed care contracts.

 

Effective January 1,2002, Option Care is operating in and reporting one segment with three servicelines: infusion and related healthcare services; specialty pharmacy; andother.  All prior period informationcontained in this Form 10-Q has been reclassified accordingly.

 

**CRITICAL ACCOUNTING POLICIES ANDESTIMATES**

 

Management’s discussion and analysis of our financial condition andresults of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these statements requires usto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses and their related disclosures.  On an ongoing basis, Option Care evaluatesits estimates and judgments based on historical experience and various otherfactors that are believed to be reasonable. Actual results may vary from these estimates under different assumptionsor conditions.  We periodically reviewour financial reporting and disclosure practices and accounting policies toensure that our financial reporting and disclosures provide accurate and transparentinformation relative to our financial condition and results of operations, aswell as our current business environment. Option Care management believes that of our significant accountingpolicies, the following policies involve a higher degree of judgment and/orcomplexity.

 

**Revenue recognition**

 

Our revenue is primarilyderived from the sale of infused and injected pharmaceuticals and provision ofrelated nursing services to patients at alternate-site settings.  Most of this revenue is billed under managedcare or other contracts, while virtually all of the remainder is billed togovernment programs, such as Medicare and Medicaid. Billed and unbilled revenueis recorded net of contractual adjustments based on our interpretation of theterms of each managed care contract or government contract or pricing schedule.The accuracy of our recorded net revenue is subject to the accuracy of payorinformation on file for each patient, and is also subject to our correctinterpretation of each underlying contract with respect to reimbursement ratesfor the drugs and services we provide. If we subsequently discover errors ineither payor information or interpretation of the reimbursement rates of ourcontracts,

 

10

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we adjust revenue in theperiod that such errors are discovered. Such adjustments may have a positive ornegative impact on the revenues and results of operations reported for thosesubsequent periods.

** **

**Accountsreceivable**

 

Option Care records allof our accounts receivable net of allowance for bad debts.  These allowances are estimated based onseveral factors, such as our past accounts receivable collection history,evaluation of the age of the accounts receivable at the end of each period, anddetailed analysis of the expected collectibility of amounts receivable fromeach significant payor based on a number of factors. In certain circumstances,our accounts receivable may also be subject to retroactive adjustments bypayors. Although we believe that our estimation of the net value of ouraccounts receivable is reasonable, actual collections may differ from ourestimates of collectibility, affecting our future financial condition andresults of operations.

** **

**Goodwill and otherintangible assets**

 

Werecord goodwill from our acquisitions equal to the excess of the total cost ofthe acquisitions over the fair value of all identified tangible and intangibleassets acquired. Beginning in 2002, in accordance with Statements of FinancialAccounting Standards No. 141, *Business Combinations* and No. 142, *Goodwill andOther Intangible Assets (SFAS No. 141 and SFAS No. 142)*, goodwill isnot to be amortized but is to be evaluated periodically for impairment. OptionCare has performed an initial impairment test of our goodwill as of January 1,2002.  No impairment was identified. Ifmarket conditions and/or the performance of our acquired businesses change infuture periods, we may be required to record impairment charges in thoseperiods.

 

11

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**RESULTS OF OPERATIONS**

 

The following table showsthe results of our operations for the three and nine months ended September 30,2002 and 2001, expressed as percentages of revenue:

 
|                                          |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                          |   | **2002**                                   |       | **2001**                                  |       | **2002** |   | **2001** |   |
|                                          |   |                                       | ** ** |                                      | ** ** |   | ** ** |   | ** ** |
| Revenue                                       |   | 100.0                                      | %          | 100.0                                     | %          | 100.0 | % | 100.0 | % |
| Cost  of revenue                              |   | 68.6                                       | %          | 66.6                                      | %          | 68.7 | % | 65.9 | % |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Gross  profit                                 |   | 31.4                                       | %          | 33.4                                      | %          | 31.3 | % | 34.1 | % |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Selling,  general and administrative expenses |   | 21.3                                       | %          | 23.1                                      | %          | 21.3 | % | 23.7 | % |
| Provision  for doubtful accounts              |   | 1.9                                        | %          | 1.7                                       | %          | 1.9 | % | 1.5 | % |
| Amortization  of goodwill                     |   | —                                     | %          | 0.4                                       | %          | — | % | 0.5 | % |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Total  operating expenses                     |   | 23.2                                       | %          | 25.2                                      | %          | 23.2 | % | 25.7 | % |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Operating  income                             |   | 8.2                                        | %          | 8.2                                       | %          | 8.1 | % | 8.4 | % |
| Interest  expense                             |   | (0.1                                       | )%         | (0.8                                      | )%         | — | % | (0.8 | )% |
| Other  expense, net                           |   | (0.1                                       | )%         | (0.2                                      | )%         | (0.1 | )% | (0.1 | )% |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Income  before income taxes                   |   | 8.0                                        | %          | 7.2                                       | %          | 8.0 | % | 7.5 | % |
| Income  tax provision                         |   | 3.2                                        | %          | 2.8                                       | %          | 3.1 | % | 2.9 | % |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Net  income                                   |   | 4.8                                        | %          | 4.4                                       | %          | 4.9 | % | 4.6 | % |

 

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**Three and Nine Months Ended September30, 2002 and 2001**

 

Revenue for the three months endedSeptember 30, 2002 was $80.9 million, which represents an increase of $24.8 million,or 44.2%, over the revenues of $56.1 million for the corresponding period ofthe prior year.  Of the total $24.8million increase, $13.9 million was due to acquisitions completed in 2002 and2001, $11.3 million was due to a 21.8% increase in same store revenues frominfusion and related services and the sale of specialty pharmaceuticals, and a$400,000 decline was attributable to other revenues.  Revenue for the nine months ended September 30, 2002 was $229.1 million,representing an increase of $77.2 million, or 50.8%, over the $151.9 million inrevenue recognized in the first nine months of 2001. Of this $77.2 millionincrease, $41.8 million was from acquisitions completed in 2002 and 2001, $36.2million was due to a 30.7% increase in same store revenues from infusion andrelated services and the sale of specialty pharmaceuticals, and an $800,000decline was attributable to other revenues.

 

For the three monthsended September 30, 2002, revenue from infusion and related healthcare serviceswas $34.8 million, representing an increase of $5.3 million, or 18.1%, from$29.5 million for the three months ended September 30, 2001.  For the nine months ended September 30,2002, revenue from infusion and related healthcare services was $94.7 million,an increase of $17.5 million, or 22.6%, from the $77.2 million in thecorresponding period of the prior year. These increases can be primarilyattributed to acquisitions completed in 2002 and the last quarter of 2001, andto same store increases in patient census for our core infusion therapies.

 

For the three monthsended September 30, 2002, specialty pharmacy revenue increased to $43.6million, representing a $19.8 million, or 83.4% increase, over the $23.8million in specialty pharmacy revenue for the three months ended September 30,2001.  For the nine month period endedSeptember 30, 2002, specialty pharmacy revenue increased by $60.5 million, or91.4%, to $126.7 million compared to $66.2 million for the corresponding periodof the prior year.  The increase in specialtypharmacy revenue can be attributed in near equal proportion to three factors:increased sales under our contract with Blue Cross and Blue Shield of Florida,increased same store sales, and sales generated by 2002 and 2001 acquisitions.  For both the three and nine months endedSeptember 30, 2002, the increases in same store sales and sales generated byacquisitions were driven by increased marketing of specialty drugs.  For the nine months ended September 30,2002, the increased sales of Synagis, a seasonal drug for the treatment ofRespiratory Synctial Virus (RSV), was partially responsible for the revenueincrease.

 

Other revenue consistsprimarily of royalty revenues from our franchise network and software sales andrentals by our wholly-owned subsidiary, Management by Information, Inc.(MBI).Other revenue was $2.4 million for the three months ended September 30, 2002, adecline of $400,000, or 13.9% compared to the $2.8 million in other revenue forthe three months ended September 30, 2001. For the nine months ended September 30, 2002, other revenue was $8.5million.  This represents a decline of$800,000, or 9.3%, compared to the $7.7 million in other income for the ninemonths ended September 30, 2002.  Thesedeclines are due to slight reductions in the number of franchised locations,which resulted in slightly lower royalty revenues, and to reduced sales ofsoftware products by our wholly-owned subsidiary, MBI.  Currently, MBI is beta testing a new softwareproduct, Emphsys, which will be released in 2003 and is expected to increasesoftware product revenues.

 

Cost of revenue for thethree months ended September 30, 2002 increased by $18.2 million, or 48.7%,over the corresponding quarter of the prior year. For the nine months endedSeptember 30, 2002, cost of revenue increased by $57.3 million, or 57.2%,compared to the nine months ended September 30, 2001. These increases areattributable to the respective $24.8 million and $77.2 million increases inrevenue in the three and nine months ended September 30, 2002 as compared tothe corresponding periods of the prior year.

 

The following table showsthe gross profit margin for each of our three service lines: infusion andrelated healthcare services; specialty pharmacy; and other revenue:

 
|                                      |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
|-------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|
|                                      |   | **2002**                             |   | **2001**                            |   | **2002** |   | **2001** |   |
|                                      |   |                                 |   |                                |   |   |   |   |   |
| Gross profit margin:                      |   |                                 |   |                                |   |   |   |   |   |
| Infusion and related  healthcare services |   | 42.1                                 | %      | 40.6                                | %      | 42.9 | % | 41.8 | % |
| Specialty pharmacy                        |   | 19.1                                 | %      | 17.1                                | %      | 18.5 | % | 16.9 | % |
| Other                                     |   | 98.0                                 | %      | 97.2                                | %      | 98.8 | % | 97.4 | % |
| Total gross profit  margin                |   | 31.4                                 | %      | 33.4                                | %      | 31.3 | % | 34.1 | % |

 

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The gross profit marginfor the three months and nine months ended September 30, 2002 were 31.4% and31.3%, respectively, which represent declines of 2.0% and 2.8% compared to thegross profit margins for the three months and nine months ended

September 30, 2001. Theprimary reason for the overall decline in gross profit margin was the growth inrevenue from the sale of specialty pharmaceuticals, which have a higher costand generate a lower gross profit margin than traditional drugs used forinfusion therapy.  The gross profitmargin on our infusion and related healthcare services revenue has increasedslightly in the current year periods compared to last year.  For the three and nine month periods endedSeptember 30, 2002, our margins on these services were 42.1% and 42.9%,respectively, compared to 40.6% and 41.8% for the three and nine-month periodsended September 30, 2001.  The increasein margin in the current year periods is due to changes in product mix and costcontainment efforts. The gross profit margin on specialty pharmaceuticalsincreased by 2.0% to 19.1% for the three months ended September 30, 2002compared to 17.1% for the three months ended September 30, 2001.  For the nine months ended September 30,2002, the margin increased by 1.6% to 18.5% compared to 16.9% for thecorresponding period of the prior year. The primary cause of these margin improvementswas the increase in specialty pharmaceutical sales by our company-owned localpharmacies.  Local pharmacy contractsgenerally cover both traditional home infusion drugs and specialty drugs andoffer better margins on specialty drugs than those contracts that exclusivelycover specialty drugs.  Another factorin the margin improvement is the current year’s revenue from the sale ofhemophilia drugs from a business acquired in the second quarter of 2002.

 

Selling, general andadministrative expenses were $17.2 million for the three months ended September30, 2002, representing an increase of $4.2 million, or 33.1%, over the $13.0million for the corresponding period of the prior year.  For the nine months ended September 30,2002, selling, general and administrative expenses were $48.7 million, anincrease of $12.7 million, or 35.3%, over the $36.0 million for the nine-monthperiod ended September 30, 2001.  Theseincreases are primarily attributable to the acquisitions made over theseperiods.  However, selling, general andadministrative expenses have declined as a percentage of revenue.  For the three and nine months endedSeptember 30, 2002, selling, general and administrative expenses equaled 21.3%of revenue, compared to 23.1% and 23.7% of revenue for the three and ninemonths ended September 30, 2001, respectively. By continuing to acquire new businesses, Option Care is able to spreadfixed selling, general and administrative expenses over a larger revenue base.  This fact combined with the increases insales of specialty pharmaceuticals, which require less selling, general andadministrative expenses per dollar of revenue, were the reasons for the declinein selling, general and administrative expenses as a percent of revenue.

 

The provision for doubtfulaccounts was $1.5 million for the three months ended September 30, 2002.  This represents an increase of approximately$600,000, or 60.8%, over the $900,000 provision for doubtful accounts for thethree months ended September 30, 2001. For the nine months ended September 30, 2002, the provision for doubtfulaccounts was $4.4 million, representing a $2.1 million, or 88.8%, increase overthe $2.3 million provision for the nine months ended September 30, 2001. Theseincreases are primarily due to the acquisitions completed over the past sixquarters, which have significantly increased company revenues over the prioryear, and due to increases in same store sales.  As a percentage of revenue, the provision for doubtful accountsincreased to 1.9% for the three months ended September 30, 2002 from 1.7% forthe three months ended September 30, 2001. For the nine months ended September 30, 2002, the provision for doubtfulaccounts increased to 1.9% of net revenue compared to 1.5% for the nine monthsended September 30, 2001. These increases are primarily due to higher bad debtprovisions that have been needed by some of our acquired offices during theirprocess of integration and/or consolidation with neighboring offices.

 

In compliance with thenew accounting standards presented in SFAS No.142, *Goodwill and Other Intangible Assets*,Option Care did not amortize goodwill during the nine months ended September30, 2002.  Goodwill amortization expensefor the three and nine months ended September 30, 2001 was $300,000 and$700,000, respectively.  Had we adoptedthe non-amortization provisions of SFAS No. 142 as of the beginning of 2001,our net income for the three and nine months ended September 30, 2001 wouldhave increased by $200,000 and $500,000, respectively.

 

Interest expense for thethree months ended September 30, 2002 was $100,000, which is 86.2% lower thanthe interest expense of $500,000 for the corresponding period of the prioryear.  For the nine months ended September30, 2002, interest expense was $100,000, which is 93.5% lower than the $1.2million interest expense for the nine months ended September 30, 2001. Theinterest expense incurred in 2001 was primarily related to borrowings on ourprevious credit facility to fund acquisitions completed in 2000 and in thefirst nine months of 2001.  Uponcompleting an underwritten public offering of stock in October 2001, whichgenerated $50 million in cash, we were able to pay off this debt and had apositive cash balance.  The $100,000 ofinterest expense for the three and nine months ended September 30, 2002 wasprimarily due to borrowings on our new credit facility to fund the acquisitionof Allina Health System’s home infusion business in July 2002.

 

Income tax expense forthe three months ended September 30, 2002 increased by $1.0 million, or 60.2%,compared to the corresponding period in the prior year. Income tax expense forthe nine months ended September 30, 2002 was higher by $2.8

 

14

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million, or 62.0%, overthe income tax expense reported for the nine months ended September 30,2001. These increases are directly attributable to our respective 58.9% and60.9% increases in pretax income over the periods.  For the three months ended September 30, 2002, the effectiveincome tax rate increased to 39.2% from 38.9% in the corresponding period ofthe prior year.  For the nine monthsended September 30, 2002, the effective income tax rate increased to 39.3% from39.0% in the prior year.  Theserespective increases are due to business increases in states with highereffective income tax rates.

 

Net income grew to $3.9million, or $0.19 per diluted share, for the three months endedSeptember 30, 2002.  Thisrepresents an increase of $1.4 million, or 58.1%, over the net income of $2.5million for the three months ended September 30, 2001.  For the nine months ended September 30,2002, net income was $11.1 million, or $0.53 per diluted share.  This represents a 60.2% increase over thenet income of $6.9 million for the nine months ended September 30, 2001.These increases in net income were primarily due to the incremental revenuesand net income generated by offices acquired since January 1, 2001, and toincreased sales by our company-owned local pharmacies.  As a percentage of revenue, net income hasincreased to 4.8% and 4.9%, respectively, for the three and nine months endedSeptember 30, 2002, compared to 4.4% and 4.6% in the corresponding periods ofthe prior year.  These increases can belargely attributed to the reduction in interest expense in the current yearperiods compared to the prior year due to the repayment of long-term debt fromthe proceeds of the Company’s underwritten public stock offering completed inOctober 2001.

 

Option Care completed a5-for-4 stock split effective May 1, 2002 for holders of record onApril 10, 2002.  All sharesoutstanding and per share amounts in this Quarterly Report on Form 10-Q havebeen adjusted to reflect the effects of the split.

 

Total diluted shares forboth the three and nine month periods ended September 30, 2002 were 21.1million, compared to 16.4 million and 16.1 million for the corresponding threeand nine month periods in 2001.  Therespective 4.7 million and 5.0 million increases in diluted shares areprimarily due to the issuance of approximately 4.5 million new shares of stockthrough an underwritten public offering of stock completed in October 2001. Theremaining increases are related to the issuance of new shares from employeestock option exercises, an increase in the number of unexercised “in the money”stock options, and the issuance of shares to participants in Option Care’sEmployee Stock Purchase Plan.

 

Net income perdiluted share increased 26.7% to $0.19 per share for the three months endedSeptember 30, 2002 compared to $0.15 per share for the corresponding period inthe prior year.  For the nine monthsended September 30, 2002, net income per diluted share increase 23.3%, from$0.53 in the current year compared to $0.43 in the prior year.  These increases reflect the rise in netincome over the prior year periods, offset in part by the larger number ofshares outstanding due to the issuance of 4.5 million new shares in October2001.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

For the nine-month periodended September 30, 2002, we financed our operations and acquisitions throughoperating cash flows, the use of cash reserves and borrowings under our creditfacility.  In previous periods, we alsofinanced our operations and acquisitions through an underwritten publicoffering of common stock.

 

Netcash flow provided by operations equaled $7.9 million for the nine months endedSeptember 30, 2002, compared to $5.7 million used by operations during the ninemonths ended September 30, 2001.  The year to year change is primarily due totwo factors: the $4.2 million increase in net income in 2002 compared to 2001,and lower funding of the operating cash flow needs of acquisitions in thecurrent year compared to the prior year. During the first nine months of 2002, we acquired accounts receivable inthree of our five acquisitions, allowing us to receive immediate cash inflowfrom those offices by collecting their existing accounts receivable.  By contrast, in the first nine months of2001, we acquired accounts receivable in only one of our seven acquisitions,causing initial negative operating cash flows from six of the sevenacquisitions and causing our overall operating cash flow to be negative for thenine months ended September 30, 2001.

 

Another factor contributing to thecurrent year’s positive cash flow provided by operations was our consistentdays sales outstanding (DSO) calculated by the exhaustion method, which was 79days as of September 31, 2002 compared to 80 days as of December 31, 2001. ThisDSO consistency has limited the growth of our accounts receivable balance,contributing to our positive cash flows from operations.  The higher DSO of certain acquisitionoffices, particularly in Texas, has been mostly offset by our increases inspecialty pharmacy business, for which DSO numbers tend to be lower.

 

Netcash flow used in investing activities during the nine months ended September 30, 2002 was $25.8 million, representing anincrease of $13.4 million from the $12.4 million used during the correspondingperiod in the prior year. In both periods, the use of cash was primarily due tothe completion of several acquisitions. During the nine months ended September 30, 2002, Option Care invested $20.3 million inacquisitions, consisting of $17.0 million paid at closing for acquisitionscompleted in 2002 and $3.3 million paid as additional consideration on prioryears’ acquisitions.  Payments forpurchase of equipment equaled $5.4 million for the nine months ended September 30, 2002, compared to $2.2 million in the prioryear. Of the $5.4 million spent on equipment purchases in the nine months endedSeptember 30, 2002, approximately$1.1 million was spent to purchase new infusion pumps to replace existing pumpsthat were being rented, and $1.0 million was spent on the development of newsoftware products.  The remaining $3.3million was spent for infrastructure improvements such as office furniture,computer equipment and leasehold improvements, and revenue-producing durablemedical equipment.

 

Net cash flow provided byfinancing activities equaled $9.7 million for the nine months ended September 30, 2002, compared to $18.1 millionprovided by financing activities in the corresponding period of the prioryear.  Of the $9.7 million provided inthe current year, $8.4 million related to borrowings under our revolving creditfacility to fund the cost of acquisitions, $2.1 million was provided from theexercise of stock options, and $600,000 was used to pay loan origination costsand fees related to Option Care’s Credit and Security Agreement with J.P.Morgan Commercial Finance Corp.  In theprior year, of the $18.1 million in cash provided by financing activities,$16.3 million was provided from borrowings on our credit facility to fundacquisitions and their working capital needs.

 

As of March 29, 2002,Option Care signed a new senior secured credit facility with JP MorganCommercial Finance Corp. Availability under this revolving credit facility isrelated to percentages of our outstanding accounts receivable and inventorybalances, less certain ineligible amounts, as defined in the facility. Overallborrowings allowable under the revolving credit facility are limited to thelesser of $60 million or the total allowable collateral base. The agreementrequires us to comply with various financial covenants. As ofSeptember 30, 2002, our total allowable collateral borrowing base underthe facility was $33.6 million based on the accounts receivable and inventorybalances as of that date.  Option Carehad an outstanding balance under the credit facility of $8.4 million as ofSeptember 30, 2002, with additional availability of$25.2 million.  The JP Morgancredit facility expires on March 29, 2005.

 

As of September 30, 2002,we had $300,000 in cash and cash equivalents, compared to $8.5 million as ofDecember 31, 2001. This reduction in cash during the nine months endedSeptember 30, 2002 was primarily due to payments for acquisitions completedduring that period, plus funding their operational cash flow needs immediatelyafter purchase for the two acquisitions in which we did not acquire accountsreceivable.  Should we need to borrow tofund future acquisitions or our operating cash flow needs, we are able toborrow on our existing credit facility with JP Morgan on a daily basis.  During times when we have an outstandingbalance under this credit facility, excess available cash on hand is used topay down our outstanding balance, causing us to maintain a cash balance at ornear zero.

 

16

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

 

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

 

**Goodwill and Other Intangible Assets**

 

Asof September 30, 2002, net goodwill and other intangible assets equaled $57.6million, consisting of $55.7 million of goodwill and $1.9 million of otherintangible assets such as non-compete agreements, patient records, and managedcare contracts.  This total representsan increase of $17.7 million over the $39.9 million of net goodwill and otherintangible assets at December 31, 2001. The increases of $17.3 million ingoodwill and $400,000 of other intangible assets was primarily due to theacquisitions we made during the nine months ended September 30, 2002, plusadditional consideration on various acquisitions completed in prior years.

 

OptionCare has tested goodwill for impairment as of January 1, 2002, as required byStatement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets(SFAS No. 142)*.  No impairmentof goodwill was identified.

 

**Regulatory andOther Developments**

 

Many governmental payorsreimburse us for some pharmaceuticals based on the pharmaceutical’s averagewholesale price (AWP). In many cases, we purchase pharmaceuticals at less thanAWP. AWP for most pharmaceuticals is compiled and published by privatecompanies, including First DataBank, Inc. It has been reported that there arecurrently several lawsuits pending against manufacturers of certainpharmaceuticals. These government investigations and lawsuits involveallegations that manufacturers have misrepresented to First DataBank the actualselling price of certain pharmaceuticals. First DataBank has announced that itwill now base AWP on market prices certified by the manufacturer. As a resultof this change, First DataBank has published a Market Price Survey that reducesthe AWP significantly for a number of the products we currently supply topatients. We cannot predict the eventual results of these investigations, northe changes made in AWP by First DataBank. If AWP on the products we purchasewas reduced, or if the AWP system was replaced with a different reimbursementsystem, our gross profit margins could be narrowed.

 

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

 

We are subject to marketrisk from exposure to changes in interest rates based on our financing and cashmanagement activities. We utilize a mix of debt maturities along with bothfixed-rate and variable-rate debt to manage our exposure to changes in interestrates. Although there can be no assurances that interest rates will not changesignificantly, we do not expect changes in interest rates to have a materialeffect on income or cash flows in 2002. As of September 30, 2002, ourfixed-rate debt was $600,000 and our corresponding variable-rate debt was $8.4million.  Based on Option Care’svariable-rate debt balance at September 30, 2002, a one-percent change ininterest rates would result in an annual change in interest expense ofapproximately $84,000.

 

**ITEM4.  Controls and Procedures**

 

**Evaluation of Disclosure Controls andProcedures**

We maintain disclosure controls andprocedures which have been designed to ensure that information related toOption Care is recorded, processed, summarized and reported by Option Care on atimely basis. Within 90 days of the filing of this Quarterly Report on Form10-Q, our Chief Executive Officer, Rajat Rai, and our Chief Financial Officer,Paul Mastrapa, carried out an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures.  Based upon this evaluation, Mr. Rai and Mr. Mastrapa concludedthat our disclosure controls and procedures are effective in causing materialinformation to be recorded, processed, summarized and reported by management ona timely basis and ensuring that the quality and timeliness of our publicdisclosures comply with our disclosure obligations under the SecuritiesExchange Act of 1934.

 

**Changes in Internal Controls**

There were no significantchanges in internal controls or other factors that could significantly affectour internal controls after the date of the most recent evaluation by our ChiefExecutive Officer and Chief Financial Officer.

 

17

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**PARTII.  OTHER INFORMATION**

 

**ITEM 1.  LegalProceedings**

 

Option Care has been named as a defendant in a lawsuit filed onSeptember 10, 2002 in the Superior Court, County of Ventura, State ofCalifornia, under the caption *Rios vs. Profession Home Health Services*, *et. al*.,No. SC033894.  Plaintiffs allege thatdefendants negligently prepared, sold and dispensed a certain prescriptionresulting in fatal injuries.  Plaintiffsseek unspecified compensatory damages. The lawsuit is currently in the preliminary pleadings stage.  Option Care denies, and intends tovigorously defend against, the allegations contained in the complaint. TheCompany believes that to the extent a monetary award is rendered against OptionCare, that monetary award will fall within the limits of the Company’s generalliability insurance policy coverage for that claim.

 

Aside from the lawsuit mentioned above, Option Care is not a party toany material legal proceedings.  OptionCare may become a party to various claims and legal actions arising in the ordinarycourse of business.

 

**ITEM 2.  Changes inSecurities and Use of Proceeds**

 

None.

 

**ITEM 3. Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**ITEM 5.  OtherInformation**

 

None.

 

**ITEM 6(a).  Exhibits**

 

See Exhibit Index.

 

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

 

None.

 

18

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**SIGNATURE**

 

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

 
|                          |   | OPTION CARE, INC. |
|-------------------------------|--------|------------------------|
| Date:  November 13, 2002 |   | By:                    | /s/  Paul Mastrapa |   |
|                          |   |                   | *Paul Mastrapa* |
|                          |   |                   | *Chief  Financial Officer* |
|                          |   |                   | *(Principal  Accounting Officer and**Principal  Financial Officer)* |

 

19

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**CERTIFICATION**

 

I, Rajat Rai, certifythat:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Option Care, Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of a materialfact or omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by the report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant'sother certifying officer(s) and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly reports is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant'sother certifying officer(s) and I have disclosed, based on our most recentevaluation, to the registrant's auditors and the audit committee of theregistrant's board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant's ability to record, process, summarize andreport financial data and have identified for the registrant's auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have a significantrole in the registrant's internal controls; and

 

6.               The registrant'sother certifying officer(s) and I have indicated in this quarterly reportwhether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date: November 13,  2002 | By:    | /s/ Rajat Rai                          |   |
|-------------------------------|--------|----------------------------------------|--------|
|                          |   | Rajat Rai                              |   |
|                          |   | President and Chief  Executive Officer |   |

 

20

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**CERTIFICATION**

 

I, Paul Mastrapa, certifythat:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Option Care, Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by the report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for,the periods presented in this quarterly report;

 

4.               The registrant'sother certifying officer(s) and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly reports is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on  ourevaluation as of the Evaluation Date;

 

5.               The registrant'sother certifying officer(s) and I have disclosed, based on our most recentevaluation, to the registrant's auditors and the audit committee of theregistrant's board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which could adverselyaffect the registrant's ability to record, process, summarize and reportfinancial data and have identified for the registrant's auditors any materialweaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant's internal controls; and

 

6.     The registrant's other certifyingofficer(s) and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date: November 13,  2002 | By:    | /s/ Paul Mastrapa                                  |   |
|-------------------------------|--------|----------------------------------------------------|--------|
|                          |   | Paul Mastrapa                                      |   |
|                          |   | Senior Vice President  and Chief Financial Officer |   |

 

21

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**EXHIBIT INDEX**

 
| **Exhibit   Number** |   |                                                                                                                                                                                                                                                                                                                                                        |
|----------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 3.1                  |   | Certificate  of Incorporation of the Registrant, together with Certificate of Amendment  thereto filed February 18, 1992. Filed as Exhibit 3(a) to Option  Care’s Registration Statement (No. 33-45836) dated April 15, 1992  and incorporated by reference herein.                                                                |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 3.2                  |   | Certificate  of Amendment to Certificate of Incorporation of the Registrant filed  March 25, 1992. Filed as Exhibit 3(c) to Option Care’s Registration  Statement (No. 33-45836) dated April 15, 1992 and incorporated by  reference herein.                                                                                       |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 3.3                  |   | Certificate  of Amendment to Certificate of Incorporation of the Registrant filed with the  Delaware Secretary of State on June 18, 2002 and incorporated by  reference herein.                                                                                                                                                                        |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 3.4                  |   | Restated  By-laws of the Registrant dated June 1, 1994. Filed as Exhibit 10.5  to Option Care’s Annual Report on Form 10-K for the year ending December 31,  1994 and incorporated by reference herein.                                                                                                                            |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.5                 |   | Option  Care, Inc. 401(k) Profit Sharing Plan. Filed as Exhibit 10(b) to  Option Care’s Registration Statement (No. 33-45836) dated April 15, 1992  and incorporated by reference herein.                                                                                                                                               |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.6                 |   | Amendment  to the 1992 401(k) Profit Sharing Plan of the Registrant dated  January 1, 1996. Filed as Exhibit 10.3(a) to Option Care’s Annual  Report on Form 10-K for the year ending December 31, 1997 and  incorporated by reference herein.                                                                                     |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.8                 |   | Form  of Franchise Agreement. Filed as Exhibit 10.5 to Option Care’s Annual  Report on Form 10-K for the year ending December 31, 1996 and  incorporated by reference herein.                                                                                                                                                           |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.10                |   | Consulting  Agreement between the Registrant and EJ Financial Enterprises, Inc. Filed as  Exhibit 10(o) to Option Care’s Registration Statement  (No. 33-45836) dated April 15, 1992 and incorporated by reference  herein.                                                                                                                  |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.14                |   | Executive  Severance Agreement between Cathy Bellehumeur and Option Care, Inc.,  dated November 12, 1997. Filed as Exhibit 10.18 to Option Care’s  Annual Report for the year ending December 31, 1997 and incorporated by  reference herein.                                                                                      |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.22                |   | Amendment  No. 1 to the Consulting Agreement By and Between EJ Financial  Enterprises, Inc. and Option Care, Inc., dated October 1,  1999. Filed as Exhibit 10.30 to Option Care’s Annual Report for the year  ended December 31, 1999 and incorporated by reference herein.                                        |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.24                |   | 2001  Employee Stock Purchase Plan. Filed as Exhibit A to the registrants  definitive proxy statement for the 2000 Annual Shareholders Meeting and  incorporated by reference herein.                                                                                                                                                                  |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.26                |   | Participation  Agreement between Health Options, Inc. and Option Care, Inc. effective  as of June 1, 1997. 2001. Filed as Exhibit 10.26 to Option Care’s  Amendment No. 1 to its Annual Report on Form 10-K/A filed  September 10, 2001 and incorporated by reference herein.                                            |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.27                |   | Prescription  Drug Agreement among Blue Cross and Blue Shield of Florida, Inc., Health  Options, Inc. and Option Care, Inc. dated March 8, 2000. Filed  as Exhibit 10.27 to Option Care’s Amendment No. 1 to its Annual  Report on Form 10-K/A filed September 10, 2001 and incorporated by  reference herein. |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.28                |   | Amendment  to Participation Agreement between Health Options, Inc. and Option Care, Inc.  dates as of April 1, 2001.   Incorporated by reference herein.                                                                                                                                                                                               |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.29                |   | Deferred  Compensation Plan for certain Executives, effective as of January 1,  2001.  Incorporated by reference  herein.                                                                                                                                                                                                                              |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.32                |   | Injectable  Drugs Agreement effective as of September 5, 2001 between Health Option, Inc.  and OptionMed, Inc.  Filed on October  10, 2001 as Exhibit 10.1 to Form 8-K/A and incorporated herein by reference.                                                                                                                                         |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 99.1                 |   | Certification  of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                          |
|                 |   |                                                                                                                                                                                                                                                                                                                                                        |
| 99.2                 |   | Certification  of Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                             |

 

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