**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

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

 

**Forthe quarterly period ended**

 

**March 31,2004**

 

**Commissionfile number 0-19878**

 

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**OPTION CARE, INC.**

(Exact name of registrant as specified in itscharter)

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

 

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

 

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

 

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

 
|   | **Class**                    |   | **Issued and  Outstanding  as of  May 5, 2004** |   |
|--------|------------------------------|--------|------------------------------------------------------|--------|
|   |                         |   |                                                 |   |
|   | Common Stock - .01 par value |   | 21,293,317                                           |   |

 

 

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**INDEX**

 

**OPTIONCARE, INC. AND SUBSIDIARIES**

 
| **DESCRIPTION** |                                                                                                  |   |
|-----------------|-------------------------------------------------------------------------------------------------------|--------|
|            |                                                                                                  |   |
| **PART I**      | **FINANCIAL INFORMATION**                                                                             |   |
|            |                                                                                                  |   |
| Item 1.         | Financial Statements (Unaudited)                                                                      |   |
|            |                                                                                                  |   |
|            | Condensed consolidated balance  sheets—March 31, 2004 and December 31, 2003            |   |
|            |                                                                                                  |   |
|            | Condensed consolidated statements of  operations—Three months ended March 31, 2004 and 2003 |   |
|            |                                                                                                  |   |
|            | Condensed consolidated statements of cash  flows—Three months ended March 31, 2004 and 2003 |   |
|            |                                                                                                  |   |
|            | Notes to condensed consolidated financial  statements—March 31, 2004                        |   |
|            |                                                                                                  |   |
| Item 2.         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations           |   |
|            |                                                                                                  |   |
| Item 3.         | Quantitative and Qualitative Disclosures  about Market Risk                                           |   |
|            |                                                                                                  |   |
| Item 4.         | Controls and Procedures                                                                               |   |
|            |                                                                                                  |   |
| **PART  II**    | **OTHER  INFORMATION**                                                                                |   |
|            |                                                                                                  |   |
| Item 1.         | Legal Proceedings                                                                                     |   |
|            |                                                                                                  |   |
| Item 2.         | Changes in Securities and Use of Proceeds                                                             |   |
|            |                                                                                                  |   |
| Item 3.         | Defaults Upon Senior Securities                                                                       |   |
|            |                                                                                                  |   |
| Item 4.         | Submission of Matters to a Vote of Security  Holders                                                  |   |
|            |                                                                                                  |   |
| Item 5.         | Other Information                                                                                     |   |
|            |                                                                                                  |   |
| Item  6(a).     | Exhibits                                                                                              |   |
|            |                                                                                                  |   |
| Item 6(b).      | Reports on Form 8-K                                                                              |   |
|            |                                                                                                  |   |
| **SIGNATURES**  |                                                                                                  |

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**Item1.  FinancialStatements**

 

**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Balance Sheets**

(in thousands, except per share amounts)

 
|                                                                                                                                                                                |   | **March 31,  2004** |    | **December 31,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                |   | **(Unaudited)**          |    | **(Note 1)**                |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Assets                                                                                                                                                                              |   |                     |    |                        |   |
| Current assets:                                                                                                                                                                     |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                                                           |   | $                        | 6,649   |                        | $      | 3,961 |   |
| Accounts receivable, net                                                                                                                                                            |   | 65,721                   |    | 62,190                      |   |
| Inventory                                                                                                                                                                           |   | 8,248                    |    | 11,522                      |   |
| Deferred income tax benefit                                                                                                                                                         |   | 3,976                    |    | 4,442                       |   |
| Other current assets                                                                                                                                                                |   | 4,218                    |    | 5,279                       |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total current assets                                                                                                                                                                |   | 88,812                   |    | 87,394                      |   |
| Equipment and other fixed assets, net                                                                                                                                               |   | 12,176                   |    | 12,145                      |   |
| Goodwill, net                                                                                                                                                                       |   | 65,661                   |    | 64,970                      |   |
| Other assets                                                                                                                                                                        |   | 1,874                    |    | 2,025                       |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total assets                                                                                                                                                                        |   | $                        | 168,523 |                        | $      | 166,534 |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Liabilities and stockholders’ equity                                                                                                                                           |   |                     |    |                        |   |
| Current liabilities:                                                                                                                                                                |   |                     |    |                        |   |
| Trade accounts payable                                                                                                                                                              |   | $                        | 18,523  |                        | $      | 19,940 |   |
| Current portion of long-term debt                                                                                                                                                   |   | 112                      |    | 424                         |   |
| Other current liabilities                                                                                                                                                           |   | 9,054                    |    | 10,253                      |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total current liabilities                                                                                                                                                           |   | 27,689                   |    | 30,617                      |   |
| Long-term debt, less current portion                                                                                                                                                |   | 29                       |    | 82                          |   |
| Long-term deferred income tax liability                                                                                                                                             |   | 5,983                    |    | 5,677                       |   |
| Other liabilities                                                                                                                                                                   |   | 702                      |    | 711                         |   |
| Minority interest                                                                                                                                                                   |   | 468                      |    | 427                         |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total liabilities                                                                                                                                                                   |   | 34,871                   |    | 37,514                      |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Stockholders’ equity:                                                                                                                                                          |   |                     |    |                        |   |
| Common stock, $.01 par value per share,  60,000 shares authorized, 21,232 and 20,942 shares issued and outstanding at  March 31, 2004 and December 31, 2003, respectively |   | 212                      |    | 209                         |   |
| Common stock to be issued, 27 and 144  shares at March 31, 2004 and December 31, 2003, respectively                                                                       |   | 276                      |    | 834                         |   |
| Additional paid-in capital                                                                                                                                                          |   | 106,019                  |    | 104,173                     |   |
| Retained earnings                                                                                                                                                                   |   | 28,250                   |    | 23,965                      |   |
| Less treasury stock, at cost, common shares  101 and 15, respectively                                                                                                               |   | (1,105                   | )       | (161                        | )      |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total stockholders’ equity                                                                                                                                                     |   | 133,652                  |    | 129,020                     |   |
|                                                                                                                                                                                |   |                     |    |                        |   |
| Total liabilities and stockholders’ equity                                                                                                                                     |   | $                        | 168,523 |                        | $      | 166,534 |   |

 

*See notes tocondensed consolidated financial statements*

 

3

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**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Statements of Income**

(Unaudited)

(in thousands, except per share amounts)

 
|                                            |   | **Three  months ended March 31,** |   |
|-------------------------------------------------|--------|----------------------------------------|--------|
|                                            |   | **2004**                               |   | **2003** |   |
|                                            |   |                                   |   |   |   |
| Revenue:                                        |   |                                   |   |   |   |
| Specialty pharmacy services                     |   | $                                      | 64,932 |   | $ | 57,034 |   |
| Infusion and related healthcare services        |   | 34,946                                 |   | 33,073 |   |
| Other                                           |   | 3,271                                  |   | 2,455 |   |
| Total revenue                                   |   | 103,149                                |   | 92,562 |   |
| Cost of revenue:                                |   |                                   |   |   |   |
| Cost of goods sold                              |   | 63,808                                 |   | 54,824 |   |
| Cost of services provided                       |   | 10,644                                 |   | 10,458 |   |
| Total cost of revenue                           |   | 74,452                                 |   | 65,282 |   |
|                                            |   |                                   |   |   |   |
| Gross profit                                    |   | 28,697                                 |   | 27,280 |   |
|                                            |   |                                   |   |   |   |
| Selling, general and administrative  expenses   |   | 19,249                                 |   | 18,030 |   |
| Provision for doubtful accounts                 |   | 1,559                                  |   | 1,878 |   |
| Depreciation and amortization                   |   | 681                                    |   | 668 |   |
|                                            |   |                                   |   |   |   |
| Total operating expenses                        |   | 21,489                                 |   | 20,576 |   |
|                                            |   |                                   |   |   |   |
| Operating income                                |   | 7,208                                  |   | 6,704 |   |
| Interest income (expense)                       |   | 1                                      |   | (99 | ) |
| Other expense, net                              |   | (67                                    | )      | (9 | ) |
|                                            |   |                                   |   |   |   |
| Income before income taxes                      |   | 7,142                                  |   | 6,596 |   |
| Income tax provision                            |   | 2,857                                  |   | 2,630 |   |
|                                            |   |                                   |   |   |   |
| Net income                                      |   | $                                      | 4,285  |   | $ | 3,966 |   |
|                                            |   |                                   |   |   |   |
| Net income per common share:                    |   |                                   |   |   |   |
| Basic                                           |   | $                                      | 0.20   |   | $ | 0.19 |   |
|                                            |   |                                   |   |   |   |
| Diluted                                         |   | $                                      | 0.20   |   | $ | 0.19 |   |
|                                            |   |                                   |   |   |   |
| Shares used in computing net income per  share: |   |                                   |   |   |   |
| Basic                                           |   | 21,091                                 |   | 20,807 |   |
| Diluted                                         |   | 21,556                                 |   | 21,156 |   |

 

*See notes tocondensed consolidated financial statements*

 

4

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**OptionCare, Inc. and Subsidiaries**

**CondensedConsolidated Statements of Cash Flows**

(Unaudited)

(in thousands)

 
|                                                                               |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                               |   | **2004**                                |   | **2003** |   |
|                                                                               |   |                                    |   |   |   |
| Cash flows from operating activities:                                              |   |                                    |   |   |   |
| Net income                                                                         |   | $                                       | 4,285  |   | $ | 3,966 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                                    |   |   |   |
| Depreciation and amortization                                                      |   | 1,204                                   |   | 1,069 |   |
| Provision for doubtful accounts                                                    |   | 1,559                                   |   | 1,878 |   |
| Deferred income taxes                                                              |   | 806                                     |   | 750 |   |
| Income tax benefit from exercise of stock  options                                 |   | 456                                     |   | 52 |   |
| Changes in assets and liabilities:                                                 |   |                                    |   |   |   |
| Accounts receivable                                                                |   | (4,709                                  | )      | (4,784 | ) |
| Inventory                                                                          |   | 3,342                                   |   | 581 |   |
| Accounts payable                                                                   |   | (1,417                                  | )      | 335 |   |
| Income taxes receivable/payable                                                    |   | 1,331                                   |   | 1,089 |   |
| Change in other assets and liabilities                                             |   | (1,631                                  | )      | (266 | ) |
|                                                                               |   |                                    |   |   |   |
| Net cash provided by operating activities                                          |   | 5,226                                   |   | 4,670 |   |
|                                                                               |   |                                    |   |   |   |
| Cash flows from investing activities:                                              |   |                                    |   |   |   |
| Purchases of equipment and other, net                                              |   | (975                                    | )      | (1,390 | ) |
| Payments for acquisitions, net of cash  acquired                                   |   | (1,090                                  | )      | (3,058 | ) |
| Proceeds from disposals                                                            |   | —                                  |   | 84 |   |
|                                                                               |   |                                    |   |   |   |
| Net cash used in investing activities                                              |   | (2,065                                  | )      | (4,364 | ) |
|                                                                               |   |                                    |   |   |   |
| Cash flows from financing activities:                                              |   |                                    |   |   |   |
| Net borrowing on credit agreements                                                 |   | —                                  |   | 43 |   |
| Payments on capital leases and other debt                                          |   | (364                                    | )      | (80 | ) |
| Proceeds from issuance of stock                                                    |   | 835                                     |   | 317 |   |
| Payments for purchase of treasury stock                                            |   | (944                                    | )      | — |   |
|                                                                               |   |                                    |   |   |   |
| Net cash provided by (used in) financing  activities                               |   | (473                                    | )      | 280 |   |
|                                                                               |   |                                    |   |   |   |
| Net increase in cash and cash equivalents                                          |   | 2,688                                   |   | 586 |   |
| Cash and cash equivalents, beginning of  period                                    |   | 3,961                                   |   | 488 |   |
| Cash and cash equivalents, end of period                                           |   | $                                       | 6,649  |   | $ | 1,074 |   |

 

*See notes tocondensed consolidated financial statements*

 

5

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**OptionCare, Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements**

**March 31,2004**

(Unaudited)

 

**1.   Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded. Operating results for the three months ended March 31, 2004 arenot necessarily indicative of the results that may be expected for the yearending December 31, 2004.

 

The balance sheet at December 31, 2003 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.

 

For further information, refer to the consolidated financial statementsand footnotes thereto included in Option Care’s Annual Report on Form 10-Kfor the year ended December 31, 2003.

 

**2.   Long-Term Debt**

 

We entered into a three-year, $60 million revolving Credit and SecurityAgreement on March 29, 2002 with J.P. Morgan Business Credit Corporation,J.P. Morgan Chase Bank and LaSalle Bank, N.A. (the “Lenders”).  Availability under the Credit and SecurityAgreement is related to various percentages of our outstanding accountsreceivable and inventory balances, less certain capped and ineligible amounts,as defined in the agreement.  Overallborrowings under the agreement will be limited to the lesser of the remainingavailability and the total allowable collateral borrowing base.  The facility is secured by substantially allcompany assets.  In addition tocustomary events of default, the facility provides that a change in controlwould give rise to an event of default. The facility requires us to meetcertain financial covenants.  We paid afacility fee of approximately $400,000 upon signing the agreement.  The agreement provides for a commitment fee,calculated and paid quarterly on a sliding scale from 0.45% to 0.25%, based onthe average daily unused portion of the facility.  For a fee, we may secure up to $5 million in letters of credit.  Depending on our level of borrowing underthe agreement, we may select interest rates ranging from the Eurodollar Rateplus 2% to 2.75%, or the bank’s reference rate plus 0% to 0.75%.  The agreement is scheduled to expire onMarch 29, 2005.

 

As of March 31, 2004 and December 31, 2003, we had no balanceoutstanding under this facility.   AtMarch 31, 2004, we had borrowing availability of $38.4 million based onthe accounts receivable and inventory balances as of that date, while atDecember 31, 2003 we had additional borrowing capacity of $37.7 million.

 

On October 23, 2003, the Lenders and Option Care signed anamendment to the Credit and Security Agreement to address the $6.8 millionspecial provision for doubtful accounts recorded in the quarter endedSeptember 30, 2003 related to our Texas accounts receivable.  The amendment allows us to exclude the $6.8million charge when calculating our fixed charge coverage ratio in the currentand subsequent quarters.  This change incalculation method allowed us to remain in compliance with our financialcovenants for the quarters ended September 30 and December 31,2003.  For the quarter endedMarch 31, 2004, we were in compliance with our financial covenants beforeconsideration of the amendment.

 

6

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**3.    Earnings Per Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated (in thousands, except per shareamounts):

 
|                                                                            |   | **Three  months ended March 31,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                            |   | **2004**                               |   | **2003** |   |
| Basic:                                                                          |   |                                   |   |   |   |
| Net income                                                                      |   | $                                      | 4,285  |   | $ | 3,966 |   |
|                                                                            |   |                                   |   |   |   |
| Average shares outstanding                                                      |   | 21,091                                 |   | 20,807 |   |
|                                                                            |   |                                   |   |   |   |
| Basic earnings per share                                                        |   | $                                      | 0.20   |   | $ | 0.19 |   |
|                                                                            |   |                                   |   |   |   |
| Diluted:                                                                        |   |                                   |   |   |   |
| Net income                                                                      |   | $                                      | 4,285  |   | $ | 3,966 |   |
|                                                                            |   |                                   |   |   |   |
| Average shares outstanding                                                      |   | 21,091                                 |   | 20,807 |   |
| Net effect of dilutive stock options –  Based on the treasury stock method |   | 465                                    |   | 349 |   |
|                                                                            |   |                                   |   |   |   |
| Total diluted shares                                                            |   | 21,556                                 |   | 21,156 |   |
|                                                                            |   |                                   |   |   |   |
| Diluted earnings per share                                                      |   | $                                      | 0.20   |   | $ | 0.19 |   |

 

**4.   Operating Segments**

 

Option Care has oneidentifiable business segment, with three service lines: specialty pharmacyservices; infusion and related healthcare services; and other.  Specialty pharmacy services involve thedistribution of injectible and infused pharmaceuticals to treat a wide range ofchronic health conditions.  Thepharmaceuticals can be directly distributed to the patient’s home or to theirphysician’s office for in-office administration.  These pharmaceuticals may require refrigeration during shippingas well as special handling to prevent potency degradation.  Patients receiving treatment usually requirespecial counseling and education regarding their condition and treatmentprogram.  Infusion and relatedhealthcare services primarily involves the intravenous administration ofmedications at the patient’s home or other non-hospital sites such at one ofour infusion suites.  Infusion pharmacyservices treat a wide range of acute and chronic health conditions, includinginfections, dehydration, cancer, pain and nutritional deficiencies.  All of our company-owned pharmacies provide infusionpharmacy services.  Some of thesepharmacies also provide related healthcare services, such as home healthnursing, home hospice services, respiratory therapy services and durablemedical equipment.  Other revenueconsists of royalties and other fees generated from our franchised pharmacynetwork and the software licensing and support revenue generated by oursubsidiary, Management by Information, Inc. (“MBI”).

 

7

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

 
|                                                    |   | **Three  months ended March 31,** |    |
|---------------------------------------------------------|--------|----------------------------------------|---------|
|                                                    |   | **2004**                               |    | **2003** |   |
|                                                    |   |                                   |    |   |   |
| Specialty pharmacy services                             |   | $                                      | 64,932  |   | $ | 57,034 |   |
| Infusion and related healthcare services:               |   |                                   |    |   |   |
| Infusion therapy                                        |   | 29,642                                 |    | 27,233 |   |
| Related healthcare services                             |   | 5,304                                  |    | 5,840 |   |
| Total infusion and related healthcare  services revenue |   | 34,946                                 |    | 33,073 |   |
| Other revenue:                                          |   |                                   |    |   |   |
| Franchise-related                                       |   | 2,899                                  |    | 2,144 |   |
| Software licensing and support                          |   | 372                                    |    | 311 |   |
| Total other revenue                                     |   | 3,271                                  |    | 2,455 |   |
|                                                    |   |                                   |    |   |   |
| Total revenue                                           |   | $                                      | 103,149 |   | $ | 92,562 |   |

 

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

 

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

 
|                                   |                     | **Revenue** |                        | **Accounts  Receivable** |   |
|----------------------------------------|--------------------------|-------------|-----------------------------|--------------------------|--------|
| **Three  months ended March 31,** | **March 31,  2004** |        | **December 31,  2003** |
| **2004**                               |                     | **2003**    |
|                                   |                     |        |                        |                     |   |   |   |   |   |
| Blue Cross and Blue Shield of Florida  |                     | 15          | %                           | 17                       | %      | 7 | % | 9 | % |
|                                   |                     |        |                        |                     |   |   |   |   |   |
| Medicare                               |                     | 7           | %                           | 7                        | %      | 9 | % | 10 | % |
| Medicaid                               |                     | 13          | %                           | 11                       | %      | 9 | % | 10 | % |
| Total – government payors         |                     | 20          | %                           | 18                       | %      | 18 | % | 20 | % |
|                                   |                     |        |                        |                     |   |   |   |   |   |
| All other payors (1)                   |                     | 65          | %                           | 65                       | %      | 75 | % | 71 | % |
|                                   |                     |        |                        |                     |   |   |   |   |   |
| Total                                  |                     | 100         | %                           | 100                      | %      | 100 | % | 100 | % |

 

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(1) No other payor represents 10% or more of revenue or accountsreceivable as of the dates and for the periods presented.

 

We generate the majority of our revenue from managed care contracts andother agreements with commercial third party payors from our provision ofhealth care services to their members. Our principal managed care contract is with Blue Cross and Blue Shieldof Florida, to whose members we provide infusion pharmacy services and specialtypharmacy services.  For the three monthsended March 31, 2004 and 2003, respectively, 15% and 17% of our revenuewas related to this contract.  As ofMarch 31, 2004 and December 31, 2003, 7% and 9% of our accountsreceivable, respectively, was due from Blue Cross and Blue Shield of Florida.  The contract is terminable by either partyon 90 days’ notice and, unless terminated, renews annually eachSeptember for an additional one-year term.

 

Option Care also generates revenue from government healthcare programssuch as Medicare and Medicaid.  For thethree months ended March 31, 2004 and 2003, respectively, 20% and 18% ofour revenue came from government healthcare programs. Of our total accountsreceivable as of March 31, 2004 and December 31, 2003, approximately18% and 20%, respectively, was due from government healthcare programs.

 

8

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**6.   Seasonal Revenue Trends**

 

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

 

 Option Care’s quarterlySynagis® revenue for 2003 and the first quarter of 2004 was as follows (amountsin thousands):

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

 

**7.   Acquisitions**

 

Duringthe quarter ended March 31, 2004, we completed two small acquisitionsthrough asset purchase agreements.  Weconsolidated the results of the newly acquired businesses as of the dates theywere acquired.

 

OnJanuary 13, 2004, we acquired certain assets and the respiratory therapyand durable medical equipment (RT/DME) business of JCMG Ancillary Services, aprovider located in Jefferson City, Missouri. This acquisition increased our RT/DME market share in centralMissouri.  Management of the operationsof this business was immediately consolidated with that of our existingpharmacy, hospice and RT/DME business located in Columbia, Missouri.  The total purchase price was $565,000, paidin cash.

 

OnJanuary 22, 2004, we acquired certain assets and the infusion pharmacybusiness of our franchise in Upper Darby, Pennsylvania.  This acquisition consolidates our presencein the Philadelphia area, as the territory served by this franchise wasadjacent to the territory of one of our company-owned pharmacies.  We consolidated the operations of thisbusiness with our existing Philadelphia area pharmacy immediately uponconsummating the agreement.  The totalpurchase price was $725,000, of which $525,000 was paid in cash at closing and$200,000 will be payable in future periods, subject to certain contingenciesregarding collection of purchased accounts receivable.

 

Thefollowing table presents our allocation of the total purchase price for theseacquisitions (in thousands):

 
| Accounts receivable, net                                  |   | $     | 368    |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Inventory                                                 |   | 68    |   |
| Equipment and other fixed assets                          |   | 85    |   |
| Goodwill                                                  |   | 691   |   |
| Other intangible assets                                   |   | 78    |   |
| Total purchase price                                      |   | 1,290 |   |
| Less deferred purchase price liability                    |   | (200  | )      |
| Total cash paid in the quarter ended  March 31, 2004 |   | $     | 1,090  |   |

 

9

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**8.   Stock-based Compensation**

 

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

 

Had compensation cost for Option Care’s stock-based compensation planbeen determined based on FASB Statement No. 123, Option Care’s net income andincome per common share for the three months ended March 31, 2004 and 2003on a pro-forma basis would have been (in thousands, except per share amounts):

 
|                                                                                                                                                         |   | **Three  months ended March 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                                                         |   | **2004**                               |   | **2003** | ** ** |
| Net income:                                                                                                                                                  |   |                                   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | 4,285  |   | $ | 3,966 |   |
| Deduct: Total stock-based employee  compensation expense determined under the fair value based method for the  following awards, net of related tax effects: |   |                                   |   |   |   |
| Stock option grants                                                                                                                                          |   | (332                                   | )      | (573 | ) |
| Employee stock purchase plan withholdings                                                                                                                    |   | (35                                    | )      | (53 | ) |
|                                                                                                                                                         |   |                                   |   |   |   |
| Pro forma                                                                                                                                                    |   | $                                      | 3,918  |   | $ | 3,340 |   |
|                                                                                                                                                         |   |                                   |   |   |   |
| Net income per common share-basic:                                                                                                                           |   |                                   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | 0.20   |   | $ | 0.19 |   |
| Pro forma                                                                                                                                                    |   | $                                      | 0.19   |   | $ | 0.16 |   |
|                                                                                                                                                         |   |                                   |   |   |   |
| Net income per common share-diluted:                                                                                                                         |   |                                   |   |   |   |
| As reported                                                                                                                                                  |   | $                                      | 0.20   |   | $ | 0.19 |   |
| Pro forma                                                                                                                                                    |   | $                                      | 0.18   |   | $ | 0.16 |   |

 

**9.   Comprehensive Income**

 

Net income was our only component of comprehensive income for thequarters ended March 31, 2004 and 2003.

 

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

 

**FORWARD LOOKINGSTATEMENTS**

 

The following discussion should be read in conjunction with our AnnualReport on Form 10-K for the year ended December 31, 2003. The PrivateSecurities Litigation Reform Act of 1995 provides a “safe harbor” forforward-looking statements. Certain information included in this QuarterlyReport on Form 10-Q and other materials filed or to be filed by us withthe Securities and Exchange Commission (as well as information included in oralstatements or other written statements made or to be made by us) containstatements that are or will be forward-looking, such as statements relating toacquisitions and other business development activities, future capitalexpenditures and the effects of future regulation and competition. Suchforward-looking information involves important risks and uncertainties thatcould significantly affect anticipated results in the future and, accordingly,such results may differ from those expressed in any forward-looking statementsmade by us, or on our behalf. These risks and uncertainties include, but arenot limited to, uncertainties affecting our businesses and our franchiseesrelating to acquisitions and divestitures (including continuing obligationswith respect to completed transactions), sales and renewals of franchises,government and regulatory policies (including federal, state and local effortsto reform the delivery of and payment for healthcare services), generaleconomic conditions (including economic conditions affecting the healthcareindustry in particular), the pricing and availability of equipment andservices, technological developments and changes in the competitive environmentin which we operate.

 

**OVERVIEW**

 

We provide pharmacy services to patients on behalf of managed careorganizations and other third party payors. We contract with payors to provide specialty pharmacy services, infusionpharmacy and other related healthcare services to patients at home or at otheralternate-site settings, such as physicians’ offices or infusion suites at ourpharmacy locations.  Our services areprovided through our national network of company-owned and franchise-owned pharmacies.

 

We have three service lines: specialty pharmacy services, infusion andrelated healthcare services, and other. Specialty pharmacy services involve thedistribution of injectible and infused pharmaceuticals to treat a wide range ofchronic health conditions.  Thepharmaceuticals can be directly distributed to the patient’s home or to theirphysician’s office for in-office administration.  These pharmaceuticals may require refrigeration during shippingas well as special handling to prevent potency degradation.  Patients receiving treatment usually requirespecial counseling and education regarding their condition and treatmentprogram.  Infusion and related servicesprimarily involves the intravenous administration of medications at thepatient’s home or other non-hospital site such as one of our infusionsuites.  Infusion pharmacy servicestreat a wide range of acute and chronic health conditions, includinginfections, dehydration, cancer, pain and nutritional deficiencies.  All of our company-owned pharmacies provideinfusion therapies.  Some of thesepharmacies also provide related healthcare services, such as home healthnursing, home hospice services, respiratory therapy services and durablemedical equipment.  Other revenueconsists of royalties and other fees generated from our franchised pharmacynetwork and the software licensing and support revenue generated by oursubsidiary, MBI.

 

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

 
|                                      |   | **Three months ended March 31, 2004** |    | **Three months ended March 31, 2003** |   |
|-------------------------------------------|--------|--------------------------------------------|---------|--------------------------------------------|--------|
|                                      |   | **Revenue**                                |    | **%****of  total**                         |   | **Gross  Profit** |   | **Gross  profit%** |   | **Revenue** |   | **%****of  total** |   | **Gross  Profit** |   | **Gross  profit%** |   |
|                                      |   |                                       |    |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty pharmacy services               |   | $                                          | 64,932  |                                       | 62.9   | % | $ | 10,526 |   | 16.2 | % | $ | 57,034 |   | 61.6 | % | $ | 11,034 |   | 19.3 | % |
| Infusion  and related healthcare services |   | 34,946                                     |    | 33.9                                       | %      | 15,029 |   | 43.0 | % | 33,073 |   | 35.7 | % | 13,879 |   | 42.0 | % |
| Other                                     |   | 3,271                                      |    | 3.2                                        | %      | 3,142 |   | 96.1 | % | 2,455 |   | 2.7 | % | 2,367 |   | 96.4 | % |
|                                      |   |                                       |    |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenue                             |   | $                                          | 103,149 |                                       | 100.0  | % | $ | 28,697 |   | 27.8 | % | $ | 92,562 |   | 100.0 | % | $ | 27,280 |   | 29.5 | % |

 

The majority of our revenue is generated from managed care contractsand other agreements with commercial third party payors.  Our principal managed care contract is withBlue Cross Blue Shield of Florida for the provision of specialty pharmacyservices and infusion pharmacy services to their members. For the three monthsended March 31, 2004 and 2003, respectively, approximately

 

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15% and 17% of our revenue was generated from this contract.  As of March 31, 2004 andDecember 31, 2003, respectively, 7% and 9% of our accounts receivable wasdue from Blue Cross Blue Shield of Florida. The contract is terminable byeither party on 90 days’ notice and, unless terminated, renews annually eachSeptember for an additional one-year term.

 

We also generate revenue from government healthcare programs such asMedicare and Medicaid.  For the threemonths ended March 31, 2004 and 2003, approximately 20% and 18% of ourrevenue, respectively, was generated from government healthcare programs.  As of March 31, 2004 andDecember 31, 2003, respectively, 18% and 20% of our total accountsreceivable was due from these government healthcare programs.

 

Many of the pharmaceuticals we provide are reimbursed at somepercentage of the Average Wholesale Price (AWP) for those pharmaceuticals.  AWP for most pharmaceuticals is compiled andpublished by private companies, including First DataBank, Inc.  In recent years, we have seen reductions toAWP for certain of the pharmaceuticals that we provide to patients in theaftermath of government investigations and other legal and regulatoryactions.  Any modifications to the AWPsystem or reductions in AWP for the products we provide to patients couldnarrow our gross profit margins.

 

TheMedicare Prescription Drug, Improvement and Modernization Act of 2003 changedthe way in which covered outpatient drugs are reimbursed by the Medicareprogram.  Starting in January 2004,payment for most drugs covered by Medicare will decrease to 85% of the AWP forthose drugs, determined as of April 1, 2003.  Beginning in 2005, reimbursement for non-self administered drugsfurnished to patients in conjunction with other Medicare covered services willbe set at either 106% of the average sales price (ASP) or through a competitiveacquisition program to be phased in beginning in 2006.  For infusion drugs administered inconnection with covered durable medical equipment, the payment rate generallywill continue to be 95% of the AWP as of October 1, 2003, until such drugsare subject to the implementation of a competitive acquisition program.  While the majority of our revenue isreimbursed by managed care organizations and other non-government payors, thesechanges to the way in which Medicare pays for outpatient drugs and biologicalsmay have some impact on us or our franchisees. In addition, as the Center for Medicare and Medicaid Services (CMS)implements the ASP reimbursement model, managed care organizations may push foradoption of ASP as the basis of pharmaceutical reimbursement as well.  If managed care organizations do adopt theASP model, our future financial condition and results of operations could bematerially affected based on our ability to renegotiate pricing using the ASPmethodology.

 

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

 

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

 

***Revenuerecognition and contractual adjustments***

 

Our revenue is primarily derived from the sale of pharmaceuticals andmedical supplies and the provision of related nursing services to patientsoutside the hospital at alternate-site settings. Most of this revenue is billedunder managed care or other contracts, with a smaller amount billed undergovernment healthcare programs, such as Medicare and Medicaid. We bill uponreceipt of all required documentation from payors, physicians and our staff. Atthe end of any period, a portion of our earned revenue remains unbilledawaiting completion of all documentation requirements. Billed and unbilledrevenue is recorded net of contractual adjustments based on our interpretationof the terms of each managed care contract or government contract or pricingschedule, as loaded into our computerized billing and pharmacy managementsoftware systems. In most cases, our contractual adjustments are calculatedautomatically by our billing system when the claim is billed, subject to reviewby the biller. If our billing system cannot automatically generate thecontractual adjustment for a given claim, we calculate the contractualadjustment manually and key the adjustment into our billing system when theclaim is billed. The contractual adjustments on unbilled amounts must beestimated manually through

 

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claim-by-claim analysis of the unbilled claims, by applying historicalcontractual adjustment percentages to the gross unbilled amounts, or acombination of the two methods. The accuracy of our recorded net revenue issubject to the accuracy of payor information on file for each patient, and isalso subject to our correct interpretation of each underlying contract withrespect to reimbursement rates for the drugs and services we provided. Ifchanges or corrections to our estimates of net revenue prove to be necessary,we adjust net revenue in the period that such changes or corrections areidentified. Such adjustments may have a positive or negative impact on therevenues and results of operations reported for those subsequent periods.Historically, such adjustments have not been significant to our statements ofincome.

 

***Accountsreceivable and allowances for doubtful accounts***

 

Our accounts receivable are reported net of contractual adjustments andallowances for doubtful accounts. The majority of our accounts receivable aredue from private insurance carriers and government healthcare programs such asMedicare or Medicaid. Third party reimbursement is a complicated process, witheach payor having its own claim requirements. The ultimate collection of ouraccounts receivable is dependent upon complete and accurate patient intake,timely submission of clean claims to payors, and timely and effective follow-upon outstanding claims. Our collection process involves multiple steps. Thefirst step is to bill each claim correctly, with proper coding, after havingreceived all prerequisite authorizations from the patient’s physician andinsurance company, as applicable. For claims submitted electronically, wereceive electronic acceptance of the claim from the insurance company orgovernmental agency responsible for paying the claim. This helps to assurecollection of the account. For mailed insurance claims or those for whichelectronic confirmation of acceptance is unavailable, the billing staff memberresponsible for that claim will contact the payor if payment is not receivedpromptly. The billing staff member will inquire as to the status of the claim,and will re-bill the claim or provide additional information as requested bythe payor. Upon rebilling, the billing staff member will contact the payor toconfirm receipt of the re-billed claim, and will follow up periodically untilpayment is received.

 

We write off accounts receivable as bad debts after all collectionefforts have been exhausted, according to the following procedures. Our billingstaff members review the status of their unpaid claims on a regular basis.During that review, the billing staff member will identify the reason fornon-payment of a given claim. Should the reason relate to a correctable errorwith the claim itself, or incomplete or inadequate documentation provided tothe payor, the billing staff member will attempt to address those issues and re-submita corrected claim or provide additional information to the payor, asappropriate. In the event the claim error or documentation error cannot becorrected, the allowed time to correct and re-submit the claim has expired, orthe claim is not paid due to a payor-related issue such as bankruptcy, thebilling staff member will submit a formal request for write-off. Theappropriate supervisor will review the request and authorize the claim to bewritten off if that supervisor agrees that the account is truly uncollectable.The identity of the appropriate supervisor to authorize a write-off isdetermined based on the reporting structure within each office and based on thedollar amount to be written off, with higher-level authorization required forlarger dollar write-offs.

 

Our allowance for doubtful accounts is estimated based on severalfactors, including our past accounts receivable collection history, the agingof our accounts receivable at the end of each period as reported to us throughour computerized billing systems, our mix of business, and the financialcondition of our payors. We evaluate historical write-off percentages by agingcategory to help us determine the appropriate reserve needed at each balancesheet date based on the aging of our receivables at that date. We also takeinto account certain internal factors, such as computer systems conversions,office acquisitions and consolidations, and operational changes within ourbilling and reimbursement function. Although we believe that our estimation ofthe net value of our accounts receivable is reasonable, we continually monitorour accounts receivable and our methods for calculating the appropriateallowance for doubtful accounts, and we adjust our allowances and calculationmethods as needed. If actual collections differ from our estimates, we may needto establish an additional allowance for doubtful accounts, which couldmaterially impact our financial condition and results of operations in futureperiods.

 

***Goodwilland other intangible assets***

 

We record goodwill from our acquisitions equal to the excess of thetotal cost of the acquisitions over the fair value of all identified tangibleand intangible assets acquired. In accordance with Statement of FinancialAccounting Standards (SFAS) No. 142, *Goodwill and Intangible Assets*, effectiveJanuary 1, 2002 we no longer amortize goodwill but instead test ourgoodwill at least annually for impairment. Since we operate in one businesssegment, we test for goodwill impairment on a company-wide basis. Therefore,our method of impairment testing consists of comparing the market value of ourcompany to its book value. The market value is equal to the current value pershare of our common stock, times the total number of shares outstanding. Wetest goodwill for impairment

 

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annually each October 1st, or whenever we identify events orconditions that could potentially result in impairment of our goodwill.

 

Other intangible assets primarily consist of non-compete agreements andmanaged care contracts. These intangible assets are amortized straight-lineover periods ranging from two to five years. Their amortization period equalstheir estimated useful lives, or in the case of non-compete agreements, the amortizationperiod equals their contractual term.

 

***Computer softwaredeveloped costs***

 

 Software developed for sale toexternal customers

 

Our subsidiary, MBI, has internally developed a computer softwareprogram, iEmphsys, designed specifically for management of home infusionpharmacy businesses. iEmphsys has been designed both for external sale toindependent home infusion businesses and for internal use by our company-ownedpharmacies.

 

We account for software designed for sale to external customers in accordancewith Statement of Financial Accounting Standard No. 86 (SFAS No. 86)—Accountingfor the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.Accordingly, the costs incurred subsequent to establishing technologicalfeasibility for the software program have been capitalized. These costs includecoding and testing performed subsequent to establishing technologicalfeasibility. Capitalization of the software program costs ceased when theproduct became available for general release to customers.

 

The annual amortization expense for the software program is computedusing the greater of (a) the amount computed using the ratio that current grossrevenues for a product bear to the total of current and anticipated futuregross revenues for that product or (b) the straight-line method over theremaining estimated life of the product, including the period being reportedon. At each balance sheet date, the unamortized capitalized costs of thesoftware program are compared to its net realizable value. If the estimated netrealizable value of the software program exceeds its unamortized capitalizedcosts, we will write off the amount by which the unamortized capitalized costsexceeds the net realizable value.

 

Software developed for internal use only

 

We havedeveloped and are developing various software products designed only for use byus in the operation of our business. Such software development projects areaccounted for in accordance with Statement of Position 98-1 (SOP98-1)—Accounting for the Costs of Computer Software Developed or Obtained forInternal Use, issued by the Accounting Standards Executive Committee of theAmerican Institute of Certified Public Accountants (AICPA). We account forsoftware development costs for internal-use software according to the followingcriteria:

 

(a)  Computer software coststhat are incurred in the preliminary project stage are expensed;

 

(b)  Once the capitalizationcriteria under the SOP have been met, external direct costs of materials andservices consumed in developing or obtaining internal-use computer software;payroll and payroll-related costs for employees who are directly associatedwith and who devote time to the internal-use computer software project; andinterest costs incurred when developing computer software for internal use arecapitalized and;

 

(c)  Once the product isoperative, internal and external training costs and maintenance costs areexpensed as incurred.

 

We amortize capitalized costs of computer software developed orobtained for internal use on a straight-line basis over the estimated usefullife of the software. We will recognize impairment on the capitalized computersoftware developed for internal use, if one of the following conditions ispresent:

 

(a)  The internal use softwareis not expected to provide substantive service potential,

 

(b)  A significant change occursin the extent or manner in which the software is used or is expected to beused,

 

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(c)  A significant change ismade or will be made to the software program, and

 

(d)  Costs of developing ormodifying internal-use computer software significantly exceed the amountoriginally expected to develop or modify the software.

 

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**RESULTS OF OPERATIONS**

 

Thefollowing table shows the results of our operations for the three months endedMarch 31, 2004 and 2003, expressed in amounts and percentages of revenue(amounts in thousands):

 
|                                          |   | **Three  Months Ended  March 31, 2004** |   | **Three months  Ended  March 31, 2003** |   |
|-----------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|                                          |   | **Amount**                                   |   | **% of  Revenue**                            |   | **Amount** |   | **% of  Revenue** |   |
| Revenue:                                      |   |                                         |   |                                         |   |   |   |   |   |
| Specialty pharmacy services                   |   | $                                            | 64,932 |                                         | 62.9   | % | $ | 57,034 |   | 61.6 | % |
| Infusion and related healthcare services      |   | 34,946                                       |   | 33.9                                         | %      | 33,073 |   | 35.7 | % |
| Other                                         |   | 3,271                                        |   | 3.2                                          | %      | 2,455 |   | 2.7 | % |
| Total revenue                                 |   | 103,149                                      |   | 100.0                                        | %      | 92,562 |   | 100.0 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Cost of revenue:                              |   |                                         |   |                                         |   |   |   |   |   |
| Cost of goods sold                            |   | 63,808                                       |   | 61.9                                         | %      | 54,824 |   | 59.2 | % |
| Cost of services provided                     |   | 10,644                                       |   | 10.3                                         | %      | 10,458 |   | 11.3 | % |
| Total cost of revenue                         |   | 74,452                                       |   | 72.2                                         | %      | 65,282 |   | 70.5 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Gross profit                                  |   | 28,697                                       |   | 27.8                                         | %      | 27,280 |   | 29.5 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Selling, general and administrative  expenses |   | 19,249                                       |   | 18.7                                         | %      | 18,030 |   | 19.5 | % |
| Provision for doubtful accounts               |   | 1,559                                        |   | 1.5                                          | %      | 1,878 |   | 2.0 | % |
| Depreciation and amortization                 |   | 681                                          |   | 0.6                                          | %      | 668 |   | 0.8 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Total operating expenses                      |   | 21,489                                       |   | 20.8                                         | %      | 20,576 |   | 22.3 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Operating income                              |   | 7,208                                        |   | 7.0                                          | %      | 6,704 |   | 7.2 | % |
| Interest expense                              |   | 1                                            |   | —                                       | %      | (99 | ) | (0.1 | )% |
| Other income (expense), net                   |   | (67                                          | )      | (0.1                                         | )%     | (9 | ) | — | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Income before income taxes                    |   | 7,142                                        |   | 6.9                                          | %      | 6,596 |   | 7.1 | % |
| Income tax provision                          |   | 2,857                                        |   | 2.7                                          | %      | 2,630 |   | 2.8 | % |
|                                          |   |                                         |   |                                         |   |   |   |   |   |
| Net income                                    |   | $                                            | 4,285  |                                         | 4.2    | % | $ | 3,966 |   | 4.3 | % |

 

**Three Months EndedMarch 31, 2004 and 2003**

 

We achieved recordrevenue of $103.1 million and net income of $4.3 million during the quarterended March 31, 2004.  Thesefigures represent increases of 11.4% and 8.0% over our revenue and net incomefrom the corresponding prior year quarter. Net income per diluted share was $0.20 for the quarter endedMarch 31, 2004 compared to $0.19 in the prior year quarter.  The revenue increase was attributable tostrong organic growth in infusion pharmacy and specialty pharmacy services,with the largest increases from seasonal sales of Synagis® as well as fromXolair®, a specialty drug recently approved for the treatment of moderate tosevere allergic asthma.  Our renewed andrefocused sales efforts in recent months contributed to our overall revenuegrowth.

 

Our days salesoutstanding (DSO) dropped to 57 days as of March 31, 2004 compared to 61days at December 31, 2003 due to continued improvements in cashcollections and billing practices.  Weended the quarter with $6.6 million in cash reserves compared to $4.0 million atDecember 31, 2003.  As ofMarch 31, 2004, we had no outstanding balance on our credit facility andvirtually no debt.

 

As sales of Synagis®decline cyclically in the quarter ending June 30, 2004, we intend to focuson maintaining our growth rate for both home infusion and specialty pharmacyservices.  We plan to continue to driveimprovements in our operations, focusing on purchasing leverage, controllingour operating expenses and continuing to improve our accounts receivablemanagement.   We will also continue toevaluate potential strategic acquisition opportunities designed to enhance ourfuture growth in revenue and net income.

 

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**Revenue:**

We report our operating results in one segment, consisting of threeservice lines: specialty pharmacy services; infusion and related healthcareservices; and other.  Revenue for thequarter ended March 31, 2004 was $103.1 million, which represents anincrease of $10.6 million, or 11.4%, over the prior year quarter.  This revenue increase is primarily due to our$7.9 million increase in specialty pharmacy services revenue and $1.9 millionincrease in infusion and related healthcare services revenue during the perioddue to increased sales efforts for existing products and sales generated from anew specialty pharmaceutical.

 

**Specialty pharmacyservices revenue:**

For thequarter ended March 31, 2004, our specialty pharmacy services revenue was$64.9 million, which represents an increase of $7.9 million, or 13.8%, over theprior year quarter.  On a same storebasis, factoring out disposal and acquisition activities, the specialtypharmacy services revenue growth rate was 15.3%. The overall $7.9 millionincrease was primarily attributable to higher sales of Synagis® and humangrowth hormone, as well as increased sales of Xolair®, a recently-approved drugfor the treatment of moderate to severe allergic asthma that is not adequatelycontrolled by the use of inhaled corticosteroids.  In addition, our revenue from our Florida specialty pharmaciesalso increased compared to the prior year. Our Synagis® revenue reached $14.3 million in the quarter endedMarch 31, 2004, representing an increase of $2.3 million over thecorresponding prior year quarter. Synagis® is a drug used to prevent respiratory synctial virus (RSV) inpremature and other high-risk infants. RSV is a seasonal condition with the season generally lasting fromOctober through April. Accordingly, our Synagis® revenue is at its peak in the quarter endingMarch 31 of each year. Revenue from sales of human growth hormoneincreased by $1.6 million in the quarter ended March 31, 2004 versus theprior year quarter.  We distribute humangrowth hormone nationally from our specialty care pharmacy in Ann Arbor,Michigan.  Increased sales effortsfocusing on the efficiency and clinical data reporting capabilities of thispharmacy were the main drivers of this increase.  We began to sell Xolair® during the quarter endedSeptember 30, 2003, and have seen steady increases in revenue since then.

 

**Infusion and relatedhealthcare services revenue:**

For the quarter ended March 31, 2004, infusion and relatedhealthcare services revenue was $34.9 million, an increase of $1.9 million, or5.7%, over the corresponding prior year quarter.  Infusion pharmacy services increased $2.4 million, or 9.0%, whilerelated healthcare services, such as RT/DME and home health nursing, declinedby $500,000, or 9.2%.  The increase ininfusion pharmacy services is due to refocused sales efforts put in place aspart of the operational restructuring that we completed late in 2003.  Within our mix of infusion therapies, thelargest revenue increase was from anti-infective therapies, which representedapproximately 38% of our infusion pharmacy services revenue for the quarterended March 31, 2004.  On a samestore basis, factoring out disposal and acquisition activities, infusionpharmacy services increased by 10.6% in the current year over the correspondingprior year quarter.  The $500,000decrease in other related healthcare services was primarily due to our decisionto scale back our provision of home health nursing services, particularly inmarkets exhibiting low profitability for these services, and focus instead ongrowing our core businesses of specialty pharmacy services and infusionpharmacy services.

 

**Other revenue:**

Otherrevenue consists of two primary elements: (1) revenue generated from ourfranchise network, consisting of royalties, franchise fees and vendor rebatesearned through our franchises’ purchases under our contracts, and; (2) softwarelicensing and support services provided by our wholly-owned subsidiary, MBI.Other revenue was equal to $3.3 million for the quarter ended March 31,2004 compared to $2.5 million in the corresponding prior year quarter.  Of this $800,000 increase, $700,000 relatedto revenue from franchise operations and $100,000 was from software licensingand support revenue.  Of the increase infranchise-related revenue, $400,000 was from the amortization of a non-competeagreement, expiring in May 2004, with the buyers of a former franchise.  The remaining $300,000 was from an increasein royalties and other related fees. Software licensing and support fees increased by $100,000 as a result ofsales of MBI’s new iEmphsys software.

 

**Cost of revenue:**

Cost ofrevenue consists of the cost of goods sold and the cost of serviceprovided.  For the quarter endedMarch 31, 2004, due to the $10.6 million increases in revenue, our cost ofrevenue increased by $9.2 million, or 14.0%, over the corresponding quarter ofthe prior year.

 

Cost of goods sold for the quarter ended March 31, 2004 was $63.8million, or 61.9% of revenue.  In theprior year quarter, cost of goods sold equaled $54.8 million, or 59.2% ofrevenue.  The $9.0 million increase,year over year, was the result of our $10.6 million increase in revenue duringthis period.  The increase in cost ofgoods sold as a percentage of revenue was due to the fact that specialtypharmacy services revenue increased at a faster pace than infusion and relatedhealthcare services revenue.  Specialtypharmacy services revenue has a much higher cost of goods component thaninfusion and related healthcare services.

 

Cost ofservice consists of salaries and related costs for employees directly involvedin patient care, including pharmacists, nurses, therapists and deliverydrivers.  Cost of service also includesthe cost of shipping or delivering products and services to the patient.

 

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Cost ofservice for the quarter ended March 31, 2004 was $10.6 million, or 10.3%of revenue, compared to $10.5 million, or 11.3% of revenue, for the quarterended March 31, 2003.  The declinein cost of service as a percentage of revenue was anticipated due to an increasein specialty pharmacy revenue, which has a very small service component, alongwith the decline in home health nursing services, which has a much higherservice component.

 

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

 
|                                     |   | **Three  months ended March 31,** |   |
|------------------------------------------|--------|----------------------------------------|--------|
|                                     |   | **2004**                               |   | **2003** |   |
|                                     |   |                                   |   |   |   |
| Gross profit margin:                     |   |                                   |   |   |   |
| Specialty pharmacy services              |   | 16.2                                   | %      | 19.3 | % |
| Infusion and related healthcare services |   | 43.0                                   | %      | 42.0 | % |
| Other                                    |   | 96.1                                   | %      | 96.4 | % |
| Overall gross profit margin              |   | 27.8                                   | %      | 29.5 | % |

 

Ourgross profit margin for the quarter ended March 31, 2004 was 27.8%compared to 29.5% for the quarter ended March 31, 2003. This decline inoverall margin was primarily due to a shift in service mix toward specialtypharmacy services, which produce a lower gross profit margin than our otherservices.  The specialty pharmacyservices gross profit margin declined from 19.3% to 16.2%.  This decline was primarily related to ashift in mix of products and therapies. Most of the specialty pharmacy revenue increase was from Synagis®, humangrowth hormone and Xolair® that are distributed nationally through ourspecialty care pharmacy in Ann Arbor, Michigan.  These products generate lower profit margins than many of theother specialty pharmaceuticals that we provide to patients.  In addition, we saw increases in specialtypharmacy revenue at our Florida pharmacies, which focus on executing our managedcare strategy, producing high sales volume at lower margins under agreementswith select managed care partners. Within the infusion and related healthcare service line, our grossprofit margin increased from 42.0% to 43.0% due to changes in therapy mix andour efforts to contain costs through strict purchasing and inventory-handlingpolicies.  Other revenue, which consistsof franchise-related revenues and software sales and support, has minimaldirect costs and therefore produces a gross profit margin near 100%.

 

**Selling, general andadministrative expenses:**

For the quarter ended March 31, 2004, selling, general andadministrative expenses were $19.2 million, an increase of $1.2 million, or6.8%, over the corresponding prior year quarter.  The expense categories that produced the largest dollar increasewere the following: building rent, wages and related costs, recruiting expensesand business insurance costs. Building rent increased by $400,000 primarily dueto the relocation of several of our pharmacies during the past twelve months inorder to accommodate growth.  Wages andrelated costs increased by $300,000, or 2.4%, in the quarter endedMarch 31, 2004 over the prior year quarter. Recruiting expenses increasedby $300,000 as we continued to strengthen our human capital by recruiting thestrongest possible candidates to manage our operations.  Business insurance costs increased by$200,000 due to the premium increases we experienced at our last annual renewalin June 2003.

 

**Provision fordoubtful accounts:**

Ourprovision for doubtful accounts for the quarter ended March 31, 2004 was$1.6 million, or 1.5% of revenue, compared to $1.9 million, or 2.0% of revenue,for the corresponding prior year quarter. The reduction in expense in the current year was due to two mainfactors: (1) a shift in our mix of business toward products with lowerreimbursement risk, and (2) operational improvements that have reduced our baddebt provision requirements at our Texas pharmacies and elsewhere.  Due to the manner of billing andreimbursement for many of the specialty drugs we sell, our risk ofnon-collection of the related accounts receivable is small.  As our mix of business has shifted towardspecialty pharmacy services, our provision for doubtful accounts has decreasedaccordingly.   In addition to thisfactor, we have improved and standardized our billing and collection practicesthroughout our network of company-owned pharmacies, particularly our Texaspharmacies, which has reduced our anticipated incidence of bad debtwrite-offs.  In the prior year quarterwe had recorded much higher provisions in these pharmacies than in the currentyear quarter.

 

**Depreciation andamortization:**

For thequarter ended March 31, 2004, depreciation and amortization was $700,000,which was approximately equal to our depreciation and amortization for thecorresponding prior year quarter.  Thedepreciation expense of $500,000 contained within this line item only relatesto non-revenue producing assets, such as furniture and fixtures and leaseholdimprovements.  Depreciation forrevenue-producing equipment such as rental medical equipment and deliveryvehicles is included in cost of revenue. Amortization expense of $200,000 relates to intangible assets withfinite lives that were obtained through business acquisitions and to theamortization of financing costs related to our credit facility.

 

18

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**Operating income:**

OptionCare recognized operating income of $7.2 million for the quarter ended March 31,2004 compared to $6.7 million for the quarter ended March 31, 2003.  This increase in operating income resultedfrom the increase in revenue in the current year.  As a percentage of revenue, operating income equaled 7.0% for thequarter ended March 31, 2004 compared to 7.2% in the prior yearquarter.  The small drop in operatingincome as a percentage of revenue is related to our increases in specialtypharmacy revenue, which produce a smaller operating margin than our infusionpharmacy and related healthcare services.

 

**Interest Income/(Expense):**

Duringthe quarter ended March 31, 2004 we had a net positive cash balance andlimited borrowing under our credit facility. Therefore we incurred minimal interest expense during the period whichwas more than offset by interest income earned from our cash on hand.  During the quarter ended March 31,2003, we incurred approximately $100,000 in interest expense, which was relatedto borrowings on our credit facility to finance acquisitions completed in 2002.

 

**Income taxes:**

For thequarter ended March 31, 2004, our provision for income taxes was $2.9million compared to $2.6 million in the prior year quarter.  As a percentage of pre-tax income, ourprovision for income taxes equaled 40.0% in the quarter ended March 31,2004, virtually unchanged from the 39.9% provision taken in the correspondingprior year quarter.

 

**Net income:**

Our netincome was $4.3 million for the quarter ended March 31, 2004 compared to$4.0 million in the prior year quarter. Our revenue growth during the period was the primary reason for theincrease in net income.

 

**Diluted shares &earnings per share:**

For thethree months ended March 31, 2004, total diluted shares equaled 21.6million compared to 21.2 million during the corresponding prior yearquarter.  The increase was due toissuance of new shares due to stock option exercises and purchases under theemployee stock purchase plan, partially offset by our purchase of treasurystock in early January 2004. Earnings per diluted share equaled $0.20 for the quarter endedMarch 31, 2004 versus $0.19 in the prior year period, an increase of 5.3%.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

Duringthe three months ended March 31, 2004, we financed our operations andacquisition activities through operating cash flows, the use of cash reservesand periodic borrowings under our credit facility.  We continue to generate positive operating cash flows, whichstrengthened our net cash position during the quarter.

 

**Operating Cash Flows:**

Operations provided $5.2 million of positive cash flow during the threemonths ended March 31, 2004 compared to $4.7 million provided byoperations during the three months ended March 31, 2003.  The primary causes of our positive operatingcash flow for the quarter ended March 31, 2004 were our net income duringthe period, our improvement in collection of accounts receivable, and our lowincome taxes paid during the quarter. Due to strong cash collections during the quarter ended March 31,2004, our DSO decreased from 61 to 57 days, helping to offset the increase inaccounts receivable that resulted from our revenue growth during thequarter.  Income tax payments in thequarter ended March 31, 2004 were minimal, at approximately $300,000,while our tax provision on quarterly earnings was $2.9 million.  We carried a substantial tax overpaymentinto 2004 due to our net loss in the quarter ended September 30,2003.  Therefore, in the quarter endedMarch 31, 2004, we paid no federal income tax installment.

 

**Investing Cash Flows.** During the three months ended March 31, 2004, we used cash of $2.1million in investing activities compared to $4.4 million used during thecorresponding prior year quarter.  Ofthe current year expenditure of $2.1 million, $1.1 million was related to ouracquisition of two small businesses in January 2004, one an Option Carefranchised pharmacy near Philadelphia and the other an RT/DME provider incentral Missouri.  The remaining $1.0million was used to acquire equipment and other fixed assets.  Of this total, approximately $700,000 wasspent on infusion pumps and other revenue-generating medical equipment,$200,000 was spent on infrastructure items such as furniture, fixtures andcomputer equipment, and $100,000 was spent on ongoing software developmentprojects.

 

**Financing Cash Flows:**

We used$500,000 in cash for financing activities during the quarter endedMarch 31, 2004, compared to $300,000 provided by financing activities inthe prior year period.  In the currentyear quarter, we generated $800,000 from the issuance of stock to employeesexercising stock options and from employee payroll withholdings for our 2004employee stock purchase plan.  Thisgeneration of cash from issuance of stock was offset by $900,000 used toacquire treasury stock.  In addition, weused $400,000 for

 

19

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scheduledpayments on capital leases and other fixed-rate debt.  There was no net activity under our credit facility, as we beganand ended the quarter with no outstanding balance.

 

**Credit Facility:**

OptionCare signed a $60 million senior secured credit facility with JP MorganCommercial Finance Corp on March 29, 2002.  Borrowing availability under this facility is related topercentages of our outstanding accounts receivable and inventory balances, lesscertain ineligible amounts, as defined in the facility agreement.  The agreement requires us to comply withvarious financial covenants. The JP Morgan credit facility expires onMarch 29, 2005.  As stated above,we had no outstanding balance under this facility as of March 31, 2004 orDecember 31, 2003.  We hadborrowing availability of approximately $38.4 million as of March 31, 2004and $37.7 million as of December 31, 2003 based on our accounts receivableand inventory balances on those dates.

 

On October 23, 2003, Option Care and JP Morgan Commercial FinanceCorp signed an amendment to the Credit and Security Agreement to address the$6.8 million special provision for doubtful accounts recorded in the quarterended September 30, 2003 related to our Texas accounts receivable.  The amendment allows Option Care to excludethe $6.8 million charge when calculating our fixed charge coverage ratio in thecurrent and subsequent quarters.  Thischange in calculation method allowed Option Care to remain in compliance withour financial covenants for the quarters ended September 30, 2003 andDecember 31, 2003.  We were incompliance with our financial covenants for the quarter ended March 31,2004 exclusive of this amendment.

 

**Accounts Receivable:**

Thefollowing table sets forth information regarding our accounts receivable as ofthe dates indicated (dollar amounts in thousands):

 

|                                                         |   | **March 31,  2004** |   | **December 31,  2003** |   |
|--------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                         |   |                     |   |                        |   |
| Accounts receivable                                          |   | $                        | 74,092 |                        | $      | 70,692 |   |
| Less allowance for doubtful accounts                         |   | (8,371                   | )      | (8,502                      | )      |
|                                                         |   |                     |   |                        |   |
| Accounts receivable, net of allowance for  doubtful accounts |   | $                        | 65,721 |                        | $      | 62,190 |   |
|                                                         |   |                     |   |                        |   |
| Days sales outstanding (DSO)(1)                              |   | 57                       |   | 61                          |   |

 

----

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

 

Ouraccounts receivable, net of bad debt reserves, was $65.7 million as ofMarch 31, 2004 compared to $62.2 million as of December 31,2003.  This increase in accountsreceivable was related to our increase in sequential quarterly revenue, whichgrew from $95.7 million in the quarter ended December 31, 2003 to $103.1million in the quarter ended March 31, 2004.

 

20

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Thefollowing table sets forth the percentage breakdown of our trade accountsreceivable by aging category and by major payor as of the dates indicated:****

 

|                                  |   | **March 31,  2004** |   | **December 31,  2003** |   |
|---------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| By Aging Category (2):                |   |                     |   |                        |   |
| Aged 0-90 days                        |   | 71.5                     | %      | 72.4                        | %      |
| Aged 91-180 days                      |   | 14.5                     | %      | 12.5                        | %      |
| Aged 181-365 days                     |   | 8.1                      | %      | 10.7                        | %      |
| Aged over 365 days                    |   | 5.9                      | %      | 4.4                         | %      |
|                                  |   |                     |   |                        |   |
| Total                                 |   | 100.0                    | %      | 100.0                       | %      |
|                                  |   |                     |   |                        |   |
| By Major Payor:                       |   |                     |   |                        |   |
| Medicare and Medicaid                 |   | 18                       | %      | 20                          | %      |
| Blue Cross and Blue Shield of Florida |   | 7                        | %      | 9                           | %      |
| All other payors                      |   | 75                       | %      | 71                          | %      |
|                                  |   |                     |   |                        |   |
| Total                                 |   | 100                      | %      | 100                         | %      |

 

----

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

 

Our dayssales outstanding (DSO) declined to 57 days as of March 31, 2004 comparedto 61 days as of December 31, 2003. Continued billing and collections performance improvements wereresponsible for the improvement, as well as our continuing growth of specialtypharmacy services revenue, which has a shorter collection cycle than infusionpharmacy and our other related healthcare services.

 

As ofMarch 31, 2004, we had cash and cash equivalents of approximately $6.6million, an increase of $2.7 million over the balance at December 31,2003.  Strong operating cash flowsallowed us to increase our cash reserves even though we used $1.1 million incash for acquisitions and another $900,000 to buy treasury stock during theperiod.  We believe that cash flow fromoperations and amounts available under our revolving credit facility will besufficient to meet our operating cash needs for the immediate future, includingany interest due on our credit facility or other debts.  In the event that additional capital isrequired, management cannot assure that such capital can be obtained from othersources on terms acceptable to us, if at all.

 

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

 

**Goodwill and OtherIntangible Assets**

 

As ofMarch 31, 2004, we had net goodwill and other intangible assets totaling$66.7 million, consisting of $65.7 million of goodwill and $1.0 million of otherintangible assets such as non-compete agreements and managed carecontracts.  As of December 31,2003, net goodwill and other intangible assets equaled $66.1 million,consisting of $65.0 million of goodwill and $1.1 million of other intangibleassets.  During the quarter endedMarch 31, 2004, goodwill increased $700,000 as a result of acquisitionscompleted in January 2004.  Otherintangible assets increased $100,000 as a result of these acquisitions, offsetby amortization of $200,000 during the quarter.

 

As required by Statements of Financial Accounting Standards No. 142, *Goodwill andOther Intangible Assets (SFAS No. 142)*, we do not amortize goodwill,but test our goodwill for impairment annually each October 1st,or whenever we identify events or conditions that could potentially result inimpairment of our goodwill.  During thequarter ended March 31, 2004, no impairment of goodwill was identified.

 

**Regulatory and OtherDevelopments**

 

***Health InsurancePortability and Accountability Act of 1996 (HIPAA)****.*  To improve the efficiency and effectivenessof the health care system, the Health Insurance Portability and AccountabilityAct (HIPAA) of 1996, Public Law 104-191, included “AdministrativeSimplification” provisions that required the Department of Health and HumanServices (HHS) to adopt national standards for electronic health caretransactions. At the same time, Congress recognized that advances in electronictechnology could erode the

 

21

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privacy of health information. Consequently, Congress incorporatedprovisions into HIPAA that mandated the adoption of Federal privacy protectionsfor individually identifiable health information.

 

In response to the HIPAA mandate, in December 2000, HHS publisheda final regulation in the form of the Privacy Rule, which became effective onApril 14, 2001. This Privacy Rule set national standards for theprotection of health information, as applied to the three types of coveredentities: health plans, health care clearinghouses, and health care providerswho conduct certain health care transactions electronically. InMarch 2002, HHS published proposed modifications to the Privacy Rule, toimprove workability and avoid unintended consequences that could have impeded patientaccess to delivery of quality health care. Following another round of publiccomment, in August 2002, HHS adopted as a final Rule the modificationsnecessary to ensure that the Privacy Rule worked as intended. Pursuant to thePrivacy Rule, as of April 14, 2003, covered entities were required to havestandards in place to protect and guard against the misuse of individuallyidentifiable health information. (Small health plans have until April 14,2004 to implement such standards.) Failure to timely implement these standardsmay, under certain circumstances, trigger the imposition of civil or criminalpenalties.

 

The Privacy Rule establishes a foundation of Federal protections forthe privacy of protected health information. The Privacy Rule does not replace Federal,State, or other laws that grant individuals even greater privacy protections,and covered entities are free to retain or adopt more protective policies orpractices. Penalties for non-compliance with the Privacy Rule range from acivil penalty of $100 per person, per incident (which can total up to $25,000per person per year), to criminal penalties, including up to $50,000 and/or oneyear imprisonment, up to $100,000 and/or five years imprisonment if the offenseis committed under false pretenses and up to $250,000 and/or ten yearsimprisonment for violating a standard with the intent to sell, transfer or useindividually identifiable health information for commercial purposes.

 

In addition to regulating privacy of individual health information, HIPAAincludes several anti-fraud and abuse laws, extends criminal penalties toprivate health care benefit programs and, in addition to Medicare and Medicaid,to other federal health care programs, and expands the Office of InspectorGeneral’s authority to exclude persons and entities from participating in theMedicare and Medicaid programs.

 

We have implemented the standards set forth in the Privacy Rule, andthese standards were in place on April 14, 2003. We believe that we andall of our franchisees are in compliance with the Privacy Rule or any morestringent federal or state laws relating to privacy.

 

***MedicarePrescription Drug, Improvement and Modernization Act of 2003****.*  The Medicare Prescription Drug, Improvementand Modernization Act of 2003 changes the way in which covered outpatient drugsare reimbursed by the Medicare program. Starting in January 2004, paymentfor most drugs covered by Medicare will decrease to 85% of the AverageWholesale Price (AWP) determined as of April 1, 2003. Beginning in 2005,reimbursement for non-self administered drugs furnished to patients inconjunction with other Medicare covered services will be set at either 106% ofthe average sales price (ASP) or through a competitive acquisition program tobe phased in beginning in 2006. The competitive acquisitions program will beestablished by CMS and will enable physicians in designated competitiveacquisition areas to purchase drugs through contractors that have successfullybid for that right. Each physician will elect annually whether to obtain drugsthrough the competitive acquisition program. CMS will re-bid the contracts atleast every three years. For infusion drugs administered in connection withcovered durable medical equipment (DME), the payment rate generally will continueto be 95% of the AWP as of October 1, 2003, until such drugs are subjectto the implementation of the competitive acquisition program discussed above.

 

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

 

**ITEM3.  Quantitative andQualitative Disclosures About Market Risk**

 

We are subject to market risk from exposure to changes in interestrates based on our financing and cash management activities. We utilize a mixof debt maturities along with both fixed-rate and variable-rate debt to manageour exposure to changes in interest rates. Although there can be no assurancesthat interest rates will not change significantly, we do not expect changes ininterest rates to have a material effect on income or cash flows in 2004. As ofMarch 31, 2004, our fixed-rate debt was $100,000 and we had no variablerate debt. Since we had no variable rate debt as of March 31, 2004, aone-percent increase in interest rates would have no impact on our annualinterest expense.

 

22

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**ITEM4.  Controlsand Procedures**

 

We carried out an evaluation, under the supervision and with theparticipation of our management, including our chief executive officer andchief financial officer, of the effectiveness of the design and operation ofour disclosure controls and procedures, (as defined in Rules 13a-15(e)under the Securities Exchange Act of 1934 (the Exchange Act)) as ofMarch 31, 2004. Based upon that evaluation, the chief executive officerand chief financial officer concluded that our disclosure controls andprocedures are effective. Disclosure controls and procedures are controls andprocedures that are designed to ensure that information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurity and Exchange Commission’s rules and forms.

 

In addition, no change in our internal control over financial reporting(as defined in Rule 13a-15(f) under the Exchange Act) occurred during thefourth quarter of our fiscal quarter ended March 31, 2004 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PARTII.  OTHERINFORMATION**

 

**ITEM1.  LegalProceedings**

 

We are subject to claims and legal actions that may arise in theordinary course of business. However, we maintain insurance to protect againstsuch claims or legal actions. We are not aware of any litigation either pendingor filed that we believe are likely to have a material adverse effect on ourresults of operation or financial condition.

 

We were named as a defendant in a lawsuit filed on December 31,2002 in the District Court, Bexar County, State of Texas under the caption *CandaceBooker, et. al. vs. Option Care, Inc. et. al,* No. 2002 CI18401. Plaintiffs allege that we negligently prepared a prescription resultingin a fatal injury. Plaintiffs seek unspecified compensatory damages. The lawsuitis currently in the discovery stage. We deny, and intend to vigorously defendagainst, the allegations contained in the complaint. We believe that to theextent a monetary award is rendered against us, that monetary award will fallwithin the limits of our general and professional liability insurance coveragefor that claim.

 

We maintain insurance for general and professional liability claims inthe amount of $1 million per claim and $3 million in aggregate, plus$5 million in umbrella coverage. Accordingly, the maximum coverage for afirst claim is $6 million and the maximum aggregate coverage for allclaims is $8 million. We also require each franchisee to maintain generaland professional liability insurance covering both the franchise and us, at coveragelevels that we believe to be sufficient. These insurance policies providecoverage on a claims-made or occurrence basis and have certain exclusions fromcoverage. There can be no assurance that insurance coverage will be adequate tocover claims that may be asserted against us or that adequate insurance will beavailable in the future at acceptable cost, if at all. To the extent thatliability insurance is not adequate to cover liability claims against us, wewill be responsible for the excess. Our current professional liabilityinsurance policy contains a $500,000 deductible per claim. Any claims madeagainst us during the term of this policy could have a material adverse effecton our results of operations or financial condition.

 

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

 

None.

 

**ITEM3.  Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

23

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**ITEM5.  OtherInformation**

 

None.

 

**ITEM6(a).  Exhibits**

 

See Exhibit Index.

 

**ITEM6(b).  Reportson Form 8-K**

 

On February 20, 2004, we filed a current report on Form 8-Kregarding a press release we issued on February 17, 2004 to announce ourearnings for the quarter and year ended December 31, 2003.

 

On February 24, 2004, we filed a current report on Form 8-Kcontaining the transcript of our conference call with investors onFebruary 17, 2004 to announce and discuss our results of operations forthe quarter and year ended December 31, 2003.

 

On April 19, 2004, we filed a current report on Form 8-K regardinga press release we issued on April 15, 2004 to announce our anticipatedoperating results for the quarter ended March 31, 2004.

 

24

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**SIGNATURE**

 

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

 
|                    |   | OPTION CARE, INC. |
|-------------------------|--------|------------------------|
| Date: May 10, 2004 |   | By:                    | /s/ Paul Mastrapa |   |
|                    |   |                   | *Chief Financial  Officer* |
|                    |   |                   | *(Principal  Accounting Officer and**Principal Financial Officer)* |

 

25

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**EXHIBITINDEX**

 
| **Exhibit  Number** |   |                                                                                                                                                                                                                                                                                        |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                        |
| 3.1                 |   | Certificate of Incorporation of the Registrant, together with  Certificate of Amendment thereto filed February 18, 1992. Filed as  Exhibit 3(a) to Option Care’s Registration Statement (No. 33-45836)  dated April 15, 1992 and incorporated by reference herein. |
|                |   |                                                                                                                                                                                                                                                                                        |
| 3.2                 |   | Certificate of Amendment to Certificate of Incorporation of the Registrant  filed March 25, 1992. Filed as Exhibit 3(c) to Option Care’s  Registration Statement (No. 33-45836) dated April 15, 1992 and  incorporated by reference herein.                        |
|                |   |                                                                                                                                                                                                                                                                                        |
| 3.3                 |   | Certificate of Amendment to Certificate of Incorporation of the  Registrant filed with the Delaware Secretary of State on June 18, 2002  and incorporated by reference herein.                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                        |
| 3.4                 |   | Restated By-laws of the Registrant dated June 1, 1994. Filed as  Exhibit 10.5 to Option Care’s Annual Report on Form 10-K for the  year ending December 31, 1994 and incorporated by reference herein.                                                             |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.1                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.2                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.3                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.4                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.5                |   | Option Care, Inc. 401(k) Profit Sharing Plan. Filed as  Exhibit 10(b) to Option Care’s Registration Statement  (No. 33-45836) dated April 15, 1992 and incorporated by reference  herein.                                                                          |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.6                |   | Amendment to the 1992 401(k) Profit Sharing Plan of the Registrant  dated January 1, 1996. Filed as Exhibit 10.3(a) to Option Care’s  Annual Report on Form 10-K for the year ending December 31, 1997  and incorporated by reference herein.                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.7                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.8                |   | Form of Franchise Agreement. Filed as Exhibit 10.5 to Option  Care’s Annual Report on Form 10-K for the year ending December 31,  1996 and incorporated by reference herein.                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.9                |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.10               |   | Consulting Agreement between the Registrant and EJ Financial  Enterprises, Inc. Filed as Exhibit 10(o) to Option Care’s Registration  Statement (No. 33-45836) dated April 15, 1992 and incorporated by  reference herein.                                              |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.11               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.12               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.13               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.14               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.15               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.16               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.17               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                        |
| 10.18               |   | Intentionally omitted.                                                                                                                                                                                                                                                                      |

 

26

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| 10.19  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.20  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.21  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.22  |   | Amendment No. 1 to the Consulting Agreement By and Between  EJ Financial Enterprises, Inc. and Option Care, Inc., dated  October 1, 1999. Filed as Exhibit 10.30 to Option Care’s Annual  Report for the year ended December 31, 1999 and incorporated by  reference herein.                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.23  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.24  |   | 2001 Employee Stock Purchase Plan. Filed as Exhibit A to the  registrants definitive proxy statement for the 2000 Annual Shareholders  Meeting and incorporated by reference herein. *                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.25  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.26  |   | Participation Agreement between Health Options, Inc. and Option  Care, Inc. effective as of June 1, 1997. 2001. Filed as  Exhibit 10.26 to Option Care’s Amendment No. 1 to its Annual Report  on Form 10-K/A filed September 10, 2001 and incorporated by  reference herein.                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.27  |   | Prescription Drug Agreement among Blue Cross and Blue Shield of  Florida, Inc., Health Options, Inc. and Option Care, Inc.  dated March 8, 2000. Filed as Exhibit 10.27 to Option Care’s  Amendment No. 1 to its Annual Report on Form 10-K/A filed  September 10, 2001 and incorporated by reference herein.                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.28  |   | Amendment to Participation Agreement between Health Options, Inc. and  Option Care, Inc. dated April 1, 2001. **                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.29  |   | Deferred Compensation Plan for certain Executives, effective as of  January 1, 2001. **                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.30  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.31  |   | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.32  |   | Injectable Drugs Agreement effective as of September 5, 2001  between Health Option, Inc. and OptionMed, Inc.  Filed on October 10, 2001 as Exhibit 10.1 to Form 8-K/A  and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.33  |   | Credit and Security  Agreement, dated March 29, 2002, by and among Option Care, Inc. and the  domestic subsidiaries of Option Care party thereto, as Borrowers, the Lending  Institutions party thereto, as Lenders, J.P. Morgan Business Credit Corp., as  Advisor, and JPMorgan Chase Bank, as Administrative and Collateral Agent and  Arranger, and LaSalle Bank National Association, as Co-Agent.  Filed as Exhibit 10.21 to Option Care’s  Current Report on Form 8-K filed May 15, 2002 and incorporated by reference  herein. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.34  |   | Employment Agreement between Richard M. Smith and Option Care, Inc.,  dated May 7, 2003.  Filed as Exhibit  10.34 to our Quarterly Report on Form 10-Q for the quarter ended  June 30, 2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.35  |   | Employment Offer Letter between Option Care, Inc. and Paul Mastrapa,  dated January 18, 2002.  Filed as  Exhibit 10.35 to our Quarterly Report on Form 10-Q for the quarter ended  June 30, 2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.36  |   | Employment Offer Letter between Option Care, Inc. and Joseph P.  Bonaccorsi, dated December 31, 2001.   Filed as Exhibit 10.36 to our Quarterly Report on Form 10-Q for the  quarter ended June 30, 2003 and incorporated by reference herein. *                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.37  |   | Fourth Amendment to Credit and Security Agreement, dated  October 23, 2003, by and among Option Care, Inc. and the domestic  subsidiaries party thereto, as Borrowers, the Lending Institutions party  thereto, as Lenders, J.P. Morgan Business Credit Corp., as Advisor, and  JPMorgan Chase Bank, as Administrative and Collateral Agent and Arranger, and  LaSalle Bank National Association, as Co-Agent.  Filed as Exhibit 10.37 to our Quarterly Report on Form 10-Q for                                                             |

 

27

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|   |   | the quarter ended  September 30, 2003.                                                                                                                                                                                                             |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                    |
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                    |
| 31.2   |   | Certification of Senior Vice President and Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                    |
| 32.1   |   | Certifications of Chief Executive Officer and Senior Vice President  and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and  Exchange Act Rule 13a-14(b). |

 

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*                 Management contracts and compensatoryplans and arrangements.

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

 

28

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