** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

(Mark One)

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

 

**For the quarterly periodended March 31, 2006**

** **

**Or**

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

 

**For the transition period from ______________ to ______________**

**Commission file number 0-19878**

**OPTION CARE, INC.**

**(Exact name of registrant asspecified in its charter)**

| **Delaware**                                                                        |   | **36-3791193**                     |
|-------------------------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                     |   | (IRS Employer  Identification No.) |
|                                                                                |   |                               |
| **485  Half Day Road, Suite 300**                                              |   | ** **                         |
| **Buffalo  Grove, Illinois**                                                        |   | **60089**                          |
| (Address of  principal executive offices)                                           |   | (zip code)                         |
| ** **                                                                          |   | ** **                         |
| **(847) 465-2100**                                                             |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |   | ** **                         |
| **Not applicable**                                                                  |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):Large accelerated filer oAccelerated filer x  Non-accelerated filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

|                                 |   | **Issued  and Outstanding** |
|---------------------------------|--------|-----------------------------|
| **Class**                       |   | **as of  May 1, 2006** |
|                            |   |                        |
| Common Stock -  $0.01 par value |   | 33,657,237                  |
|                            |   |                        |

 

 

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**OPTIONCARE, INC. AND SUBSIDIARIES**

**INDEX**

**DESCRIPTION**
| **PART I**  | ** ** | **FINANCIAL  INFORMATION**                                                                                 |
|------------------|------------|------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                 |
| Item 1.          |       | Financial  Statements (Unaudited)                                                                          |
|             |       |                                                                                                       |
|             |       | Condensed consolidated balance sheets—March 31,  2006 and December 31, 2005                 |
|             |       |                                                                                                       |
|             |       | Condensed consolidated statements of income—Three  months ended March 31, 2006 and 2005          |
|             |       |                                                                                                       |
|             |       | Condensed consolidated statements of cash flows—Three  months ended March 31, 2006 and 2005 |
|             |       |                                                                                                       |
|             |       | Notes to condensed consolidated financial  statements—March 31, 2006                             |
|             |       |                                                                                                       |
| 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  1A.        |       | Risk  Factors                                                                                              |
|             |       |                                                                                                       |
| Item 2.          |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                               |
|             |       |                                                                                                       |
| Item 3.          |       | Defaults Upon  Senior Securities                                                                           |
|             |       |                                                                                                       |
| Item 4.          |       | Submission of  Matters to a Vote of Security Holders                                                       |
|             |       |                                                                                                       |
| Item  5.         |       | Other  Information                                                                                         |
|             |       |                                                                                                       |
| Item  6.         |       | Exhibits                                                                                                   |
|             |       |                                                                                                       |
|             |       |                                                                                                       |
|             |       |                                                                                                       |
| **SIGNATURES**   | ** ** | ** **                                                                                                 |

 

2

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**PART I. FINANCIALINFORMATION**

**Item 1. FinancialStatements**

**Option Care, Inc.and SubsidiariesCondensed Consolidated Balance Sheets**(in thousands, except per share amounts)
| ** **                                                                                                                                                                          | ** ** | **March 31, 2006  (Unaudited)** | ** ** | **December 31, 2005  (Restated-Note 1)** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | ** **                                | ** ** | ** **                                              | ** ** |
| Assets                                                                                                                                                                              |       |                                      |       |                                                    |       |
| Current assets:                                                                                                                                                                     |       |                                      |       |                                                    |       |
| Cash and cash equivalents                                                                                                                                                           |       | $                                         | 12,611     |                                                    | $          | 7,816 |   |
| Short-term investments                                                                                                                                                              |       | 14,250                                    |       | 41,042                                                  |       |
| Accounts receivable, net                                                                                                                                                            |       | 113,548                                   |       | 95,297                                                  |       |
| Inventory                                                                                                                                                                           |       | 18,634                                    |       | 15,490                                                  |       |
| Deferred income tax benefit                                                                                                                                                         |       | 3,544                                     |       | 2,856                                                   |       |
| Other current assets                                                                                                                                                                |       | 6,410                                     |       | 9,942                                                   |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total current  assets                                                                                                                                                               |       | 168,997                                   |       | 172,443                                                 |       |
| Equipment and  other fixed assets, net                                                                                                                                              |       | 21,317                                    |       | 18,905                                                  |       |
| Goodwill, net                                                                                                                                                                       |       | 141,050                                   |       | 112,220                                                 |       |
| Other assets                                                                                                                                                                        |       | 13,343                                    |       | 12,996                                                  |       |
| Assets held for  sale                                                                                                                                                               |       | 282                                       |       | —                                                  |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total assets                                                                                                                                                                        |       | $                                         | 344,989    |                                                    | $          | 316,564 |   |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Liabilities and  stockholders’ equity                                                                                                                                          |       |                                      |       |                                                    |       |
| Current liabilities:                                                                                                                                                                |       |                                      |       |                                                    |       |
| Trade accounts payable                                                                                                                                                              |       | $                                         | 38,358     |                                                    | $          | 29,958 |   |
| Current portion of long-term debt                                                                                                                                                   |       | 49                                        |       | 48                                                      |       |
| Other current liabilities                                                                                                                                                           |       | 15,840                                    |       | 9,743                                                   |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total current  liabilities                                                                                                                                                          |       | 54,247                                    |       | 39,749                                                  |       |
| Long-term debt,  less current portion                                                                                                                                               |       | 86,293                                    |       | 86,306                                                  |       |
| Deferred income  tax liability                                                                                                                                                      |       | 9,776                                     |       | 9,084                                                   |       |
| Other  liabilities                                                                                                                                                                  |       | 816                                       |       | 665                                                     |       |
| Minority  interest                                                                                                                                                                  |       | 655                                       |       | 593                                                     |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total  liabilities                                                                                                                                                                  |       | 151,787                                   |       | 136,397                                                 |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Stockholders’ equity:                                                                                                                                                          |       |                                      |       |                                                    |       |
| Common stock, $.01 par value per share, 60,000  shares authorized, 33,081 and 32,838 shares issued and outstanding at  March 31, 2006 and December 31, 2005, respectively |       | 331                                       |       | 328                                                     |       |
| Common stock to be issued, 596 and 134 shares at  March 31, 2006 and December 31, 2005, respectively                                                                      |       | 7,902                                     |       | 1,311                                                   |       |
| Additional paid-in capital                                                                                                                                                          |       | 130,470                                   |       | 128,158                                                 |       |
| Retained earnings                                                                                                                                                                   |       | 54,499                                    |       | 50,370                                                  |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total  stockholders’ equity                                                                                                                                                    |       | 193,202                                   |       | 180,167                                                 |       |
|                                                                                                                                                                                |       |                                      |       |                                                    |       |
| Total liabilities and  stockholders’ equity                                                                                                                                    |       | $                                         | 344,989    |                                                    | $          | 316,564 |   |

 

*See notes to condensedconsolidated financial statements*

3

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**OptionCare, Inc. and SubsidiariesCondensed Consolidated Statements of Income**(Unaudited)(in thousands, except per share amounts)
| ** **                                               | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                             | ** ** | **2005  (Restated-Note 1)** | ** ** |
|                                                     |       |                                                 |       |   |   |
| Revenue:                                                 |       |                                                 |       |   |   |
| Specialty pharmacy services                              |       | $                                                    | 95,799     |   | $ | 74,897 |   |
| Infusion and related healthcare services                 |       | 57,378                                               |       | 42,848 |   |
| Other                                                    |       | 2,076                                                |       | 3,010 |   |
| Total revenue                                            |       | 155,253                                              |       | 120,755 |   |
| Cost of revenue:                                         |       |                                                 |       |   |   |
| Cost of goods sold                                       |       | 98,179                                               |       | 75,692 |   |
| Cost of services provided                                |       | 16,203                                               |       | 11,843 |   |
| Total cost of  revenue                                   |       | 114,382                                              |       | 87,535 |   |
|                                                     |       |                                                 |       |   |   |
| Gross profit                                             |       | 40,871                                               |       | 33,220 |   |
|                                                     |       |                                                 |       |   |   |
| Selling, general  and administrative expenses            |       | 28,576                                               |       | 22,443 |   |
| Provision for  doubtful accounts                         |       | 3,468                                                |       | 2,326 |   |
| Depreciation and  amortization                           |       | 1,144                                                |       | 904 |   |
|                                                     |       |                                                 |       |   |   |
| Total operating  expenses                                |       | 33,188                                               |       | 25,673 |   |
|                                                     |       |                                                 |       |   |   |
| Operating income                                         |       | 7,683                                                |       | 7,547 |   |
| Interest income  (expense)                               |       | 8                                                    |       | (44 | ) |
| Other expense,  net                                      |       | (62                                                  | )          | (47 | ) |
|                                                     |       |                                                 |       |   |   |
| Income before  income taxes                              |       | 7,629                                                |       | 7,456 |   |
| Income tax  provision                                    |       | 2,512                                                |       | 2,784 |   |
|                                                     |       |                                                 |       |   |   |
| Net income from  continuing operations                   |       | $                                                    | 5,117      |   | $ | 4,672 |   |
|                                                     |       |                                                 |       |   |   |
| Discontinued  operations:                                |       |                                                 |       |   |   |
| Loss on  discontinued operations, net of income taxes    |       | (327                                                 | )          | — |   |
|                                                     |       |                                                 |       |   |   |
| Net income                                               |       | $                                                    | 4,790      |   | $ | 4,672 |   |
|                                                     |       |                                                 |       |   |   |
| Net income from  continuing operations per common share: |       |                                                 |       |   |   |
| Basic                                                    |       | $                                                    | 0.15       |   | $ | 0.15 |   |
|                                                     |       |                                                 |       |   |   |
| Diluted                                                  |       | $                                                    | 0.15       |   | $ | 0.14 |   |
|                                                     |       |                                                 |       |   |   |
| Net income per common  share:                            |       |                                                 |       |   |   |
| Basic                                                    |       | $                                                    | 0.14       |   | $ | 0.15 |   |
|                                                     |       |                                                 |       |   |   |
| Diluted                                                  |       | $                                                    | 0.14       |   | $ | 0.14 |   |
|                                                     |       |                                                 |       |   |   |
| Shares used in  computing net income per share:          |       |                                                 |       |   |   |
| Basic                                                    |       | 33,163                                               |       | 32,103 |   |
| Diluted                                                  |       | 35,091                                               |       | 33,414 |   |
|                                                     |       |                                                 |       |   |   |
| Cash dividends per  share                                |       | $                                                    | 0.02       |   | $ | 0.0133 |   |

 

*See notes to condensed consolidated financialstatements*

* *

4

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**OptionCare, Inc. and SubsidiariesCondensed Consolidated Statements of Cash Flows**(Unaudited)(in thousands)
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                         | ** ** | **2005  (Restated-Note 1)** | ** ** |
| ** **                                                                         | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                             |       |                                             |       |   |   |
| Net income                                                                         |       | $                                                | 4,790      |   | $ | 4,672 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                      |       | 1,879                                            |       | 1,366 |   |
| Provision for doubtful accounts                                                    |       | 3,542                                            |       | 2,326 |   |
| Loss from equity investees                                                         |       | (33                                              | )          | — |   |
| Non-cash stock compensation expense                                                |       | 89                                               |       | 945 |   |
| Deferred income taxes                                                              |       | (154)                                            |       | 189 |   |
| Changes in  assets and liabilities:                                                |       |                                             |       |   |   |
| Accounts and notes receivable                                                      |       | (11,453                                          | )          | (5,197 | ) |
| Inventory                                                                          |       | (1,358                                           | )          | 3,469 |   |
| Accounts payable                                                                   |       | (8                                               | )          | (1,851 | ) |
| Income taxes receivable/payable                                                    |       | 2,012                                            |       | (81) |   |
| Change in other assets and liabilities                                             |       | 2,543                                            |       | 52 |   |
|                                                                               |       |                                             |       |   |   |
| Net cash provided by operating activities                                          |       | 1,849                                            |       | 5,890 |   |
|                                                                               |       |                                             |       |   |   |
| Cash flows from  investing activities:                                             |       |                                             |       |   |   |
| Purchases of short-term investments                                                |       | (4,000                                           | )          | (88,954 | ) |
| Sales of short-term investments                                                    |       | 30,792                                           |       | 78,510 |   |
| Purchases of equipment and other, net                                              |       | (3,416                                           | )          | (989 | ) |
| Payments for acquisitions, net of cash acquired                                    |       | (21,246                                          | )          | (7,082 | ) |
|                                                                               |       |                                             |       |   |   |
| Net cash provided by (used in) investing activities                                |       | 2,130                                            |       | (18,515 | ) |
|                                                                               |       |                                             |       |   |   |
| Cash flows from  financing activities:                                             |       |                                             |       |   |   |
| Increase in financing costs                                                        |       | —                                           |       | (134 | ) |
| Income tax benefit from exercise of stock options                                  |       | 282                                              |       | 1,288 |   |
| Payments on capital leases and other debt                                          |       | (12                                              | )          | (10 | ) |
| Proceeds from issuance of stock                                                    |       | 1,207                                            |       | 3,697 |   |
| Payments of dividends to common stockholders                                       |       | (661                                             | )          | (428 | ) |
|                                                                               |       |                                             |       |   |   |
| Net cash provided by financing activities                                          |       | 816                                              |       | 4,413 |   |
|                                                                               |       |                                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 4,795                                            |       | (8,212 | ) |
| Cash and cash  equivalents, beginning of period                                    |       | 7,816                                            |       | 19,816 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                                | 12,611     |   | $ | 11,604 |   |

 

*See notes to condensedconsolidated financial statements*

5

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**Option Care, Inc. andSubsidiariesNotes to Condensed Consolidated Financial StatementsMarch 31, 2006(Unaudited)**

**1.  Basis of Presentation**

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions toQuarterly Report on Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States for complete financial statements. In the opinion of management,all adjustments (consisting of normal recurring accruals) considered necessaryfor a fair presentation have been included. Operating results for the threemonths ended March 31, 2006 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2006.

Thebalance sheet at December 31, 2005 has been derived from the auditedfinancial statements at that date but does not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States for complete financial statements. For further information, refer to theconsolidated financial statements and footnotes thereto included in Option Care’sAnnual Report on Form 10-K for the year ended December 31,2005. 

Inaddition, the balance sheet at December 31, 2005 and statements of incomeand cash flows for the three months ended March 31, 2005 have beenrestated to reflect the impact of the adoption of Statement of FinancialAccounting Standards (“SFAS”) No. 123(R),*Share-Based Payment*, as of January 1,2006 utilizing the modified retrospective method (see also Note 9, *Stock-based Compensation)*and to reflect the correction oferrors in previously reported pro-forma disclosures of stock-based compensationas then required by SFAS No. 123, *Accounting for Stock-BasedCompensation*. The errors in previously reported pro-formadisclosures of stock-based compensation were due to improper tax treatment ofcompensation expense from our employee stock purchase plan and improperaccelerated expensing of certain prior years’ grants.

The following table setsforth the impact of the adoption of SFAS No. 123(R) utilizing themodified retrospective method and the correction of errors in previouslyreported pro-forma disclosures of stock-based compensation on the CondensedConsolidated Balance Sheet as of December 31, 2005 (in thousands):

 

|                                                              | ** ** | **As Reported** | ** ** | **Effect of FAS  123(R) Adoption** | ** ** | **As Restated** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
|                                                         |       |                 |       |                                              |       |                 |       |
| Total current  assets                                        |       | $                    | 172,443    |                                              | $          | —               |       | $ | 172,443 |   |
| Equipment and  other fixed assets, net                       |       | 18,905               |       | —                                            |       | 18,905               |       |
| Goodwill, net                                                |       | 112,220              |       | —                                            |       | 112,220              |       |
| Other intangible  assets, net(1)                             |       | 3,450                |       | —                                            |       | 3,450                |       |
| Investment in  affiliates(1)                                 |       | 4,911                |       | —                                            |       | 4,911                |       |
| Non-current  portion of deferred income tax benefit(1)  |       | 230                  |       | 2,886                                             |       | 3,116                |       |
| Other long-term  assets(1)                                   |       | 1,519                |       | —                                            |       | 1,519                |       |
|                                                         |       |                 |       |                                              |       |                 |       |
| Total assets                                                 |       | $                    | 313,678    |                                              | $          | 2,886                |       | $ | 316,564 |   |
|                                                         |       |                 |       |                                              |       |                 |       |
| Total liabilities                                            |       | 136,397              |       | —                                            |       | 136,397              |       |
|                                                         |       |                 |       |                                              |       |                 |       |
| Common stock and  common stock to be issued                  |       | 1,639                |       | —                                            |       | 1,639                |       |
| Additional  paid-in capital                                  |       | 113,686              |       | 14,472                                            |       | 128,158              |       |
| Retained  earnings                                           |       | 61,956               |       | (11,586                                           | )          | 50,370               |       |
|                                                         |       |                 |       |                                              |       |                 |       |
| Total stockholders’ equity                              |       | 177,281              |       | 2,886                                             |       | 180,167              |       |
|                                                         |       |                 |       |                                              |       |                 |       |
| Total  liabilities and stockholders’ equity             |       | $                    | 313,678    |                                              | $          | 2,886                |       | $ | 316,564 |   |

----

(1) Included in the accompanying restated Condensed ConsolidatedBalance as of December 31, 2005 in Other assets.

The following table sets forththe impact of the adoption of SFAS No. 123(R) utilizing the modifiedretrospective method and the correction of errors in previously reportedpro-forma disclosures of stock-based compensation on the Condensed ConsolidatedStatement of Income for the three months ended March 31, 2005 (inthousands, except per share amounts):

6

----

 

|                                                 | ** ** | **As Reported** | ** ** | **Effect of FAS  123(R) Adoption** | ** ** | **As Restated** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
|                                            |       |                 |       |                                              |       |                 |       |
| Total revenue                                   |       | $                    | 120,755    |                                              | $          | —               |       | $ | 120,755 |   |
|                                            |       |                 |       |                                              |       |                 |       |
| Cost of goods sold                              |       | 75,692               |       | —                                            |       | 75,692               |       |
| Cost of services provided                       |       | 11,800               |       | 43                                                |       | 11,843               |       |
| Total cost of  revenue                          |       | 87,492               |       | 43                                                |       | 87,535               |       |
|                                            |       |                 |       |                                              |       |                 |       |
| Gross profit                                    |       | 33,263               |       | (43                                               | )          | 33,220               |       |
|                                            |       |                 |       |                                              |       |                 |       |
| Selling, general  and administrative expenses   |       | 21,541               |       | 902                                               |       | 22,443               |       |
| Other operating  expenses                       |       | 3,230                |       | —                                            |       | 3,230                |       |
| Total operating  expenses                       |       | 24,771               |       | 902                                               |       | 25,673               |       |
|                                            |       |                 |       |                                              |       |                 |       |
| Operating income                                |       | 8,492                |       | (945                                              | )          | 7,547                |       |
| Interest expense                                |       | (44                  | )          | —                                            |       | (44                  | )          |
| Other expense,  net                             |       | (47                  | )          | —                                            |       | (47                  | )          |
|                                            |       |                 |       |                                              |       |                 |       |
| Income before  income taxes                     |       | 8,401                |       | (945                                              | )          | 7,456                |       |
| Income tax  provision                           |       | 3,116                |       | (332                                              | )          | 2,784                |       |
| Net income                                      |       | $                    | 5,285      |                                              | $          | (613                 | )          | $ | 4,672 |   |
|                                            |       |                 |       |                                              |       |                 |       |
| Net income per common  share:                   |       |                 |       |                                              |       |                 |       |
|                                            |       |                 |       |                                              |       |                 |       |
| Basic                                           |       | $                    | 0.16       |                                              | $          | (0.01                | )          | $ | 0.15 |   |
|                                            |       |                 |       |                                              |       |                 |       |
| Diluted                                         |       | $                    | 0.16       |                                              | $          | (0.02                | )          | $ | 0.14 |   |
|                                            |       |                 |       |                                              |       |                 |       |
| Shares used in  computing net income per share: |       |                 |       |                                              |       |                 |       |
| Basic                                           |       | 32,103               |       | —                                            |       | 32,103               |       |
| Diluted                                         |       | 33,265               |       | 149                                               |       | 33,414               |       |

 

The following table setsforth the impact of the adoption of SFAS No. 123(R) utilizing themodified retrospective method and the correction of errors in previouslyreported pro-forma disclosures of stock-based compensation on the CondensedConsolidated Statement of Cash Flows for the three months ended March 31,2005 (in thousands):

 

|                                                                                | ** ** | **As Reported** | ** ** | **Effect of FAS  123(R) Adoption** | ** ** | **As Restated** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
|                                                                           |       |                 |       |                                              |       |                 |       |
| Cash flows from  operating activities:                                         |       |                 |       |                                              |       |                 |       |
| Net income                                                                     |       | $                    | 5,285      |                                              | $          | (613                 | )          | $ | 4,672 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       |                 |       |                                              |       |                 |       |
| Non-cash stock compensation expense                                            |       | —               |       | 945                                               |       | 945                  |       |
| Deferred income taxes                                                          |       | 521                  |       | (332                                              | )          | 189                  |       |
| Income tax benefit from exercise of stock options                         |       | 1,288                |       | (1,288                                            | )          | —               |       |
| Other changes in assets and liabilities                                        |       | 84                   |       | —                                            |       | 84                   |       |
|                                                                           |       |                 |       |                                              |       |                 |       |
| Net cash provided by operating activities                                      |       | 7,178                |       | (1,288                                            | )          | 5,890                |       |
|                                                                           |       |                 |       |                                              |       |                 |       |
| Net cash used in investing activities                                          |       | (18,515              | )          | —                                            |       | (18,515              | )          |
|                                                                           |       |                 |       |                                              |       |                 |       |
| Cash flows from  financing activities:                                         |       |                 |       |                                              |       |                 |       |
| Income tax benefit from exercise of stock options                         |       | —               |       | 1,288                                             |       | 1,288                |       |
| Other cash flows from financing activities                                     |       | 3,125                |       | —                                            |       | 3,125                |       |
|                                                                           |       |                 |       |                                              |       |                 |       |
|                                                                                |            |                      |            |                                                   |            |                      |            |  |  |  |

 

7

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| Net cash provided by  financing activities     |   | 3,125  |   | 1,288  |   | 4,413  |   |
|------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
|                                           |   |   |   |   |   |   |   |
| Net decrease in cash and cash equivalents      |   | (8,212 | )      | — |   | (8,212 | )      |
| Cash and cash equivalents, beginning of period |   | 19,816 |   | — |   | 19,816 |   |
| Cash and cash  equivalents, end of period      |   | $      | 11,604 |   | $      | — |   | $ | 11,604 |   |
|                                                |        |        |        |        |        |        |        |  |  |  |

 

**2.  Long-TermDebt**

On November 2,2004, we completed an offering of $75 million of 2.25% convertible senior notesdue 2024 in a private placement to qualified institutional buyers. The initialpurchasers were granted the option to purchase up to an additional $11.25million principal amount of notes and exercised this option in full on November 9,2004. We filed a Registration Statement on Form S-3 on January 24,2005, as subsequently amended, to register the notes under the Securities Actof 1933. The notes are convertible into cash and, if applicable, shares of ourcommon stock based on an initial conversion rate, subject to adjustment, of55.5278 shares per $1,000 principal amount of notes (which represents aninitial conversion price of $18.01 per share), in certain circumstances. Theconversion rate and conversion price were subsequently adjusted to 83.4199 and$11.99 per share, respectively, pursuant to the terms of the notes as a resultof our 3-for-2 common stock split on March 31, 2005 and $0.02per share dividends paid on June 10, September 2, and December 2,2005 and March 24, 2006. Holders may convert their notes into cash and, ifapplicable, shares of our common stock prior to the stated maturity only underthe following circumstances: (1) during any calendar quarter after thecalendar quarter ended December 31, 2004, if the closing sale price of ourcommon stock for each of 20 or more consecutive trading days in a period of 30consecutive trading days ending on the last trading day of the immediatelypreceding calendar quarter exceeds 120% of the conversion price in effect onthe last trading day of the immediately preceding calendar quarter; (2) duringthe five business day period after any five consecutive trading day period (the“note measurement period”) in which the average trading price per $1,000principal amount of notes was equal to or less than 97% of the averageconversion value of the notes during the note measurement period; (3) uponthe occurrence of specified corporate transactions; or (4) if we havecalled the notes for redemption. In general, upon conversion, the holder ofeach note will receive the conversion value of the note payable in cash, up tothe principal amount of the note, and common stock for the note’s conversionvalue in excess of such principal amount (plus an additional cash payout inlieu of fractional shares). If the notes are surrendered for conversion inconnection with certain fundamental changes that occur before November 1,2009, holders will in certain circumstances also receive a make-whole premiumin addition to the cash and shares to which holders are otherwise entitled toreceive upon conversion. The convertible senior notes will mature on November 1,2024 and will not be redeemable by us prior to November 1, 2009. Holdersof the convertible notes may require us to repurchase all or a portion of theconvertible notes for cash on November 1, 2009, November 1, 2014 and November 1,2019. Interest will be paid at 2.25% per annum, payable semi-annually inarrears on May 1 and November 1 of each year to the holders of recordat the close of business on the preceding April 15 and October 15,respectively. The notes are senior unsecured obligations and rank equally withall of our existing and future senior unsecured indebtedness. None of therequired conditions for potential conversion of the notes by the holdersoccurred during the first quarter of 2006. The holders of the notes possess nostockholder rights, such as dividend or voting rights, unless and until theyconvert their notes into cash and shares of our common stock.

**3.   Earnings Per Share Data**

Thefollowing table sets forth the computation of basic and diluted earnings pershare for the periods indicated (in thousands, except per share amounts):

 

|                                                     | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                             | ** ** | **2005  (Restated)** | ** ** |
| Basic:                                              |       |                                                 |       |   |   |
| Net income from continuing operations               |       | $                                                    | 5,117      |   | $ | 4,672 |   |
| Net loss from discontinued operations               |       | (327                                                 | )          | — |   |
|                                                |       |                                                 |       |   |   |
| Net income                                          |       | $                                                    | 4,790      |   | $ | 4,672 |   |
|                                                |       |                                                 |       |   |   |
| Average shares outstanding                          |       | 33,163                                               |       | 32,103 |   |
|                                                |       |                                                 |       |   |   |
| Basic earnings from continuing operations per share |       | $                                                    | 0.15       |   | $ | 0.15 |   |
| Basic loss from discontinued operations per share   |       | (.01                                                 | )          | — |   |
|                                                |       |                                                 |       |   |   |

 

8

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| Basic earnings per share                                                        |   | $      | 0.14   |   | $      | 0.15  |   |
|---------------------------------------------------------------------------------|--------|--------|--------|--------|--------|-------|--------|
|                                                                            |   |   |   |   |   |
| Diluted:                                                                        |   |   |   |   |   |
| Net income from continuing operations                                           |   | $      | 5,117  |   | $      | 4,672 |   |
| Net loss from discontinued operations                                           |   | (327   | )      | — |   |
|                                                                            |   |   |   |   |   |
| Net income                                                                      |   | $      | 4,790  |   | $      | 4,672 |   |
|                                                                            |   |   |   |   |   |
| Average shares outstanding                                                      |   | 33,163 |   | 32,103 |   |
| Net effect of dilutive stock options — Based on the  treasury stock method |   | 1,034  |   | 1,162  |   |
| Net effect of dilutive contingently convertible debt  (1)                       |   | 894    |   | 149    |   |
|                                                                            |   |   |   |   |   |
| Total diluted shares                                                            |   | 35,091 |   | 33,414 |   |
|                                                                            |   |   |   |   |   |
| Diluted earnings from continuing operations per  share                          |   | $      | 0.15   |   | $      | 0.14  |   |
| Diluted loss from discontinued operations per share                             |   | (.01   | )      | — |   |
|                                                                            |   |   |   |   |   |
| Diluted earnings  per share                                                     |   | $      | 0.14   |   | $      | 0.14  |   |

----

(1) Weighted average shares issuable uponconversion of all $86.3 million of our 2.25% convertible senior notes due 2024.

**4.  Operating Segments**

We report our results ofoperations from one identifiable segment, with three service lines: specialtypharmacy services, infusion and related healthcare services, and other.**Specialty pharmacy services**involve the distribution of injectable and infused pharmaceuticals to treat awide range of chronic health conditions. We purchase specialty pharmaceuticalsfrom manufacturers and wholesale distributors, fill prescriptions provided byphysicians, and label, package and deliver the pharmaceuticals to patients’homes or physicians’ offices, either ourselves or through contract couriers.These pharmaceuticals may require refrigeration during shipping as well asspecial handling to prevent potency degradation. Depending on therapy, wemay also administer the specialty pharmaceuticals to the patient at one of ourambulatory infusion centers. Patients receiving treatment are often providedspecial counseling and education regarding their condition and treatmentprogram.**Infusion and related healthcare services**typically involve the intravenous administration of medications at the patient’shome or other non-hospital sites such as one of our ambulatory infusion suites.Infusion pharmacy services treat a wide range of acute and chronic healthconditions, including infections, dehydration, cancer, pain and nutritionaldeficiencies. All of our company-owned pharmacies provide infusion pharmacyservices. Several of our company-owned pharmacies also provide home healthnursing services, respiratory therapy services and home medical equipment salesand rentals. We also have one location that provides home hospice services.**Other revenue** consists ofroyalties and other fees generated from our franchised pharmacy network and,for the quarter ended March 31, 2005, software licensing and supportrevenue generated by our subsidiary, Management by Information, Inc. (“MBI”).The MBI business was sold during the fourth quarter of 2005 and therefore otherrevenue for the quarter ended March 31, 2006 does not include softwarelicensing and support revenue.

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

Wegenerate the majority of our revenue from managed care contracts and otheragreements with commercial third party payors by our provision of health careservices to their members. Our principal managed care contract is with BlueCross and Blue Shield of Florida, to whose members we provide infusion pharmacyservices and specialty pharmacy services. The contract is terminable by eitherparty on 90 days’ notice and, unless terminated, renews annually each September foran additional one-year term. We also generate revenue from governmenthealthcare programs such as Medicare and Medicaid.

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

9

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|                                        | ** ** | **Revenue**                                          | ** ** | **Accounts Receivable** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Three months ended March 31,** | ** ** | **March 31,**           | ** ** | **December 31,** | ** ** |
| ** **                             | ** ** | **2006**                                             | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                   |       |                                                 |       |                         |       |   |   |   |   |
| Blue Cross and  Blue Shield of Florida |       | 13                                                   | %          | 15                           | %          | 8 | % | 9 | % |
| Medicare &  Medicaid          |       | 19                                                   | %          | 17                           | %          | 23 | % | 22 | % |
| All other payors  (1)                  |       | 68                                                   | %          | 68                           | %          | 69 | % | 69 | % |
|                                   |       |                                                 |       |                         |       |   |   |   |   |
| Total                                  |       | 100                                                  | %          | 100                          | %          | 100 | % | 100 | % |
|                                   |       |                                                 |       |                         |       |   |   |   |   |

----

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

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

Synagis®, one of thespecialty pharmaceuticals that we provide to patients, is seasonal. Synagis® isa drug used for the prevention of respiratory syncytial virus (RSV) inhigh-risk pediatric patients. RSV infection is a seasonal condition, with theseason generally lasting from October through April.

OptionCare’s quarterly Synagis® revenue for the year 2005 and the first quarter of2006 was as follows (in thousands):

|                                        | ** ** | **Synagis® revenue** | ** ** | **%** of Total  Revenue(1) | ** ** |
|----------------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|
| Quarter ended  March 31, 2005     |       | $                              | 15,536     |                                 | 12.9       | % |
| Quarter ended  June 30, 2005      |       | 4,492                          |       | 3.8                                  | %          |
| Quarter ended  September 30, 2005 |       | 862                            |       | 0.7                                  | %          |
| Quarter ended  December 31, 2005  |       | 15,905                         |       | 11.2                                 | %          |
| Fiscal year 2005                       |       | $                              | 36,795     |                                 | 7.3        | % |
|                                   |       |                           |       |                                 |       |
| Quarter ended  March 31, 2006     |       | $                              | 27,102     |                                 | 17.5       | % |
|                                   |       |                           |       |                                 |       |

----

(1) Percentof total revenue is calculated based on total revenue from continuingoperations.

**7.****              Acquisitions**

Effective March 13, 2006 (the “Effective Date”),we entered into a binding purchase agreement to acquire a home infusionbusiness with operations in New York, New York. The purchase price was $25.0million, of which $16.5 million was paid in cash on the Effective Date, $7.5million was paid in shares of our common stock and $1.0 million is payablepursuant to the terms of a note. Under terms of the purchase agreement, we willreceive the acquired interest in the business at the closing date, which willbe the earlier of two days following the receipt of approval from the New YorkDepartment of Health or six months subsequent to the Effective Date. The totalcost of the acquisition is subject to working capital and earn-out adjustments.The total purchase price was allocated $21.9 million to goodwill and theremainder to accounts receivable and other working capital items. This purchaseprice allocation is preliminary and subject to further adjustments based onadditional information to be provided by the seller. We anticipate that all ofthe goodwill will be deductible for tax purposes.

Financial Accounting Standards Board Interpretation No. 46(Revised December 2003), *Consolidation of VariableInterest Entities*, addresses the consolidation of businessenterprises to which customary conditions of consolidation, such as a majorityvoting interest, do not apply. As a result of the purchase agreement andrelated joint coordination agreement, the acquired business is deemed to be avariable interest entity (“VIE”) and we are the primary beneficiary of this VIEas of the Effective Date. Accordingly, we have included the business in ourconsolidated financial reporting as of the Effective Date. Prior to the closingdate, and subsequent to the Effective Date, creditors of the VIE will not haverecourse to the assets of our company. Subsequent to the closing date, theacquired business will cease to be a VIE and will become a wholly-ownedsubsidiary of our company.

EffectiveMarch 1, 2006, we acquired a home infusion and RT/DME business withoperations in Connecticut, Illinois, New Jersey and Ohio. Through thisacquisition we acquired full equity ownership of one “C” corporation and onelimited liability company for

10

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$5.0million in cash, subject to certain adjustments. The total purchase price,including assumed liabilities, is allocated $3.6 million to goodwill, $3.5million to accounts receivable, and the remainder to fixed assets, intangiblesand certain working capital items. Thispurchase price allocation is preliminary and subject to further adjustmentsbased on additional information to be provided by the seller. We anticipatethat substantially all of the goodwill will be deductible for tax purposes.

The following table sets forth information regardingthe changes in our gross and net goodwill during the quarter ended March 31,2006 (in thousands):

|                                 | ** ** | **Goodwill** | ** ** | **Accumulated  Amortization** | ** ** | **Goodwill, net** | ** ** |
|---------------------------------|------------|--------------|------------|-------------------------------|------------|------------------------|------------|
|                            |       |         |       |                          |       |                   |       |
| December 31,  2005         |       | $            | 116,160    |                          | $          | 3,940                  |       | $ | 112,220 |   |
| Acquisitions                    |       | 25,868       |       | —                        |       | 25,868                 |       |
| Prior year  acquisitions        |       | 3,057        |       | —                        |       | 3,057                  |       |
| Held for sale  reclassification |       | (95          | )          | —                        |       | (95                    | )          |
|                            |       |         |       |                          |       |                   |       |
| March 31, 2006             |       | $            | 144,990    |                          | $          | 3,940                  |       | $ | 141,050 |   |

 

**8.****              DiscontinuedOperations**

In January 2006, webegan exploring strategic alternatives for our home health agency (HHA) inPortland, Oregon, including the possible sale or disposition of certainoperating assets of the HHA business. The HHA was acquired on October 1,2005 and is not viewed as a strategic asset of the company. At the end of thefirst quarter of 2006, a determination was made that the HHA business would besold or cease operations. The net book value of these operating assets was$300,000 as of March 31, 2006 and these assets are classified as held forsale in accordance with SFAS No. 144, in our Condensed ConsolidatedBalance Sheet as of that date. In addition, the HHA incurred a pre-tax loss of$500,000 for the quarter ended March 31, 2006. This pre-tax loss isincluded in the $300,000 net loss on discontinued operations, shown net of a$200,000 income tax benefit, in our Condensed Consolidated Statement of Incomefor the three months ended March 31, 2006 and represents a $0.01 reductionto net income per diluted share for that period. We expect to consummate a saleor disposition of the HHA business during 2006.

The following table setsforth operating results from discontinued operations for the three months endedMarch 31, 2006 (in thousands):

 

|                                                        | ** ** | **Three months ended  March 31, 2006** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------|------------|
|                                                   |       |                                                       |       |
| Total revenue                                          |       | $                                                          | 1,842      |   |
|                                                   |       |                                                       |       |
| Loss from  discontinued operations before income taxes |       | (487                                                       | )          |
| Income tax  provision                                  |       | (160                                                       | )          |
| Net loss from  discontinued operations                 |       | $                                                          | (327       | ) |
|                                                   |       |                                                       |       |

 

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

Effective January 1, 2006, we adopted SFAS No. 123(R),*Share-Based Payment*, utilizingthe modified retrospective method*.*Priorto January 1, 2006, we accounted for stock-based compensation under therecognition and measurement provisions of Accounting Principles Board (APB)Opinion No. 25, *Accounting for StockIssued to Employees*, as permitted by SFAS No. 123,*Accounting for Stock-Based Compensation*. SFASNo. 123(R) supersedes Accounting Principles Board (APB) Opinion No. 25,*Accounting for Stock Issued to Employees*,and amends SFAS No. 95, *Statement ofCash Flows*. SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options and shares purchasedunder our employee stock purchase plan, to be recognized in the incomestatement based on their fair values. We have restated the results for allprior periods to include compensation cost for all share-based payments basedon the grant date fair value estimated in accordance with the originalprovisions of SFAS No. 123.

The following table sets forth the impact to our incomebefore taxes, net income and basic and diluted earnings per common share forthe three months ended March 31, 2006 and 2005 of the adoption of SFAS No. 123(R) utilizingthe modified retrospective method (in

11

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thousands, except per share amounts):

 

|                                                          | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Impact on net income  for all stock-based compensation:  |       |                                                 |       |   |   |
| Stock option grants                                      |       | (464                                                 | )          | (356 | ) |
| Employee stock purchase plan withholdings                |       | (108                                                 | )          | (92 | ) |
| Cumulative effect of a change in estimate                |       | 483                                                  |       | — |   |
| Correction of pro-forma disclosure compensation  expense |       | —                                               |       | (497 | ) |
|                                                     |       |                                                 |       |   |   |
| Total impact on income before income taxes               |       | (89                                                  | )          | (945 | ) |
|                                                     |       |                                                 |       |   |   |
| Provision for income taxes                               |       | (7                                                   | )          | 176 |   |
| Correction of pro-forma disclosure income tax  benefit   |       | —                                               |       | 156 |   |
|                                                     |       |                                                 |       |   |   |
| Total impact on  net income                              |       | $                                                    | (96        | ) | $ | (613 | ) |
|                                                     |       |                                                 |       |   |   |
| Impact on net income  per common share:                  |       |                                                 |       |   |   |
| Basic                                                    |       | $                                                    | (0.00      | ) | $ | (0.01 | ) |
| Diluted                                                  |       | $                                                    | (0.00      | ) | $ | (0.02 | ) |
|                                                     |       |                                                 |       |   |   |

 

Prior to the adoption of SFAS No. 123(R), wepresented all tax benefits of deductions resulting from the exercise of stockoptions as operating cash flows in the Statement of Cash Flows. SFAS No. 123(R) requiresthe cash flows resulting from the tax benefits resulting from tax deductions inexcess of the compensation cost recognized for those options (excess taxbenefits) to be classified as financing cash flows. Accordingly, we havereclassified the $1.3 million excess tax benefit as a financing cash inflow onthe Condensed Consolidated Statement of Cash Flows for the three months ended March 31,2005.

We amortize the calculated fair value of our outstandingstock options straight-line over the vesting period of the options. The fairvalue of options granted under our stock option plan during the quarters ended March 31,2006 and 2005 was estimated on the date of grant using the Black-Scholes optionpricing model with the following assumptions:

 

|                                                           | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|
| ** **                                                | ** ** | **2006**           | ** ** | **2005** | ** ** |
|                                                      |       |               |       |   |   |
| Annual dividend  yield per share                          |       | $                  | 0.08       |   | $ | 0.08 |   |
| Expected  volatility                                      |       | 26                 | %          | 40 | % |
| Weighted average  risk-free interest rate                 |       | 4.58               | %          | 3.54 | % |
| Expected grant  life (years)                              |       | 4.7                |       | 4.0 |   |
| Weighted average per  share fair value of options granted |       | $                  | 4.09       |   | $ | 4.15 |   |

 

During the quarter ended March 31,2006, we issued 110,000 shares of our common stock for the exercise of optionsgranted from our stock incentive plan and 133,000 shares of our common stockfor shares purchased from our employee stock purchase plan.

**10.****       Quarterly Dividends**

In May 2004, ourBoard of Directors authorized the adoption of a quarterly dividend policy. Eachquarter, our Board of Directors will determine the dividend amount per share,if any. During each of the fiscal quartersbeginning with the quarter ended June 30, 2004 through the quarter ended March 31,2005, our board declared a dividend of $0.0133 per share. During each of thefiscal quarters beginning with the quarter ended June 30, 2005 our Boarddeclared a $0.02 per share dividend. The $0.02 per share dividend in thequarter ended March 31, 2006 was paid March 24, 2006 to stockholdersof record as of March 10, 2006.

**11.****       Subsequent Events**

On May 5,2006, we entered into a Credit Agreement (the “Agreement”) and related Guarantyand Collateral Agreement with LaSalle Bank National Association, which willserve as Administrator, Collateral Agent and Arranger of a five-year, $35million revolving credit facility created pursuant to the Agreement. Theobligations under the Agreement are secured by substantially all of the assetsof Option Care and our subsidiaries.

TheAgreement provides for a commitment fee, calculated and paid quarterly on asliding scale from 0.225% to 0.150%, based on the average daily unused portionof the facility. Depending on our level of borrowing under the credit facilityand amount of other debt

12

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commitmentsas defined in the Agreement, Option Care may select interest rates ranging fromthe LIBOR plus 1.00% to 1.75%, or the bank’s base rate plus 0% to 0.25%. Theinterest owed from borrowings under the credit facility is also calculated andpaid quarterly.

ThisAgreement requires us to meet certain financial covenants customary fortransactions of this type. We may elect to increase the available borrowingsunder the credit facility by a minimum of $20 million per election up to amaximum available credit of $100 million within the first two years of theAgreement. In addition, for a fee, Option Care may secure up to $2.5 million inletters of credit. The Agreement expires on May 5, 2011.

On May 5,2006, our Board of Directors declared a dividend of $0.02 per share. Thisdividend is payable on June 5, 2006 for stockholders of record as of May 22,2006.

**12.****       Comprehensive Income**

Net income was our only componentof comprehensive income for the quarters ended March 31, 2006 and 2005.

13

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**Item2.**                          Management’sDiscussion and Analysis of Financial Condition and Results of Operations

**FORWARDLOOKING STATEMENTS**

The following discussionshould be read in conjunction with our Annual Report on Form 10-Kfor the year ended December 31, 2005. The Private Securities LitigationReform Act of 1995 provides a “safe harbor” for forward-looking statements.Certain information included in this Quarterly Report on Form 10-Qand other materials filed or to be filed by us with the Securities and ExchangeCommission (as well as information included in oral statements or other writtenstatements made or to be made by us) contain statements that are or will beforward-looking, such as statements relating to acquisitions and other businessdevelopment activities, future capital expenditures and the anticipated orpotential effects of future regulation and competition. Such forward-lookinginformation involves important risks and uncertainties that could significantlyaffect anticipated results in the future and, accordingly, such results maydiffer from those expressed in any forward-looking statements made by us, or onour behalf. These risks and uncertainties include, but are not limited to,uncertainties affecting our businesses and our franchisees relating to acquisitionsand divestitures (including continuing obligations with respect to completedtransactions), sales and renewals of franchises, government and regulatorypolicies (including federal, state and local efforts to reform the delivery ofand payment for healthcare services), general economic conditions (includingeconomic conditions affecting the healthcare industry in particular), thepricing and availability of equipment and services, technological developmentsand changes in the competitive environment in which we operate. For a morecomprehensive description of risks applicable to our business, see Risk Factorsin our Annual Report on Form 10-K for the year ended December 31,2005. We do not undertake any obligation to release publicly any revisions tosuch forward-looking statements to reflect events or circumstances occurringafter the date of this Annual Report or to reflect the occurrence ofunanticipated events.

**OVERVIEW**

We provide specialtypharmacy services and infusion pharmacy and other related healthcare servicesto patients at home or at alternate sites such as infusion suites and physician’soffices. We contract with managed care organizations and other third partypayors who reimburse us for the services we provide to their subscriber members.Our services are provided through our national network of 56 company-owned andmanaged locations, our 65 franchise-owned pharmacies and our two company-owned,high-volume distribution facilities.We have three service lines: specialty pharmacy services, infusion and relatedhealthcare services, and other. Specialty pharmacy services involve thedistribution of injectable and infused pharmaceuticals to treat a wide range ofchronic health conditions. We purchase specialty pharmaceuticals from manufacturersand wholesale distributors, fill prescriptions provided by physicians, andlabel, package and deliver the pharmaceuticals to patients’ homes or physicians’offices, either ourselves or through contract couriers. These pharmaceuticalsmay require refrigeration during shipping as well as special handling toprevent potency degradation. Depending on therapy, we may also administerthe specialty pharmaceuticals to the patient at one of our ambulatory infusioncenters. Patients receiving treatment are often provided special counseling andeducation regarding their condition and treatment program. Infusion and relatedhealthcare services typically involve the intravenous administration ofmedications at the patient’s home or other non-hospital sites such as one ofour ambulatory infusion suites. Infusion pharmacy services treat a wide rangeof acute and chronic health conditions, including infections, dehydration,cancer, pain and nutritional deficiencies. All of our company-owned pharmaciesprovide infusion pharmacy services. Several of our company-owned pharmaciesalso provide home health nursing services, respiratory therapy services andhome medical equipment sales and rentals. We also have one location thatprovides home hospice services. Other revenue consists of royalties and otherfees generated from our franchised pharmacy network and, for the quarter ended March 31,2005, software licensing and support revenue generated by our subsidiary, MBI. TheMBI business was sold during the fourth quarter of 2005 and therefore otherrevenue for the quarter ended March 31, 2006 does not include softwarelicensing and support revenue.

Summarized informationabout revenues and gross profit from continuing operations for each of ourservice lines is provided in the following table (amounts in thousands):

 
| ** **                               | ** ** | **Three months ended March 31, 2006** | ** ** | **Three months ended March 31, 2005** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                               | ** ** | **Revenue**                                                    | ** ** | **% of   Total**                                     | ** ** | **Gross  Profit** | ** ** | **Gross  Profit %** | ** ** | **Revenue** | ** ** | **% of   Total** | ** ** | **Gross  Profit** | ** ** | **Gross  Profit %** | ** ** |
| ** **                               |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty  pharmacy services             |       | $                                                              | 95,799     |                                                           | 61.7       | % | $ | 13,180 |   | 13.8 | % | $ | 74,897 |   | 62.0 | % | $ | 11,553 |   | 15.4 | % |
| Infusion and related healthcare services |       | 57,378                                                         |       | 37.0                                                           | %          | 25,615 |   | 44.6 | % | 42,848 |   | 35.5 | % | 18,754 |   | 43.8 | % |
| Other                                    |       | 2,076                                                          |       | 1.3                                                            | %          | 2,076 |   | 100.0 | % | 3,010 |   | 2.5 | % | 2,913 |   | 96.8 | % |
|                                     |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                    |       | $                                                              | 155,253    |                                                           | 100.0      | % | $ | 40,871 |   | 26.3 | % | $ | 120,755 |   | 100.0 | % | $ | 33,220 |   | 27.5 | % |

 

14

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We derive most of ourrevenue from contracts with third party payors, such as managed careorganizations, insurance companies, self-insured employers and Medicare andMedicaid programs. Our principal managed care contract is with Blue Cross BlueShield of Florida for the provision of specialty pharmacy services and infusionpharmacy services to their members. For the three months ended March 31,2006 and 2005, respectively, approximately 13% and 15% of our revenue wasgenerated from this contract. As of March 31, 2006 and December 31,2005, respectively, 8% and 9% of our accounts receivable was due from BlueCross Blue Shield of Florida. The contract is terminable by either party on 90days’ notice and, unless terminated, renews annually each September for anadditional one-year term. No other single managed care payor represents morethan 10% of our revenue.

We also provide servicesthat are reimbursable through government healthcare programs such as Medicareand state Medicaid programs. For the three months ended March 31, 2006 and2005, respectively, approximately 19% and 17% of our revenue was generated fromgovernment healthcare programs. As of March 31, 2006 and December 31,2005, respectively, 23% and 22% of our total accounts receivable was due fromthese government healthcare programs.

Many of thepharmaceuticals we provide are reimbursed at some percentage of the AverageWholesale Price (AWP) for those pharmaceuticals. AWP for most pharmaceuticalsis compiled and published by private companies, including First DataBank, Inc.In recent years, we have seen reductions to AWP for certain of thepharmaceuticals that we provide to patients as a result of governmentinvestigations and other legal and regulatory actions. Any modifications to theAWP system or reductions in AWP for the products we provide to patients couldnarrow our gross profit margins. In addition, some managed care providers are adopting ASP as the standard measurefor determining reimbursement rates in new or renegotiated contracts. ASP-basedpricing is generally lower than AWP-based pricing. To the extent that we arenot able to negotiate new ASP-based contracts with managed care providers thatcontain gross profit margins comparable to our existing AWP-based contracts,our revenue and gross profit may be reduced.

The Medicare Prescription Drug, Improvement andModernization Act of 2003 regulates the manner in which covered outpatientdrugs are reimbursed by the Medicare program, which could result in lowerreimbursement for physicians. A smallportion of the home infusion drugs we provide are covered under Medicare’sdurable medical equipment (DME) benefit. The payment rates for drugs and servicesadministered by us in this manner generally were not affected by the enactedlegislation and will continue to be 95% of the AWP in effect as of October 1,2003.

As partof the Medicare Prescription Drug, Improvement and Modernization Act of 2003, aprescription drug benefit has been added under Medicare Part D. Under the Part Dfinal regulations, additional home infusion drugs that were not previouslycovered under Part B are now covered under Part D.

While the majority of ourrevenue is reimbursed by managed care organizations and other non-governmentpayors, these changes to the way Medicare pays for outpatient drugs andbiologicals may reduce our revenue and gross margins on services provided toMedicare patients. Further, adoption of ASP as the standard measure fordetermining reimbursement by state Medicaid programs for the drugs we providemay reduce our revenue and gross margins.

15

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** **

**RESULTS OFOPERATIONS**

Thefollowing table shows the results of our operations for the three months ended March 31,2006 and 2005, expressed in amounts and percentages of revenue (in thousands):

 
| ** **                                             | ** ** | **Three Months EndedMarch 31, 2006** | ** ** | **Three months Ended  March 31, 2005  (Restated)** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Amount**                                               | ** ** | **% of  Revenue**                                                 | ** ** | **Amount** | ** ** | **% of  Revenue** | ** ** |
| Revenue:                                               |       |                                                     |       |                                                                   |       |   |   |   |   |
| Specialty pharmacy services                            |       | $                                                        | 95,799     |                                                                   | 61.7       | % | $ | 74,897 |   | 62.0 | % |
| Infusion and related healthcare services               |       | 57,378                                                   |       | 37.0                                                                   | %          | 42,848 |   | 35.5 | % |
| Other                                                  |       | 2,076                                                    |       | 1.3                                                                    | %          | 3,010 |   | 2.5 | % |
| Total revenue                                          |       | 155,253                                                  |       | 100.0                                                                  | %          | 120,755 |   | 100.0 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Cost of revenue:                                       |       |                                                     |       |                                                                   |       |   |   |   |   |
| Cost of goods sold                                     |       | 98,179                                                   |       | 63.3                                                                   | %          | 75,692 |   | 62.7 | % |
| Cost of services provided                              |       | 16,203                                                   |       | 10.4                                                                   | %          | 11,843 |   | 9.8 | % |
| Total cost of  revenue                                 |       | 114,382                                                  |       | 73.7                                                                   | %          | 87,535 |   | 72.5 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Gross profit                                           |       | 40,871                                                   |       | 26.3                                                                   | %          | 33,220 |   | 27.5 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Selling, general  and administrative expenses          |       | 28,576                                                   |       | 18.4                                                                   | %          | 22,443 |   | 18.6 | % |
| Provision for  doubtful accounts                       |       | 3,468                                                    |       | 2.2                                                                    | %          | 2,326 |   | 1.9 | % |
| Depreciation and  amortization                         |       | 1,144                                                    |       | 0.8                                                                    | %          | 904 |   | 0.8 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Total operating  expenses                              |       | 33,188                                                   |       | 21.4                                                                   | %          | 25,673 |   | 21.3 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Operating income                                       |       | 7,683                                                    |       | 4.9                                                                    | %          | 7,547 |   | 6.3 | % |
| Interest income  (expense), net                        |       | 8                                                        |       | ―                                                                | %          | (44 | ) | ― | % |
| Other expense,  net                                    |       | (62                                                      | )          | ―                                                                | %          | (47 | ) | ― | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Income from  continuing operations before income taxes |       | 7,629                                                    |       | 4.9                                                                    | %          | 7,456 |   | 6.2 | % |
| Income tax  provision                                  |       | 2,512                                                    |       | 1.6                                                                    | %          | 2,784 |   | 2.3 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Net income from  continuing operations                 |       | $                                                        | 5,117      |                                                                   | 3.3        | % | $ | 4,672 |   | 3.9 | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Discontinued  operations:                              |       |                                                     |       |                                                                   |       |   |   |   |   |
| Loss on  discontinued operations, net of income taxes  |       | (327                                                     | )          | (0.2                                                                   | )%         | ― |   | ― | % |
|                                                   |       |                                                     |       |                                                                   |       |   |   |   |   |
| Net income                                             |       | $                                                        | 4,790      |                                                                   | 3.1        | % | $ | 4,672 |   | 3.9 | % |

 

**ThreeMonths Ended March 31, 2006 and 2005**

In the quarter ended March 31, 2006, our revenuefrom continuing operations was $155.3 million, representing an increase of$34.5 million, or 28.6%, over the corresponding quarter in 2005. Revenuesincreased in both specialty pharmacy services and infusion and relatedhealthcare services due to a combination of internal growth and acquisitions. Indollars, our gross profit increased by 23.0% to $40.9 million in the currentyear quarter. Our overall gross profit margin declined slightly due to a shiftin mix of business within specialty pharmaceuticals; increased product costsfor the IVIG therapy, immune globulin drugs designed to treat immune systemdeficiencies; and a decline in other revenue. As a result of our increasedrevenues, net income from continuing operations per diluted share increased to$0.15 for the quarter ended March 31, 2006 compared to $0.14 in the prioryear quarter.

We continued to generate positive cash flows fromoperations, producing $1.8 million in operating cash flows during the quarterended March 31, 2006. We ended the quarter with cash and short-terminvestments totaling $26.9 million compared to $48.9 million as of December 31,2005. Our positive operating cash flows, cash generated from the net sale ofshort-term investments, and cash generated from the issuance of common stockfrom stock option exercises and employee stock purchase plan withholdings morethan offset the cash we used for acquisitions and capital expenditures duringthe quarter.

16

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We completed two acquisitions during the quarter endedMarch 31, 2006. We acquired a home infusion business with operations inNew York and a home infusion and RT/DME business with operations inConnecticut, Illinois, New Jersey and Ohio. We expect to combine the locationsacquired in New York, Illinois and Ohio with our existing operations in thoseareas. The total consideration paid for these acquisitions was approximately$30.0 million in cash, common stock and a note payable, subject to certainadjustments. On May 5, 2006 we entered into an agreement with LaSalle BankNational Association to establish a five-year, $35 million revolving creditfacility. We anticipate utilizing this credit facility to finance future growthinitiatives.

**Revenue:**

We report our operatingresults in one segment, consisting of three service lines: specialty pharmacyservices; infusion and related healthcare services; and other. For the quarterended March 31, 2006, our revenue from continuing operations was $155.3million, which represents an increase of $34.5 million, or 28.6%, over thecorresponding prior year quarter. This increase is due to sales growth formultiple products and therapies, including Synagis®, and from the effects ofacquisitions.

**Specialty pharmacy servicesrevenue:**

Duringthe quarter ended March 31, 2006, specialty pharmacy services revenue fromcontinuing operations was $95.8 million, an increase of $20.9 million, or27.9%, over the prior year quarter.  Forthe quarter ended March 31, 2006, our largest revenue-producing specialtydrug was Synagis®, which produced $27.1 million in sales compared to $15.5million in sales in the prior year quarter. Synagis® is a seasonal drug for theprevention of respiratory syncytial virus (RSV) in premature and otherhigh-risk infants. RSV season runs through the cold months, generally from October throughApril. Accordingly, our Synagis® revenue will decline in our quarter ending June 30,2006 as the current Synagis® season reaches its conclusion. In addition tosales of Synagis®, our specialty revenue grew throughout our network ofcompany-owned pharmacies and high-volume distribution centers across a widevariety of therapies.

**Infusion and related healthcareservices revenue:**

For the quarter ended March 31,2006, infusion and related healthcare services revenue from continuingoperations was $57.4 million, an increase of $14.5 million, or 33.9%, over thecorresponding prior year quarter. Infusion pharmacy services from continuingoperations increased $12.1 million, or 33.2%, while other related healthcareservices, such as respiratory therapy services, durable medical equipment salesand home health nursing services, increased by $2.4 million, or 37.9%. Infusionpharmacy services revenue increased in most of our company-owned pharmacies andacross a wide variety of therapies. Continuing sales efforts contributed to theincreases, as well as the effect of acquisitions completed in 2005 and thefirst quarter of 2006.

**Other revenue:**

Otherrevenue consists of royalties and other fees generated from our franchisedpharmacy network and, for the quarter ended March 31, 2005, softwarelicensing and support revenue generated by our subsidiary, Management byInformation, Inc. (“MBI”). The MBI business was sold during the fourthquarter of 2005 and therefore other revenue for the quarter ended March 31,2006 does not include software licensing and support revenue. Other revenuefrom continuing operations decreased $900,000 to $2.1 million in the quarterended March 31, 2006 compared to $3.0 million in the corresponding prioryear quarter. This decrease was due in part to an $800,000 settlement gainrecorded in the prior year quarter related to the termination of our franchiseagreement with our St. Cloud, Minnesota franchise upon completing ouracquisition of that business. In addition, our royalty revenue declined by$500,000 in the quarter ended March 31, 2006 compared to the correspondingprior year quarter as a result of franchise terminations and acquisitions. Thesedecreases were partly offset by an increase in accounts receivable collectionfees recognized in 2006 related to acquisitions completed during 2005.

**Cost of revenue:**

Cost ofrevenue consists of the cost of goods sold and the cost of service provided. Forthe quarter ended March 31, 2006, our cost of revenue from continuingoperations was $114.4 million, which represents an increase of $26.8 million,or 30.7%, over the prior year quarter. The primary cause of this increase wasour 28.6% increase in revenue over the same period.

Cost of goods sold fromcontinuing operations for the quarter ended March 31, 2006 was $98.2million, or 63.2% of revenue, while in the prior year quarter, cost of goodssold was $75.7 million, or 62.7% of revenue. The primary causes of the increasein cost of goods sold as a percentage of revenue were shifts in mix of businesswithin our specialty pharmaceuticals toward higher-cost products, costincreases for IVIG due to supply shortages, and a decrease in other revenue,which has no associated cost of goods.

Cost ofservice consists of salaries and related costs for employees directly involvedin patient care, including pharmacists, nurses, therapists and delivery drivers.Cost of service also includes the cost of shipping or delivering products andservices to the patient. Our cost of service from continuing operations for thequarter ended March 31, 2006 was $16.2 million, or 10.4% of revenue,compared to $11.8 million, or 9.8% of revenue in the prior year. This increasein cost of service as a percentage of revenue was due to an increase in therelative mix of infusion and related healthcare services revenue due toacquisitions completed during

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2005, asinfusion and related healthcare services have a much higher cost of servicecomponent than do specialty pharmacy services.

**Grossprofit margin.**Thefollowing table sets forth the gross profit margin from continuing operationsfor each of our three service lines: specialty pharmacy services, infusion andrelated healthcare services, and other:

 

|                                          | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Gross profit margin:                     |       |                                                 |       |   |   |
| Specialty pharmacy services              |       | 13.8                                                 | %          | 15.4 | % |
| Infusion and related healthcare services |       | 44.6                                                 | %          | 43.8 | % |
| Other                                    |       | 100.0                                                | %          | 96.8 | % |
|                                     |       |                                                 |       |   |   |
| Overall gross profit  margin             |       | 26.3                                                 | %          | 27.5 | % |

 

Ourgross profit margin from continuing operations for the quarter ended March 31,2006 was 26.3% compared to 27.5% for the quarter ended March 31, 2005. Ourspecialty pharmacy services gross profit margin from continuing operationsdeclined from 15.4% for the quarter ended March 31, 2005 to 13.8% for thequarter ended March 31, 2006. This decrease is primarily due to lowergross margin for IVIG therapy as a result of increased product cost as well asa decrease in gross margins on a variety of specialty pharmacy therapies. Theproduct cost for IVIG therapy for the quarter ended March 31, 2006,however, remained steady as compared to the sequential quarter ended December 31,2005. Overall, our infusion and related healthcare services gross profit marginfrom continuing operations improved slightly, showing an increase from 43.8% inthe quarter ended March 31, 2005 to 44.6% in the quarter ended March 31,2006. This increase was due primarily to margin improvement in theanti-infective therapies. Other revenue, which consists of primarily offranchise-related revenues, has minimal direct costs and therefore produces agross profit margin of approximately 100%.

**Selling, general andadministrative expenses:**

For the quarter ended March 31,2006, selling, general and administrative expenses from continuing operationswere $28.6 million, an increase of $6.1 million, or 27.3% over the prior yearperiod.  This increase is primarilyrelated to our revenue growth during the period. The largest increases were inwages and related costs, which increased by $4.5 million, facilities rentalexpense, which increased by $700,000 and consulting and other professionalservices, which increased by $400,000. The increases in wages and related costswas due to our increases in staff to manage our continued growth, along withthe effects of business acquisitions completed in 2005 and the first quarter of2006, while the increases in facilities rental expense was primarily related toleases assumed in connection with acquisitions completed in 2005 and the firstquarter of 2006. These increases were offset by an $800,000 decrease incompensation expense related to employee stock options, as the current yearquarter included a $500,000 cumulative effect of a change in estimate toaccount for the impact of anticipated stock option forfeitures.

**Provision for doubtful accounts:**

Ourprovision for doubtful accounts from continuing operations for the quarterended March 31, 2006 was $3.5 million, or 2.2% of revenue, compared to$2.3 million, or 1.9% of revenue, in the prior year period. In general, werecord a higher provision for doubtful accounts for revenue generated from ourlocally delivered services than from our central distribution facilities. This differencein provision rates reflects the difference in collection risk involved in theseservices as the services from our central distribution facilities are billedunder pharmacy benefits whereas the services from our local pharmacies aretypically billed under major medical benefits and typically require higherpatient co-payments and deductibles. The increase in our provision for doubtfulaccounts in both dollar amount and percentage of revenue was primarily due toour higher growth rate in infusion and related healthcare services revenuecompared to specialty pharmacy services revenue, as our infusion and relatedservices have a much higher component of locally delivered services than do ourspecialty pharmacy services. Infusion and related healthcare services revenuegrew 33.9% over the period, while specialty pharmacy services revenue grew by27.9%.

**Depreciation and amortization:**

For thequarter ended March 31, 2006, depreciation and amortization expense fromcontinuing operations was $1.1 million, an increase of $200,000, or 26.5%, overthe corresponding prior year period. This increase is primarily related todepreciation of tangible assets and amortization of intangible assets weacquired through business acquisitions in 2005 and the first quarter of 2006.The depreciation expense contained within this line item relates to non-revenueproducing assets only, such as furniture and fixtures and leaseholdimprovements. Depreciation for revenue-producing equipment such as rentalmedical equipment and delivery vehicles is included in cost of revenue.

**Operating income:**

Ouroperating income from continuing operations was $7.7 million in the quarterended March 31, 2006 representing an increase of $100,000, or 1.8%, overthe prior year quarter. This increase resulted primarily from an increase in totalrevenues, offset by

18

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anincrease in the rate used for the provision for doubtful accounts as well as adecrease in other revenue, which has no associated cost of sales. Our operatingincome from continuing operations was 5.0% and 6.2% of revenue for the quartersended March 31, 2006 and 2005, respectively.

**Interest income(expense):**

For thequarter ended March 31, 2006, our interest income from continuingoperations, net of interest expense, was $8,000. In the prior year, interestexpense, net of interest income, was $44,000. In November 2004, wecompleted an $86.3 million offering of 2.25% convertible senior notes due 2024.Our interest expense on these notes for the quarters ended March 31, 2006and 2005 was approximately $485,000. The funds raised from this offering wereinvested in commercial paper, variable-rate bonds and preferred stocks andother related instruments. During the quarter ended March 31, 2006, theinterest earned on these investments offset the interest expense on the bondsdue to an overall increase in market interest rates as compared to the prioryear quarter.

**Income taxes:**

Ourincome tax provision from continuing operations for the quarter ended March 31,2006 was $2.5 million compared to $2.8 million in the prior year period. As apercentage of pre-tax income, our provision for income taxes from continuingoperations was 32.9% compared to 37.3% for the prior year quarter ended March 31,2005. The decline in income taxes as a percentage of pre-tax income isprimarily due to an excess provision for prior year income taxes and ongoingtax planning initiatives.

**Net income:**

Our netincome from continuing operations was $5.1 million for the quarter ended March 31,2006 compared to $4.7 million in the prior year quarter. Our growth in revenuegenerated both internally and through acquisitions was the primary cause of ourincrease in net income over the period. As a percentage of revenue, our netincome from continuing operations declined to 3.3% from 3.9% in the prior yearperiod.

**Diluted shares and earnings pershare:**

For thequarter ended March 31, 2006, the total number of diluted shares was 35.1million compared to 33.4 million during the corresponding prior year quarter. Theincrease was due to the following factors: (1) issuance of 113,000 newshares from stock option exercises; (2) increase in the value ofin-the-money stock options due to an increase in the average trading price ofour common stock; (3) purchases under our employee stock purchase plan; (4) issuanceof 560,000 shares related to acquisitions; and (5) the dilutive effect ofcontingently convertible debt. Our earnings from continuing operations perdiluted share were $0.15 for the quarter ended March 31, 2006 versus $0.14for the quarter ended March 31, 2005. Diluted shares in future periodscould increase due to the dilutive effects of our $86.3 million convertiblesenior notes. These notes are contingently convertible into cash and shares ofour common stock based on a conversion price of $11.99 per share. In thequarter ended March 31, 2006, the weighted average price per share of ourcommon stock was $13.69, compared to $12.26 in the prior year quarter. As aresult, the impact of the contingently convertible debt on diluted shares wassignificantly higher in the quarter ended March 31, 2006 than in the prioryear quarter.

**Discontinuedoperations:**

In January 2006, webegan exploring strategic alternatives for our home health agency (HHA) inPortland, Oregon, including the possible sale or disposition of certainoperating assets of the HHA business. The HHA was acquired on October 1,2005 and has is not considered a strategic asset of the company. At the end ofthe first quarter of 2006, a determination was made that the HHA business wouldbe sold or cease operations. The net book value of these operating assets was$300,000 as of March 31, 2006 and these assets are classified as held forsale in accordance with SFAS No. 144, on our Condensed ConsolidatedBalance Sheet as of March 31, 2006. In addition, the HHA incurred apre-tax loss of $500,000 for the quarter ended March 31, 2006. Thispre-tax loss is included in the $300,000 loss on discontinued operations, netof a $200,000 income tax benefit, in our Condensed Consolidated Statement ofIncome for the three months ended March 31, 2006 and represents a $0.01reduction to net income per diluted share for that period. We expect toconsummate a sale or disposition of the HHA business during the second quarterof 2006.

**LIQUIDITYAND CAPITAL RESOURCES**

Duringthe quarter ended March 31, 2006, we financed our operations andacquisition activities through operating cash flows and cash proceeds providedby the net sales of our short-term investments. During the quarter ended March 31,2006, our positive operating cash flows, cash generated from the net sale ofshort-term investments, and cash generated from the issuance of common stockfrom stock option exercises and employee stock purchase plan withholdings morethan offset the cash we used for acquisitions and capital expenditures duringthe quarter. Our cash and cash equivalents increased by $4.8 million during thequarter ended March 31, 2006, as the cash proceeds from our net sales ofshort-term investments slightly exceeded our expenditures for acquisitions andother capital investments.

**OperatingCash Flows:**

We generated $1.8 millionin positive cash flows from operations in the quarter ended March 31, 2006compared to $5.9 million of

19

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positive operating cashflow in the corresponding prior year period. The decrease in cash flows fromoperations as compared to the prior year quarter was primarily driven by anincrease in accounts receivable and inventory from certain acquisitionscompleted during the second half of 2005 and the first quarter of 2006 as wellas the increase in Synagis® revenue. Our positive operating cash flows in thequarter ended March 31, 2006 was primarily due to our net income of $4.8million and consistent collections of accounts receivable. Our consistentcollection of accounts receivable is evidenced by our steady days’ salesoutstanding (DSO), which remained at 59 days for both of the quarters ended December 31,2005 and March 31, 2006.

**Investing Cash Flows:**

Investing activities provided $2.1 million in cash in thequarter ended March 31, 2006 compared to $18.5 million used in investingactivities in the corresponding prior year period. We used $21.2 million incash for two acquisitions during the quarter ended March 31, 2006, thelarger of which we paid $15.9 million in cash, net of cash received in theacquisition. Net sales of short-term investments provided $26.8 million in cashproceeds. In addition, we used $3.4 million for the purchase of equipment andother depreciable assets. Of the $18.5 million in cash used in investingactivities during the quarter ended March 31, 2005, $7.1 million was usedfor acquisitions and $1.0 million was used to acquire equipment and otherdepreciable assets. The remaining $10.4 million used in investing activities inthe prior year quarter was utilized for the net purchase of short-terminvestments.

**FinancingCash Flows:**

Financingactivities provided $800,000 in positive cash flows in the quarter ended March 31,2006, compared to $4.4 million used in financing activities in the prior yearquarter ended March 31, 2005. In the current year quarter, $1.2 million incash was generated from the issuance of common stock, principally from employeestock option exercises, and $300,000 was generated from a related income taxbenefit. This cash inflow was partially offset by our use of $700,000 to paydividends to our stockholders. In the prior year quarter, issuance of stockgenerated $3.7 million and a related $1.3 million income tax benefit.

**ConvertibleSenior Notes:**

In November 2004,we completed the offering of 2.25% convertible senior notes, due 2024 (the “notes”).The funds may be used for acquisitions, stock repurchases, operating cash needsand other general corporate purposes. We completed the offering for $75.0million of the notes on November 2, 2005, with an option for an additional$11.25 million. This option was exercised in full on November 9, 2004. Wewill pay 2.25% interest per annum on the principal amount of the notes, payablesemi-annually in arrears on May 1 and November 1 of each year to theholder of record at the close of business on the preceding April 15 and October 15,respectively. The notes are convertible into cash and, if applicable, shares ofour common stock based on our stock’s market price and other conditions. Thenotes cannot be redeemed by us prior to November 1, 2009. On each of November 1,2009, November 1, 2014 and November 1, 2019, the holders can requireus to purchase all or a portion of the outstanding notes for their principalamount plus accrued interest. At any time on or after November 1, 2009, wemay redeem the notes, in whole or in part, at a redemption price equal to 100%of the principal amount of the notes we redeem, plus any accrued and unpaidinterest. We incurred deferred financing costs of $3.2 million related to thisoffering, consisting of underwriting, legal and other related costs.  These costs are being amortized over afive-year period. See “Note 2, Long-Term Debt” in our Notes to CondensedConsolidated Financial Statements for additional information regarding thenotes.

**AccountsReceivable:**

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

|                                                              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                         |       |                     |       |                        |       |
| Accounts  receivable                                         |       | $                        | 120,983    |                        | $          | 101,294 |   |
| Less allowance  for doubtful accounts                        |       | (7,435                   | )          | (5,997                      | )          |
|                                                         |       |                     |       |                        |       |
| Accounts  receivable, net of allowance for doubtful accounts |       | $                        | 113,548    |                        | $          | 95,297 |   |
|                                                         |       |                     |       |                        |       |
| Days sales  outstanding (DSO)(1)                             |       | 59                       |       | 59                          |       |
|                                                         |       |                     |       |                        |       |

----

(1)          DSO is calculated using theexhaustion method based on accounts receivable net of allowance for doubtfulaccounts, and considers only our specialty pharmacy service line and infusionand related healthcare services line.

Ouraccounts receivable, net of bad debt reserves, was $113.5 million as of March 31,2006 compared to $95.3 million as of December 31, 2005. This increase inaccounts receivable was related to our increase in sequential quarterly revenuefrom continuing operations, which grew from $142.4 million in the quarter endedDecember 31, 2005 to $155.3 million in the quarter ended March 31,2006.

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,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| By Aging  Category (1):        |       |                     |       |                        |       |
| Aged 0-90  days                |       | 76                       | %          | 78                          | %          |
| Aged 91-180  days              |       | 14                       | %          | 12                          | %          |
| Aged 181-365  days             |       | 7                        | %          | 7                           | %          |
| Aged over 365  days            |       | 3                        | %          | 3                           | %          |
|                           |       |                     |       |                        |       |
| Total                          |       | 100                      | %          | 100                         | %          |
|                           |       |                     |       |                        |       |
| By Major Payor:                |       |                     |       |                        |       |
| Managed care and  other payors |       | 77                       | %          | 78                          | %          |
| Medicare and  Medicaid         |       | 23                       | %          | 22                          | %          |
|                           |       |                     |       |                        |       |
| Total                          |       | 100                      | %          | 100                         | %          |
|                           |       |                     |       |                        |       |

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

Our dayssales outstanding (DSO) remained steady at 59 days for the both of quartersending December 31, 2005 and March 31, 2006. Our DSO calculation forthe quarter ending December 31, 2005 was adjusted from a previouslyreported total of 60 days to 59 days to reflect the subsequent allocation ofcertain cash on hand amounts as of December 31, 2005.

As of March 31,2006, we had cash and cash equivalents of $12.6 million and short-terminvestments of $14.3 million compared to cash and cash equivalents of $7.8million and short-term investments of $41.0 million at December 31, 2005. Wegenerated positive cash flow from operations of $1.8 million during the quarterended March 31, 2006, which, along with the cash proceeds provided by thenet sale of our short-term securities, allowed us to increase our cash and cashequivalents by $4.8 million. We believe that cash flow from operations and ourcurrent reserves of cash and short-term investments will be sufficient to meetour operating cash needs for the immediate future, including any interest dueon our $86.3 million of 2.25% convertible senior notes. In the event thatadditional capital is required, there can be no assurance that such capital canbe obtained from other sources on terms acceptable to us, if at all.

Our business strategyincludes the selective acquisition of additional local pharmacy facilities andspecialty pharmacy operations. Accordingly, we may require additional capitalin order to complete these acquisitions. It is impossible to predict the amountof capital that may be required for acquisitions, and there is no assurancethat sufficient financing for these activities will be available on termsacceptable to us, if at all. On May 5, 2006 we entered into an agreementwith LaSalle Bank National Association to establish a five-year, $35 millionrevolving credit facility. We anticipate utilizing this credit facility tofinance future growth initiatives.

**Goodwilland Other Intangible Assets**

As of March 31, 2006, we had net goodwill and otherintangible assets of $144.3 million, consisting of $141.0 million of goodwilland $3.3 million of other intangible assets such as non-compete agreements andmanaged care contracts. As of December 31, 2005, net goodwill and otherintangible assets totaled $115.7 million, consisting of $112.2 million ofgoodwill and $3.5 million of other intangible assets. During the quarter ended March 31,2006, goodwill increased $29.0 million as a result of two acquisitionscompleted during the quarter and payments made pursuant to prior yearacquisitions. Other intangible assets decreased by $200,000 as a result ofamortization expense recognized during the quarter.

Asrequired by Statements of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets (SFAS No. 142)*, wedo not amortize goodwill, but test our goodwill for impairment annually each October 1,or whenever we identify events or conditions that could potentially result inimpairment of our goodwill. During the quarter ended March 31, 2006, noimpairment of goodwill was identified.

**Regulatory and other developments:**

***Health Insurance Portability andAccountability Act of 1996 (HIPAA)****.*Toimprove the efficiency and effectiveness of the health care system, the HealthInsurance Portability and Accountability Act (HIPAA) of 1996, Public Law 104-191,included

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“Administrative Simplification” provisions thatrequired the Department of Health and Human Services (HHS) to adopt nationalstandards for electronic health care transactions. At the same time, Congressrecognized that advances in electronic technology could erode the privacy ofhealth information. Consequently, Congress incorporated provisions into HIPAAthat mandated the adoption of Federal privacy protections for individuallyidentifiable health information. In response to the HIPAA mandate, in December 2000, HHS published a finalregulation in the form of the Privacy Rule, which became effective on April 14,2001. This Privacy Rule set national standards for the protection ofhealth information, as applied to the three types of covered entities: healthplans, health care clearinghouses, and health care providers who conductcertain health care transactions electronically. Pursuant to the Privacy Rule,covered entities are required to have standards in place to protect and guardagainst the misuse of individually identifiable health information.The Privacy Rule established a foundation of Federal protections for theprivacy of protected health information. The Privacy Rule does not replacefederal, state, or other laws that grant individuals even greater privacyprotections, and covered entities are free to retain or adopt more protectivepolicies or practices. We have implemented the standards set forth in the PrivacyRule, and believe that we and all of our franchisees are in compliance with thePrivacy Rule or any more stringent federal or state laws relating toprivacy. Additionally, the Administrative Simplification provisions address electronichealth care transactions and the security of electronic health informationsystems. Providers are required to comply with the standards by specificcompliance dates established by HHS. For standards relating to electronichealth care transactions, all providers were required to comply by October 16,2003. The security standards applicable to individually identifiable healthinformation maintained electronically were required to be implemented by April 21,2005. We were materially compliant with these standards by the applicablecompliance date. The standards for a unique national health identifier forproviders used in connection with the electronic healthcare transactions mustbe implemented by May 23, 2007. We expect to be able to materially complywith this requirement by the applicable compliance date. Penalties for non-compliance with the Privacy Rule and other HIPAAAdministrative Simplification provisions range from a civil penalty of $100 foreach violation (which can total up to $25,000 per person per year), to criminalpenalties, including up to $50,000 and/or one year imprisonment, up to $100,000and/or five years imprisonment if the offense is committed under falsepretenses and up to $250,000 and/or ten years imprisonment for violating astandard with the intent to sell, transfer or use individually identifiablehealth information for commercial advantage, personal gain or malicious harm.In addition to regulating privacy of individual health information and otherprovisions relating to Administrative Simplification, HIPAA includes severalanti-fraud and abuse laws, extends criminal penalties to private health carebenefit programs and, in addition to Medicare and Medicaid, to other federalhealth care programs, and expands the Office of Inspector General’s authorityto exclude persons and entities from participating in the Medicare and Medicaidprograms.

**ITEM 3. Quantitativeand Qualitative Disclosures About Market Risk**

We are subject to marketrisk primarily in relation to our cash and cash equivalents and short-terminvestments. As of March 31, 2006, we had no variable-rate debt. In November 2004,we completed an $86.3 million offering of 2.25% convertible senior notes due2024. The interest rate on this debt is fixed. However, the interest rate wemay earn on the cash generated from this offering, as well as cash generatedfrom our operations, is subject to market fluctuations. We utilize a mix ofinvestment maturities based on our anticipated cash needs and evaluation ofexisting interest rates and market conditions.

The following table setsforth our cash and cash equivalents and short-term investments as of March 31,2006 and December 31, 2005 (in thousands):

 

|                                | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                           |       |                     |       |                        |       |
| Cash and cash  equivalents (1) |       | $                        | 12,611     |                        | $          | 7,816 |   |
| Short-term  investments (2)    |       | 14,250                   |       | 41,042                      |       |
|                           |       |                     |       |                        |       |
| Total                          |       | $                        | 26,861     |                        | $          | 48,858 |   |

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(1)          Cash equivalents includeshighly-liquid investments having a maturity of three months or less at time ofpurchase.

(2)          Short-term investments consist ofcommercial paper with maturities of three months or more at time ofacquisition, as well as variable-rate municipal demand notes, preferred stocksand similar instruments that are either perpetual in nature or have finalmaturities greater than three months.

While we attempt tominimize market risk and maximize return, changes in market conditions may significantlyaffect the income

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we earn on our cash andcash equivalents and short-term investments. Based on our actual cash and cashequivalents and short-term investment balances at March 31, 2006, a 100basis point decline in interest rates would reduce our interest income by$269,000 on an annualized basis.

**ITEM 4. Controlsand Procedures**

We carried out an evaluation, under the supervision andwith the participation of our management, including our chief executive officerand chief financial officer, of the effectiveness of the design and operationof our disclosure controls and procedures, (as defined in Rules 13a-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31,2006. Based upon that evaluation, the chief executive officer and chieffinancial officer concluded that our disclosure controls and procedures areeffective as of March 31, 2006 to ensure that information required to bedisclosed in our reports filed or submitted under the Exchange Act (i) isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, and (ii) isaccumulated and communicated to management, including our chief executiveofficer and chief financial officer, to allow timely decisions regardingrequired disclosure.

In addition, no change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under theExchange Act) occurred during our fiscal quarter ended March 31, 2006 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

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**PART II. OTHERINFORMATION**

**ITEM 1. LegalProceedings**

We are subject to claims and legal actions that mayarise in the ordinary course of business. However, we maintain insurance toprotect against such claims or legal actions. We are not aware of any litigation,either pending or filed, that we believe is likely to have a material adverseeffect on our results of operation or financial condition. We currently maintain insurance for general and professional liability claimsin the amount of $1 million per claim and $3 million in aggregate perpolicy year, plus $5 million in umbrella coverage. Accordingly, themaximum coverage for a first claim in any policy year is $6 million, andthe maximum aggregate coverage for all claims in a policy year is$8 million. We also require each franchisee to maintain general liabilityand professional liability insurance covering both the franchise and us, atcoverage levels that we believe to be sufficient. These policies providecoverage on a claims-made or occurrence basis and have certain exclusions fromcoverage. These insurance policies generally must be renewed annually. Therecan be no assurance that our insurance coverage will be adequate to coverliability claims that may be asserted against us.

**ITEM 1A. RiskFactors**

Therehave been no material changes to the risk factors previously disclosed inOption Care’s Annual Report on Form 10-K for the year ended December 31,2005.

**ITEM 2. UnregisteredSales of Equity Securities and Use of Proceeds**

**None.**

**ITEM 3. DefaultsUpon Senior Securities**

None.

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

None.

**ITEM 5. OtherInformation**

None.

**ITEM 6. Exhibits**

See Exhibit Index.

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** **

**SIGNATURE**

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

 
|                          |     | OPTION CARE, INC. |
|--------------------------|----------|------------------------|
| Date:  May 10, 2006 |     | By:                    |   | /s/ Paul Mastrapa |
| * *                 | * * | * *               | * * | *Senior Vice President and Chief Financial Officer* |
| * *                 | * * | * *               | * * | *(Principal Accounting Officer and Principal  Financial Officer)* |

 

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**EXHIBIT INDEX**

** **
| Exhibit  Number | ** ** | ** **                                                                                                                                                                                                                                                                                          |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.43           |       | Credit Agreement, dated May 5, 2006, by and  among Option Care, Inc. and certain subsidiaries of Option Care, Inc. party  thereto, as Borrowers, the Lending Institutions party thereto, as Lenders,  LaSalle Bank National Association, as Administrative and Collateral Agent and  Arranger. |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.44           |       | Guaranty and Collateral Agreement, dated May 5,  2006, by and among Option Care, Inc. and certain subsidiaries of Option Care,  Inc. party thereto, as Grantors, and LaSalle Bank National Association, as  Administrative Agent.                                                              |
|            |       |                                                                                                                                                                                                                                                                                                |
| 31.1            |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                |
| 31.2            |       | Certification of Senior Vice President and Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                |
| 32              |       | Certification of Chief Executive Officer and Senior  Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350,  and Rule 13a-14(b) of the Exchange Act.                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                |

 

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