UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2005

OR

For the transition period from                            to                           

Commission file number 0-19878

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

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

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

INDEX

OPTION CARE, INC. AND SUBSIDIARIES

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Option Care, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

See notes to condensed consolidated financial statements

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Option Care, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

(in thousands, except per share amounts)

See notes to condensed consolidated financial statements

4

Option Care, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

See notes to condensed consolidated financial statements

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Option Care, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2005

(Unaudited)

1.   Basis of Presentation

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

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

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

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

2.   Long-Term Debt

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

The convertible notes are senior unsecured obligations of Option Care and will be convertible into cash and, if applicable, shares of our common stock based on an initial conversion rate of 55.5278 shares per $1,000 principal amount of notes, which represents an initial conversion price of $18.01 per share, subject to adjustment in certain circumstances.  The conversion rate and conversion price were subsequently adjusted to 83.3338 and $12.00 per share, respectively, pursuant to the terms of the notes as a result of our 3-for-2 common stock split on March 31, 2005 and $0.02 per share dividend paid on June 10, 2005.  Note holders may convert their notes into cash and, if applicable, shares of our common stock prior to the stated maturity only under the following circumstances: (1) during any calendar quarter beginning after December 31, 2004, if the closing sale price of our common stock for each of 20 or more consecutive trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the conversion price in effect on the last trading day of the immediately preceding calendar quarter; (2) during the five business day period after any five consecutive trading day period in which the average trading price per $1,000 principal amount of notes was equal to or less than 97% of the average conversion value of the notes during the note measurement period; (3) upon the occurrence of specified corporate transactions; or (4) if we have called the notes for redemption.  In general, upon conversion, the holder of each note will receive the conversion value of the note payable in cash, up to the principal amount of the note, and common stock for the notes’ conversion value in excess of such principal amount (plus an additional cash payout in lieu of fractional shares).  If the notes are surrendered for conversion in connection with certain fundamental changes that occur before November 1, 2009, holders will in certain circumstances also receive a make-whole premium in addition to the cash and shares that holders are otherwise entitled to receive upon conversion.  The convertible senior notes will mature on November 1, 2024 and will not be redeemable by us prior to November 1, 2009.  Holders of the convertible notes may require us to repurchase all or a portion of the convertible notes for cash on November 1, 2009, 2014 and 2019.  Interest will be paid at 2.25% per annum, payable semi-annually in arrears on May 1 and November 1 of each year to the holders of record at the close of business on the preceding April 15 and October 15, respectively.  The notes are senior unsecured obligations and will rank equally with all of our existing and future senior unsecured indebtedness.

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3.    Earnings Per Share Data

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

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

4.   Operating Segments

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

•      Specialty pharmacy services involve the distribution of injectible and infused pharmaceuticals to treat a wide range of chronic health conditions.  The pharmaceuticals can be directly distributed to the patient’s home or to their physician’s office for in-office administration.  These pharmaceuticals may require refrigeration during shipping as well as special handling to prevent potency degradation.  Patients receiving treatment usually require special counseling and education regarding their condition and treatment program.

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

•      Other revenue consists of royalties and other fees generated from our franchised pharmacy network and the software licensing and support revenue generated by our subsidiary, Management by Information, Inc. (“MBI”).

5.   Significant Customers and Concentration of Credit Risk

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

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

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

6.     Seasonal Revenue Trends

Synagis®, one of the specialty pharmaceuticals that we provide to patients, is seasonal.  Synagis® is a drug used for the prevention of respiratory synctial virus (RSV) in high-risk pediatric patients. RSV infection is a seasonal condition, with the season generally lasting from October through April.

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

7.     Acquisitions

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

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

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

8.     Franchise-related Revenue

We maintain a national franchise network through which we generate a portion of our revenue.  Our franchise-related revenues include: (1) royalties; (2) vendor rebates and administration fees; and (3) franchise settlement and related fees.  Each of these types of revenue can fluctuate over time, with the largest potential fluctuations relating to franchise terminations.

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

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

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

9.     Stock-based Compensation

Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, encouraged, but did not require, companies to record compensation cost for stock-based compensation plans at fair value.  We have chosen to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.  Accordingly, compensation expense for stock options is measured as the excess, if any, of the quoted market price of Option Care common stock at the date of grant over the amount an employee must pay to acquire the stock.  We grant options at fair market value and therefore recognize no compensation expense when options are granted.  Likewise, our Employee

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

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

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

10.  Recently Issued Accounting Pronouncement

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

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

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

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

•      A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

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

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

11.  Quarterly Dividends

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

12.  Comprehensive Income

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

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

FORWARD LOOKING STATEMENTS

The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information included in this Quarterly Report on Form 10-Q and other materials filed or to be filed by us with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by us) contain statements that are or will be forward-looking, such as statements relating to acquisitions and other business development activities, future capital expenditures and the effects of future regulation and competition. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by us, or on our behalf. These risks and uncertainties include, but are not limited to, uncertainties affecting our businesses and our franchisees relating to acquisitions and divestitures (including continuing obligations with respect to completed transactions), sales and renewals of franchises, government and regulatory policies (including federal, state and local efforts to reform the delivery of and payment for healthcare services), general economic conditions (including economic conditions affecting the healthcare industry in particular), the pricing and availability of equipment and services, technological developments and changes in the competitive environment in which we operate.  For a more comprehensive description of risks applicable to our business, see Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2004.

OVERVIEW

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

We have three service lines: specialty pharmacy services, infusion and related healthcare services, and other. Specialty pharmacy services involve the distribution of injectible and infused pharmaceuticals to treat a wide range of chronic health conditions.  The pharmaceuticals can be directly distributed to the patient’s home or to their physician’s office for in-office administration.  Depending on therapy type, we may also administer specialty pharmaceuticals to patients at our ambulatory infusion centers. These pharmaceuticals may require refrigeration during shipping as well as special handling to prevent potency degradation.  Patients receiving treatment usually require special counseling and education regarding their condition and treatment program.  Infusion and related services primarily involves the intravenous administration of medications at the patient’s home or other non-hospital site such as one of our infusion suites.  Infusion pharmacy services treat a wide range of acute and chronic health conditions, including infections, dehydration, cancer, pain and nutritional deficiencies.  All of our company-owned pharmacies provide infusion therapies. Some of these pharmacies also provide related healthcare services, such as home health nursing, home hospice services, respiratory therapy services and durable medical equipment.  Other revenue consists of royalties and other fees generated from our franchised pharmacy network and the software licensing and support revenue generated by our subsidiary, MBI.

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

REVENUE

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GROSS PROFIT

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

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

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RESULTS OF OPERATIONS

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