WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended

September 30, 2004

Commission file number 00-19878

OPTION CARE, INC.

(Exact name of registrant as specified in its charter)

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 Operations

(Unaudited)

(in thousands, except per share amounts)

See notes to condensed consolidated financial statements

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Option Care, Inc. and Subsidiaries

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(in thousands, except per share amounts)

(1) Amended and Restated Stock Incentive Plan and Employee Stock Purchase Plan.

See notes to condensed consolidated financial statements

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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

September 30, 2004

(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 nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

The balance sheet at December 31, 2003 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.

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, 2003.

2.   Long-Term Debt

As of September 30, 2004, we were party to a $20 million revolving Credit and Security Agreement with J.P. Morgan Business Credit Corporation, J.P. Morgan Chase Bank and LaSalle Bank, N.A. (the “Lenders”).  This agreement was initially signed on March 29, 2002 as a three-year, $60 million revolving Credit and Security Agreement.  On June 15, 2004, we agreed with the Lenders on an amendment to reduce the overall facility to $20 million throughout the remaining term of the agreement.  On October 25, 2004, we notified the lenders that we were terminating the Credit and Security Agreement.  We incurred no penalties for terminating this agreement before its scheduled expiration on March 29, 2005.

As of both September 30, 2004 and December 31, 2003, we had no balance outstanding under our Credit and Security Agreement and had one outstanding letter of credit in place for $1.0 million.  At September 30, 2004, based on our minimum ongoing availability requirements we had borrowing availability of $17.0 million.  As of December 31, 2003, we had additional borrowing capacity of $37.7 million against the $60 million facility then in place, based on our accounts receivable and inventory balances on that date.

On November 2, 2004, we closed on the offering of $75 million in 2.25% Convertible Senior Notes due 2024 in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended.  The initial purchasers were granted the option to purchase up to an additional $11.25 million principal amount of notes.  The convertible notes are senior unsecured obligations of Option Care and will be convertible, under certain circumstances, into a combination of cash and common stock.  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 note’s conversion value in excess of such principal amount.  The initial conversion price is $18.01 per share.  The convertible notes will mature on November 1, 2024 and will not be redeemable by us prior to November 1, 2009.  Holders of the convertible notes will be able to require us to repurchase all or a portion of the convertible notes for cash on November 1, 2009, 2014 and 2019.

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3.    Earnings Per Share Data

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

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”).

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5.   Significant Customers and Concentration of Credit Risk

The following table presents information regarding revenue and accounts receivable attributable 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.

We generate the majority of our revenue from managed care contracts and other agreements with commercial third party payors from our provision of 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.  For the three and nine months ended September 30, 2004, respectively, 17% and 16% of our revenue was related to this contract.  In the prior year, for the three and nine months ended September 30, 2003, respectively, 18% and 17% of our revenue was related to this contract. Of our accounts receivable, 8% and 9% was due from Blue Cross and Blue Shield of Florida as of September 30, 2004 and December 31, 2003, respectively.  The contract is terminable 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 nine months ended September 30, 2004, respectively, 17% and 19% of our revenue came from government healthcare programs.  In the prior year, for the three and nine months ended September 30, 2003, 17% and 18% of our revenue came from government healthcare programs. Of our accounts receivable, 17% and 20% was attributable to government healthcare programs as of September 30, 2004 and December 31, 2003, respectively.

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.

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Option Care’s quarterly Synagis® revenue for 2003 and for the first three quarters of 2004 was as follows (amounts in thousands):

7.                                      Acquisitions

During the quarter ended September 30, 2004, we completed two small acquisitions in markets that we currently serve.  The combined purchase price was $1.8 million, with contingent additional consideration of approximately $1.4 million payable in future periods.  While we anticipate that these acquisitions will be accretive to earnings, they are not expected to have a material effect on our overall revenue or net income.

We completed no acquisitions during the quarter ended June 30, 2004.  During the quarter ended March 31, 2004, we completed two small acquisitions in existing markets that we serve, at a total cost of $1.3 million in cash. These acquisitions are not expected to have a material effect on our revenue or net income.

8.  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, encourages, but does not require, companies to record compensation cost for stock-based compensation plans at fair value.  Option Care has 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 our 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 recognizes no compensation expense when options are granted.  Likewise, our Employee 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 our Employee Stock Purchase Plan.

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Had compensation cost for our stock-based compensation plan been determined based on FASB Statement No. 123, our net income and income per common share for the three and nine months ended September 30, 2004 and 2003 on a pro-forma basis would have been (in thousands, except per share amounts):

9.                                      Quarterly Dividends

Our Board of Directors initiated a quarterly dividend policy at their meeting on May 11, 2004 and have declared quarterly dividends of $0.02 per share during each of the quarters ended June 30, 2004 and September 30, 2004, and quarter ending December 31, 2004. The dividend declared during the quarter ended September 30, 2004 was paid on August 31, 2004 to shareholders of record as of August 16, 2004.  On November 3, 2004, our Board of Directors declared a $0.02 per share dividend payable on November 30, 2004 to shareholders of record as of November 15, 2004.

10.                               Comprehensive Income

Net income was our only component of comprehensive income for the three and nine month periods ended September 30, 2004 and 2003.

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

OVERVIEW

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

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.  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 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, Management by Information, Inc.

Summarized information about revenues and gross profit for each service line is provided in the following tables (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 and Blue Shield of Florida for the provision of specialty pharmacy services and infusion pharmacy services to their members. For the three and nine months ended September 30, 2004, respectively, 17% and 16% of our revenue was generated from this contract.  In the prior year, for the three and nine months ended September 30, 2003, respectively, 18% and 17% of our revenue was generated from this contract.  As of September 30, 2004 and December 31, 2003, 8% and 9% of our accounts receivable was due from Blue Cross Blue Shield of Florida. The contract is terminable 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 nine months ended September 30, 2004, 17% and 19% of our revenue was generated from these programs.  In the prior year, for the three and nine months ended September 30, 2003, 17% and 18% of our revenue was generated from government healthcare programs.  As of September 30, 2004 and December 31, 2003, respectively, 17% and 20% of our total accounts receivable was due from these government healthcare programs.

Many of the pharmaceuticals we provide are reimbursed at some percentage of the Average Wholesale Price (AWP) for those pharmaceuticals.  AWP for most pharmaceuticals is compiled and published by private companies, including First DataBank, Inc.  In recent years, we have seen reductions to AWP for certain of the pharmaceuticals that we provide to patients as a result of various government investigations and other legal and regulatory actions.  Any modifications to the AWP system or reductions in AWP for the products we provide to patients could narrow our gross profit margins.

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 changed the way in which covered outpatient drugs are reimbursed by the Medicare program.  In January 2004, payment for most drugs covered by Medicare decreased to 85% of the AWP, determined as of April 1, 2003.  Beginning in 2005, reimbursement for non-self administered drugs furnished to patients in conjunction with other Medicare covered services will be set at either 106% of the average sales price (ASP) or through a competitive acquisition program to be phased in beginning in 2006.  The competitive acquisitions program will be established by the Center for Medicare and Medicaid Services (CMS) and will enable physicians in designated competitive acquisition areas to purchase drugs through contractors that have successfully bid for that right.  Each physician will elect annually whether to obtain drugs through the competitive acquisition program.  CMS will re-bid the contracts at least every three years.  For infusion drugs administered in connection with covered durable medical equipment, the payment rate generally will continue to be 95% of the AWP as of October 1, 2003, until such drugs are subject to the implementation of the competitive acquisition program discussed above.  While the majority of our revenue is reimbursed by managed care organizations and other non-government payors, these changes to the way in which Medicare pays for outpatient drugs and biologicals may have some impact on us or our franchisees.  In addition, as CMS implements the ASP reimbursement model, managed care organizations may push for adoption of ASP as the basis of pharmaceutical reimbursement as well.  If managed care organizations do adopt the ASP model, our future financial condition and results of operations could be materially affected based on our ability to renegotiate pricing using the ASP methodology.

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RESULTS OF OPERATIONS

The following table shows the results of our operations for the three and nine months ended September 30, 2004 and 2003, expressed in amounts and percentages of revenue (amounts in thousands):