Option Care Health - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

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CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)

UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)

UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)

     These unaudited consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, and other information included in the Annual Report on Form 10-K of BioScrip, Inc. (the “Company”) for the year ended December 31, 2005 (the “Form 10-K”) filed with the U.S. Securities and Exchange Commission (“the SEC”) on March 31, 2006. The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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 GAAP for complete financial statements.

     In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the consolidated balance sheets, statements of operations, statement of stockholders’ equity and statement of cash flows for the periods presented have been included. Operating results for the three and six month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2006. The accounting policies followed for interim financial reporting are similar to those disclosed in Note 2 of Notes to Consolidated Financial Statements included in the Form 10-K.

     Certain prior period amounts have been reclassified to conform to the current year presentation. Such reclassifications had no material effect on the Company’s previously reported consolidated financial position, results of operations or cash flows.

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

     The net loss per diluted share for the periods ended June 30, 2006 and 2005 excludes the effect of common stock equivalents, as their inclusion would be anti-dilutive.

     At June 30, 2006, the Company has several stock-based employee compensation plans (the “Plans”) pursuant to which incentive stock options (“ISOs”) and non-qualified stock options (“NQSOs”) awards may be granted to employees and non-employee directors. Prior to January 1, 2006, those plans were accounted for under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”), and related interpretations, as

permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), issued by the Financial Accounting Standards Board (“FASB”). Under APB 25, only the intrinsic value of stock options was recognized in the Statement of Operations for periods prior to January 1, 2006. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), using the modified-prospective-transition method. Under that transition method, compensation cost recognized during the first quarter of 2006 includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated. Under these plans there were a total of 15,087,596 shares authorized for issuance. As of June 30, 2006, there remain 2,986,190 shares available for grant under the Plans.

     Options granted under the Plans typically vest over a three-year period and, in certain limited instances, fully vest upon a change in control of the Company. In addition, such options are generally exercisable for 10 years after the date of grant, subject to earlier termination in certain circumstances. The exercise price of such options is equal to the fair market value on the date of grant. The exercise price of ISOs granted under the Plans will not be less than 100% of the fair market value on the date of grant (110% for ISOs granted to a stockholder holding 10% or more of the Company’s common stock).

     The fair value of each option award is estimated on the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life of options granted is derived from previous history of stock exercises from the grant date and represents the period of time that options granted are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The Company has never paid dividends on its Common Stock and does not anticipate doing so in the foreseeable future.

     As a result of adopting SFAS 123(R) on January 1, 2006, the Company incurred stock option expense of $0.5 million and $1.1 million for the three and six month periods ended June 30, 2006, respectively.

     The following table illustrates the effect on net income and earnings per share had the Company applied the fair value recognition provisions of SFAS 123 to options granted under the Company’s stock option plans in all periods presented prior to adopting SFAS 123(R). For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing formula and amortized to expense on a straight line basis over the options’ vesting periods (in thousands, except per share amounts).

     Prior to the adoption of SFAS 123(R), the Company presented the tax benefit resulting from the exercise of stock options as a cash inflow from operating activities in the Statement of Cash Flows. SFAS 123(R) requires the cash flows from tax benefits in excess of the tax deductions of the compensation cost to be classified as financing cash inflows. The excess tax benefit classified as financing cash inflow would have been classified as an operating cash inflow if the Company had not adopted SFAS 123(R). Prior periods are not restated to reflect adoption of SFAS 123(R).

     Stock option activity under the Plans for the first six months of 2006 is as follows:

     Options outstanding as of June 30, 2006 expire on various dates ranging from July 8, 2006 through May 23, 2016. The following table outlines the Company’s outstanding and exercisable stock options as of June 30, 2006:

     Stock option activity for non-vested shares under the Plans for the first six months of 2006 is as follows:

     As of June 30, 2006, there was $2.1 million of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized over a weighted-average period of 1.5 years. The total intrinsic value of options exercised for the six months ended June 30, 2006 was $0.3 million.

     As compensation expense for options granted is recorded over the vesting period of options, future stock-based compensation expense may be greater as additional options are granted.

     The Company operates in two reportable segments: (1) Specialty Services, which is comprised of specialty pharmacy distribution and clinical management services; and (2) PBM Services, which is comprised of fully integrated pharmacy benefit management and traditional mail services. Corporate overhead is allocated between the two segments based on adjusted revenue for each segment.

     The following table sets forth revenue information regarding significant customer(s) by segment (in thousands):

     On March 12, 2005 the Company acquired all of the issued and outstanding capital stock of Chronimed Inc. (“Chronimed”) in a stock-for-stock transaction pursuant to which each share of Chronimed common stock was exchanged for 1.12 shares of the Company’s common stock. The results of operations of Chronimed have been included in the Consolidated Statements of Operations since March 12, 2005. The acquisition of Chronimed added 28 specialty pharmacies throughout the U.S. to the Company’s existing pharmacies.

     The aggregate purchase price paid for Chronimed was $105.3 million, including direct expenses of $3.7 million associated with the acquisition. The 14,380,551 shares of common stock exchanged and 2,612,146 stock options assumed in the acquisition were valued using the average market price of the Company’s common stock during the period beginning two days before and ending two days after the revised merger agreement was announced. The purchase price has been allocated to the acquired assets and liabilities based on management’s estimates of their fair value and an independent outside valuation.

     The following unaudited consolidated pro forma financial information for the six months ended June 30, 2005 has been prepared assuming Chronimed was acquired as of January 1, 2005. The number of basic and diluted shares has been adjusted assuming the exchange ratio of 1.12 shares of common stock of the Company exchanged for each outstanding share of Chronimed common stock. The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results that would have been realized had the acquisition occurred on January 1, 2005 (in thousands, except per share amounts):

     On October 7, 2005 the Company acquired all of the issued and outstanding capital stock of JPD, Inc. d/b/a Northland Medical Pharmacy (“Northland”), a community-based specialty pharmacy located in Columbus, Ohio, for approximately $12.0 million in cash plus a potential earn-out payment contingent on Northland achieving certain future performance benchmarks in 2006. Had this acquisition taken place on January 1, 2005, the Company’s consolidated sales and income would not have been significantly different from the reported amounts at June 30, 2005.

     On March 1, 2006 the Company acquired all of the issued and outstanding capital stock of Intravenous Therapy Services, Inc. (“ITS”), a specialty home infusion company located in Burbank, California, for approximately $13.1 million in cash, which resulted in approximately $10.5 million of goodwill, plus a potential earn-out payment contingent on ITS achieving certain future performance benchmarks. Had this acquisition taken place on January 1, 2006, the Company’s consolidated sales and income would not have been significantly different from the reported amounts at June 30, 2006.

     The acquisition of Chronimed resulted in the consolidation of certain finance and information technology functions. The Company’s Rhode Island offices, which included finance and information technology functions, were closed as a result of these consolidations and these functions were transitioned to the Company’s Minnesota office. Accordingly, there have been restructuring costs associated with these consolidations.

     On March 4, 2005, in connection with the consolidation of the finance and information technology departments, the Company notified 67 employees that their employment with the Company would be involuntarily terminated. All of these employees were terminated by December 31, 2005. Severance costs were recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, with the expense being allocated over the estimated retention period of employees, which ended December 31, 2005. Current year adjustments to provisions have been recorded in selling, general and administrative expense in the Specialty Services segment. The following table provides a reconciliation of the restructuring liability at June 30, 2006 (in thousands):

     The following table outlines information concerning contracts with Plan Sponsors having revenues and/or accounts receivable that individually exceeded 10% of the Company’s total revenues and/or accounts receivable during the time periods indicated:

     The following discussion should be read in conjunction with the audited consolidated financial statements, including the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (the “Form 10-K”) filed with the U.S. Securities and Exchange Commission (the “SEC”), as well as our unaudited consolidated interim financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006 (this “Report”).

     This Report contains statements not purely historical and which may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements regarding our expectations, hopes, beliefs, intentions or strategies regarding the future. These forward looking statements may include statements relating to our business development activities, sales and marketing efforts, the status of material contractual arrangements, including the negotiation or re-negotiation of such arrangements, future capital expenditures, the effects of regulation and competition on our business, future operating performance and the results, benefits and risks associated with the integration of acquired companies. Investors are cautioned that any such forward-looking statements are not guarantees of future performance, involve risks and uncertainties and that actual results may differ materially from those possible results discussed in the forward-looking statements as a result of various factors. These factors include, among other things, risks associated with risk-based or “capitated” contracts, increased government regulation related to the health care and insurance industries in general and more specifically, pharmacy benefit management and specialty pharmaceutical distribution organizations, the existence of complex laws and regulations relating to our business, changes in reimbursement rates from government and private payors, and increased competition from our competitors, including competitors with greater financial, technical, marketing and other resources. This Report contains information regarding important factors that could cause such differences.

     You should not place undue reliance on such forward-looking statements as they speak only as of the date they are made. Except as required by law, we assume no obligation to publicly update or revise any forward-looking statement even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

     We are a comprehensive specialty pharmacy services and pharmacy benefit management (“PBM”) services provider. Our specialty pharmacy distribution and clinical management services (collectively, “Specialty Services”) include distributing specialty and traditional prescription medications, coordinating customer benefits and providing specialized therapy management services for people with certain health conditions, particularly those treated with biotech injectable or infusable medications, as well as those afflicted with potentially life threatening or debilitating diseases or genetic disorders requiring specialty medications. Our PBM services include network claims processing, benefit design consultation, drug utilization review and formulary management. We work with patients, physicians and pharmaceutical manufacturers. We also work directly with a variety of health insurers, including HMO’s, indemnity plans and PPO’s, managed care organizations, other insurance companies, and, to a lesser extent, labor unions, self-funded employer groups, government agencies (including Medicaid and Medicare) and other self-funded plan sponsors (collectively, “Plan Sponsors”), as well as through third-party administrators. We work with all of these constituents in a concerted effort to improve clinical and economic outcomes while enhancing the quality of life for the individuals living with chronic conditions.

     Our services are reported under two operating segments: (i) Specialty Services; and (ii) pharmacy benefit management and traditional mail services (collectively, “PBM Services”).

     Our Specialty Services are provided primarily to patients who either have chronic health conditions or are afflicted with potentially life threatening or debilitating diseases or genetic disorders which require specialty medications. These specialty services include the distribution of biotech and other high cost injectable, oral and infusable prescription medications and the provision of pharmacy-related clinical management services, product administration and disease state programs. Specialty Services are also offered to physicians, in a variety of practice and/or hospital settings, on behalf of their patients. Many of these physicians have network affiliations with Plan Sponsors, who in turn have a relationship with us.

     Infusion therapies are generally provided to patients requiring immunological blood products, parenteral nutrition products, and infused antibiotic therapies. We strive to maximize therapy outcomes through strict adherence to the clinical guidelines or protocols for a particular prescription therapy while at the same time managing the costs of such therapies on behalf of a Plan Sponsor or patient. Unlike the other specialty programs, infusion patients have their therapies administered intravenously either at home by IV certified nurses or in physician’s offices.

     Historically, our PBM Services were offered to Plan Sponsors and were designed to promote a broad range of cost-effective, clinically appropriate pharmacy benefit management services through our network of retail pharmacies and our dedicated traditional mail service distribution facility. Over the past several years we have focused on building our Specialty Services for strategic growth, and have lost a significant amount of PBM Services business, particularly the recent loss of our contracts with Centene Corporation, which is negatively impacting 2006 revenue. Consequently, the PBM Services’ managed care business has decreased as a percentage of total revenue.

     As part of our business we develop and maintain existing relationships with pharmaceutical manufacturers through a dedicated pharmaceutical relations department. These efforts have been concentrated on the creation and execution of new drug distribution and service contracts in our core specialty therapeutic areas, including cancer, multiple sclerosis, HIV, immune deficiency and other chronic illnesses and life threatening diseases. The specialty management services that we provide through our Specialty Services segment are attractive to the pharmaceutical manufacturer community, demonstrated by recent successes in being selected for participation in national specialty distribution networks for newly approved, high-cost medications. These new contracts provide new sales and revenue opportunities which we began to realize in 2005 and expect to continue in 2006 and beyond.

     We are the sole vendor for the Centers for Medicare and Medicaid Services’ new Competitive Acquisition Program (“CAP”) for certain Part B drugs and biologicals commencing July 1, 2006. The CAP is a voluntary program that offers physicians who choose to enroll in the program the option to acquire many of the drugs they use in their practice from an approved CAP vendor, thus reducing the time they spend buying and billing for drugs. The CAP applies only to certain drugs covered under Medicare Part B which are administered to a Medicare beneficiary in the physician’s office and does not apply to drugs included in the Medicare prescription drug benefit (Medicare Part D).

     Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates, and different assumptions or conditions may yield different estimates. The accounting policies followed for interim financial reporting are similar to those disclosed in Note 2 of Notes to Consolidated Financial Statements included in the Form 10-K. Material updates to policies disclosed in the Form 10-K are discussed below.

     We adopted the fair-value-based method of accounting for share-based payments effective January 1, 2006 under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (“SFAS 123(R)”) , issued by the Financial Accounting Standards Board (“FASB”) , using the modified-prospective-transition method. Under that transition method, compensation cost recognized during the first six months of 2006 includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated.

     Prior to the adoption of SFAS 123(R) we accounted for employee stock and stock-based compensation plans through the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations, as permitted by SFAS 123, and as such, generally recognized no compensation expense for employee stock options. As a result of adopting SFAS 123(R) as of January 1, 2006, our loss before income taxes for the first six months of 2006 increased $1.1 million, or $0.02 per share, compared to continuing to account for share-based compensation under APB 25.

     As of June 30, 2006, there was $2.1 million of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under our stock option plans. That cost is expected to be recognized over a weighted-average period of 1.5 years.

     In June, 2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 100. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements. This Interpretation will result in increased relevance and comparability in financial reporting of income taxes. FIN 48 is effective for fiscal years beginning after December 15, 2006, and we will adopt this Interpretation in the first quarter of 2007. We are currently assessing the requirements of FIN 48 and the impact of adoption.

     The table below presents the reconciliation between our GAAP (reported) and non-GAAP (pro forma) consolidated results, assuming the acquisition of Chronimed had occurred on January 1, 2005. We believe this information to be more helpful in gaining an understanding of future results and trends. In the following Management’s Discussion and Analysis we provide discussion of reported results for the second quarter 2006 compared to the same period a year ago. Discussion of six month results is on a pro forma basis for enhanced comparability to prior year due to the acquisition of Chronimed on March 12, 2005 (in thousands, except share and per share amounts).

Revenue. Revenue for the second quarter of 2006 was $279.6 million compared to $286.6 million in the second quarter of 2005. Specialty Services revenue for the second quarter of 2006 was $210.5 million, an increase of $17.4 million from the same period a year ago, primarily attributable to strong growth in infused products, the acquisitions of JPD, Inc d/b/a Northland Medical Pharmacy (“Northland”) in October 2005 and Intravenous Therapy Services, Inc. (“ITS”) in March 2006, as well as growth in specialty mail. PBM Services revenue for the second quarter of 2006 was $69.1 million, a decrease of $24.4 million from the same period a year ago, primarily attributable to the loss of our PBM contracts with Centene Corporation. That decrease was partially offset by revenue increases in traditional mail.

          Revenue for the six months ended June 30, 2006 was $579.3 million compared to $589.1 million on a pro forma basis for the same period in 2005. Specialty Services revenue for the six months ended June 30, 2006 was $414.1 million, an increase of $11.1 million, or 2.8%, from $403.0 million on a pro forma basis for the same period a year ago, primarily due to strong growth in infused products and the acquisition of Northland in October 2005 and ITS in March 2006. This increase was partially offset by the loss of Chronimed’s Aetna contract which terminated on February 28, 2005. PBM Services revenue for the six months ended June 30, 2006 was $165.2 million, a decrease of $20.9 million, or 11.3%, from the same period a year ago on a pro forma basis primarily due to the loss of our customer Centene Corporation that was previously communicated to take place throughout the year.

     Cost of Revenue and Gross Profit. Cost of revenue for the second quarter of 2006 was $250.8 million compared to $256.1 million for the same period in 2005. Gross margin as a percentage of revenue declined from 10.6% in the second quarter of 2005 to 10.3% in the second quarter of 2006. The gross margin rate decline is the result of program changes associated with the implementation of Medicare Part D on January 1, 2006, and reimbursement pressures.

     Cost of revenue decreased $5.0 million, or 1.0%, to $520.2 for the six month period ended June 30, 2006 from $525,2 million on a pro forma basis for the same period in 2005. Gross profit for the six months ended June 30, 2006 was $59,1 million, a decrease of $4.8 million, or 7.5%, from $63.9 million on a pro forma basis for the six months ended June 30, 2005. We experienced a decline in gross margin as a percentage of revenue in the six months ended June 30, 2006 to 10.2% compared to gross margin of 10.8% on a pro forma basis for the same period last year, primarily as a result of program changes associated with the implementation of Medicare Part D on January 1, 2006, and reimbursement pressures.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) for the second quarter of 2006 increased to $31.1 million, or 11.1% of total revenue, from $26.3 million, or 9.2% of total revenue, for the second quarter of 2005. The increase in SG&A is due primarily to $1.4 million in severance expense related to the departure of former senior management members, $1.5 million in ongoing operating expenses associated with acquisitions made by us since June 30, 2005, $0.5 million in stock option expense due to the adoption of SFAS 123(R) at January 1, 2006 and $0.4 million in finance and IT expenses to improve receivable collections and system infrastructure.

     SG&A expenses for the six months ended June 30, 2006 were $59.0 million, or 10.2% of total revenue, compared to $52.4 million, or 8,9% of total revenue, on a pro forma basis for the same period in 2005. The increase in SG&A is primarily due to $1.8 million in severance expense related to the departure of former senior management members, $2.2 million in operating expenses associated with acquisitions made by us since June 30, 2005, $1.1 million in stock option expense due to the adoption of SFAS 123(R) at January 1, 2006 and $0.8 million in finance and IT expenses to improve receivable collections and system infrastructure.

     Bad Debt Expense. For the second quarter of 2006 bad debt expense increased to $4.4 million compared to $1.3 million for the same period a year ago. In applying the bad debt reserve methodology consistent with year end 2005, we are providing reserves at a higher rate than the same period of 2005 due to continued lower than expected collections.

     For the six months ended June 30, 2006, bad debt expense increased to $6.7 million compared to $2.0 million for the same period a year ago and $2.9 million on a pro forma basis for the same period of 2005. The increased bad debt expense reflects a higher bad debt accrual rate due to continued lower than expected collections. We have added resources and are enhancing our collection process to improve receivable collection performance.

     Amortization of Intangibles. For the second quarter of 2006 we recorded amortization of intangibles of $1.6 million compared to $2.0 million for the same period in 2005. The decrease in 2006 was primarily the result of the write-off of certain intangible assets in 2005.

     The amortization of intangibles for the six months ended June 30, 2006 was $3.3 million compared to a pro forma basis of $3.8 million for the same period a year ago. The decrease was primarily the result of the write-off of certain intangible assets in 2005.

     Merger Related Expenses. There were no merger-related or integration expenses incurred during the second quarter of 2006 compared to $0.7 million for the same period in 2005. Merger-related and integration expenses in the prior year period include expenses incurred to consolidate the acquisition of Chronimed, including severance and re-branding costs.

     Merger-related and integration expense decreased to $0.1 million for the six months ended June 30, 2006 from $3.2 million on a pro forma basis in the same period of 2005. The integration expense for 2005 includes pre-merger expenses recorded by Chronimed.

     Net Interest Expense. Net interest expense was $0.7 million for the second quarter of 2006 compared to net interest income of less than $0.1 million for the same period a year ago. This interest expense is associated with the line of credit which was used to fund the acquisition of ITS and greater general working capital requirements.

     Net interest expense was $1.2 million for the six months ended June 30, 2006 compared to $0.1 million on a pro forma basis for the six months ended June 30, 2005. The increase is principally the result of additional borrowings associated with the acquisition of ITS and to support the working capital requirements of the business. Interest expense for the line of credit was partially offset by interest income received on short term investments and money market accounts in the six months ended June 30, 2005.

     Provision for Income Taxes. A $4.2 million tax benefit was recorded for the first six months of 2006 compared to $1.0 million for the first six months of 2005. The effective tax rate for these periods was 38.1% and 35.9%, respectively.

     The pro forma basis tax rate was 39.0%. This resulted in a pro forma income tax benefit of $1.7 million for the first six months of 2005, based on the pro forma income before taxes compared to an income tax benefit of $4.2 million for the first six months of 2006.

     Net Loss and Loss Per Share. Net loss for the second quarter of 2006 was $5.7 million, or $0.15 per share, compared to net loss of $3.5 million, or $0.10 per share, for the same period last year. The decline in net income is due to items previously discussed in our Results of Operations.

     Net loss for the six months ended June 30, 2006 was $6.9 million, or $0.18 per share. This compares to net loss of $2.6 million, or $0.07 per share, on a pro forma basis for the six months ended June 30, 2005.

     For the six months ended June 30, 2006 net cash used in operating activities totaled $12.2 million compared to $8.3 million for the same period last year. Increases in net receivables and inventory of $4.9 million and $3.3 million, respectively, as well as a reduction in claims payable of $21.0 million due to the loss of the Centene Corporation PBM business were partially offset by increases in accounts payable of $12.1 million.

     Net cash used in investing activities during the six months ended June 30, 2006 was $16.7 million, primarily due to the acquisition of ITS on March 1, 2006, for $13.1 million in cash. This compares to $17.1 million provided by investing activities in the same period in 2005, primarily from cash on hand acquired with the acquisition of Chronimed.

     For the six months ended June 30, 2006 net cash provided by financing activities was $31.5 million compared to net cash used in financing activities of $6.3 million for the same period in 2005. At June 30, 2006 there was $38.2 million of outstanding bank borrowings under our revolving credit facility (the “Facility”) with an affiliate of Healthcare Finance Group, Inc. (“HFG”), a $30.7 million increase in the six months ended June 30, 2006 compared to a decrease of $7.3 million the same period in 2005. Outstanding borrowings increased in the six months ended June 30, 2006 primarily as a result of the acquisition of ITS and increased working capital requirements.

     At June 30, 2006 we had working capital of $53.6 million compared to $67.5 million at December 31, 2005.

     The Facility was increased in July 2006 to provide for borrowings up to $75 million at the London Inter-Bank Offered Rate (LIBOR) plus 2.4%. The current term of the Facility expires on November 1, 2006. We have reached an agreement in

principal to extend the Facility for four years, through November 1, 2010. The Facility permits us to request an increase in the amount available for borrowing up to $100 million, as well as converting a portion of any outstanding borrowings from a Revolving Loan into a Term Loan. The borrowing base utilizes receivables balances, among other things, as collateral.

     The Facility contains various covenants that, among other things, require us to maintain certain financial ratios, as defined in the agreements governing the Facility. We have received a waiver from HFG on a certain financial ratio (debt to earnings before interest, taxes, depreciation and amortization) that we were not in compliance with as of June 30, 2006, due to losses incurred in 2006. We were in compliance with all other covenants.

     As we continue to grow, we anticipate that our working capital needs will also continue to increase. We believe that our cash on hand, together with funds available under the current and potentially expanded Facility and cash expected to be generated from operating activities will be sufficient to fund our anticipated working capital, IT systems investments and other cash needs for the next twelve months as our business is currently configured. We have recently been selected by the Centers for Medicare and Medicaid Services as the national vendor for the initial phase of the new Competitive Acquisition Program (“CAP”) for certain Part B drugs and biologicals commencing July 1, 2006. During the six month period ended June 30, 2006, we have invested $1.5 million for capitalized IT infrastructure associated with the implementation of the CAP program. Growth in this program may require an increase in our line of credit to fund working capital requirements associated with CAP.

     We also may pursue joint venture arrangements, business acquisitions and other transactions designed to expand our business, which we would expect to fund from borrowings under the Facility, other future indebtedness or, if appropriate, the private and/or public sale or exchange of our debt or equity securities.

     At December 31, 2005 we had Federal net operating loss carry forwards (“NOLs”) of approximately $14.0 million, which will begin expiring in 2017. If the NOLs are not utilized in the year they are available they may be utilized in a future year to the extent they have not expired.

     We make available through our website, www.bioscrip.com, access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, any amendments to those reports (when applicable), and other reports filed with the SEC. Such access is free of charge and is available as soon as reasonably practicable after such information is filed with the SEC. This information may also be accessed through the SEC website at www.sec.gov.

     Exposure to market risk for changes in interest rates relates to our outstanding debt. At June 30, 2006 we did not have any long-term debt. We are exposed to interest rate risk primarily through our borrowing activities under our line of credit discussed in Item 2 of this report. A 10% increase in interest rates would not have a significant effect on our interest expense. Interest rate risk on our investments is immaterial due to our level of investment dollars. Foreign currency exchange rate risk, commodity price risk, or other market risks (e.g. equity price) are not present. We do not use financial instruments for trading or other speculative purposes and are not a party to any derivative financial instruments.

     At June 30, 2006, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, claims payable, payables to plan sponsors and others and line of credit approximate fair value due to their short-term nature.

     Because management does not believe that our exposure to interest rate market risk is material at this time, we have not developed or implemented a strategy to manage this market risk through the use of derivative financial instruments or otherwise. We will assess the significance of interest rate market risk from time to time and will develop and implement strategies to manage that market risk as appropriate.

     We maintain disclosure controls and procedures that are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported on a timely basis and that such information is accumulated and communicated to management, including the Chief Executive

     Officer (“CEO”) and the Chief Financial Officer (“CFO”) as appropriate, to allow for timely decisions regarding required disclosures.

     In connection with the preparation of our 2005 Form 10-K, an evaluation was performed under the supervision and with the participation of management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13d-15(e) and 15d-15(e)). Based on that evaluation, management concluded that our disclosure controls as of December 31, 2005 were not effective as a result of material weaknesses in internal control over financial reporting. The material weaknesses identified by management were in the areas of information technology, revenue recognition and accounts receivable. The material weaknesses were disclosed in Item 9A of our 2005 Form 10-K.

     As part of its evaluation of the effectiveness of the design and operation of our internal control over financial reporting as of the end of the period covered by this report, management has identified no material weaknesses other than those described in the Form 10-K. Although we believe that progress has been made to address these material weaknesses, management has concluded that the material weaknesses disclosed in our 2005 Form 10-K continue to exist as of the quarter ended June 30, 2006, and therefore, has also concluded that our disclosure controls and procedures were not effective as of June 30, 2006 for the same reasons disclosed in the 2005 Form 10-K.

     In light of the material weaknesses in internal control over financial reporting which continue to exist as of June 30, 2006, management performed additional analysis and procedures to ensure the consolidated financial statements were prepared in accordance with GAAP. Accordingly, management believes that the consolidated financial statements and schedules included in this Form 10-Q fairly present in all material respects our financial position, results of operations and cash flows for the periods presented.

     Management, with oversight from the Audit Committee, is working to remediate the material weaknesses in internal control over financial reporting disclosed in the 2005 Form 10-K. No additional changes in our internal controls over financial reporting occurred during the quarter ended June 30, 2006 that materially affected, or is reasonably likely to materially affect, such internal control over financial reporting other than those remedial actions previously disclosed in Form 10-K.

     On February 14, 2005, a complaint was filed in the Alabama Circuit Court for Barbour County, captioned Eufaula Drugs, Inc. v. ScriptSolutions [sic]. It is one of approximately fourteen substantially identical complaints commenced in Alabama courts against various unrelated pharmacy benefit management companies. On April 8, 2005, the plaintiff filed an amended complaint against one of our subsidiaries, BioScrip PBM Services f/k/a ScripSolutions (“PBM Services”), alleging breach of contract and related claims on behalf of a putative nationwide class of pharmacies alleging insufficient reimbursement for prescriptions dispensed, principally on the theory that PBM Services was obligated to update its prescription pricing files on a daily rather than weekly basis. PBM Services has made efforts to have the case heard by the federal courts. Those efforts have not been successful, although its petition to the Supreme Court is pending. On June 6, 2006, PBM Services made a motion in the Barbour County Circuit Court to dismiss the action. On July 11, 2006, the Circuit Court heard argument and reserved decision. PBM Services has not yet answered the complaint, but intends to deny the allegations and defend the claims vigorously.

     The following risk factor is in addition to those previously disclosed in the 2005 Form 10-K:

     BioScrip was selected by the Centers for Medicare and Medicaid Services (“CMS”) as the national vendor for the initial phase of the Competitive Acquisition Program (“CAP”) for certain Medicare Part B-covered drugs and biologicals, which program commenced July 1, 2006. Under CAP, participating physicians will obtain Medicare Part B-covered drugs from BioScrip and administer them to the beneficiary, rather than purchasing them directly from distributors and being reimbursed for the drug by Medicare. Physicians administering these drugs to beneficiaries will continue to receive reimbursement from CMS for administering the drug (but not the cost of the drug). Under the provisions of CAP, CMS will pay BioScrip for the drugs supplied to participating physicians and BioScrip will collect the amount of any applicable deductibles and coinsurance directly from the beneficiary. However, under the CAP rules, payment to BioScrip from CMS for drugs provided to participating physicians, as well as BioScrip’s ability to collect any applicable deductibles and coinsurance from a beneficiary, is conditioned upon the physician administering the drug and billing CMS for the administration of the drug. Failure on the part of participating physicians to administer drugs ordered from BioScrip or timely submit claims for administration of such drugs will prevent or delay us from seeking reimbursement from CMS as well as from collecting any applicable deductibles and coinsurance and may adversely affect our financial condition, liquidity and results of operations.

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