UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from _________ to _________

Commission File No. 0-19842

PolyMedica Corporation

     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 þ No [ ]

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

     As of November 8, 2004, there were 27,421,636 shares of the registrant’s Common Stock issued and outstanding.

POLYMEDICA CORPORATION
TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

PolyMedica Corporation
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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PolyMedica Corporation
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

4

PolyMedica Corporation
Consolidated Statements of Income
(Unaudited)
(In thousands, except per share amounts)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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PolyMedica Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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     PolyMedica Corporation was organized in 1988 and has been in the medical product and pharmaceutical business for over 15 years. Today, through our primary segment, Liberty Diabetes, we are a leading provider of direct-to-consumer diabetes testing supplies, primarily to Medicare-eligible seniors, and provide a simple and reliable way for our patients to obtain their supplies and medications. Through our Liberty Respiratory segment, we provide direct-to-consumer respiratory medications, primarily to Medicare-eligible seniors. Through our Pharmaceuticals segment, we sell prescription medications directly to existing Liberty Diabetes and Liberty Respiratory patients and their spouses, and we also manufacture and sell prescription and over-the-counter urology products to distributors and retailers.

     Accounting

     The accompanying interim consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. These consolidated financial statements include the accounts of PolyMedica and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted. The interim consolidated financial statements, in the opinion of management, reflect all adjustments (consisting only of normal recurring accruals) necessary to fairly present the results as of and for the periods ended September 30, 2004 and 2003. Certain prior year amounts have been reclassified to conform with the fiscal 2005 presentation.

     The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for any future period or the entire fiscal year. Accordingly, these interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended March 31, 2004 which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on June 14, 2004 and our unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the period ended June 30, 2004 filed with the SEC on August 6, 2004. Consequently, the interim consolidated financial statements do not include all disclosures normally required by accounting principles generally accepted in the United States of America for annual audited financial statements.

     Revenue Recognition and Accounts Receivable

     We recognize revenue related to product sales to patients who have placed orders upon shipment of such orders, provided that risk of loss has passed to the patient and we have received and verified any written documentation required to bill Medicare, other third-party payers, and patients. We record revenue at the amounts expected to be collected from Medicare, other third-party payers, and directly from patients. As a result, our contractual allowances are immaterial. Revenue recognition is delayed for product shipments for which we have not yet received the required written forms until the period in which those documents are collected and verified.

     Revenue related to Medicare reimbursement is calculated based on government-determined reimbursement prices for Medicare-covered items. The reimbursements that Medicare pays are subject to review by appropriate government regulators. Medicare reimburses at 80% of the government-determined prices for reimbursable supplies, and we bill the remaining balance to either third-party payers or directly to patients.

     Approximately $70.03 million and $70.86 million of net revenues or 62.8% and 67.3% of consolidated net revenues for the three months ended September 30, 2004 and 2003, respectively, were reimbursable by Medicare for products provided to Medicare beneficiaries. Approximately $142.62 million and $138.80 million of net revenues or 64.1% and 68.0% of consolidated net revenues for the six months ended September 30, 2004 and 2003, respectively, were reimbursable by Medicare for products provided to Medicare beneficiaries.

     Accounts receivable allowances consist of an allowance for doubtful accounts, an allowance for product returns, and other sales allowances. As of September 30 and March 31, 2004, accounts receivable allowances were $31.36

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million and $29.70 million, respectively, or 38.8% and 31.8% of gross accounts receivable, respectively.

     The valuation of accounts receivable is based upon the credit-worthiness of patients and third-party payers as well as our historical collection experience. Allowances for doubtful accounts are recorded as a selling, general and administrative expense for estimated amounts expected to be uncollectible from third-party payers and patients. We base our estimates on our historical collection and write-off experience, current trends, credit policy, and on our analysis of accounts receivable by aging category.

     Our accounts receivable are generally due from Medicare, private insurance companies, Medicaid and our patients. The collection process is time consuming, complex and typically involves the submission of claims to multiple payers whose payment of claims may be contingent upon the payment of another payer. As a result, our collection efforts may be active up to 18 months from the initial billing date. In accordance with applicable regulatory requirements, we make reasonable and appropriate efforts to collect our accounts receivable, including deductible and copayment amounts, in a consistent manner for all payer classes. During the three months ended September 30, 2004 and 2003, we provided for allowances for doubtful accounts at a rate of approximately 4.8% and 5.4% of net revenues, respectively. During the six months ended September 30, 2004 and 2003, we provided for allowances for doubtful accounts at a rate of approximately 4.9% and 5.6% of net revenues, respectively.

     Sales allowances are recorded for estimated product returns as well as estimated claim denials, as a reduction of revenue. We analyze sales allowances using historical data adjusted for significant changes in volume, patient demographics, and business conditions. The reserve for sales allowances and the rate at which we provide for such allowances are periodically adjusted to reflect actual returns and claim denials. During the three months ended September 30, 2004 and 2003, we provided for sales allowances at a rate of approximately 3.9% and 4.3% of gross revenues, respectively. During the six months ended September 30, 2004 and 2003, we provided for sales allowances at a rate of approximately 3.7% and 4.6% of gross revenues, respectively.

     Accounting for Stock-Based Compensation

     PolyMedica accounts for its stock-based compensation plan under the recognition and measurement principles of APB 25, “Accounting for Stock Issued to Employees” and related Interpretations. We have adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure”, an amendment of SFAS No. 123. Therefore, no stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

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     The fair value of each option granted during the three and six months ended September 30, 2004 and 2003 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

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2.		Inventories
		Inventories consist of the following:

     Due to the medical nature of the products we provide, patients sometimes request supplies before we have received the required written documents, if applicable, to bill Medicare, other third-party payers and patients. Because we do not recognize revenue until we have received and verified such documents, included in inventories as of September 30 and March 31, 2004, is $2.44 million and $2.45 million, respectively, of inventory shipped to patients for which we have received an order but have not yet received and verified the required written documents, if applicable, to bill Medicare, other third-party payers and patients, and to recognize revenue.

3.

Goodwill and Other Intangible Assets

     We have three reporting units with goodwill: Liberty Medical Supply, Inc. (“Liberty”), included in the Liberty Diabetes reporting segment, and PolyMedica Pharmaceuticals (U.S.A.), Inc. and PolyMedica Healthcare, Inc., both included in the Pharmaceuticals reporting segment. The carrying amounts of goodwill and intangible assets, excluding direct-response advertising, as of September 30 and March 31, 2004, by reportable segment, were as follows:

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     On July 27, 2004, PolyMedica purchased for $5.50 million, certain diabetes business assets of a direct-to-consumer provider of diabetes testing supplies, including inventory and a customer list but excluding working capital, subject to a post-closing price adjustment based upon the number of customers we successfully sign up as Liberty Diabetes patients. The customer list is comprised of over 15,000 active patients, substantially all of whom are Medicare-eligible diabetics. From the purchase date through September 30, 2004, we had shipped to approximately 7,000 of these patients with the expectation of shipping to additional patients in the coming months.

     Amortization expense for intangible assets was approximately $336,000 and $48,000 for the three months ended September 30, 2004 and 2003, respectively, and approximately $390,000 and $113,000 for the six months ended September 30, 2004 and 2003, respectively. The customer list impairment of $152,000 is the excess of the carrying value of certain prior period customer list purchases over the probable remaining future net cash flows expected to result directly from such assets. As of September 30, 2004, amortization expense on existing intangibles for the remainder of fiscal 2005 and the next four fiscal years is as follows (table in thousands):

4.

Direct-Response Advertising

     In accordance with Statement of Position 93-7 (“SOP 93-7”), direct-response advertising and associated costs for our diabetes supplies and related products, included in the Liberty Diabetes segment, for the periods presented are capitalized and amortized to selling, general and administrative expenses over a four-year period. The amortization rate is such that 55% of such costs are expensed on a straight-line basis over two years from the date they are incurred, and the remaining 45% is expensed on a straight-line basis over the next two years. Management assesses the realizability of the amounts of direct-response advertising costs reported as assets at each balance sheet date by comparing the carrying amounts of such assets to the probable remaining future net cash flows expected to result directly from such advertising. Advertising that does not meet the capitalization requirements of SOP 93-7 is expensed in the current period.

     Any change in existing accounting rules or a business change that impacts expected net cash flows or that shortens the period over which such net cash flows are estimated to be realized, currently four years for our diabetes products and two years for our respiratory supplies, could result in accelerated charges against our earnings. In addition, new or different marketing initiatives that may not qualify for direct-response advertising could result in accelerated charges against our earnings.

     Net realizable value is determined by comparing the carrying amounts of direct-response advertising costs capitalized as assets at each balance sheet date to the probable remaining future net cash flows expected to result directly from such advertising. If the carrying amount of the assets exceeds the probable remaining future net cash flows expected to result directly from such assets, an impairment loss is recognized in an amount equal to that excess. We perform net realizable value tests of our direct-response advertising asset at each reporting period and whenever events or changes in circumstance suggest that the carrying value may not be recoverable and record any impairment as a cost of continuing operations.

     Due to the reduction in reimbursement rates for inhalation drugs contemplated by the Medicare Modernization Act, we expect that our Liberty Respiratory segment will continue to generate less revenue and earnings than it has historically. As a result, we suspended all Liberty Respiratory direct-response advertising in December 2003 and recorded a $14.44 million impairment charge of Liberty Respiratory’s direct-response advertising asset to adjust the asset’s carrying value down to its net realizable value.

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     In accordance with SOP 93-7, we recorded the following activity related to our direct-response advertising asset for the periods presented:

5.		Accrued Expenses
		Accrued expenses consist of the following:

     The amount accrued for settlement reflects our estimate as of September 30, 2004 of the amount that would be due to resolve the civil investigation conducted by the U.S. Attorney’s Office for the Southern District of Florida, with the assistance of the Federal Bureau of Investigation (“FBI”) and the Department of Health and Human Services’ Office of Inspector General (“OIG”). Our estimate as of that date was $35 million. The amount accrued for settlement also reflects our estimate of $700,000 of settlement-related direct costs and expenses. Of the total settlement accrual of $35.70 million, $5.71 million was accrued in the fiscal year ended March 31, 2004. Therefore, the required accrual adjustment booked in the quarter ended September 30, 2004 was a pretax settlement charge of $29.99 million.

     On November 3, 2004, we reached a final settlement of the investigation. Under the terms of the settlement, we will make a one-time payment of $35 million and not admit any wrongdoing. See Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” for further detail.

     As of September 30, 2004, there was $1.74 million of amounts reserved for overpayments by Medicare and others included in the “Other” category in the table above, for amounts due to Medicare, secondary insurers and Medicare beneficiaries related to a change in interpretation of the reimbursement formula for albuterol and ipratropium combinations furnished by our Liberty Respiratory segment, discussed in more detail in Note E to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, filed with the SEC on June 14, 2004. We reduced the accrual related to the reimbursement formula for albuterol and ipratropium by $302,000 and $508,000 in the three and six months ended September 30, 2004, respectively, consistent with the expiration of Medicare’s right to contest certain claims for the albuterol and ipratropium combinations. Medicare carriers in general must deny claims within four years of the billing date.

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     The government’s Medicare regulations are complex and sometimes subjective and therefore may require management’s interpretation. Accruals for overpayments by Medicare and others also occur in the normal course of business when, based on our assessment of the facts and circumstances, we believe that the amounts due are probable and estimable.

6.

Commitments and Contingencies

Contingencies

U.S. Attorney’s Office

     We disclosed previously that the U.S. Attorney’s Office for the Southern District of Florida, with the assistance of the FBI and the OIG, was investigating allegations of healthcare fraud, improper revenue recognition and obstruction of justice by Liberty and Liberty Home Pharmacy. This investigation was civil and criminal. We have cooperated with the government in its investigations. In addition, we implemented changes in our business processes and in our compliance program.

     Based on the progress of the government’s investigation, our cooperation and the changes noted above, we were able to and did enter into serious settlement negotiations with the government in September 2004. The government’s investigation related to certain Medicare billing and documentation practices. These practices related to diabetes testing and respiratory therapy supplies billed during the period from October 1, 1998 to June 30, 2002. We contended and continue to contend that, notwithstanding these issues, we provided medically necessary diabetes testing and respiratory therapy items to Medicare beneficiaries throughout this period.

     Nevertheless, it was our objective to resolve and settle the investigation on the most favorable terms possible once the opportunity for serious negotiations with the government was available to us. We believed and continue to believe it is in the best interests of our shareholders, employees and patients to avoid the risk and expense of continued investigation and litigation. It was also our goal to enable the Company to move forward to pursue its growth objectives for the benefit of our shareholders, employees and patients, unencumbered by the investigation.

     For these reasons, we pursued settlement negotiations with the government in September. Based on these negotiations, we were able to estimate that the total amount of the payment we would need to make to resolve the investigation was $35 million. This amount is inclusive of the $5.71 million that was previously accrued for estimated overpayments by Medicare and others in the fiscal year ended March 31, 2004. We estimated an additional $700,000 of settlement-related direct costs and expenses. Therefore we accrued a charge of $29.99 million in the quarter ended September 30, 2004 to provide for our estimate of the settlement amount and costs ($35.70 million estimate of settlement amount and settlement-related costs, less $5.71 million previously accrued).

     The $35 million settlement amount also eliminates the approximately $12 million contingency previously disclosed relating to a category of claims where our documentation was consistent with the quantity of supplies shipped and billed, but was not strictly in accordance with Medicare rules, which we previously disclosed based on a study of our Medicare claims by an outside consulting firm. Consequently, as a result of the settlement accrual, we no longer have the approximately $12 million contingency.

     On November 3, 2004, we entered into a civil settlement agreement with the United States Department of Justice and the OIG. Under the terms of the settlement agreement, we will make a one-time payment of $35 million. Under the agreement, we admit no wrongdoing. The Department of Justice and OIG provide us with a release of all claims that were under investigation. As noted, this covers the period from October 1, 1998 to June 30, 2002. In addition, the government’s release includes the billing issue studied by the outside consulting firm, described above, for the period from August 1, 1997 through June 30, 2003. Therefore, no additional payments will be required in connection with the results of the study by this outside consulting firm (including the previously disclosed contingency). The agreement reflects that the parties entered into the settlement to avoid the risk and expense of continued investigation and litigation.

     As part of the civil settlement, we have entered into a 5 year corporate integrity agreement. This agreement provides for an annual review of a sample of our Medicare claims by an independent review organization for a 3 to 5 year period, and obligates us to continue our compliance program and the measures we have implemented to promote our

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compliance with Medicare regulations.

     We have also received a non-prosecution agreement, in which the United States Attorney’s Office for the Southern District of Florida has agreed not to prosecute the Company, Liberty or Liberty Home Pharmacy in connection with the allegations that were the subject matter of the investigation.

     Class Action Lawsuit

     On November 27, 2000, Richard Bowe SEP-IRA filed a purported class action lawsuit in the United States District Court for the District of Massachusetts against PolyMedica and Steven J. Lee, PolyMedica’s former Chief Executive Officer and Chairman of the Board, on behalf of himself and purchasers of common stock. The lawsuit seeks an unspecified amount of damages, attorneys’ fees and costs and claims violations of Sections 10(b), 10b-5, and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), alleging various statements were misleading with respect to our revenue and earnings based on an alleged scheme to produce fictitious sales. Several virtually identical lawsuits were subsequently filed in the United States District Court for the District of Massachusetts against PolyMedica. On July 30, 2001, the Court granted the plaintiffs’ motion to consolidate the complaints under the caption In re: PolyMedica Corp. Securities Litigation, Civ. Action No. 00-12426-REK.

     Plaintiffs filed a consolidated amended complaint on October 9, 2001. The consolidated amended complaint extended the class period to October 26, 1998 through August 21, 2001, and named as defendants PolyMedica, Liberty, and certain former officers of PolyMedica. Defendants moved to dismiss the consolidated amended complaint on December 10, 2001. Plaintiffs filed their opposition to this motion on February 11, 2002, and defendants filed a reply memorandum on March 11, 2002. The Court denied the motion without a hearing on May 10, 2002. On June 20, 2002, defendants filed answers to the consolidated amended complaint.

     On January 28, 2004, plaintiffs filed a motion for class certification to which defendants filed an opposition on February 27, 2004. Plaintiffs filed a reply memorandum on April 12, 2004 followed by additional briefing by the parties. The Court heard oral argument on the motion on June 2, 2004. On September 8, 2004, the court allowed the plaintiffs’ motion and certified the class. On September 21, 2004, the defendants filed a petition requesting that they be permitted to appeal the decision to the First Circuit Court of Appeals. The plaintiffs filed a response to the defendants’ petition on October 7, 2004, opposing defendants’ request to appeal the class certification. Also on October 7, 2004, the Court stayed sending notice of the class action pending a ruling on defendants’ appeal of class certification. Discovery is ongoing in the underlying suit.

     We believe that we have meritorious defenses to the claims made in the consolidated amended complaint and intend to contest the claims vigorously. We are unable to express an opinion as to the likely outcome of this litigation. An unfavorable outcome could have a material effect on our financial position and results of operations.

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Segment Information

     Our reportable segments are strategic business units or divisions that offer different products. These units have separate financial information that is evaluated by senior management. The segments are as follows:

     Liberty Diabetes – Through our Liberty Diabetes segment, we provide diabetes testing supplies and related products to patients suffering from diabetes and related chronic diseases. We offer a wide array of diabetes supplies from a broad range of manufacturers.

     Liberty Respiratory – Through our Liberty Respiratory segment, we provide prescription respiratory medications and supplies to patients suffering from chronic obstructive pulmonary disease (“COPD”) and other breathing disorders.

     Pharmaceuticals – Through our Pharmaceuticals segment, we provide prescription medications directly to existing Liberty Diabetes and Liberty Respiratory patients and sell to distributors prescription urology and suppository products, over-the-counter female urinary discomfort products, and home medical diagnostic kits.

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     Selling, general and administrative expenses attributable to PolyMedica’s corporate headquarters are allocated to the operating segments according to the segment’s relative percentage of total net revenues. Selling, general and administrative expenses incurred by Liberty Healthcare Group, Inc., part of the Liberty Diabetes segment, that were incurred on behalf of all of our businesses located in Florida for shared services, are allocated to the operating segments primarily in accordance with the segment’s relative percentage of total employees and square footage in addition to management’s estimates.

     Effective for the quarter ended June 30, 2004, we changed the way we segment cash, cash equivalents and marketable securities, in order to reflect how management currently views these assets. Segment assets belonging to PolyMedica’s corporate headquarters, which included $104.54 million and $76.65 million of cash, cash equivalents and marketable securities as of September 30 and March 31, 2004, respectively, are not allocated as they are considered separately for management evaluation purposes.

     As a result of these allocations, the segment information may not be indicative of the financial position or results of operations that would have been achieved had these segments operated as unaffiliated entities. The depreciation and amortization amounts below include amortization of direct-response advertising. We do not organize our units geographically, as our products are sold throughout the United States only. There are no intersegment sales for the periods presented. The income before income tax segment results for the three and six months ended September 30, 2004 include a pretax settlement charge of $29.99 million to accrue the remainder of the settlement payment owed to the OIG and estimated related direct costs to be incurred by PolyMedica. The details of the investigation settlement are discussed in further detail in Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office.” Information concerning the operations in these reportable segments is as follows:

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8.

Shareholders’ Equity – Cash Dividends and Stock Incentive Plan

     In the quarter ended September 30, 2004, we paid a $0.15 per share cash dividend on 27,278,467 common shares outstanding for a total payment of $4.09 million to our common shareholders of record as of the close of business on August 5, 2004, as compared to a $0.125 per share cash dividend on 24,785,074 common shares outstanding for a total payment of $3.10 million to our common shareholders of record as of the close of business on August 5, 2003. In the six months ended September 30, 2004 and 2003, we paid total cash dividends of $8.11 million and $6.17 million, respectively, to our common shareholders of record.

     At our Annual Meeting of Stockholders, held on September 17, 2004, our shareholders approved an amendment to our 2000 Stock Incentive Plan, increasing the number of shares authorized for issuance under the plan from 4,600,000 shares to 6,400,000 shares.

9.

Calculations of Earnings Per Share

Calculations of earnings per share are as follows:

     Potentially Dilutive Stock Options

     Options to purchase shares of common stock with exercise prices in excess of the average market price of the common shares are not included in the computation of diluted earnings per share. There were 236,000 and 244,500 options not included in the diluted earnings per share computation as of September 30, 2004 and 2003, respectively. During the six months ended September 30, 2004 and 2003, options to purchase 756,000 and 1,374,470 shares of common stock, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

10.

Comprehensive Income

     Our total comprehensive income is equal to our net income for the three and six months ended September 30, 2004 and 2003. Unrealized gains (losses) on investments were not material for any periods presented.

11.

Subsequent Events

     On November 3, 2004, we announced that we had entered into a civil settlement agreement with the United States Department of Justice and the OIG regarding those agencies’ investigations of Liberty and Liberty

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Home Pharmacy. Under the terms of the settlement agreement, we will make a one-time payment of $35 million and admit no wrongdoing, and the government provides us with a release of the claims under investigation. We accrued a charge of $29.99 million during the quarter ended September 30, 2004 to provide for our estimate of the settlement amount and related costs, which is in addition to the $5.71 million that was previously accrued for estimated overpayments by Medicare in the fiscal year ended March 31, 2004. We have also received a non-prosecution agreement, in which the United States Attorney’s Office for the Southern District of Florida has agreed not to prosecute the Company, Liberty or Liberty Home Pharmacy in connection with the allegations that were the subject matter of the investigation. See Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” for further detail.

     On October 18, 2004, we announced that our Board declared a $0.15 per share cash dividend to PolyMedica common shareholders of record as of the close of business on November 5, 2004, payable on November 15, 2004.

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

Future Operating Results

     Forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, are made throughout this Quarterly Report on Form 10-Q. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause our results to differ materially from those indicated by such forward-looking statements, including those detailed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Future Operating Results.”

     In addition, any forward-looking statements represent our view only as of the day this Quarterly Report on Form 10-Q was first filed with the SEC and should not be relied upon as representing our view as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our views change.

Overview

     PolyMedica Corporation was organized in 1988 and has been in the medical product and pharmaceutical business for over 15 years. Today, through our primary segment, Liberty Diabetes, we are a leading provider of direct-to-consumer diabetes testing supplies, primarily to Medicare-eligible seniors, and provide a simple and reliable way for our patients to obtain their supplies and medications. Through our Liberty Respiratory segment, we provide direct-to-consumer respiratory medications, primarily to Medicare-eligible seniors. Through our Pharmaceuticals segment, we sell prescription medications directly to our existing Liberty Diabetes and Liberty Respiratory patients and their spouses, and we also manufacture and sell prescription and over-the-counter urology products to distributors and retailers.

     Liberty Diabetes

     Through our Liberty Diabetes segment we provide diabetes testing supplies and related products, including insulin, syringes, and other ancillary products, to our patients suffering from diabetes. As of September 30, 2004, we had approximately 654,000 active diabetes patients, compared to approximately 584,000 active patients as of September 30, 2003. Approximately 98.0% of our Liberty Diabetes patients are covered by Medicare. We meet the needs of our diabetes patients by:

	•		providing mail order delivery of supplies directly to our patients’ homes;
	•		billing Medicare and/or private insurance companies directly for those diabetes related supplies that are reimbursable;
	•		providing 24-hour telephone support to patients; and
	•		using sophisticated software and advanced order fulfillment systems to provide diabetes related products.

     The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”), signed into law on December 8, 2003, has frozen for the 2004 calendar year the reimbursement rates for diabetes testing supplies at the rates that were in effect for the 2003 calendar year. Commencing January 1, 2005, reimbursement rates for diabetes test strips and lancets will be reduced by the percentage difference between the median amounts paid by the Federal Employees Health Benefit Program in the 2002 calendar year and the amount reimbursed by the Medicare program in the 2002 calendar year. The maximum downward adjustment for test strips and lancets for calendar year 2005 appears to be 4.1% for diabetes test strips and 5.36% for lancets, but the actual percentage decrease in payment amounts for any particular provider will depend on the geographic distribution of its patients. No further adjustments for test strips and lancets are expected for calendar year 2006. Based on a preliminary interpretation of the Medicare Modernization Act, we currently expect an overall reduction in reimbursement rates for test strips and lancets of approximately 3.0% in calendar year 2005.

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     A bill has been introduced in the House of Representatives, H.R. 4491, to repeal the reduction in Medicare reimbursement for diabetes test strips and lancets described above. We do not know whether this bill will be enacted.

     The Medicare Modernization Act also contains provisions that may have a positive effect on the future performance of our Liberty Diabetes segment. Beginning January 1, 2005, Medicare coverage will be provided for an initial physical examination and for regular diabetes screening tests. This coverage may increase the incidence of diagnosis of diabetes and potentially expand the Medicare market for testing supplies and other diabetes products. The Medicare Modernization Act also provides up to $100 million over the next three years for chronic care improvement programs to improve clinical quality while potentially reducing the long-term cost of chronic diseases such as diabetes.

     Liberty Respiratory

     Through our Liberty Respiratory segment we sell prescription respiratory medications and supplies to our patients suffering from COPD and other breathing disorders. As of September 30, 2004, we had approximately 59,000 active respiratory patients, down from approximately 67,000 active patients as of September 30, 2003. Like our Liberty Diabetes segment, through our Liberty Respiratory segment we deliver respiratory medications and supplies to our patients’ homes and bill Medicare and/or private insurance companies (if applicable) directly for those prescription respiratory medications and supplies that are reimbursable.

     The Medicare Modernization Act, signed into law on December 8, 2003, provided for a reduction in reimbursement rates for inhalation drugs, which we provide through our Liberty Respiratory segment. Specifically, beginning January 1, 2004, reimbursement for these drugs was reduced from 95% of the average wholesale price (“AWP”) to 80% of the AWP. Beginning January 1, 2005, reimbursement rates for inhalation drugs will be reduced to 106% of the average price of sales by manufacturers (“ASP”), a new benchmark that will be determined by sales data submitted by the drug manufacturers to the Centers for Medicare and Medicaid Services (“CMS”), plus a dispensing fee. On November 2, 2004, in the final Physician Fee Schedule Rule for calendar year 2005 issued by CMS (CMS-1429-FC), CMS announced that it would pay a dispensing fee of $57 per 30-day order or $80 per 90-day order in addition to the 106% of ASP payment for inhalation drugs. We continue to believe that the business will produce little to no bottom line profit beginning in January. The benefit of receiving this dispensing fee will be that it will allow us to stay in the business of providing these drugs to our patients and at the same time allow us the opportunity to look at a number of initiatives within the area of chronic pulmonary disease. Despite the changing reimbursement landscape and the lack of television advertising to attract new respiratory patients, our respiratory medication business is performing better than expected. Our patients continue to reorder in a predictable manner. We will evaluate in the next quarter, opportunities to continue to build the relationship with these patients including looking at the distribution of oxygen, a logical next step for us, which would allow us to keep patients for a longer portion of the life cycle of their disease.

     Due to the anticipated reimbursement reductions described above, we suspended all direct-response advertising for our Liberty Respiratory segment in December 2003 and net revenues for the three and six months ended September 30, 2004, as compared with the comparable prior year periods, decreased 26.7% and 23.7%, respectively. For further discussion of this matter, see “Results of Operations – Net Revenues.”

     Pharmaceuticals

     Through our Pharmaceuticals segment we provide prescription medications directly to consumers and we manufacture and sell for further distribution prescription urology and suppository products and over-the-counter female urinary discomfort products. Within our Pharmaceuticals segment, our Liberty Pharmacy business markets and sells prescription medications primarily to our existing Liberty Diabetes and Liberty Respiratory patients. PolyMedica’s line of prescription urology products, which includes urinary analgesics, antispasmodics, local anesthetics and analgesic suppositories, are sold to large drug distributors in the United States. Our female urinary discomfort products and home medical diagnostic kits are sold under our AZO brand name to a network of large drug store chains, major supermarkets, mass merchandisers and drug distributors in the United States.

     The Medicare Modernization Act establishes a voluntary prescription drug benefit under the Medicare program. Beginning January 1, 2006, coverage will be available through both prescription drug plans and Medicare Advantage prescription plans. This new benefit will include coverage for insulin and syringes, as well as other prescription drugs.

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     Liberty Pharmacy was one of only 27 applicants to be approved as an issuer of a national Medicare-approved card. This Medicare-approved prescription drug discount card program went into effect in June 2004. This benefit may be voluntarily elected by certain Medicare beneficiaries who do not have an existing outpatient prescription drug benefit. Sponsors of these cards will offer Medicare beneficiaries access to outpatient prescription drugs at discounted prices. Liberty Pharmacy began distributing its own Medicare approved drug discount card to patients and their spouses in May 2004. To date, our involvement in the drug discount card program has not materially benefited our results of operations.

     In December 2003, the service benefit administrator of the Federal Employee Program, which we refer to as FEP, notified Liberty Pharmacy and other durable medical equipment suppliers that as of February 1, 2004 certain supplies and medications would only be reimbursable through FEP’s pharmacy benefit administrator. The service benefit administrator subsequently notified us that this reimbursement change was postponed until January 1, 2005. If the reimbursement change is implemented as proposed, processing these supplies and medications as a pharmacy benefit would result in increased costs to some of our FEP patients as well as lower reimbursement rates to us. We are continuing to evaluate the impact of this change. The FEP program currently comprises a substantial portion of Liberty Pharmacy’s net revenues.

Critical Accounting Policies

     There have been no material changes in our critical accounting policies from those set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, filed with the SEC on June 14, 2004.

Recent Developments

     On September 27, 2004, we announced that our Board of Directors had hired Patrick T. Ryan as our President and Chief Executive Officer and had further appointed Mr. Ryan to our Board of Directors. Mr. Ryan assumed the position of President and Chief Executive Officer from Samuel L. Shanaman, who resigned from that position effective September 27, 2004. Mr. Shanaman is continuing for the time being as an employee of Polymedica to assist with transitional issues and will remain Chairman of our Board of Directors. Also on September 24, 2004, we announced that Stephen C. Farrell had been appointed to the position of Chief Operating Officer of PolyMedica. Mr. Farrell will continue to serve as President of Liberty Healthcare Group, Inc., our principal operating subsidiary, and a Senior Vice President of PolyMedica.

     On October 22, 2004, we announced that John K.P. Stone III had retired from the position of General Counsel of PolyMedica. Mr. Stone will remain a Senior Vice President of PolyMedica until December 31, 2004 and shall remain on our Board of Directors. On October 21, 2004, we announced that William B. Eck had been appointed to the position of Senior Vice President, General Counsel and Chief of Health Care Affairs. Previously, Mr. Eck held the position of Senior Vice President, Deputy General Counsel and Chief of Health Care Affairs.

Other

     Advertising rates may fluctuate during the year, which may affect our acquisition of new patients. We may purchase less advertising when rates are higher, which generally occurs in November and December. As a result, our acquisition of new patients during this period is generally reduced and our net revenues may fluctuate accordingly.

     We operate from manufacturing and distribution facilities located in Massachusetts and Florida, respectively. All of our product sales are denominated in U.S. dollars.

     Period-to-period comparisons of changes in net revenues are not necessarily indicative of results to be expected for any future period.

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Results of Operations

Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003

     Net Revenues

     The following table presents segment net revenues expressed as a percentage of net revenues for the three months ended September 30, 2004 and 2003.

     Our growth during the second quarter was below expectations as a result of the disruption caused by the two hurricanes sustained by our Florida-based facilities, home of our Liberty Diabetes, Liberty Respiratory and Liberty Pharmacy businesses. We have estimated that the hurricanes resulted in the loss of approximately $3.60 million of net revenues that we had forecasted for the fiscal 2005 second quarter, primarily related to our Liberty Diabetes segment.

     The increase in Liberty Diabetes net revenues of 8.2% was due primarily to the 12.0% growth in our patient base, which grew to 654,000 active patients as of September 30, 2004, from approximately 584,000 as of September 30, 2003, offset by fewer required documents collected on product shipments in the quarter ended September 30, 2004, as compared with the quarter ended September 30, 2003, due primarily to the delay in the delivery of those documents as a result of the two hurricanes sustained by our Florida-based facilities in the current year. Collection of these documents is required prior to recognizing revenue for our product shipments. The growth in our patient base was primarily due to the continued success of our direct-response advertising program. The average net revenue generated per shipment remained fairly consistent this year, as compared with last year’s second quarter.

     The decrease in Liberty Respiratory net revenues of 26.7% was due primarily to the reduction in reimbursement rates for inhalation drugs from 95% of AWP to 80% of AWP effective January 1, 2004 through enactment of the Medicare Modernization Act. In addition, due to the anticipated decline in revenues and earnings, we suspended all direct-response advertising for our Liberty Respiratory segment in December 2003, resulting in the decline in our patient base of approximately 11.9% to 59,000 active patients as of September 30, 2004 from 67,000 active patients as of September 30, 2003. The new Medicare legislation is discussed in further detail in “Future Operating Results — Liberty Respiratory.”

     The increase in Pharmaceuticals net revenues was due primarily to the 55.4% growth in Liberty Pharmacy’s direct-to-consumer sales of prescription medications, which represented 76.8% of total Pharmaceuticals segment net revenues in the three months ended September 30, 2004, as compared with 69.4% in the three months ended September 30, 2003. The current patient base for these products consists primarily of our existing Liberty Diabetes and Liberty Respiratory patients and their spouses. We expect this business to help position us for the prescription drug benefit under the Medicare Modernization Act beginning in calendar year 2006. This benefit may be voluntarily elected by certain Medicare beneficiaries who do not have an existing outpatient prescription drug benefit. Sponsors of these cards will offer Medicare beneficiaries access to outpatient prescription drugs at discounted prices. Liberty Pharmacy began distributing its own Medicare approved drug discount card to patients and their spouses in May 2004. To date, our involvement in the drug discount card program has not materially benefited our results of our operations.

     The growth of the other businesses included in this segment, the manufacture and sale of over-the-counter female urinary discomfort products and prescription urology and suppository products from our Massachusetts based

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facility, was less than that of Liberty Pharmacy. Revenues generated by our Massachusetts-based businesses represented less than 30% of the segment’s net revenues and less than 5% of total consolidated net revenues.

     Gross Margin

     The following table presents segment gross margins and gross margin percentages for the three months ended September 30, 2004 and 2003.

     Gross margin in the three months ended September 30, 2004, as compared with the three months ended September 30, 2003, decreased primarily as a result of the 15% cut in Medicare reimbursement for our Liberty Respiratory inhalation drugs and a 55.4% increase in Liberty Pharmacy sales, included in our Pharmaceuticals segment, for which we have historically reported gross margins in the 30% range.

     We expect that our gross margin for the foreseeable future will be lower than it has been historically primarily as a result of the 15% Medicare reimbursement cuts for inhalation drugs currently in effect and further Medicare reimbursement reductions proposed by the Medicare Modernization Act and scheduled to take place January 1, 2005. See “Future Operating Results — Liberty Respiratory.”

     Selling, General and Administrative Expenses

     A reduction, due to the suspension of advertising for our Liberty Respiratory segment in December 2003, in direct-response advertising amortization as a percentage of net revenues, from 10.3% in the three months ended September 30, 2003 to 8.1% in the three months ended September 30, 2004, was the primary reason for the decrease in selling, general and administrative costs as a percentage of net revenues. At 10.3% of net revenues, direct-response advertising amortization for the three months ended September 30, 2004, would have been $2.42 million more than reported.

     Realized economies of scale resulting from our growing business and progress in our efforts to identify opportunities to streamline our business were other key factors in the improvement, as evidenced by the decrease in

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employee compensation as a percentage of net revenues due primarily to improved utilization of existing staff and fewer new hires. Had employee compensation remained at 15.0% of net revenues as reported in the three months ended September 30, 2003, the expense in the three months ended September 30, 2004 would have been approximately $783,000 higher than reported. Reductions in our provision for doubtful accounts as a percentage of net revenues, due primarily to improved cash collections, also contributed to the improvement. These economies of scale were partially offset by a $1.46 million one-time charge to selling, general and administrative expense related to the retirement of PolyMedica’s former General Counsel as well as $1.48 million of expenses incurred related to the two hurricanes sustained by our Florida-based businesses in the quarter ended September 30, 2004.

     Settlement Charge

     On November 3, 2004, we announced that we had entered into a civil settlement agreement with the United States Department of Justice and the OIG regarding those agencies’ investigations of Liberty and Liberty Home Pharmacy. Under the terms of the settlement agreement, we will make a one-time payment of $35 million and admit no wrongdoing. We accrued a charge of $29.99 million during the quarter ended September 30, 2004 to provide for our estimate of the settlement amount and related costs, which is in addition to $5.71 million that was previously accrued for estimated overpayments by Medicare and others in the fiscal year ended March 31, 2004. See Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” to our consolidated financial statements for further detail.

     Investment Income

     The following table presents investment income earned on our cash, cash equivalents, marketable securities and deferred compensation plan balances for the periods presented.

     Investment income increased primarily as a result of higher average cash and cash equivalents balances, rising interest rates, and new short term investment instruments which yielded higher returns for the quarter ended September 30, 2004, as compared with the returns earned on investment holdings during the period ended September 30, 2003. In addition, we began investing a portion of the cash and cash equivalent balances in short term tax-exempt securities.

     Income Taxes

     The following table presents the income tax provision/(benefit) and effective tax rates for the three months ended September 30, 2004 and 2003.

     The effective tax rates, excluding the effect of the settlement charge described below, for the three months ended September 30, 2004 and 2003 were higher than the Federal U.S. statutory rates due primarily to state taxes. In the three months ended September 30, 2004, we recorded a pretax settlement charge of $29.99 million for which we recorded an income tax benefit at the full statutory federal and state

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rates. The effective tax rate for the current year excluding the settlement charge remained at 37.2%, the amount recorded in the first quarter of fiscal 2005.

Six Months Ended September 30, 2004 Compared to Six Months Ended September 30, 2003

     Net Revenues

     The following table presents segment net revenues expressed as a percentage of net revenues for the six months ended September 30, 2004 and 2003.

     Our growth during the six months ended September 30, 2004 as compared with the prior year comparable period was below expectations as a result of the disruption caused by the two hurricanes sustained by our Florida-based facilities, home of our Liberty Diabetes, Liberty Respiratory and Liberty Pharmacy businesses, in the quarter ended September 30, 2004. We have estimated that the hurricanes resulted in the loss of approximately $3.60 million of net revenues that we had forecasted for the fiscal 2005 second quarter, primarily related to our Liberty Diabetes segment.

     The increase in Liberty Diabetes net revenues of 12.1% was due primarily to the 12.0% growth in our patient base, which grew to 654,000 active patients as of September 30, 2004, from approximately 584,000 as of September 30, 2003. The average net revenue generated per shipment remained fairly consistent. The growth in our patient base was primarily due to the continued success of our direct-response advertising program.

     The decrease in Liberty Respiratory net revenues of 23.7% was due primarily to the reduction in reimbursement rates for inhalation drugs from 95% of AWP to 80% of AWP effective January 1, 2004 through enactment of the Medicare Modernization Act. In addition, due to the anticipated decline in revenues and earnings, we suspended all direct-response advertising for our Liberty Respiratory segment in December 2003, which resulted in a decline in our patient base of approximately 11.9% to 59,000 active patients as of September 30, 2004 from 67,000 active patients as of September 30, 2003. The new Medicare legislation is discussed in further detail in “Future Operating Results — Liberty Respiratory.”

     The increase in Pharmaceuticals net revenue was due primarily to the 56.4% growth in Liberty Pharmacy’s direct-to-consumer sales of prescription medications, which represented 77.1% of total Pharmaceuticals segment net revenues in the six months ended September 30, 2004, as compared with 70.6% in the six months ended September 30, 2003. The current patient base for these products consists primarily of our existing Liberty Diabetes and Liberty Respiratory patients and their spouses. We expect this business to help position us for the prescription drug benefit under the Medicare Modernization Act beginning in calendar year 2006. This benefit may be voluntarily elected by certain Medicare beneficiaries who do not have an existing outpatient prescription drug benefit. Sponsors of these cards will offer Medicare beneficiaries access to outpatient prescription drugs at discounted prices. Liberty Pharmacy began distributing its own Medicare approved drug discount card to patients and their spouses in May 2004. To date, our involvement in the drug discount card program has not materially benefited our results of our operations.

     The growth of the other businesses included in this segment, the manufacture and sale of over-the-counter female urinary discomfort products and prescription urology and suppository products from our Massachusetts based facility, was less than that of Liberty Pharmacy. Revenues generated by our Massachusetts-based businesses represented less than 30% of the segment’s net revenues and less than 5% of total consolidated net revenues.

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     Gross Margin

     The following table presents segment gross margins and gross margin percentages for the six months ended September 30, 2004 and 2003.

     Gross margin in the six months ended September 30, 2004, as compared with the six months ended September 30, 2003, decreased primarily as a result of the 15% cut in Medicare reimbursement for our Liberty Respiratory inhalation drugs and a 56.4% increase in Liberty Pharmacy sales, included in our Pharmaceuticals segment, for which we have historically reported gross margins in the 30% range.

     A $500,000 increase in inventory reserves for shoes and inserts provided through our Liberty Diabetes segment, also contributed to the decline in overall gross margin. Due to the low profitability of these products, we discontinued offering them to our patients effective October 2004.

     We expect that our gross margin for the foreseeable future will be lower than it has been historically primarily as a result of the 15% Medicare reimbursement cuts for inhalation drugs currently in effect and further Medicare reimbursement reductions proposed by the Medicare Modernization Act and scheduled to take place January 1, 2005.

     Selling, General and Administrative Expenses

     A reduction in direct-response advertising amortization as a percentage of net revenues, from 10.4% in the six months ended September 30, 2003 to 8.1% in the six months ended September 30, 2004, due to in part to fewer advertisements run in the current year as a result of increased advertising rates and competition driven primarily by coverage of the presidential campaigns, was the primary reason for the decrease in selling, general and administrative costs as a percentage of net revenues. At 10.4% of net revenues, direct-response advertising amortization for the six months ended September 30, 2004, would have been $5.06 million more than reported.

     Realized economies of scale resulting from our growing business and progress in our efforts to identify opportunities to streamline our business were other key factors in the improvement, as evidenced by the decrease in employee compensation as a percentage of net revenues, which dropped approximately one net revenue percentage point, due primarily to improved utilization of existing staff and fewer new hires. Had employee compensation remained at

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15.1% of net revenues as reported in the six months ended September 30, 2003, the expense in the six months ended September 30, 2004 would have been approximately $2.05 million higher than reported. Reductions in our provision for doubtful accounts as a percentage of net revenues, due primarily to improved cash collections, also contributed to the improvement.

     Settlement Charge

     On November 3, 2004, we announced that we had entered into a civil settlement agreement with the United States Department of Justice and the OIG regarding those agencies’ investigations of Liberty and Liberty Home Pharmacy. Under the terms of the settlement agreement, we will make a one-time payment of $35 million and admit no wrongdoing. We accrued a charge of $29.99 million during the quarter ended September 30, 2004 to provide for our estimate of the settlement amount and related costs, which is in addition to $5.71 million that was previously accrued for estimated overpayments by Medicare and others in the fiscal year ended March 31, 2004. See Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” to our consolidated financial statements for further detail.

     Investment Income

     The following table presents investment income earned on our cash, cash equivalents, marketable securities and deferred compensation plan balances for the periods presented.

     Investment income increased primarily as a result of higher average cash and cash equivalents balances, rising interest rates, and new short term investment instruments which yielded higher returns for the six months ended September 30, 2004 as compared with the returns earned on investment holdings during the period ended September 30, 2003. In addition, we began investing a portion of the cash and cash equivalent balances in short term tax-exempt securities.

     Income Taxes

     The following table presents the income tax provision and effective tax rates for the periods presented.

     The effective tax rates, excluding the effect of the settlement charge described below, for the six months ended September 30, 2004 and 2003 were higher than the Federal U.S. statutory rates due primarily to state taxes. In the six months ended September 30, 2004 we recorded a pretax settlement charge of $29.99 million for which we recorded an income tax benefit at the full statutory federal and state rates. The effective tax rate for the current year excluding the settlement charge remained at 37.2%, the amount recorded in the first quarter of fiscal 2005.

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     Liquidity and Capital Resources

     The following table summarizes our sources and uses of cash during the six months ended September 30, 2004 and 2003.

     Our cash and cash equivalents balance increased $28.68 million from March 31, 2004, to $97.91 million as of September 30, 2004, due primarily to increased sales and improved accounts receivable collections, increased proceeds from common stock issuances related to the exercise of employee stock options, and progress in our efforts to identify opportunities to streamline our business, thereby reducing operating expenses.

     The growth of our business is funded primarily through cash flow from operations. The increase in cash flow from operations was driven primarily by increased sales and improved cash collections of accounts receivable as evidenced by the decrease in our quarterly days sales outstanding calculation, from 42 days in the second quarter of fiscal 2004 to 40 days in the second quarter of fiscal 2005. This collection improvement, coupled with $7.42 million less in income tax payments in the current year, partially offset by a $9.33 million increase in inventory levels in the six months ended September 30, 2004, as compared with a $1.95 million decrease in the six months ended September 30, 2003, resulted in increased cash flow provided by operations.

     The $6.93 million decrease in total cash used for investing activities in the six months ended September 30, 2004, as compared with the six months ended September 30, 2003, was primarily due to a $5.68 million decrease in property plant and equipment purchases and an increase of $5.64 million of proceeds from the sale or maturity of marketable securities, offset by a $5.48 million increase in purchases of customer lists. Property, plant and equipment purchases have decreased primarily as a result of reductions in building acquisitions and renovations in the current year as compared with the prior year.

     The $126,000 increase in total cash provided by financing activities in the six months ended September 30, 2004, as compared with the six months ended September 30, 2003, was due primarily to a $1.42 million decrease in capital lease and note payable obligations. This increase in cash flow from financing activities was offset by an increase of $1.94 million in cash dividend payments to shareholders in the six months ended September 30, 2004, as compared with the six months ended September 30, 2003. The current intention of our Board is to pay a cash dividend to PolyMedica common shareholders on a quarterly basis for the foreseeable future. We expect the quarterly cash dividend payment to average approximately $4.10 million. Other financing activities included an increase in proceeds from issuance of common stock and a decrease in amounts set aside for executive deferred compensation plans in the six months ended September 30, 2004, as compared with the six months ended September 30, 2003.

     On July 27, 2004, PolyMedica purchased for $5.50 million, certain diabetes business assets of a direct-to-consumer provider of diabetes testing supplies, including inventory and a customer list but excluding working capital, subject to a post-closing price adjustment based upon the number of customers we successfully sign up as Liberty Diabetes patients. The customer list is comprised of over 15,000 active patients, substantially all of whom are Medicare-eligible diabetics. From the purchase date through September 30, 2004, we had shipped to approximately 7,000 of these patients with the expectation of shipping to additional patients in the coming months. To the extent that we can reduce our incremental costs of attracting additional patients through acquisitions, we will do so. Going forward, we expect acquisitions to become an increasingly important means of growing our patient base.

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     We believe that our cash, cash equivalents and marketable securities balance as of September 30, 2004 of $104.54 million, and cash flows generated from operations, will be sufficient to meet working capital, capital expenditure and financing needs, including the payment of dividends to shareholders and the $35 million investigation settlement payment discussed in further detail in Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” to our consolidated financial statements. In the event that we undertake to make acquisitions of complementary businesses, products or technologies, we may require substantial additional funding beyond currently available working capital and funds generated from operations. Other factors which could negatively affect our liquidity include, among other things, a reduction in the demand for our products, an unfavorable outcome of pending litigation and investigations, or additional reductions in Medicare reimbursement for our products. A significant portion of our net revenues in both our Liberty Diabetes and Liberty Respiratory segments depend on the continued availability of Medicare reimbursement. Effective January 1, 2005, the Medicare Modernization Act calls for further reductions in reimbursement rates for inhalation drugs, which we sell through our Liberty Respiratory segment, and reduces reimbursement rates for diabetes test strips and lancets by approximately 3%, which we sell through our Liberty Diabetes segment. For a further discussion of these reimbursement rate reductions, including their financial impact on our business, please see “Future Operating Results” — “Liberty Diabetes” and “Liberty Respiratory.”

FASB Exposure Drafts

     In March 2004, the FASB issued an exposure draft, “Stock-Based Payment” (“ED”). The proposed standard would be effective for periods beginning after June 15, 2005, therefore PolyMedica would be required to adopt the standard effective July 1, 2005. If the ED is adopted by the FASB, we will be required to report stock-based compensation expense at the grant date fair value of the related stock-based awards. We currently account for our stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations (“APB 25”) and have adopted the disclosure-only provisions of SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure” (“SFAS No. 148”), an amendment of SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”). The adoption of this ED by the FASB and subsequently PolyMedica could have a material impact on our financial position and results of operations.

     There have been no material changes in our contractual obligations and off-balance sheet arrangements from those set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, filed with the SEC on June 14, 2004.

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Factors Affecting Future Operating Results

     Our future operating results remain difficult to predict. We continue to face many risks and uncertainties which could affect our operating results, including without limitation, those described below.

We could experience significantly reduced revenues and profits if Medicare or other government programs change, delay or deny reimbursement

     Sales of a significant portion of our Liberty Diabetes, Liberty Respiratory and Pharmaceuticals segments depend on the continued availability of reimbursement of our patients by government and private insurance plans. Any reduction in Medicare or other government program or private plan reimbursements currently available for our products would reduce our revenues. Certain significant reductions under the Medicare Modernization Act are discussed in “Future Operating Results” — “Liberty Diabetes” and “Liberty Respiratory.” Other reductions are possible. Without a corresponding reduction in the cost of such products, the result would be a reduction in our overall profit margin. Similarly, any increase in the cost of such products would reduce our overall profit margin unless there was a corresponding increase in Medicare or other government program reimbursement. Our profits could also be affected by the imposition of more stringent regulatory requirements for Medicare or other government program reimbursement or adjustments to previously reimbursed amounts.

Litigation may materially adversely affect us

     PolyMedica and three former officers of PolyMedica are defendants in a lawsuit alleging violations of certain sections and rules of the Exchange Act, which was initiated in U.S. District Court for the District of Massachusetts in November 2000. PolyMedica believes it has meritorious defenses to the claims made against it in this action in which it is a defendant and intends to contest the claims vigorously. We cannot accurately predict the outcome of this proceeding at this time, and have therefore not recorded any charges relating to this proceeding. An unfavorable outcome could have a material effect on our financial position and results of operations. Please see Item 3 of Part I, “Legal Proceedings” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, filed with the SEC on June 14, 2004, for a more complete description of this claim.

Under new regulations required by the Sarbanes-Oxley Act of 2002, an adverse opinion on internal controls could be issued by our auditor, and this could have a negative impact on our stock price.

     Section 404 of the Sarbanes-Oxley Act of 2002 requires that we establish and maintain an adequate internal control structure and procedures for financial reporting and assess on an on-going basis the design and operating effectiveness of our internal control structure and procedures for financial reporting. Our auditors are required to audit both the design and operating effectiveness of our internal controls and management’s assessment of the design and the effectiveness of its internal controls. Although no known material weaknesses exist at this time, this will be the first year that we have undergone an audit of our internal controls and procedures, and it is possible that material weaknesses could be found. If we are unable to remediate the weaknesses the auditors could be required to issue an adverse opinion on our internal controls.

     Because opinions on internal controls have not been required in the past, it is uncertain what impact an adverse opinion would have upon our stock price.

Our stock price could be volatile

     The trading price of our common stock has been volatile and is likely to continue to be volatile. The stock market in general, and the market for healthcare-related companies in particular, has experienced extreme volatility. This volatility has often been unrelated to the operating performance of particular companies. Investors may not be able to sell their common stock at or above the price at which they purchased the stock. Prices for the common stock will be determined in the marketplace and may be influenced by many factors, including variations in our financial results, changes in earnings estimates by industry research analysts, investors’ perceptions of us and general economic, industry and market conditions.

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We plan to continue our expansion; if we do not manage our growth successfully, our growth and profitability may slow or stop

     The expansion of our operations has created significant demand on our administrative, operational and financial personnel and other resources. Additional expansion in existing or new markets could strain these resources and increase our need for capital. Our personnel, systems, procedures, controls and existing space may not be adequate to support further expansion.

The loss of senior management or other key personnel, or our inability to attract and retain additional senior management or other key personnel, could affect our ability to execute our business plan.

     If we are unable to retain our senior managers or other key personnel necessary to operate our business, our ability to execute our business plan may be impaired. Our success in the future may also depend on our ability to attract and retain additional qualified senior management and other key personnel.

Geopolitical events may reduce our ability to obtain favorable advertising rates for our direct-response advertising efforts, which may adversely affect our operating results.

     The effectiveness of our direct-response advertising is subject to the risks arising from geopolitical events. For example, around the clock news coverage on the war in Iraq and the war on terrorism affected our ability to obtain favorable rates for our product advertisements and thus affected our ability to obtain new patients. Such geopolitical events may in the foreseeable future have a negative impact on our results of operations.

The profitability of our Liberty Diabetes and Liberty Respiratory segments will decrease if we do not receive recurring orders from patients

     The profitability of our Liberty Diabetes and Liberty Respiratory segments depends in large part on recurring and sustained reorders. Reorder rates are inherently uncertain due to several factors, many of which are outside our control, including changing patient preferences, competitive price pressures, patient transition to extended care facilities, patient mortality and general economic conditions. We generally incur losses and negative cash flow with respect to the first order from a new patient, due primarily to the marketing and regulatory compliance costs associated with initial patient qualification.

We could experience significantly reduced profits from our Liberty Diabetes segment if new technologies that reduce or eliminate the need for consumable testing supplies are developed for glucose monitoring

     The majority of our Liberty Diabetes net revenues are from consumable testing supplies, used to draw and test small quantities of blood for the purpose of measuring and monitoring glucose levels. Numerous research efforts are underway to develop more convenient and less intrusive glucose measurement techniques. The commercialization and widespread acceptance of new technologies that eliminate or reduce the need for consumable testing supplies could negatively affect our Liberty Diabetes segment.

We could experience a charge to earnings as a result of an impairment of our goodwill

     We are required to perform impairment tests under SFAS No. 142 annually and whenever events or changes in circumstance suggest that the carrying value of an asset may not be recoverable. The valuation of our goodwill is based upon the results of these impairment tests. Changes in assumptions used and forecasted results of operations of the reporting unit carrying goodwill, could affect the quantification of an impairment value, should one exist.

We could be liable for harm caused by products that we sell

     The sale of medical products entails the risk that users will make product liability claims. A product liability claim could be expensive. Our insurance may not provide adequate coverage.

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We could lose patients and revenues to new or existing competitors

     Competition from other sellers of products offered through our Liberty Diabetes, Liberty Respiratory and Pharmaceuticals segments, manufacturers of healthcare products, pharmaceutical companies and other competitors is intense and expected to increase. Many of our competitors and potential competitors are large companies with well-known names and substantial resources. These companies may develop products and services that are more effective or less expensive than any that we are developing or selling. They may also promote and market these products more successfully than we promote and market our products.

Loss of use of manufacturing or data storage facilities could significantly reduce revenues and profits from our businesses

     We manufacture substantially all of our prescription urology and suppository products and many of our AZO brand name products at our facility in Woburn, Massachusetts. In addition, we process and store most of our patient data in our facility in Port St. Lucie, Florida. If we cannot use any of these facilities as a result of the FDA, Occupational Safety and Health Administration or other regulatory action, fire, natural disaster or other event, our revenues and profits would decrease significantly. We might also incur significant expense in remedying the problem or securing alternative manufacturing or data storage sources.

If we or our suppliers do not comply with applicable government regulations, we may be prohibited from selling our products

     The majority of the products that we sell are regulated by the FDA and other regulatory agencies. If any of these agencies mandate a suspension of production or sales of our products or mandate a recall, we may lose sales and incur expenses until we are in compliance with the regulations or change to another acceptable supplier.

We could have difficulty selling our pharmaceuticals products if we cannot maintain and expand our sales to distributors

     We rely on third party distributors to market and sell our over-the-counter female urinary discomfort products and prescription urology and suppository products. Future sales of these products depend in part on our maintaining and expanding marketing and distribution relationships with pharmaceutical, medical device, personal care and other distributors and on the success of those distributors in marketing and selling our products.

Our quarterly revenues or operating results could vary, which may cause the market price of our securities to decline

     We have experienced fluctuations in our quarterly operating results and anticipate that such fluctuations could continue. Results may vary significantly depending on a number of factors, including:

	•		changes in reimbursement guidelines and amounts;
	•		changes in regulations affecting the healthcare industry;
	•		changes in suppliers;
	•		the timing of patient orders;
	•		the timing and cost of our advertising campaigns;
	•		the timing of the introduction or acceptance of new products offered by us or our competitors; and
	•		changes in the mix and costs of our products; product mix and costs are significantly influenced by the product brand chosen by the patients of our mail-order diabetes supply business. We provide a wide range of product brand choices to our patients, purchased at varying costs from suppliers. Our ability to sustain current gross margin levels is dependent both on our ability to continue securing favorable pricing from suppliers and on the brand choices of our patients.

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A reduction in working capital or a change in our business could prevent us from paying dividends to shareholders

     A significant decline in our cash balances or a change in our business could cause us to reduce or eliminate the payment of dividends to shareholders.

We may make acquisitions that will strain our financial and operational resources

     We regularly review potential acquisitions of businesses’ products and assets. Acquisitions involve a number of risks that might adversely affect our financial and operational resources, including:

	•		diversion of the attention of senior management from important business matters;
	•		amortization of substantial intangible assets;
	•		difficulty in retaining key personnel of an acquired business;
	•		failure to assimilate operations of an acquired business;
	•		possible operating losses and expenses of an acquired business;
	•		exposure to legal claims for activities of an acquired business prior to acquisition; and
	•		incurrence of debt and related interest expense.

We may issue preferred stock with rights senior to the common stock

     Our articles of organization authorize the issuance of up to 2,000,000 shares of preferred stock without shareholder approval. The shares may have dividend, voting, liquidation and other rights and preferences that are senior to the rights of the common stock. The rights and preferences of any such class or series of preferred stock would be established by our Board in its sole discretion.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We own certain money market funds, commercial bonds and mutual funds that are sensitive to market risks as part of our investment portfolio. The investment portfolio is used to preserve our capital until it is required to fund operations, investing or financing activities. None of the market-risk sensitive instruments held in our investment portfolio are held for trading purposes. We do, however, hold some market-risk sensitive instruments in our executive deferred compensation plans, for trading purposes. These investments are accounted for under SFAS No. 115, “Accounting for certain investments in Debt and Equity Securities.” The investments are recorded at fair value, and changes in fair value are recorded as compensation expense and investment income for the period. We do not own derivative financial instruments in our investment portfolio. We do not believe that the exposure to market risks in our investment portfolio is material.

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Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. PolyMedica’s management, with the participation of PolyMedica’s chief executive officer and chief financial officer, evaluated the effectiveness of PolyMedica’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2004. Based on this evaluation, PolyMedica’s chief executive officer and chief financial officer concluded that, as of September 30, 2004, PolyMedica’s disclosure controls and procedures were (1) designed to ensure that material information relating to PolyMedica, including its consolidated subsidiaries, is made known to PolyMedica’s chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by PolyMedica in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Changes in internal controls. No change in PolyMedica’s internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, PolyMedica’s internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

     Please refer to Item 3 of our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, filed with the SEC on June 14, 2004, for a complete description of our legal proceedings and Item 1 of Part II of our Quarterly Report on Form 10-Q, filed with the SEC on August 6, 2004 for any material developments during the quarter ended June 30, 2004. Any material developments regarding these legal proceedings for the three months ended September 30, 2004 are set forth below.

     U.S. Attorney’s Office

     We disclosed in our prior quarterly and annual filings on Forms 10-Q and 10-K, respectively, that the U.S. Attorney’s Office for the Southern District of Florida, with the assistance of the FBI and the OIG, was investigating allegations of healthcare fraud, improper revenue recognition and obstruction of justice by Liberty and Liberty Home Pharmacy. This investigation was civil and criminal.

     On November 3, 2004, we announced final settlement of the investigation and entered into a civil settlement agreement with the United States Department of Justice and the OIG. Under the terms of the settlement agreement, we will make a one-time payment of $35 million and admit no wrongdoing. This agreement was filed on a Form 8-K dated November 8, 2004. The Department of Justice and OIG have provided us with a release of all claims that were under investigation. For a discussion of the accounting implications of the $35 million payment, please see Note 6, “Commitments and Contingencies; Contingencies; U.S. Attorney’s Office” to our consolidated financial statements for further detail.

     As part of the civil settlement, we have entered into a 5 year corporate integrity agreement which provides for an annual review of a sample of our Medicare claims by an independent review organization for a 3 to 5 year period, and further obligates us to continue our compliance program and the measures we have implemented to promote our compliance with Medicare regulations. This corporate integrity agreement has also been filed on a Form 8-K dated November 8, 2004.

     We have also received a non-prosecution agreement, in which the United States Attorney’s Office for the Southern District of Florida has agreed not to prosecute the Company, Liberty or Liberty Home Pharmacy in connection with the allegations that were the subject matter of the investigation.

     Class Action Lawsuit

     Plaintiffs filed a consolidated amended complaint on October 9, 2001. The consolidated amended complaint extended the class period to October 26, 1998 through August 21, 2001, and named as defendants PolyMedica, Liberty, and certain former officers of PolyMedica. Defendants moved to dismiss the consolidated amended complaint on December 10, 2001. Plaintiffs filed their opposition to this motion on February 11, 2002, and defendants filed a reply memorandum on March 11, 2002. The Court denied the motion without a hearing on May 10, 2002. On June 20, 2002, defendants filed answers to the consolidated amended complaint.

     On January 28, 2004, plaintiffs filed a motion for class certification to which defendants filed an opposition on February 27, 2004. Plaintiffs filed a reply memorandum on April 12, 2004 followed by additional briefing by the parties. The Court heard oral argument on the motion on June 2, 2004. On September 8, 2004, the court allowed the plaintiffs’ motion and certified the class. On September 21, 2004, the defendants filed a petition requesting that they be permitted to appeal the decision to the First Circuit Court of Appeals. The plaintiffs filed a response to the defendants’ petition on October 7, 2004, opposing defendants’ request to appeal the class certification. Also on October 7, 2004, the Court stayed sending notice of the class action pending a ruling on defendants’ appeal of class certification. Discovery is ongoing in the underlying suit.

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Item 4. Submission of Matters to a Vote of Security Holders

     At our Annual Meeting of Stockholders held on September 17, 2004, the following proposals were submitted to a vote of our stockholders:

1. To elect the following three (3) nominee directors as Class III Directors of PolyMedica for the ensuing three years

2. To amend PolyMedica’s 2000 Stock Incentive Plan, increasing from 4,600,000 to 6,400,000 the number of shares available for issuance under the 2000 Stock Incentive Plan:

3. To ratify the selection by the Board of PricewaterhouseCoopers LLP as PolyMedica’s public accountants for the fiscal year ending March 31, 2005:

Item 6. Exhibits

     See Exhibit Index immediately following this report, which is incorporated herein by reference.

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SIGNATURES

     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.

	PolyMedica Corporation (registrant)
	/s/ Patrick T. Ryan
	Patrick T. Ryan
	President and Chief Executive Officer (Principal Executive Officer)

	/s/ Fred H. Croninger III
	Fred H. Croninger III
	Chief Financial Officer (Principal Financial and Accounting Officer)

Dated: November 9, 2004

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Exhibit Index

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