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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2004

Commission File Number 000-50940

ROTECH HEALTHCARE INC.

(Exact Name of Registrant as Specified in Its Charter)

(407) 822-4600

(Registrant’s Telephone Number, Including Area Code)

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 ¨ No x

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

As of November 12, 2004, the registrant had 25,218,120 shares of common stock outstanding.

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

ITEM 1—Condensed Consolidated Financial Statements

ROTECH HEALTHCARE INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except share and per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

2

ROTECH HEALTHCARE INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

3

ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

The accompanying unaudited condensed consolidated financial statements include the accounts of Rotech Healthcare Inc. and its subsidiaries and have been prepared in accordance with the instructions to Form 10-Q and, therefore do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. Interim results are not necessarily indicative of results to be expected for the full year. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Rotech Medical Corporation emerged from bankruptcy on March 26, 2002 and transferred to Rotech Healthcare Inc. substantially all of its assets used by it in connection with its businesses and operations (including the stock of substantially all of its subsidiaries), in a restructuring transaction. As used in these notes, unless otherwise specified or the context otherwise requires, references to the “Company” refer to the business and operations of Rotech Healthcare Inc. and its subsidiaries for all periods subsequent to March 31, 2002 and to the business and operations of Rotech Medical Corporation and its subsidiaries for all periods prior to April 1, 2002.

For all periods presented herein, there were no differences between net earnings and comprehensive income.

Restatements: Subsequent to the issuance of the Company’s unaudited condensed consolidated financial statements as of and for each of the quarterly periods in 2003, the Company determined that amortization related to approximately $3.5 million of deferred financing costs associated with its $200 million senior secured term loan had not appropriately reflected the effect which the Company’s accelerated prepayments would have had on the computation of amortization for these deferred financing costs during 2003. As a result, interest expense has been restated from the amounts previously reported to account for an increase in the amortization of the deferred financing costs in accordance with the effective interest method to take into account the accelerated prepayments. The results for the three months and nine months ended September 30, 2003 include a reduction of net earnings of approximately $543 and $1,105 respectively, for the effect of the difference in amortization of deferred financing costs that was expensed versus what should have been recognized in fiscal 2003.

A summary of the unaudited effect of the restatement on the three and nine months ended September 30, 2003 (as previously reported and as restated) is as follows (dollars in thousands):

Basic earnings per share (“EPS”) are computed by dividing earnings attributable to common stockholders by the weighted average number of common shares outstanding for the periods. Diluted EPS reflects the potential dilution of securities that could share in the earnings, including stock options, and convertible preferred stock, and are based upon the weighted average number of common shares and common equivalent shares outstanding. Common stock equivalent shares totaling 582,345 and 365,182 for the three months and nine months ended September 30, 2004, respectively, and 2,666,934 and 3,344,733 for the same periods in 2003 were excluded from the computation of diluted EPS as they have an anti-dilutive effect. The Company uses the treasury stock method to compute the dilutive effects of outstanding options.

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

A reconciliation of the number of common shares used in the calculation of basic and diluted EPS is presented below:

As permitted under SFAS No. 148 and SFAS No. 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which prescribes the intrinsic value method of accounting for its stock-based awards issued to employees and directors. Accordingly, the Company does not recognize compensation expense for its stock option based awards to employees in the condensed consolidated.statements of operations. Had compensation cost been determined on the basis of fair value pursuant to SFAS No. 123, the Company’s net earnings and basic and diluted earnings per share would have been as follows:

Options to purchase approximately 3,299,413 shares of common stock at prices ranging from $14.55 to $26.00 per share were outstanding as of September 30, 2004. Options to purchase approximately 3,300,000 shares of common stock at prices ranging from $14.55 to $24.95 per share were outstanding as of September 30, 2003. In addition, the Company issued 32,000 shares of restricted stock as of August 24, 2004.

On February 6, 2003, the Company entered into an asset purchase agreement with Daniels Investment, Inc. d/b/a Northern Kentucky Respiratory Care (“NKR”) to acquire its principal operating assets and certain liabilities (including a loan and outstanding management fees owed to the Company) for a cash purchase price of up to $5,000.

Pursuant to the asset purchase agreement, the Company paid $2,000 in cash on the closing date, with the remaining cash purchase price to be paid out based on an earn-out provision in the agreement. During 2003, an additional $1,000 was paid in cash as part of the purchase price.

The business combination of NKR was accounted for by the purchase method of accounting. The results of the operations of the acquired business are included in the condensed consolidated financial statements from the purchase date. The Company acquired the following assets and liabilities in the NKR acquisition:

The purchase price is subject to adjustment if certain targets are met until December 31, 2005, the date the earn-out period expires.

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

The Company implemented certain restructuring activities that include head count reduction and real estate consolidation to improve operating effectiveness and efficiencies. During the three month period ended September 30, 2003, $456 of restructuring related charges were recognized for severances, all of which was paid in cash. During the nine month period ended September 30, 2003, $6,730 of restructuring related charges were recognized, which consisted of severance and lease cancellation charges. Of the $6,730 in charges, $6,078 was paid in cash. As of September 30, 2003, the Company had approximately $2,052 recorded in accrued expenses related to restructuring charges. The restructuring related charges are included in selling, distribution and administrative expenses in the condensed consolidated statements of operations. The Company terminated approximately 15% of its employees during the nine months ended September 30, 2003. The terminated employees consisted of corporate and administrative personnel, and field staff in a variety of capacities. During the nine month period ended September 30, 2004, there were no restructuring related charges recognized. During the three and nine month periods ended September 30, 2004, the Company paid $202 and $1,084, respectively, in cash for restructuring related charges. As of September 30, 2004 and December 31, 2003, the Company had approximately $360 and $1,676, respectively, recorded in accrued expenses related to restructuring charges. The Company expects the payment on the restructuring accrual to continue through August 2008.

The Company evaluates goodwill and other intangible assets on an annual basis under SFAS No. 142 Goodwill and Other Intangible Assets.

For impairment testing purposes, the Company has determined that it has one reporting unit, which is in the distribution business. Management further has determined that the distribution reporting unit should be reported in the aggregate based upon similar economic characteristics within each company within that unit. Management will perform the required annual impairment test during the fourth quarter.

The following table reflects the components of other identifiable intangible assets:

Amortization expense for the three months and nine months ended September 30, 2004 was approximately $246 and $826, respectively, and was approximately $334 and $998 for the three months and nine months ended September 30, 2003, respectively.

Estimated amortization expense for each of the fiscal years ended December 31, is as follows:

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

The Company has determined that it has one reportable segment because all distribution locations have similar economic characteristics, such as margins, products, customers, distribution networks and regulatory oversight. The accounting policies of the operating segment are those discussed in the Company’s consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2003.

This one line of business represents 100% of consolidated revenues from the distribution of health care products. The distribution business is comprised of three primary product lines: respiratory therapy equipment and services, durable medical equipment, and other health care products. The following table presents net revenues from distribution by each of the Company’s three primary product lines:

The Company is subject to workers’ compensation and employee health benefit claims, which are primarily self-insured. The Company does, however, maintain certain stop-loss and other insurance coverage which management believes to be appropriate. Provisions for estimated settlements relating to the workers’ compensation and health benefit plans are provided in the period of the related claim on a case-by-case basis plus an amount for incurred but not reported claims. Differences between the amounts accrued and subsequent settlements are recorded in operations in the period of settlement.

From time to time, the Company and its subsidiaries have been parties to various legal proceedings in the ordinary course of business. For more information regarding the Company’s recent legal proceedings, see note 11, “Significant Events”. In the opinion of management there are currently no proceedings which individually, after taking into account the insurance coverage maintained by the Company, would have a material adverse effect on the Company’s financial position, cash flows or results of operations.

The Company and others in the health care business are subject to certain inherent risks, including the following:

Such inherent risks require the use of certain management estimates in the preparation of the Company’s financial statements and it is reasonably possible that a change in such estimates may occur.

The Company receives payment for a significant portion of services rendered to patients from the federal government under Medicare and other federally funded programs (including the Veterans Administration) and from the states in which its facilities and/or services are located under Medicaid. Revenue derived from Medicare, Medicaid and other federally funded programs represented 70.8% and 71.3% of the Company’s patient revenue for the three and nine months ended September 30, 2004, respectively, and represented 71.3% and 70.8% of the Company’s patient revenue for the three and nine months ended September 30, 2003, respectively.

Recent legislation continues to impact and reduce Medicare payment levels. Under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), additional reductions have been imposed. Changes under MMA

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

include a freeze in payments for certain medical devices from 2004 through 2008, competitive bidding requirements, new clinical conditions for payment and quality standards. The changes affect the Company’s products generally, although specific products may be affected by some but not all of the MMA provisions. Medicare payments for certain home medical equipment (“HME”) including oxygen and nebulizers, are set at the 2003 level for 2004 through 2008, unless they are subject to competitive bidding. Furthermore, MMA may further reduce payments in 2005 for these products based on a percentage of the median payments for the items under the Federal Employee Health Benefits (“FEHB”) Program and freeze them at that reduced level through 2008. MMA also reduced payments for drugs delivered through nebulizer equipment to 80% of average wholesale price (“AWP”) in 2004 and beginning in 2005, the payment amount is to be based on 106% of average sales price. Reductions in Medicare reimbursement for oxygen, nebulizers and inhalation medications could have a material, adverse effect on the Company’s revenues and profitability.

Consistent with MMA reductions this year, Medicare payments to the Company for its HME products remain at 2003 levels and are based on the lesser of the actual charge for the item or the applicable Medicare fee schedule amount. Under MMA, from 2004 through 2008, most payments for HME will not be adjusted upward by a cost of living index and, therefore, will be “frozen,” unless the item becomes subject to competitive bidding. Further, beginning in 2005, certain items of HME, including wheelchairs, nebulizers, oxygen and oxygen equipment, will experience a further reduction in the fee schedule amount. That further reduction will be based on the percentage difference between the amount of payment otherwise determined for 2002 and the median amount of FEHB payments, as that amount is determined by the Office of Inspector General of the Department of Health and Human Services (“OIG”). The adjusted payments would remain “frozen” through 2008 unless the particular item becomes subject to competitive bidding.

A September 2004 report published by the OIG surveyed FEHB prices for oxygen equipment and found that the median 2002 prices were considerably lower than Medicare payments for those items. According to the report, the 2002 median FEHB payments for five oxygen codes showed that the FEHB median payments for stationary home oxygen equipment were approximately 15.5% less than Medicare payments and for portable home oxygen equipment, FEHB median payments were approximately 11.3% less than Medicare payments. Although the Medicare allowables for 2005 have not yet been made available, under the MMA, the OIG data is to be used to reduce Medicare payments based on the percentage difference between the Medicare amount otherwise determined for the oxygen equipment for 2002 and the amounts identified by the OIG for median FEHB payments. The precise impact on the Company of the reductions cannot be determined until the final 2005 payment rates are set.

MMA also revises the payment methodology for certain drugs, including inhalation drugs dispensed through nebulizers. Prior to MMA, Medicare paid for these drugs based on AWP, as reported by drug manufacturers. Beginning January 1, 2004, Medicare payments were reduced for most of the Company’s Part B inhalation drugs to 80% of AWP from 95% of AWP, a reduction of approximately 15%. Beginning in 2005, payments for all inhalation drugs delivered through nebulizer equipment will be based on 106% of average sales price (“ASP”). ASP is defined statutorily as the volume weighted average of manufacturers’ average sales prices, calculated by adding the products of manufacturers’ average sales prices for the drug in the fiscal quarter and the number of units sold and then dividing by the total number of units sold for all national drug codes assigned to the product. Under the ASP methodology, Medicare generally will pay 106% of ASP for multiple source drugs and 106% of the lesser of ASP or wholesale acquisition cost for single source drugs. The ASP for many drugs may be significantly less than the AWP, resulting in reduced Medicare payments for these drugs. In addition, if the ASP exceeds the widely available market price by more than 5%, the Centers for Medicare and Medicaid studies (“CMS”) (the federal agency responsible for administering the Medicare program) may substitute the widely available market price for the ASP, further reducing payment levels for those drugs. For the nine-month period ended September 30, 2004, Medicare covered inhalation drugs accounted for approximately one-sixth of the Company’s recorded revenues. While the net payment amounts for inhalation drugs under the ASP methodology have not yet been determined, the Company believes that the ASP provision, if implemented, could result in payment amounts in 2005 that are dramatically lower than payment amounts in 2004. Such reductions in Medicare reimbursement for inhalation medications could have a material, adverse effect on the Company’s revenues and profitability.

Recently, CMS conducted competitive bidding demonstrations for certain Medicare services. Under MMA, starting in 2007, Medicare will begin a nationwide competitive bidding program in ten high-population metropolitan services areas (“MSAs”) for certain high cost and high utilization items. The program will expand to cover 80 MSAs in 2009 and additional areas thereafter. Competitive bidding will require suppliers to compete for the exclusive or limited rights to provide items to beneficiaries in a defined region. Only a limited number of suppliers will be selected in any given MSA, resulting in restricted supplier choices for beneficiaries. Competitive bidding may result in lower reimbursement or the loss of the Company’s ability to provide services in certain regions. MMA permits certain exemptions from competitive bidding, including exemptions for rural areas and areas with low population density within urban areas that are not competitive, unless there is a significant national market through mail

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

order for the particular item. A large number of the Company’s facilities are located in such areas. However, the criteria for how the exemption will be applied have not yet been determined. Therefore, the impact on the Company’s business is uncertain.

On August 5, 2004, CMS published in the Federal Register proposed rules implementing certain MMA provisions relating to inhalation drugs. CMS published preliminary estimates for two inhalation drugs: albuterol sulfate and ipratropium bromide. These two drugs were selected as examples because of the high Medicare spending rates. The estimated payment amounts under the ASP payment methodology for these two drugs represented approximately 90% reductions from 2004 payment levels. The agency also indicated that given the overall reduction in payment for inhalation drugs, there are concerns about beneficiary access to these drugs and noted that the 6% above ASP would generally not be sufficient to meet the costs for shipping, handling, and other pharmacy activities. Therefore, CMS indicated that it is appropriate to continue to pay a separate dispensing fee to pharmacies that furnish inhalation drugs and sought comments on the appropriate dispensing fee amount to cover the shipping, handling, compounding and other pharmacy activities required to get the medications to Medicare beneficiaries.

On November 2, 2004, CMS released the final rule for these provisions, which, among other things, included updated ASP estimates for albuterol sulfate and ipratropium bromide and significantly increased current dispensing fees for inhalation drugs beginning in 2005. In its final rule, CMS confirmed that the payment rates for inhalation drugs under the ASP methodology would be calculated using the most recent manufacturer data. Third quarter data would be used to calculate the ASP payment amounts for the first quarter of 2005. CMS has indicated that it expects to release the initial ASP payment amounts in the beginning of December 2004. Quarterly updates would be implemented, according to CMS, to reflect the quarterly submissions by manufacturers. With respect to albuterol sulfate and ipratropium bromide, CMS noted in its final rule that ASP data submitted for the second quarter of 2004 showed a 25% and 50% increase, respectively. Despite the increase, this represents a substantial decrease in the payment rate from the AWP methodology. Given the overall reduction in payment for inhalation drugs, to address beneficiary access, CMS established a $57 dispensing fee for all inhalation drugs shipped to a beneficiary during a month or $80 for a 90-day period. CMS indicated that filling a monthly prescription as opposed to a 90-day prescription would depend on the circumstances of the beneficiary and it expects that new patients and those who are less stable would receive the 30-day prescription.

In calculating the 2005 dispensing fee, CMS took into account data submitted by commenters as well as the October 2004 report by the United States Government Accountability Office (“GAO”) for inhalation drugs dispensed through nebulizers. The GAO recommended that CMS evaluate the costs of dispensing inhalation therapy drugs and modify the existing dispensing fee, if warranted, to ensure that it reflects the costs necessary for dispensation of inhalation therapy drugs. In its final rule for 2005, CMS noted that there may have been differences in surveyed costs and services between the GAO survey and other survey data submitted by commenters, including the American Association for Homecare. CMS indicated its intent to explore further the variability in costs of furnishing inhalation drugs and the services being provided before making any determination with respect to an appropriate dispensing fee after 2005.

This dispensing fee may offset some of the cuts that would otherwise be experienced if the ASP methodology takes effect, which the Company expects will occur. The payment rates under ASP for 2005 have not yet been released. Accordingly, it is unclear to what extent the dispensing fee will offset reductions in the payment rates for the inhalation drugs. At this time, the Company believes it is likely based upon the increased 2005 dispensing fees that it will be able to continue offering inhalation drugs to Medicare patients in 2005. However, the Company recognizes that, even with the 2005 dispensing fee, pricing changes could have a material adverse effect on the Company’s revenues and profitability. Furthermore, as a result of the current uncertainties in ASP payments for inhalation drugs to become effective in 2005, the Company also recognizes that there remains a risk that it might not be economically feasible to continue to provide inhalation drugs, particularly in light of the aggregate material adverse impact from reductions in the Medicare payments for the items of HME discussed above and the reductions in payment levels for inhalation drugs.

The Company’s operations are subject to a variety of federal, state and local legal and regulatory risks, including, without limitation, federal Medicare and Medicaid fraud and abuse laws (sometimes referred to as the “Anti-Kickback Statute”) and the federal Ethics in Patient Referral Act of 1989 (“Stark I”) as amended by the Omnibus Budget and Reconciliation Act of 1993 (“Stark II” and together with Stark I, “Stark”) many of which apply to virtually all companies engaged in the health care services industry. The Anti-Kickback Statute prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of federal health care program patients, including Medicare and Medicaid patients. Stark prohibits, with limited exceptions, a physician from referring Medicare or Medicaid patients for certain designated health services to an entity with which the physician has a financial relationship. Stark also prohibits the submission of a claim to Medicare or Medicaid by the entity for designated health services furnished pursuant to a prohibited referral. Many states in which the Company operates have laws and regulations similar to Stark and the Anti-Kickback Statute with which the

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

Company must comply. Other regulatory risks assumed by the Company and other companies engaged in the health care industry are as follows:

The Company has formed a Corporate Compliance Department to help identify, prevent and deter instances of non-compliance with Medicare and Medicaid regulations. Although the Company strives to manage these regulatory risks, there can be no assurance that federal and/or state regulatory agencies that currently have jurisdiction over matters including, without limitation, Medicare, Medicaid and other government reimbursement programs, will take the position that the Company’s business and operations are in compliance with applicable law or with the standards of such regulatory agencies.

While the Company believes it complies in all material respects with all applicable regulatory requirements, an adverse determination in the governmental investigations, whether currently asserted or arising in the future, could have a material adverse effect on the Company.

The Company is also subject to general and professional liability and related claims, which arise in the normal course of business and which could have a significant effect on the Company. As a result, the Company maintains occurrence based professional and general liability insurance with coverage and deductibles which management believes to be appropriate.

The Company’s long-term debt consists of the following:

In addition to the above, as of September 30, 2004, the Company has a $75 million five-year revolving credit facility available. No debt is outstanding under this facility at September 30, 2004; however, the Company has issued letters of credit totaling $11.2 million under this facility to guaranty the Company’s payments on future insurance claims. Additionally, effective August 3, 2004, the Company repurchased $13.0 million of its 9½% senior subordinated notes which generated a loss on extinguishment of debt of $0.9 million (which is included in selling, distribution and administrative expenses) for the premium paid in association with the retirement of such notes.

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ROTECH HEALTHCARE INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(In thousands, except share and per share data)

On April 30, 2003, federal agents served search warrants at the Company’s corporate headquarters and four other facilities in three states and were provided access to a number of current and historical financial records and other materials. The Company has also received subpoenas from the United States Attorney’s Office for the Northern District of Illinois for information relating to Medicare and Medicaid billing and VA contracting. The Company is cooperating fully with the investigation; however, the Company can give no assurances as to the duration of the investigation or as to whether or not the government will institute proceedings against the Company or any of its employees or as to the violations that may be asserted. In addition, the Company received informal requests for information on March 7, 2003 and April 17, 2003 from the Division of Enforcement of the Securities and Exchange Commission related to matters that were the subject of the Company’s previously disclosed internal investigation regarding VA contracts and the Company has provided documents in response to such requests. As a health care provider, the Company is subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documentation and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by the Company for payment of services rendered to patients. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to legal process. Violations of federal and state regulations can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.

Supplemental Schedule of Noncash Investing and Financing Activities

During the nine months ended September 30, 2003, the Company purchased the principal operating assets and assumed certain liabilities of a provider of home health care products and services. In conjunction with this purchase, liabilities were assumed as follows:

Since the Company was delayed in filing the registration statement and completing the exchange offer relating to its 9½% senior subordinated notes due 2012, the Company incurred approximately $0.9 million of liquidated damages during the year ended December 31, 2002 and the quarter ended March 31, 2003. Such expense has been reserved for on the Company’s balance sheet and, effective November 10, 2004, all of the liquidated damages were paid in full. In addition, effective October 12, 2004, the Company repurchased 804 shares of its Series A convertible redeemable preferred stock for approximately $0.02 million in order to fund the cash payment of benefits under the Company’s employee profit sharing plan to certain plan participants that are no longer employed by the Company.

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ITEM 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our consolidated financial statements for the year-ended December 31, 2003 and the notes thereto included in our Annual Report on Form 10-K previously filed with the Securities and Exchange Commission. As used herein, unless otherwise specified or the context otherwise requires, references to the “Company”, “we”, “our” and “us” refer to the business and operations of Rotech Healthcare Inc. and its subsidiaries. Management’s discussion and analysis gives effect to the restatement as described in Note 2 to the unaudited condensed consolidated financial statements included in this Quarterly Report.

Executive Overview

Background. We provide home medical equipment and related products and services in the United States, with a comprehensive offering of respiratory therapy and durable home medical equipment and related services. We provide equipment and services in 48 states through approximately 500 operating centers located primarily in non-urban markets.

Our revenues are principally derived from respiratory equipment rental and related services, which accounted for 87.1% and 83.7% of our revenues for the three months ended September 30, 2004 and September 30, 2003, respectively and 86.9% and 83.3% for the nine months ended September 30, 2004 and September 30, 2003, respectively. Revenues from respiratory rental and related services include the rental of oxygen concentrators, liquid oxygen systems, portable oxygen systems, ventilator therapy systems, nebulizer equipment and sleep disorder breathing therapy systems, and the sale of nebulizer medications. We also generate revenues from the rental and sale of durable medical equipment accounting for 11.4% and 15.2% of net revenues for the three months ended September 30, 2004 and September 30, 2003, respectively and 11.8% and 15.3% for the nine months ended September 30, 2004 and September 30, 2003, respectively. Revenues from the rental and sale of durable medical equipment include the rental and sale of items such as hospital beds, wheelchairs, walkers, patient aids and ancillary supplies.

We have engaged in an ongoing series of activities to strengthen our organizational structure and reposition us for future growth. These actions have included selective reduction in headcount, renegotiation of certain vendor contracts, substantial reduction in the number of billing centers, discontinuation of certain product lines and branch locations, centralization of certain administrative functions (including billing and purchasing), development and implementation of an advanced information and billing system, and enhancement of regulatory compliance programs. We expect to continue to review our operations in order to improve operating efficiencies.

Reimbursement by Third Party Payors. We derive a majority of our revenues from reimbursement by third party payors, including Medicare, Medicaid, the Veterans Administration and private insurers. Our business has been, and may continue to be, significantly impacted by changes mandated by Medicare legislation. With the passage of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or MMA, a number of changes have been mandated to the Medicare payment methodology and conditions for coverage for our products. These changes include a freeze in payments for home medical equipment from 2004 to 2008, competitive bidding requirements, new clinical conditions for payment and quality standards. The impact of competitive bidding, new clinical conditions and quality standards are uncertain at this time. The MMA changes also include a reduction in payment rates for oxygen equipment and certain other items of home medical equipment (including wheelchairs, nebulizers, hospital beds and air mattresses), based on the percentage difference between the amount of payment otherwise determined for 2002 and the median payment amount under the Federal Employee Health Benefits (“FEHB”) Program, as determined by the Office of the Inspector General of the Department of Health and Human Services (“OIG”). If the proposed reductions in the Medicare fee schedules based on the 2002 FEHB prices for home oxygen equipment together with other home medical equipment (excluding inhalation drugs) had been implemented in 2004, we believe it would have resulted in a reduction in 2004 projected annualized revenue in the range of approximately $30 million to $35 million.

The MMA also revises the payment methodology for certain drugs, including inhalation drugs dispensed through nebulizers. Prior to MMA, Medicare paid for these drugs based on average wholesale price, or AWP, as reported by drug manufacturers. Beginning January 1, 2004, Medicare payments were reduced for most of our Part B inhalation drugs to 80% of AWP from 95% of AWP, a reduction of approximately 15%. Beginning in 2005, payments for drugs delivered through nebulizer equipment will be based on 106% of average sales price, or ASP. ASP is defined statutorily as the volume weighted average of manufacturers’ average sales prices, calculated by adding the products of manufacturers’ average sales prices for the drug in the fiscal quarter and the number of units sold and then dividing by the total number of units sold for all national drug codes assigned to the product. Under the ASP methodology, Medicare generally will pay 106% of ASP for multiple source drugs and 106% of the lesser of ASP or wholesale acquisition cost for single source drugs. The ASP for many drugs may be significantly less than the AWP, resulting in reduced Medicare payments for these drugs. In addition, if the ASP exceeds the widely available market price by more than 5%, the Centers for Medicare and Medicaid Services, or CMS, may substitute the widely available market price for the ASP, further reducing payment levels for those drugs. For the nine-month period ended September 30, 2004, Medicare covered inhalation drugs accounted for

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approximately one-sixth of our recorded revenues. While the net payment amounts for inhalation drugs under the ASP methodology have not yet been determined, we believe that the ASP provision, once implemented, could result in payment amounts in 2005 that are dramatically lower than payment amounts in 2004.

In November 2004, CMS announced a substantial increase to the current $5 monthly dispensing fee for inhalation drugs. For 2005, for all drugs shipped to a beneficiary, the dispensing fee will be $57 for monthly prescriptions and $80 for 90-day prescriptions. This dispensing fee is intended to help alleviate concerns about beneficiary access to these drugs and to ensure that inhalation drug suppliers are appropriately reimbursed for the costs for shipping, handling and other pharmacy activities they currently perform in connection with providing inhalation drugs administered through nebulizers. This dispensing fee may offset some of the cuts that would otherwise be experienced if the ASP methodology takes effect, which we expect will occur. The payment rates under ASP for 2005 have not yet been released. Accordingly, it is unclear to what extent the dispensing fee will offset reductions in the payment rates for the inhalation drugs. At this time, we believe it is likely based upon the increased 2005 dispensing fee that we will be able to continue offering inhalation drugs to Medicare patients in 2005. However, even with the payment of the 2005 dispensing fee, the Company recognizes that the reductions in Medicare reimbursement for oxygen, nebulizers and inhalation medications could have a material, adverse effect on our revenues and profitability. Furthermore, as a result of the current uncertainties in ASP payments for inhalation drugs to become effective in 2005, the Company also recognizes that there remains a risk that it might not be economically feasible to continue to provide inhalation drugs, particularly in light of the aggregate material adverse impact from reductions in the Medicare payments for the items of HME discussed above and the reductions in payment levels for inhalation drugs.

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The following table shows our results of operations for the three and nine months ended September 30, 2004 and September 30, 2003.

14

The following table shows our results of operations as a percentage of our net revenues for the three and nine months ended September 30, 2004 and September 30, 2003.