ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS

EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THE STATEMENTS IN THIS FORM 10-K MAY BE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934 AND SECTION 27A OF THE SECURITIES ACT OF 1933. FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES WHICH MAY CAUSE BIOMERICA'S RESULTS IN FUTURE PERIODS TO DIFFER MATERIALLY FROM FORECASTED RESULTS. THESE RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, THE CONTINUED DEMAND FOR THE COMPANY'S PRODUCTS, AVAILABILITY OF RAW MATERIALS, THE STATE OF THE ECONOMY, RESULTS OF RESEARCH AND DEVELOPMENT ACTIVITIES AND THE CONTINUED ABILITY OF THE COMPANY TO MAINTAIN THE LICENSES AND APPROVALS REQUIRED. THESE AND OTHER RISKS ARE DESCRIBED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K AND IN THE COMPANY'S OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.

EXCEPT AS MAY BE REQUIRED BY APPLICABLE LAW, WE MAY NOT UPDATE OR REVISE OUR FORWARD-LOOKING STATEMENTS AND THE LACK OF SUCH UPDATE DOES NOT IMPLY THAT ACTUAL EVENTS ARE AS ORIGINALLY EXPRESSED BY SUCH FORWARD-LOOKING STATEMENTS. YOU SHOULD READ THE DISCLOSURES IN THIS REPORT AND OTHER REPORTS WHICH WE FILE WITH THE SECURITIES AND EXCHANGE COMMISSION.

RESULTS OF OPERATIONS

Fiscal 2009 Compared to Fiscal 2008

Our consolidated net sales were $4,934,771 for fiscal 2009 compared to $4,926,505 for fiscal 2008. This represents an increase of $8,266, or 0% for fiscal 2009.

Cost of sales in fiscal 2009 as compared to fiscal 2009 increased by $174,025 or 6.2%. The percentage of cost of sales relative to sales increased from 56.7% to 60.0%, or by 3.3% due to various factors which included write-offs in fiscal 2009 of new product scrap, obsolete inventory, increased reserves for slow-moving inventory and to lower capitalization of labor and overhead into inventory on some work in process and finished goods.

Selling, general and administrative costs increased in fiscal 2009 as compared to fiscal 2008 by $76,848 or 5.6%. These increases were a result of a variety of factors which included increase in the reserve for bad debt, Sarbanes-Oxley consulting, trade show expense, wages, option expense and startup costs for Biomerica Europe GmbH, the Company's newly formed subsidiary.

Research and development expense was $278,308 in fiscal 2009 as compared to $259,085 in fiscal 2008. This is an increase of $19,223, or 7.4%. The Company continues to work on the development of several new products and anticipates that it will increase its efforts for development and product approvals in the next fiscal year.

Interest expense decreased from $49,542 to $27,521 in fiscal 2009 as compared to fiscal 2008, or 44.4%. The change in interest expense resulted from the decrease in the balance on the shareholder/note payable and the equipment loan, as well as a decrease in the interest rate on the accrued wages payable and equipment loan. Interest income decreased from $33,552 to $29,867, primarily due to lower interest rates.

Other income decreased by $1,132,370 in fiscal 2009 as compared to fiscal 2008. This decrease was a result of one-time income from the sale of the Company's interest in Lancer Orthodontics as well as income received as a result of the one-time sale of a warrant held in Hollister-Stier in fiscal 2008.

LIQUIDITY AND CAPITAL RESOURCES

As of May 31, 2009, the Company had cash and cash equivalents in the amount of $1,595,823, and a short-term investment (certificate of deposit) of $100,000 as compared to $2,022,380 of cash and cash equivalents as of May 31, 2008. As of May 31, 2009 and 2008, the Company had working capital of $3,831,112 and $3,428,936, respectively. In May 2008 the Company sold its investment in Lancer Orthodontics, Inc., for a net amount of $1,083,444, which increased the cash position of the Company. In June 2007 the Company also exercised a warrant and sold the underlying shares that it owned in Hollister-Stier (valued on the books at zero cost) for a net amount of $697,034. During 2009, cash used in operations was $101,999 as compared to cash used in fiscal 2008 of $194,595. During fiscal 2009, cash used in investing activities was $215,890 as compared to cash provided by investing activities of $1,515,695 in fiscal 2008. Cash of $85,890 and $264,783 for fiscal 2009 and 2008, respectively, was used for the purchase of property and equipment. In fiscal 2008 proceeds from the sale of marketable securities was $1,780,478. Cash used in financing activities in fiscal 2009 was $106,942 as compared to cash provided by financing activities of $184,380 in fiscal 2008. During fiscal 2009, Biomerica repaid shareholder debt of $95,936 as compared to $61,056 in fiscal 2008. The change in cash and cash equivalents at May 31, 2009 compared to May 31, 2008 was a decrease of $426,557.

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On February 13, 2009, the Company entered into a Small Business Banking Agreement with Union Bank of California for a one year business line (the "Line") of credit in the amount of $400,000. The interest rate for the line of credit is the prime rate in effect on the first day of the billing period, as published in the Wall Street Journal Prime West Coast Edition, plus a spread of 1.00%. Minimum monthly payments will be the sum of (i) the amount of interest charge for the billing period, plus (ii) any amount past due, plus (iii) any fees, late charges and/or out-of-pocket expenses assessed. If the Line is not renewed as of the last day of the term of the Line, the entire unpaid balance of the Line, including unpaid fees and charges will be due and payable. The Company has granted the bank security interest in the assets of the Company as collateral.

The Company must maintain for not less than thirty consecutive days in every calendar year, a period in which all amounts due under the revolving credit agreements with the Bank are at a zero balance. The Company did not owe anything on this line of credit as of May 31, 2009.

In February 2007 the Company obtained a $200,000 working capital line of credit and was approved for a $200,000 equipment loan with Commercial Bank of California. The credit line and the equipment loan were collateralized by substantially all of the assets of the Company. On February 13, 2009 the Company entered into a Small Business Bank Agreement for a Business Loan with Union Bank for $133,000. Loan proceeds were disbursed in one single funding on March 5, 2009. The loan was used for the purpose of paying off the business loan, which had been established with Commercial Bank, for the acquisition of manufacturing equipment. As of May 31, 2009 and 2008, $122,781 and $162,993 was owed on the equipment loan and there was no outstanding balance due on the working capital line of credit, respectively. The loan is payable in thirty-six monthly payments of approximately $4,000. The interest rate is 6.50% and the payments are to be made by automatic deduction from the Company's Union Bank account. Initial fees for the loan were $740.

Payments on the shareholder's note payable were made during fiscal 2009, according to the agreement through July 31, 2008, at which time the remaining balance on the loan was paid in full.

As of May 31, 2009, the Company no longer has a line of credit with Commercial Bank of California.

SUBSEQUENT EVENTS

On June 18, 2009, the Company entered into an agreement to lease a building in Irvine, California, commencing September 1, 2009 and ending August 31, 2016. The initial base rent is set at $18,490 with a security deposit of $22,080. The sum of $40,568 was due upon execution of the lease. Management is currently working on plans for the relocation of the Company which should take place by the end of the calendar year.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of operations are based on the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 2 of the Notes to Consolidated Financial Statements describes the significant accounting policies essential to the consolidated financial statements. The preparation of these financial statements requires estimates and assumptions that affect the reported amounts and disclosures.

In general, the critical accounting policies that may require judgments or estimates relate specifically to the Allowance for Doubtful Accounts, Inventory Reserves for Obsolescence and Declines in Market Value, Impairment of Long-Lived Assets, Stock Based Compensation, and Income Tax Accruals.

We believe the following to be critical accounting policies as they require more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenues from product sales are recognized at the time the product is shipped, customarily FOB shipping point, at which point title passes. An allowance is established if necessary for estimated returns as revenue is recognized.

The Allowance for Doubtful Accounts is established for estimated losses resulting from the inability of our customers to make required payments. The assessment of specific receivable balances and required reserves is performed by management and discussed with the audit committee. We have identified specific customers where collection is not probable and have established specific reserves, but to the extent collection is made, the allowance will be released. Additionally, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

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Reserves are provided for excess and obsolete inventory, which are estimated based on a comparison of the quantity and cost of inventory on hand to management's forecast of customer demand. Customer demand is dependent on many factors and requires us to use significant judgment in our forecasting process. We must also make assumptions regarding the rate at which new products will be accepted in the marketplace and at which customers will transition from older products to newer products. Once a reserve is established, it is maintained until the product to which it relates is sold or otherwise disposed of, even if in subsequent periods we forecast demand for the product.

Historically we were in a loss position for tax purposes, and established a valuation allowance against deferred tax assets, as we did not believe it was likely that we would generate sufficient taxable income in future periods to realize the benefit of our deferred tax assets. Although the Company has achieved net income in increasing amounts over the last four fiscal years, predicting future taxable income is difficult, and requires the use of significant judgment. Due to the fact that many factors can influence profitability, management determined at May 31, 2008, that $170,000 of previously allowed for deferred tax assets should be released, which resulted in an income tax benefit of $170,000 being recognized. Management has determined that the tax asset should be increased to $238,000 as of May 31, 2009. Management will re-evaluate this determination periodically.

FACTORS THAT MAY AFFECT FUTURE RESULTS

You should read the following factors in conjunction with the factors discussed elsewhere in this and our other filings with the Securities and Exchange Commission and in materials incorporated by reference in these filings. The following is intended to highlight certain factors that may affect the financial condition and results of operations of Biomerica, Inc. and are not meant to be an exhaustive discussion of risks that apply to companies such as Biomerica, Inc. Like other businesses, Biomerica, Inc. is susceptible to macroeconomic downturns in the United States or abroad, as were experienced in recently, that may affect the general economic climate and performance of Biomerica, Inc. or its customers.

Aside from general macroeconomic downturns, the additional material factors that could affect future financial results include, but are not limited to: Terrorist attacks and the impact of such events; diminished access to raw materials that directly enter into our manufacturing process; shipping labor disruption or other major degradation of the ability to ship out products to end users; inability to successfully control our margins which are affected by many factors including competition and product mix; protracted shutdown of the U.S. border due to an escalation of terrorist or counter terrorist activity; any changes in our business relationships with international distributors or the economic climate they operate in; any event that has a material adverse impact on our foreign manufacturing operations may adversely affect our operations as a whole; failure to manage the future expansion of our business could have a material adverse affect on our revenues and profitability; possible costs in complying with government regulations and the delays in receiving required regulatory approvals or the enactment of new adverse regulations or regulatory requirements; numerous competitors, some of which have substantially greater financial and other resources than we do; potential claims and litigation brought by patients or medical professionals alleging harm caused by the use of or exposure to our products; quarterly variations in operating results caused by a number of factors, including business and industry conditions; difficulties encountered during the impending move of the Company's operations to its new facility and other factors beyond our control. All these factors make it difficult to predict operating results for any particular period.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements--an amendment of ARB No. 51. This statement applies to all entities that prepare consolidated financial statements, except for non-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for annual periods beginning December 15, 2008. The Company does not believe that the adoption of SFAS No. 160 will have a material impact on its financial statements.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations. SFAS 141R establishes a defined measurement period that governs the time period within which the business combination must be reported. In addition, the revised standard significantly expands the scope of disclosure requirements. SFAS No. 141R is effective for annual periods beginning after December 15, 2008. The Company does not believe that the adoption of SFAS No. 141R will have a material impact on its financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an Amendment of FASB Statement No. 133. This Statement requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk- related contingent features in derivative agreements. SFAS No. 161 is effective for financial statements issue years and interim periods beginning after November 15, 2008. The Company does not believe that the adoption of SFAS No. 161 will have a material impact on its financial statements.

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In May, 2009 the FASB issued SFAS No. 165, "Subsequent Events". This statement established general standards of accounting for disclosure of events that occur after the balance sheet date but before financial statement are issued or are available to be issued. It requires the disclosure date through which an entity has evaluated subsequent events and the basis for that date. This would alert all users of financial statements that an entity has not evaluated subsequent events after that in the set of financial statements being presented. This statement is effective for interim and annual periods ending after June 15, 2009. The Company does not believe that the adoption of SFAS No. 165 will have a material impact on its financial statements.

The FASB issued SFAS No. 168, "The FASB Accounting Standards Codification (Codification) and the Hierarchy of Generally Accepted Accounting Principles- a replacement of Financial Statement No. 162". On the effective date of the statement, The FASB Accounting Standards Codification will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. This statement is effective for financial statements issued for interim and periods ending after September 15, 2009. The Company does not believe that the adoption of SFAS No. 168 will have a material impact on its financial statements.