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

Results of Operations

Three months ended March 31, 2012 compared to three months ended March 31, 2011

Allied had net sales of $10.7 million for the three months ended March 31, 2012, down from net sales of $11.3 million in the prior year same quarter. Domestic sales were down 10.4% while international sales, which represented 24.5% of third quarter sales, were up 12.9% from the prior year same quarter.

Sales for the three months ended March 31, 2012 include $172,050 for the recognition into income of payments resulting from the agreement with Abbott Laboratories to cease the production and distribution of BaralymeŽ. Income from the agreement will continue to be recognized at $57,350 per month until the expiration of the agreement in August 2012. Allied continues to sell CarbolimeŽ and newly developed LitholymeŽ. Both are carbon dioxide absorbents with a different formulation than BaralymeŽ. The Company ceased the sale of BaralymeŽ on August 27, 2004.

Orders for the Company's products for the three months ended March 31, 2012 of $10.6 million were $0.1 million or 1.0% higher than orders for the prior year same quarter of $10.5 million. Domestic orders are down 2.9% over the prior year same quarter while international orders, which represented 24.7% of third quarter orders, were 17.6% higher than orders for the prior year same quarter. The Company believes the drop in domestic orders from the prior year is due to normal variations in customer order patterns and does not reflect a drop in market share or a further drop in aggregate demand.

Gross profit for the three months ended March 31, 2012 was $2.3 million, or 21.5% of net sales, compared to $2.6 million, or 23.0% of net sales, for the three months ended March 31, 2011. The decrease in gross profit is primarily the result of lower sales volume. The decrease in sales for the quarter also resulted in decreased production in comparison to the prior year and less utilization of fixed overhead cost. Gross profit during the third quarter was favorably impacted from the prior year by an approximately $0.1 million reduction in shipping and other startup cost at its Stuyvesant Falls facility. The Company continues to implement changes to its operations to reduce the manufacturing cost in St. Louis and Stuyvesant Falls.

Selling, general and administrative expenses for the three months ended March 31, 2012 were $2.6 million compared to selling, general and administrative expenses of $2.5 million for the three months ended March 31, 2011. Research and development costs were approximately $90,000 higher than in the prior year.

Loss from operations was $0.2 million for the three months ended March 31, 2012 compared to income from operations of $0.1 million for the three months ended March 31, 2011. Allied had a loss before benefit from income taxes in the third quarter of fiscal 2012 of $0.2 million, compared to income before provision for income taxes of $0.1 million in the prior year period. The Company recorded a tax benefit of $89,353 for the three months ended March 31, 2012 compared to a tax provision of $36,972 for the three months ended March 31, 2011.

Net loss for the third quarter of fiscal 2012 was $145,787 or $0.02 per basic and diluted share compared to net income of $60,324 or $0.01 per basic and diluted share for the third quarter of fiscal 2011. The weighted average number of common shares outstanding, used in the calculation of basic earnings per share for the third quarters of fiscal 2012 and 2011 were 8,124,386 and 8,113,434, respectively. The number of diluted shares outstanding for the three months ended March 31, 2012 and 2011 were 8,124,386 and 8,195,174, respectively.

Nine months ended March 31, 2012 compared to nine months ended March 31, 2011

Allied had net sales of $32.8 million for the nine months ended March 31, 2012, down $1.9 million, or 5.5% from net sales of $34.7 million in the prior year same period resulting from lower order levels. Domestic sales were down 8.3% from the prior year same period while international sales were up 6.4% from the prior year same period. International business represented 21.6% of sales for the first nine months of fiscal 2012.

Sales for the nine months ended March 31, 2012 include $516,150 for the recognition into income of payments resulting from the agreement with Abbott Laboratories to cease the production and distribution of BaralymeŽ. Income from the agreement will continue to be recognized at $57,350 per month until the expiration of the agreement in August 2012. Allied continues to sell CarbolimeŽ and newly developed LitholymeŽ. Both are carbon dioxide absorbents with a different formulation than BaralymeŽ. The Company ceased the sale of BaralymeŽ on August 27, 2004.

Orders for the Company's products for the nine months ended March 31, 2012 of $31.3 million were $2.0 million or 6.0% lower than orders for the prior year same period of $33.3 million. Domestic orders are down 10.9% over the prior year same period while international orders, which represented 23.8% of orders for the first nine months of fiscal 2012, were 15.4% higher than orders for the prior year same period. The Company believes the improvement in international orders is due to the reorganization of its international sales efforts. The Company also continues to make changes to improve the effectiveness of the domestic sales force. The Company believes the drop in domestic orders from the prior year does not reflect a drop in market share or a further drop in aggregate demand. The decrease in domestic orders is also partially the result of a decrease in government orders from the prior year. The Company does not believe this fluctuation in government orders represents a decrease in market share, but represents variation in government spending from the prior year period.

Gross profit for the nine months ended March 31, 2012 was $7.5 million, or 22.9% of net sales, compared to $8.0 million, or 23.1% of net sales, for the nine months ended March 31, 2011. The decrease in gross profit is primarily the result of lower sales than in the prior year. Gross profit during the first nine months was favorably impacted from the prior year by an approximately $0.2 million reduction in shipping and other startup cost at its Stuyvesant Falls facility. Gross profit during the first nine months of fiscal 2012 was also favorably impacted by an approximately $0.2 million decrease in fringe benefits. The Company is self-insured for health care costs and has not changed its fringe benefit plans or providers from the prior year. The Company believes that the reduction in fringe benefits is primarily due to a reduction in medical claims by employees and their dependents.

Selling, general and administrative expenses for the nine months ended March 31, 2012 were $7.9 million compared to selling, general and administrative expenses of $7.8 million for the nine months ended March 31, 2011. Sales commissions are approximately $0.2 million lower than in the prior year due to the decrease in sales. This decrease has been offset by an increase of legal costs and research and development costs which are approximately $0.2 million and $0.1 million higher than the prior year, respectively.

Loss from operations was $0.4 million for the nine months ended March 31, 2012 compared to income from operations of $0.2 million for the nine months ended March 31, 2011. The Company had a loss before benefit from income taxes in the first nine months of fiscal 2012 of $0.4 million, compared to income before provision for income taxes in the first nine months of fiscal 2011 of $144,648. The Company recorded a tax benefit of $164,297 for the nine months ended March 31, 2012 compared to a tax provision of $54,966 for the nine months ended March 31, 2011.

Net loss for the nine months ended March 31, 2012 was $268,064 or $0.03 per basic and diluted share compared to net income of $89,682 or $0.01 per basic and diluted share for the first nine months of fiscal 2011. The weighted average number of common shares outstanding, used in the calculation of basic earnings per share for the first nine months of fiscal 2012 and 2011 were 8,124,386 and 8,101,643, respectively. The weighted average number of common shares outstanding, used in the calculation of diluted earnings per share for the first nine months of fiscal 2012 and 2011 were 8,124,386 and 8,121,042, respectively.

Liquidity and Capital Resources

The Company believes that available resources and anticipated cash flows from operations are sufficient to meet operating requirements in the coming year.

The Company's working capital was $17.1 million at March 31, 2012 compared to $18.3 million at June 30, 2011. The decrease in working capital was primarily a result of accounts receivable which decreased by $1.2 million largely due to a decrease in sales. Accounts receivable as measured in days of sales outstanding ("DSO") was 33 DSO at March 31, 2012; down from 41 DSO at June 30, 2011. Cash decreased $0.1 million and inventory decreased by $0.2 million. Other accrued liabilities increased by $0.4 million primarily as a result of customer prepayments. At March 31, 2012 these decreases in working capital were offset by an increase in other current assets of $0.5 million due to prepayments to vendors and insurance prepayments. In addition, deferred revenue decreased by approximately $0.4 million due to amortization of the current portion of the liability.

The Company is party to a Loan and Security Agreement, dated November 17, 2009, with Enterprise Bank & Trust (the "Credit Agreement") pursuant to which the Company has a secured revolving credit facility with borrowing availability of up to $7,500,000 (the "Credit Facility"). The Company's obligations under the Credit Facility are secured by certain assets of the Company pursuant to the terms and subject to the conditions set forth in the Credit Agreement. See Note
5 - Financing to the Company's consolidated unaudited financial statements for more information concerning the Credit Facility.

Advances under the Credit Facility will be made pursuant to a Revolving Credit Note executed by the Company in favor of Enterprise Bank & Trust. Such advances will bear interest at a rate equal to LIBOR plus 3.50%. Advances may be prepaid in whole or in part without premium or penalty. The 90-day LIBOR rate was 0.47% on March 31, 2012.

At March 31, 2012 the Company had no aggregate indebtedness, including capital lease obligations, short-term debt and long term debt.

In the event that economic conditions were to severely worsen for a protracted period of time, the Company believes it will have borrowing capacity under credit facilities that will provide sufficient financial flexibility. The Company would have options available to ensure liquidity in addition to increased borrowing. Capital expenditures are projected at $2.3 million for the fiscal year ending June 30, 2012. However, capital expenditures in future years could be postponed.

During the first nine months of fiscal 2012 the Company has experienced higher prices for raw materials due to increased commodity prices for brass and thermoplastic resins. Brass cost is driven by higher copper prices, the main component. These increases have been partially offset by higher revenues for recycled metals and purchasing initiatives for other components and finished goods.

Litigation and Contingencies

The Company becomes, from time to time, a party to personal injury litigation arising out of incidents involving the use of its products. The Company believes that any potential judgments resulting from these claims over its self-insured retention will be covered by the Company's product liability insurance.

On May 27, 2011, the Company filed a declaratory judgment action challenging the validity of a patent owned by Armstrong Medical regarding a carbon dioxide absorbent for use in anesthesiology and seeking a declaratory judgment that the Company does not infringe such patent. Among other things, the Company has asserted that Armstrong Medical's patent is invalid as being anticipated and obvious in light of material prior art. Armstrong Medical has answered, denying the Company's claims and counterclaiming that the Company's marketing and sale of LitholymeŽ infringes Armstrong's patent. See Part II, Item 1. Legal Proceedings, below for detailed information concerning this litigation. The Company cannot estimate a possible loss or range of loss for this matter because damages claimed by Armstrong Medical have not been specified and the proceedings are in early stages.

Recently Issued Accounting Guidance

The impact and any associated risks related to the Company's critical accounting policies on business operations are discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations," where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see the Company's Annual Report on Form 10-K for the year ended June 30, 2011.

See Note 1 - Summary of Significant Accounting and Reporting Policies for more information on recent accounting pronouncements and their impact, if any, on our consolidated financial statements. Management believes there have been no material changes to our critical accounting policies.