Some of the statements in this report may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 that reflect our current view on future events, future business, industry and other conditions, our future performance, and our plans and expectations for future operations and actions. In some cases, you can identify forward-looking statements by the following words: "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "ongoing," "plan," "potential," "predict," "project," "should," "will," "would," or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Our forward-looking statements in this report primarily relate to the following: our ability to receive reimbursement for our products and the effect of reimbursement on long-term margins; our expectations with respect to international opportunities, trends regarding international sales and economic conditions impacting international sales; the impact of our business strategy on revenues and earnings, including the expected contributions of new members of our sales staff; expected expenditures for research and development; our expectations regarding use of our intellectual property; future innovations in our product offerings; our expectations regarding the continued use of proceeds from our initial public offering; our expectations regarding financing of equipment purchases; and our beliefs regarding the sufficiency of working capital for the next year and our ability and intention to renew or obtain financing. These statements involve known and unknown risks, uncertainties and other factors that may cause our results or our industry's actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management's beliefs and assumptions, which in turn are based on currently available information.

You should read this report thoroughly with the understanding that our actual results and actions may differ materially from those set forth in the forward-looking statements for many reasons, including events beyond our control and assumptions that prove to be inaccurate or unfounded. Our actual results or actions could and likely will differ materially from those anticipated in the forward-looking statements for many reasons, including the reasons described in this report. These factors include, but are not limited to: the competitive nature of our market; the risks associated with expansion into international markets; changes to Medicare, Medicaid, or private insurance reimbursement policies; changes to health care laws; changes affecting the medical device industry; our need to maintain regulatory compliance and to gain future regulatory approvals and clearances; our ability to recruit, train and retain an effective sales force, reimbursement staff, and patient services staff; our ability to protect our intellectual property; the effect of litigation, including legal expenses, which may arise with respect to our intellectual property in the ordinary course of business or otherwise; the impact of tight credit markets on our ability to continue to obtain financing on reasonable terms; and general economic and business conditions.

Overview

Electromed, Inc. ("we," "us," "our," "the Company," or "Electromed") was incorporated in 1992. We are engaged in the business of providing innovative airway clearance products applying High Frequency Chest Wall Oscillation ("HFCWO") therapy in pulmonary care for patients of all ages.

We manufacture, market and sell products that provide HFCWO, including the Electromed, Inc. SmartVest® Airway Clearance System ("SmartVest System") and related products, to patients with compromised pulmonary function. The products are sold for both the home health care market and the institutional market for use by patients in hospitals, which are referred to as "institutional sales." For approximately ten years, we have marketed the SmartVest System and its predecessor products to patients suffering from cystic fibrosis, chronic obstructive pulmonary disease ("COPD"), bronchiectasis and related conditions which can result in repeated episodes of pneumonia. Additionally, we offer such products, upon physician prescription to a patient population that includes post-surgical and intensive care patients at risk of developing pneumonia, patients with end-stage neuromuscular disease, and ventilator-dependent patients. Our goal is to be a consistent innovator in providing HFCWO to patients with compromised pulmonary function.

Critical Accounting Policies and Estimates

Our significant accounting policies and estimates are disclosed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 1 to our Audited Consolidated Financial Statements, included in Part II, Item 8, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2011. The critical accounting policies used in the preparation of the financial statements as of and for the three and nine month periods ended March 31, 2012, have remained unchanged from June 30, 2011.

Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating financial statements. Such judgments are subject to an inherent degree of uncertainty. These judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. The Company believes the critical accounting policies that require the most significant assumptions and judgments in the preparation of its consolidated financial statements include: revenue recognition and the estimation of selling price adjustments, allowance for doubtful accounts, inventory obsolescence, share-based compensation, income taxes, and warranty liability.

Results of Operations

Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

     Revenues

     Revenue results for the three-month periods are summarized in the table
below (dollar amounts in thousands).


                                            Three Months Ended
                                                 March 31,
                                            2012          2011         Increase (Decrease)
Total Revenue                             $   4,774     $   5,199   $     (425 )         (8.2 )%
Home Care Revenue                         $   4,360     $   4,689   $     (329 )         (7.0 )%
International Revenue                     $     165     $     143   $       22           15.4 %
Government/Institutional Revenue          $     249     $     367   $     (118 )        (32.2 )%

Home Care Revenue. Home care revenue was approximately $4,360,000 for the three months ended March 31, 2012, representing a decrease of approximately $329,000, or 7.0%, compared to the same period in 2011. The change in revenues reflects the change in tenure of direct sales representatives, or, Clinical Area Managers ("CAMs"). During the three months ended March 31, 2012, the number of full time equivalent ("FTE") CAMs was 21, an increase of one FTE CAM from the same period the prior year. However, the number of CAMs with over three months of experience decreased from 19 to 15 compared to the same period the prior year. The decrease in tenured CAMs was caused by turnover of 16% of the CAMs in the prior quarter ended December 31, 2011.

International Revenue. International revenue was approximately $165,000 for the three months ended March 31, 2012, representing an increase of approximately $22,000, or 15.4%, compared to the same period in 2011. This increase resulted primarily from an increase in sales to Europe, from approximately $70,000 in the three months ended March 31, 2011 to approximately $102,000 in the comparable period in the current year, and offset by a decrease in sales to Asia and other countries, from approximately $73,000 in the three months ended March 31, 2011 to approximately $63,000 in the comparable period in the current year. Management believes that although international sales have increased during the three months ending March 31, 2012 compared to the same period the prior year, the increase is not indicative of a trend. Conditions in the current global economy, including the European sovereign debt situation and related austerity measures, will continue to affect international sales. Management continues to explore international opportunities while focusing on continued domestic sales growth.

Government/Institutional Revenue. Government/institutional revenue was approximately $249,000 for the three months ended March 31, 2012, representing a decrease of approximately $118,000, or 32.2%, compared to approximately $367,000 during the same period in 2011. This resulted from a $40,000 decrease in sales to the U.S. Department of Veterans Affairs and other government entities, which decreased to approximately $50,000 for the three months ended March 31, 2012 from approximately $90,000 during the same period the prior year. Institutional sales also contributed to the decrease in governmental/institutional revenue, which decreased to approximately $199,000 for the three months ended March 31, 2012 from approximately $277,000 during the same period the prior year. The decrease in government/institutional revenue was due to one large institutional purchase of approximately $96,000 in the same period in the prior year.

Gross profit decreased to approximately $3,369,000, or 70.6% of net revenues, for the three months ended March 31, 2012, from approximately $3,703,000, or 71.2% of net revenues, in the same period in 2011. The decrease in gross profit percentage was primarily the result of a change in average reimbursement from the mix of referrals during the three month period. Factors such as diagnoses that are not assured of reimbursement and insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs) affect average reimbursement received on a short-term basis. These factors tend to fluctuate on a quarterly basis. However, management does not believe the results of the quarter ended March 31, 2012 are indicative of a long-term trend in decreasing margins.

Operating expenses

Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses were approximately $2,905,000 for the three months ended March 31, 2012, representing an increase of approximately $145,000, or 5.3%, compared to SG&A expenses of approximately $2,760,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $1,432,000 for the three months ended March 31, 2012, representing an increase of approximately $50,000, or 3.6%, compared to approximately $1,382,000 in the same period the prior year. This increase primarily resulted from a 14.3% increase in employees in our reimbursement, sales, administrative, and patient services departments, from 63 SG&A FTEs for the three months ended March 31, 2011 to 72 SG&A FTEs during the same period in the current year.

Health insurance costs for FTEs were approximately $130,000 for the three months ended March 31, 2012, representing an increase of approximately $38,000, or 41.3%, from approximately $92,000 for the same period in 2011. This increase resulted primarily from the increase in employees covered under the Company's plan. Travel, meals and entertainment, and trade show expenses were approximately $375,000 in the three months ended March 31, 2012, representing a decrease of approximately $29,000, or 7.2%, compared to approximately $404,000 in the same period in the prior year. The decrease primarily resulted from the focus on expense reduction and the use of technology to facilitate certain sales meetings.

Advertising and marketing expenses for the three months ended March 31, 2012 were approximately $184,000, a decrease of approximately $35,000, or 16.0%, compared to approximately $219,000 in the same period the prior year. The decrease was related to the timing of certain marketing expenditures compared to the prior year.

Patient training expenses for the three months ended March 31, 2012 were approximately $134,000, an increase of approximately $9,000, or 7.2%, compared to approximately $125,000 in the same period the prior year. These increases reflected the increased volume of home care patient referrals for the three months ended March 31, 2012 compared to the same period in the prior year.

Professional fees for the three months ended March 31, 2012 were approximately $190,000, an increase of approximately $20,000 compared to approximately $170,000 in the same period in the prior year. These fees are for services related to reporting requirements, expenses related to information technology security and backup, interim consulting expenses, and expenses for printing and other shareholder services.

Research and development expenses. Research and development expenses were approximately $238,000 for the three months ended March 31, 2012, representing a decrease of approximately $34,000, or 12.5%, compared to approximately $272,000 in the same period the prior year. Research and development expenses for the three months ended March 31, 2012 were 5.0% of revenue, compared to 5.2% of revenue in the same period the prior year. As a percentage of sales, management expects to spend at least 5.0% of sales on research and development expenses for the foreseeable future.

Interest expense

Interest expense was approximately $43,000 for the three months ended March 31, 2012, representing an increase of approximately $5,000, or 13.2%, compared to approximately $38,000 for the same period the prior year. The increase resulted from an increase in the interest rate on the company's revolving line of credit and the increase in the amount of debt issuance costs amortized during the period.

Income tax expense

Income tax expense is estimated at approximately $88,000 for the three months ended March 31, 2012, compared to $146,000 in the same period in the prior year. The effective tax rates for the three months ended March 31, 2012 and 2011 were 48.1% and 23.0%, respectively.

Net income

Net income for the three months ended March 31, 2012 was approximately $95,000, or 2.0% of revenues, compared to approximately $487,000, or 9.4% of revenues, for the same period in the prior year. The decrease in net income as a percentage of revenues primarily resulted from increases in expenses designed to develop, support and maintain a higher sales level as well as lower revenues due to turnover of approximately 16% of the sales force in the prior quarter ended December 31, 2011. Management continues to believe the investment in the sales force and reimbursement, coupled with focused marketing and research and development efforts, will provide the talent and opportunities to drive sales growth.

Nine Months Ended March 31, 2012 Compared to Nine Months Ended March 31, 2011

     Revenues

     Revenue results for the nine-month periods are summarized in the table
below (dollar amounts in thousands).


                                              Nine Months Ended March 31,
                                                 2012              2011          Increase (Decrease)
Total Revenue                               $       14,944    $       14,050   $       894         6.4 %
Home Care Revenue                           $       13,790    $       12,738   $     1,052         8.3 %
International Revenue                       $          395    $          501   $      (106 )     (21.2 )%
Government/Institutional Revenue            $          759    $          811   $       (52 )      (6.4 )%

Home Care Revenue. Home care revenue was approximately $13,790,000 for the nine months ended March 31, 2012, representing an increase of approximately $1,052,000, or 8.3%, compared to the same period in 2011 The increase in revenues reflects the increase in CAMs offset by the change in tenure of the CAMs. During the nine months ended March 31, 2012, the number of FTE CAMs was 23, an increase from 18 FTE CAMs in the same period the prior year. However, the number of CAMs with over one year of experience remained consistent at 14. The number of tenured CAMs was affected by turnover of 16% of the CAMs in the three months ended December 31, 2011.

International Revenue. International revenue was approximately $395,000 for the nine months ended March 31, 2012, representing a decrease of approximately $106,000, or 21.2%, compared to the same period in 2011. This decrease resulted primarily from a decrease in sales to Europe, from approximately $252,000 in the nine months ended March 31, 2011 to approximately $159,000 in the comparable period in 2012, and a decrease in sales to Asia, from approximately $197,000 in the nine months ended March 31, 2011 to approximately $190,000 in the comparable period in 2012. Sales to other regions also decreased from the same period the prior year. Revenue to other regions was approximately $46,000 for the nine months ended March 31, 2012, representing a decrease of approximately $6,000, from approximately $52,000 during the same period in 2011. The sales to other regions for the nine months ended March 31, 2012 are made up primarily of sales to Argentina of approximately $36,000. Management believes the decrease in international sales has been affected by conditions in the current global economy, including the European sovereign debt situation and related austerity measures. Management continues to explore international opportunities while focusing on continued domestic sales growth.

Government/Institutional Revenue. Government/institutional revenue was approximately $759,000 for the nine months ended March 31, 2012, representing a decrease of approximately $52,000, or 6.4%, compared to approximately $811,000 during the same period in 2011. This resulted from a $26,000 decrease in sales to distributors, group purchasing organization ("GPO") members, and other institutions, which decreased to approximately $598,000 for the nine months ended March 31, 2012 from approximately $624,000 during the same period the prior year. Sales to the U.S. Department of Veterans Affairs and other government entities decreased by approximately $26,000, decreasing to $161,000 for the nine months ended March 31, 2012 from $187,000 for the same period in 2011. The decrease in government/institutional revenue was partially due to one large institutional purchase of approximately $96,000 in the same period in the prior year.

Gross profit increased to approximately $10,919,000, or 73.1% of net revenues, for the nine months ended March 31, 2012, from approximately $10,177,000, or 72.4% of net revenues, in the same period in 2011. The increase in gross profit dollars resulted primarily from the increase in sales volume. The increase in gross profit percentage was primarily the result of higher than average reimbursement from the mix of referrals during the nine month period. Factors such as diagnoses that are not assured of reimbursement and insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs) affect average reimbursement received on a short-term basis. These factors tend to fluctuate on a quarterly basis.

Operating expenses

Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses were approximately $9,435,000 for the nine months ended March 31, 2012, representing an increase of approximately $1,409,000, or 17.6%, compared to SG&A expenses of approximately $8,026,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $4,553,000 for the nine months ended March 31, 2012, representing an increase of approximately $820,000, or 21.9%, compared to approximately $3,733,000 in the same period the prior year. This increase primarily resulted from a 39.6% increase in employees in our reimbursement, sales, administrative and patient services departments, from 53 SG&A FTEs for the nine months ended March 31, 2011 to 74 SG&A FTEs during the same period in the current year.

Health insurance costs were approximately $397,000 for the nine months ended March 31, 2012, representing a decrease of approximately $25,000, or 5.9%, from approximately $422,000 for the same period in 2011. This decrease resulted primarily from management adjusting the employee participation amount of the health insurance cost. Travel, meals and entertainment and trade show expenses were approximately $1,307,000 in the nine months ended March 31, 2012, representing an increase of approximately $118,000, or 9.9%, compared to approximately $1,189,000 in the same period in the prior year. This increase was primarily due to the 22.2% increase in the size of the sales force and an increase in the overall number of trade shows in which the Company participated.

Advertising and marketing expenses for the nine months ended March 31, 2012 were approximately $635,000, a decrease of approximately $70,000, or 9.9%, compared to approximately $705,000 in the same period the prior year. The decrease in advertising and marketing expenses is a result of the timing of expenditures.

Patient training expenses for the nine months ended March 31, 2012 were approximately $397,000, an increase of approximately $54,000, or 15.7%, compared to approximately $343,000 in the same period the prior year. These increases reflected the increased volume of home care patient referrals for the nine months ended March 31, 2012 compared to the same period in the prior year.

Professional fees for the nine months ended March 31, 2012 were approximately $740,000, an increase of approximately $240,000 compared to approximately $500,000 in the same period in the prior year. These fees are for services related to reporting requirements, expenses related to information technology security and backup, interim consulting expenses, and expenses for printing and other shareholder services.

Research and development expenses. Research and development expenses were approximately $706,000 for the nine months ended March 31, 2012, representing an increase of approximately $17,000, or 2.5%, compared to approximately $689,000 in the same period the prior year. Research and development expenses for the nine months ended March 31, 2012 were 4.7% of revenue, compared to 4.9% of revenue in the same period the prior year. As a percentage of sales, management expects to spend at least 5.0% of sales on research and development expenses for the foreseeable future.

Interest expense

Interest expense was approximately $130,000 for the nine months ended March 31, 2012, representing a decrease of approximately $21,000, or 13.9%, compared to approximately $151,000 for the same period the prior year. The decrease resulted from a combination of a decrease in average debt outstanding due to payments on term loans and a decrease in the amount of debt issuance costs amortized during the period.

Income tax expense

Income tax expense is estimated at approximately $283,000 for the nine months ended March 31, 2012 compared to $420,000 in the same period in the prior year. The effective tax rates for the nine months ended March 31, 2012 and March 31, 2011 were 43.7% and 32.0%, respectively. On a quarterly basis, management estimates what its effective tax rate will be for the full fiscal year and records a quarterly income tax provision based on the anticipated rate. As the year progresses, the estimate is refined based on the facts and circumstances by each tax jurisdiction. The increase in the effective tax rate is related to changes in permanent differences including the estimate for the Federal Research and Development Tax Credit, which has not been extended past December 31, 2011 by the U.S. Congress.

Net income

Net income for the nine months ended March 31, 2012 was approximately $365,000, or 2.4% of revenues, compared to approximately $891,000, or 6.3% of revenues, for the same period the prior year. The decrease in net income as a percentage of revenues primarily resulted from increases in expenses designed to develop, support and maintain a higher sales level as well as turnover of approximately 16% of the sales force in the prior quarter ended December 31, 2011. Management continues to believe the investment in the sales force and reimbursement, coupled with focused marketing and research and development efforts, will provide the talent and opportunities to drive sales growth.

Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

For the nine months ended March 31, 2012, net cash used in operating activities was approximately $1,679,000. Cash flows used by operations consisted of approximately $365,000 in net income, adjusted for non-cash expenses of approximately $521,000, offset by increases in accounts receivable, inventories, and prepaid expenses of $1,498,000, $556,000, and $215,000, respectively. In addition, trade payables and other accrued liabilities decreased by approximately $296,000.

For the nine months ended March 31, 2011, net cash used in operating activities was approximately $1,276,000. Cash flows used by operations consisted of approximately $891,000 in net income, adjusted for non-cash expenses of approximately $504,000, offset by increases in accounts receivable, inventories, and prepaid expenses of $2,656,000, $194,000, and $150,000, respectively. In addition, trade payables and other accrued liabilities increased by approximately $329,000.

For the nine months ended March 31, 2012, net cash used in investing activities was approximately $761,000. During this period we paid approximately $736,000 for purchases of property and equipment, including $439,000 for converting approximately 10,000 square feet of a newly leased building to office space. We also paid approximately $25,000 for patent related costs.

For the nine months ended March 31, 2011, net cash used in investing activities was approximately $964,000. During the period we paid approximately $649,000 in costs related to defending our SmartVest trademark and approximately $315,000 for purchases of property and equipment.

. . .