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

Medical Device Excise Tax

Under the Health Care Education Reconciliation Act of 2010, beginning on January 1, 2013, a Medical Device Excise Tax ("MDET") will be imposed on all U.S. sales of certain medical devices. The tax is 2.3% of the selling price of the taxable product, subject to certain exceptions. The MDET will represent an additional cost burden on the Company's operations. If the excise tax were applied to 2012 revenues, it would have reduced net profits by approximately $200,000, reducing earnings per share by approximately 2 cents per share. The Company intends to mitigate the effect of the MDET through a combination of anticipated increases in market prices, by improving operational efficiency, and the increased access to healthcare anticipated by the Act. However, the Company does not have any assurance that these strategies will be successful in entirely offsetting the cost of the MDET.

Results of Operations

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

Allied had net sales of $9.9 million for the three months ended December 31, 2012, down $0.8 million from net sales of $10.7 million in the prior year same quarter. Domestic sales were down 18.0% while international sales, which represented 31.2% of second quarter sales, were up 31.6% from the prior year same quarter.

Sales for the three months ended December 31, 2012 and 2011 included $0, and $172,050 respectively for the recognition of income of payments resulting from the agreement with Abbott Laboratories to cease the production and distribution of BaralymeŽ. Income from the agreement was recognized at $57,350 per month until the expiration of the agreement in August 2012. Allied continues to sell CarbolimeŽ, a carbon dioxide absorbent with a different formulation than BaralymeŽ, as well as LitholymeŽ, a new premium carbon dioxide absorbent. The Company ceased the sale of BaralymeŽ on August 27, 2004.

Orders for the Company's products for the three months ended December 31, 2012 of $9.3 million were $0.2 million or 2.1% lower than orders for the prior year same quarter of $9.5 million. Domestic orders are down 3.8% over the prior year same quarter while international orders, which represented 26.7% of second quarter orders, were 3.3% higher than orders for the prior year same quarter. The decrease in domestic orders during the three months ended December 31, 2012 was primarily for items for the construction market. The Company does not believe that this indicates a decrease in aggregate market demand. The Company has improved its systems and processes to be more effective in this market. The Company also continues to believe that the purchase of equipment and durable goods and the purchase of equipment by hospitals and municipalities have been cut to meet budgets and conserve cash due to the slow recovery of the economy since the recession in 2008. Orders and sales remain below pre-recession levels.

Gross profit for the three months ended December 31, 2012 was $2.1 million, or 21.2% of net sales, compared to $2.7 million, or 25.2% of net sales, for the three months ended December 31, 2011. The $0.6 million reduction in gross profit is primarily attributable to the decrease in sales and production. Gross profit, as a percentage of sales, was negatively impacted by the $172,050 reduction in payments resulting from the Abbott agreement recognized in sales and income. In addition, lower sales have led to lower utilization of fixed expenses in the Company's manufacturing operations.

Selling, general and administrative expenses for the three months ended December 31, 2012 were $2.9 million compared to selling, general and administrative expenses of $2.7 million for the three months ended December 31, 2011. Salaries and benefits are approximately $216,000 higher than in the prior year and travel expenses are approximately $80,000 higher than in the prior year. These increases have been offset by decreases in other expense accounts including a $48,000 decrease in legal expenses, $36,000 reduction in sample expenses, and a $30,000 reduction in recruiting expenses.

Loss from operations was $751,132 for the three months ended December 31, 2012 compared to income from operations of $41,043 for the three months ended December 31, 2011. Allied had loss before benefit from income taxes in the second quarter of fiscal 2013 of $755,956 compared to income before provision for income taxes in the second quarter of fiscal 2012 of $36,597.

Net loss for the second quarter of fiscal 2013 was $468,693 or $0.06 per basic and diluted share compared to net income of $22,690 or $0.00 per basic and diluted share for the second quarter of fiscal 2012. The weighted average number of common shares outstanding, used in the calculation of basic earnings per share for the second quarters of fiscal 2013 and 2012 were 8,100,593 and 8,124,386, respectively. The number of diluted shares outstanding for the three months ended December 31, 2012 and 2011 were 8,100,593 and 8,124,834, respectively.

Six months ended December 31, 2012 compared to six months ended December 31, 2011

Allied had net sales of $19.2 million for the six months ended December 31, 2012, down $2.9 million, or 13.1% from net sales of $22.1 million in the prior year same period resulting from lower order levels. Domestic sales were down 20.6% from the prior year same period while international sales were up 17.3% from the prior year same period. International business represented 27.1% of sales for the first six months of fiscal 2013.

Sales for the six months ended December 31, 2012 and 2011 included $114,700 and $344,100 respectively for the recognition of income of payments resulting from the agreement with Abbott Laboratories to cease the production and distribution of BaralymeŽ. Income from the agreement was recognized at $57,350 per month until the expiration of the agreement in August 2012. Allied continues to sell CarbolimeŽ, a carbon dioxide absorbent with a different formulation than BaralymeŽ, as well as LitholymeŽ, a new premium carbon dioxide absorbent. The Company ceased the sale of BaralymeŽ on August 27, 2004.

Orders for the Company's products for the six months ended December 31, 2012 of $18.9 million were $1.8 million or 8.7% lower than orders for the prior year same period of $20.7 million. Domestic orders are down 13.6% over the prior year same period while international orders, which represented 27.4% of orders for the first six months of fiscal 2013, were 7.6% higher than orders for the prior year same period. The drop in domestic orders is primarily in the construction market and does not reflect a further drop in aggregate demand in that market. The Company is improving its systems and processes to be effective in this market. The decrease in domestic orders is also partially the result of a decrease in government orders from the prior year. The Company believes this is a fluctuation in government orders generally and does not represent a decrease in the Company's market share.

Gross profit for the six months ended December 31, 2012 was $4.1 million, or 21.4% of net sales, compared to $5.1 million, or 23.1% of net sales, for the six months ended December 31, 2011. The decrease in gross profit is primarily the result of lower sales and production levels, including the decrease in income recognized from the agreement with Abbott Laboratories, than in the prior year. Gross profit during the first six months was favorably impacted from the prior year by an approximately $0.4 million reduction in shipping and other startup cost at its Stuyvesant Falls facility. Gross Profit during the first six months of fiscal 2013 was also favorably impacted by approximately $0.2 million in cost reductions for purchased materials and manufacturing processes at the Company's St. Louis facility.

Selling, general and administrative expenses for the six months ended December 31, 2012 were $5.5 million compared to selling, general and administrative expenses of $5.3 million for the six months ended December 31, 2011. Salaries and benefits are approximately $273,000 higher than in the prior year. In addition travel expense is approximately $108,000 higher. These increases have been partially offset by decreases in other expense accounts including a $91,000 decrease in legal expenses and a $59,000 decrease in recruiting expenses.

Loss from operations was $1.4 million for the six months ended December 31, 2012 compared to loss from operations of $0.2 million for the six months ended December 31, 2011. Allied had loss before benefit from income taxes in the first six months of fiscal 2013 of $1.4 million, compared to loss before benefit from income taxes in the first six months of fiscal 2012 of $197,222. The Company recorded a tax benefit of $539,186 for the six months ended December 31, 2012 compared to a tax benefit of $74,944 for the six months ended December 31, 2011.

Net loss for the six months ended December 31, 2012 was $879,725 or $0.11 per basic and diluted share compared to net loss of $122,278 or $0.02 per basic and diluted share for the first six months of fiscal 2012. The weighted average number of common shares outstanding, used in the calculation of basic earnings per share for the first six months of fiscal 2013 and 2012 were 8,112,490 and 8,124,386, respectively. The weighted average number of common shares outstanding, used in the calculation of diluted earnings per share for the first six months of fiscal 2013 and 2012 were 8,112,490 and 8,124,386, respectively.

Liquidity and Capital Resources

The Company believes that available resources, including availability under a credit facility described below, are sufficient to meet operating requirements in the coming year.

The Company's working capital was $14.9 million at December 31, 2012 compared to $16.0 million at June 30, 2012. The decrease in working capital was primarily a result of accounts receivable which decreased by $1.3 million largely due to a decrease in sales. Accounts receivable as measured in days of sales outstanding ("DSO") was 36 DSO at December 31, 2012; down from 44 DSO at June 30, 2012. In addition cash and cash equivalents decreased by $0.7 million. At December 31, 2012 these decreases in working capital were offset by an increase in other current assets of $0.2 million and an increase in income tax receivable of $0.5 million. The increase in other current assets is a result of prepayment of the Company's insurance premiums for the fiscal year.

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 $5,000,000 (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 the 30-day LIBOR rate plus 3.50%. Advances may be prepaid in whole or in part without premium or penalty. The 30-day LIBOR rate was 0.21% on December 31, 2012.

At December 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, we believe that we 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, which are budgeted at $1.5 million for the fiscal year ended June 30, 2013, could be postponed.

Inflation has not had a material effect on the Company's business or results of operations during the first six months of fiscal 2013.

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.

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 the Company's 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, 2012.

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