Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549



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FORM 10-K

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(Mark One)

x
     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended June 30, 2010



 ̈
     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




For the transition period fromto.



Commission File No.:   001-34839

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Electromed, Inc.

(Exact name of Registrant as specified in its charter)

Minnesota
     41-1732920(State or other jurisdiction of
incorporation or organization)
     (IRS Employer
Identification No.)


500 Sixth Avenue NW, New Prague, MN

(Address of principal executive offices)



(952) 758-9299

(Registrants telephone number, including area code)



Securities registered pursuant to Section 12(b) of the Act:



Common Stock $0.01 par value
     Nasdaq Capital Market(Title of each class)
     (Name of each exchange on which registered)




Securities registered pursuant to Section 12(g) of the Exchange Act:  None

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Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes o   No   x

Indicate by
check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes o   No   x

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 o   No  x

Indicate by
check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o No o

Indicate by
check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the
definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act.

|                                                                     |                             
|-------------------------------------------------------------------- | ----------------------------
|Large
 accelerated filer o                                           | Accelerated filer
 o        
|Non-accelerated
 filer o (Do not check if smaller reporting company) | Smaller Reporting Company
 x

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Indicate by check mark whether
the registrant is a shell company (as defined in Rule 12b-2 of the Act).
    Yes   o   No
x

The registrant
completed the initial public offering of its common stock on August 18, 2010.
Accordingly, there was no public market for the registrants common stock as of
December 31, 2009, the last day of the registrants most recently completed
second fiscal quarter.

There were
7,887,885 shares of the registrants common stock outstanding as of September
16, 2010.

DOCUMENTS
INCORPORATED BY REFERENCE

Portions of
the Definitive Proxy Statement for the registrants Fiscal 2011 Annual Meeting
of Shareholders, to be filed within 120 days of June 30, 2010, are incorporated
by reference into Part III of this Form 10-K.

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Electromed, Inc. 
Index to Annual Report on Form 10-K

|         |          |  |                                                                                                               |   
|-------- | -------- |  | ------------------------------------------------------------------------------------------------------------- | --
|PART I   |          |  | 5                                                                                                            
|         | Item 1.  |  | Business                                                                                                      | 5 
|         | Item 1A. |  | Risk Factors                                                                                                  | 27
|         | Item 1B. |  | Unresolved Staff Comments                                                                                     | 27
|         | Item 2.  |  | Properties                                                                                                    | 27
|         | Item 3.  |  | Legal Proceedings                                                                                             | 27
|         | Item 4.  |  | (Removed and Reserved)                                                                                        | 28
|         |          |  |                                                                                                               |   
|PART II  |          |  | 28                                                                                                           
|         | Item 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters
 and Issuer Purchases of Equity Securities | 28
|         | Item 6.  |  | Selected Financial Data                                                                                       | 29
|         | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and
 Results of Operations                        | 29
|         | Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                    | 37
|         | Item 8.  |  | Financial Statements and Supplementary Data                                                                   | 37
|         | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and
 Financial Disclosures                        | 38
|         | Item 9A. |  | Controls and Procedures                                                                                       | 38
|         | Item 9B. |  | Other information                                                                                             | 38
|         |          |  |                                                                                                              
|Part III |          |  | 38                                                                                                           
|         | Item 10. |  | Directors, Executive Officers, and Corporate Governance                                                       | 38
|         | Item 11. |  | Executive Compensation                                                                                        | 38
|         | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and
 Related Stockholder Matters               | 39
|         | Item 13. |  | Certain Relationships and Related Transactions, and Director
 Independence                                    | 39
|         | Item 14. |  | Principal Accounting Fees and Services                                                                        | 39
|         | Item 15. |  | Exhibits, Financial Statement Schedules                                                                       | 39

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Table of Contents

INFORMATION REGARDING FORWARD LOOKING STATEMENTS

Some
of the statements in this report may contain forward-looking statements 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 relate to
the following: our business and growth strategy, our business strengths and
competitive advantages, our intent to increase international sales and
distribution, our expectation that our products will be prescribed for an
increasing number of conditions, our plan to continue to increase investment in
research and development, our intent to continue improvement of our product offerings
through innovation, our intent to add sales staff and other employees, our
belief that we will continue to expand our intellectual property portfolio, our
expectations with respect to our settlement with Hill-Rom, and our anticipated
revenues, offering proceeds, expenses, and capital requirements. Many of these
forward-looking statements are located in this report under Item 1. BUSINESS;
Item 2. PROPERTIES and Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, but they may appear in other
sections as well. 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 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. We cannot provide any
assurance with respect to our future performance or results. 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 protect our intellectual property;                                                                                                           
| |   |                                                                                                                                                              
| |  | the outcome
 of current and future litigation, including our ability to reach a definitive
 settlement agreement with Hill-Rom in the timeframe expected; and
| |   |                                                                                                                                                              
| |  | general economic and
 business conditions.                                                                                                                   

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Table of Contents

PART I

Item 1.
Business.

Overview

Electromed,
Inc. (we, us, Electromed or the Company) was founded by Mr. Robert
Hansen and Mr. Craig Hansen and incorporated in Minnesota in 1992. In August
2010 we completed an initial public offering of 1,700,000 shares of our common
stock. Our common stock is traded on the Nasdaq Capital Market under the ticker
symbol ELMD.

We
manufacture, market and sell products that provide airway clearance therapy,
including the SmartVest® Airway Clearance System (SmartVest System) and
related products, to patients with compromised pulmonary function. The
SmartVest System generates High Frequency Chest Wall Oscillation (HFCWO),
also known as High Frequency Chest Compression, a technique for airway
clearance therapy. HFCWO facilitates airway clearance by loosening and
mobilizing respiratory secretions in a patients lungs. A vest is worn over the
torso that repeatedly compresses and releases the chest at frequencies from 5
to 20 cycles per second. Each compression (or oscillation) produces pulsations
within the lungs that shear secretions from the surfaces of the airways and
propels them toward the mouth where they can be removed by normal coughing.
Unlike traditional chest physio-therapy, which must be performed on the patient
while he or she is placed in a series of often uncomfortable positions, HFCWO
can be performed with the patient sitting upright.

Studies
show that HFCWO therapy is as effective an airway clearance method for patients
who have cystic fibrosis or other forms of compromised pulmonary function as
traditional chest physio-therapy administered by a respiratory therapist.
However, HFCWO can be self-administered, relieving a caregiver of participation
in the therapy, and eliminating the attendant cost of an in-home care provider.
We believe the treatments are cost-effective primarily because they reduce a
patients risk of respiratory infections and other secondary complications that
are associated with impaired mucus transport. Secondary complications, such as
pneumonia, may be serious or life-threatening and often result in costly
hospital visits.

The
SmartVest System is a portable, programmable, and multi-positional airway
clearance machine that generates HFCWO and has been approved by the FDA to
treat the condition of excess lung secretions. Consequently, it may be
prescribed to patients suffering from cystic fibrosis, chronic obstructive
pulmonary disease, muscular dystrophy, post-surgical airway complications and a
variety of other diseases and conditions associated with impaired lung and
airway capacity. By clearing airways, patients are able to rid their lungs of
retained secretions and are therefore less likely to develop lung infections
such as pneumonia.

The
SmartVest System features a programmable electro-mechanical pulse generator and
a pneumatic therapy garment, which together provide safe, comfortable, and
effective airway clearance therapy. We believe that the lightweight, portable
design allows patients greater freedom to travel and enjoy activities of daily
living, resulting in enhanced quality of life for patients using our SmartVest
System. A broad range of vest sizes for children and adults allow for tailored
fit and function. User-friendly controls allow children to administer their own
daily therapy under adult supervision. Our goal has been to make the HFCWO
airway clearance treatments as comfortable and convenient as possible so our
patients can more easily tolerate their regimen and be able to perform their
treatments as readily as possible.

In
order to maintain and expand our position in the market for airway clearance
therapy products, we have assembled an experienced team of employees with
expertise in health care, product development, manufacturing, marketing, sales,
and financial management. For example, more than 30% of our employees are
respiratory therapists. In addition, we engage over 300 respiratory therapists
and health professionals on a non-exclusive independent contractor basis to
educate and train customers on the SmartVest System. Our team also includes
several consultants who advise us on quality assurance, product development, and
financing, and who keep us apprised of industry developments and opportunities
in Europe.

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Table of Contents

Growth Strategy

We
believe we are poised for significant sales and earnings growth, predicated on
the following objectives:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Expanding
 and repositioning our sales staff within the U.S.We select experienced medical
 professionals, usually respiratory therapists, to represent our products in
 the field. Our sales representatives, which we identify as Clinical Area
 Managers (CAMs), are employed full-time by Electromed, are assigned an
 exclusive territory, and under the supervision of a regional manager, serve
 discrete geographic areas of the U.S. They are equipped with demonstration
 models, and, where appropriate, arrange for such models to be accessed by
 patients through a demonstration program to physicians, clinics, and
 hospitals. We believe this approach is an effective sales model and ensures
 that patients, physicians, clinics, and hospitals receive reliable and
 correct training for our products. We intend to recruit additional CAMs and
 expect that doing so will increase our domestic sales. As we gain sales and
 industry contacts within each territory, we intend to continue to actively
 monitor sales opportunities by repositioning certain of our current CAMs to
 serve smaller geographic areas.                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Establishing
 and strengthening sales relationships in Europe and Asia.Internationally, we have made sales in more
 than ten countries. We are actively identifying distributors and other sales
 opportunities. Our historical practice and continued intent includes
 developing long-term relationships with distributors who possess the
 knowledge, experience, and financial maturity to serve pulmonary patients and
 reliably satisfy payment obligations. Our agreements typically allow us to
 terminate the relationship if the distributor does not meet particular sales
 thresholds on an annual basis. We believe that expanding our distributor
 relationships in Europe and Asia will generate revenue growth because it will
 allow us to establish our SmartVest System as the preferred airway clearance
 therapy product in regions where HFCWO therapy is not yet widely used.
 Attention is given to a distributor candidates knowledge and experience in
 serving respiratory physicians and patients in the host country. We then
 designate members of our regulatory staff to actively monitor the
 distributors conformity with all applicable regulations and good practices
 in the host country. We support our distributors by providing advertising
 materials and direct training opportunities at our headquarters.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Maintaining
 leadership in product innovation.We have pursued our goal of continuous improvement through an active
 research and product development program, and plan to develop and introduce
 future advancements in HFCWO products for patient use. Each product will be
 designed to provide compact, portable, and user-friendly features. In
 addition, we expect to continue enhancing our Single Patient Use Vest and
 SmartVest Wrap, which we market to hospitals and health care providers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

Business Strengths

Intellectual Property

Our
intellectual property represents one of our most significant business
strengths. It allowed us to pioneer an HFCWO device with a single-hose and
flow-through system design, leading to the competitive advantages described
below. We currently hold 19 issued U.S. patents and 5 issued foreign patents
covering the SmartVest System and its underlying technology, and have 33
additional U.S. and foreign patent applications pending. These patents and
patent applications offer coverage in the field of air pressure pulse delivery
to a human in support of airway clearance. These patents and patent
applications are described in more detail below, under the heading
Intellectual Property.

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Table of Contents

Competitive
Advantages of SmartVest System

We
believe that the SmartVest System offers competitive advantages in improved
patient comfort and satisfaction. Unlike our competitors products, which are
primarily dependent upon a two-hose, closed system for attaining consistent air
pulse transmission to the vest and lungs, the SmartVest System relies on a
single-hose, flow-through system. We believe a single-hose, flow-through system
provides the following benefits:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The single-hose system
 simplifies delivery of the air pulse energy to the lungs. The pulse is
 delivered evenly from the base of our vest, extending the force pulses upward
 and inward in strong but smooth cycles of 360-degree latitudes, which delivers
 simultaneous treatment to the patients chest and back and all lobes of the
 lungs. In addition, the single hose is less obtrusive than a two-hose system
 and is longer than the hoses used by competing products, allowing the patient
 greater comfort during the course of treatment.        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | The flow-through system
 design provides a continuous accommodation grid of air release holes in the
 vest air bladder. No matter what resistance a patients chest may be creating
 in normal aspiration (breathing), air release adjusts accordingly in the
 bladder. This can prevent lags in pulse pressure accommodation as compared to
 a closed system, in which electronic signal generators must continuously send
 changes in air fill instruction to the air pump. We believe greater patient
 comfort is realized in our flow-through system design.

Industry Contacts

Our
management team has significant business experience and has developed industry
relationships, resulting from memberships in various respiratory care
professional groups and attendance, sponsorship and participation in numerous
medical conferences in the U.S., Europe, and Asia. We believe these investments
of time and capital have increased visibility of the SmartVest System and
established a favorable reputation and perception of Electromed. In addition,
participation in industry conferences allows us to educate and train health
care professionals on the SmartVest System.

In
addition to relationships developed at the management level, our staff and
contractors, who often play a key role in the education of current and
potential customers, have developed trusted relationships across the U.S. with
physicians and other caregivers over the course of their careers. Over 30% of
our full-time employees, including our entire Patient Services Department and
nearly all of our sales representatives, are respiratory therapists. Many of
these individuals have extensive experience in the field of respiratory care,
and their relationships and experience are of great worth to us. These
individuals maintain a dialogue with clinics, patients, patient families, and
respiratory therapist trainers to ensure that our products are being properly
operated and are performing effectively. Additionally, our sales
representatives participate in various events, such as family days held by
the Cystic Fibrosis Foundation for cystic fibrosis patients, at which they have
an opportunity to demonstrate the effectiveness of the SmartVest System and
further develop relationships with patients, patient families, physicians and
hospitals. We believe that the relationships and reputation for service that
our staff and contractors have developed are key factors in our ability to gain
patients and secure reimbursement.

Engineering and
Manufacturing Departments

Another
significant business strength is the valuable know-how of our Engineering and
Manufacturing Departments. The experience of the individuals in these
departments helps ensure the efficient production of
high-quality products. In addition, we have established a network of vendors
who permit us to integrate all assembly and quality assurance on a single
campus. We believe that our efficient product development and manufacturing
processes create a business strength because they allow us to offer our
products at competitive prices and respond quickly to increases in demand.

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Table of Contents

Our Products

Our
products are primarily used in the home health care market. We also sell our
products for use in hospitals, which we refer to as institutional sales.
Accordingly, our points of contact are home health care use, hospitals,
clinics, and pulmonary rehabilitation centers, both domestically and
internationally. The SmartVest System is a doctor-prescribed therapy and,
depending on the circumstances of the patient, its cost to an individual is
generally reimbursable by Medicare, Medicaid and private insurance, or a
combination of the three. Our products have been cleared for market by the FDA.

The SmartVest System

The
SmartVest System consists of a pneumatic therapy garment, an electronic pulse
generator for creating and controlling force pulses, and a single hose which
extends the force pulses from the generator to the pneumatic vest. The
SmartVest System is a portable airway clearance therapy system that gives the
patient direct control over the most difficult and time-consuming aspects of
respiratory therapy, and provides caregivers an easier and more reproducible
means of administering therapy to disabled or bedridden patients. The SmartVest
System also has other appealing practical features, including improved ease of
use and a non-clinical appearance. We believe these attributes particularly
appeal to children, teenagers and young adults who represent the majority of the
cystic fibrosis patient population. Our system allows the patient to be
relatively mobile while therapy is being given, unlike manual chest physical
therapy in which the patient must remain in a fixed position.

We
believe the SmartVest Systems therapy garment is unique in its:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Design: We have pioneered a vest design that
 provides consistent and controlled pulse pressure that is distributed
 throughout the vest and treats the entire front and back thoracic (chest)
 cavity. The vest is low profile, featuring a soft, breathable fabric. Some
 competitive models have reduced weight and size of their vests by reducing
 coverage area of the chest and applying pressure to the chest only. We do not
 endorse or employ a partial coverage vest, and all of our products offer
 360-degree coverage. Our vest uses a flow-through system design, which
 improves patient comfort by providing a continuous accommodation grid of air
 release holes in the vest air bladder, allowing air releases to automatically
 adjust. This can prevent lags in pulse pressure accommodation as compared to
 a closed system, in which electronic signal generators must continuously send
 changes in air fill instruction to the air pump. We believe heightened
 patient comfort is realized because of our flow-through design.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | Size and Ease of Use: The SmartVest System is available in
 eight sizes to accommodate children and adults. The simple design of the
 Velcro and overlap closure system creates a broad size adjustment range to
 insure a properly tailored fit. It also makes the vest easier to clean and
 disinfect than some competitors products, which often use straps and
 buckles. The patented design includes a removable bladder, permitting the
 therapy garment to be easily washed and dried. This feature also helps
 improve infection control efforts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | Material: An attractive washable nylon shell with
 quick fit Velcro provides an appealing non-clinical look and feel, which we
 believe enhances self-esteem and patient compliance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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Table of Contents

| |   |                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Modular Assembly: The vests modular assembly allows the
 custom modification of the manifold to enhance pulsation and avoid local
 areas of sensitivity such as incisions and catheters.

The
SmartVest Systems electronic pulse generator features the following important
aspects:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Portable Design: The pulse generator for the SmartVest
 System is streamlined and fits into a roller bag for easy transport. The vest
 and hose are carried in a small companion bag. The unit is relatively
 lightweight and can be readily carried or rolled by an individual. The system
 complies with airline carry-on size limits and can be carried onto an
 airplane or stowed in the trunk of a car, allowing patients greater freedom
 to travel.                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Single-Hose System: When the SmartVest System is in use, a
 single hose delivers the pulsation to the vest, which we believe provides
 therapy in a more comfortable and unobtrusive manner than a two-hose system.
 In addition to facilitating patient comfort, the single-hose system provides
 effective treatment by simplifying delivery of the air pulse energy to the
 lungs. The pulse is delivered evenly from the base of the SmartVest therapy
 garment, extending the force pulses upward and inward in strong but smooth
 cycles of 360-degree latitudes, which delivers simultaneous treatment to the
 patients chest and back and all lobes of the lungs.                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Programmable Pulse
 Generation: The
 SmartVest System uses a pulse generator with an internal programmable memory
 feature to generate a pneumatic pulse electronically. The pulse frequency can
 be adjusted from 5 to 20 cycles per second, which accommodates the required
 therapeutic range. The range can be preset, by programmable controls, to
 assure patient safety and specific treatment requirements. For example, the
 unit can be programmed to deliver a varying pulse frequency during the course
 of a treatment session without requiring manually directed changes. We
 believe this feature adds convenience and enhances patient compliance with
 treatment protocol choices. For more information about the complexity of
 treatments typically offered to patients with chronic pulmonary dysfunction,
 please refer to the information under the heading Customers.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Power Supply: The SmartVest System also includes a
 power supply suitable for use in international markets, such that voltage and
 amperage are accommodated automatically.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

In
order to maintain and expand our position in the airway clearance therapy
industry, we plan to develop and introduce future advancements in HFCWO
products. Our goal is to provide effective treatment while improving the
quality of life for patients who suffer from chronic pulmonary conditions
resulting in impaired airway clearance. Therefore, we plan to make each product
progressively more compact, portable, and user-friendly. Our goal is to seek
improvements in design that will result in a relatively lower manufacturing
cost for each subsequent generation of the SmartVest System.

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Table of Contents

Other Products

We
market our Single Patient Use Vest (SPUV) and SmartVest Wrap® to health care
providers, particularly those working in intensive care units. Hospitals issue
the SPUV or SmartVest Wrap to one patient for
the duration of his or her stay. Both products facilitate continuity of care
because they introduce the patient to our product line and may encourage use of
the home care SmartVest System, which can be provided to the chronic condition
patient upon discharge. Both products provide full coverage pulsation. The SPUV
is a full-sized vest that is often used for patients undergoing institutional
treatment who are already accustomed to using a SmartVest System. The SPUV is
intended for short-term, in-patient use and allows the patient to avoid
contaminating his or her home-use vest while continuing treatment in a hospital
or other facility.

The
SmartVest Wrap, which we introduced in 2007, is lightweight, convenient, and
well-suited for patients recovering from surgery and short-term illnesses. We
believe that the design of the SmartVest Wrap, which lacks a vest outer shell,
makes it easy for the health care professional to operate because it does not
need to go over the patients head, minimizing the need to move post-surgical
patients and avoiding interference with other apparatuses the patient may be
using. In addition, the wrap is reversible, which allows the air pulse
generator to be aligned on either side of a hospital bed. We believe that our
ability to provide a relatively more comfortable therapy alternative to patients
results in a higher likelihood of patient cooperation and consistent use.

We
have designed and patented a mobile pedestal, which we manufacture and provide
with sales of our institutional models of the SmartVest System. The mobile
pedestal allows for easy transport within the medical facility. This unit
includes a pneumatic feature, permitting ease of movement in raising and
lowering the vertical position of the generator.

Our Markets

Overview

We
market our HFCWO products to a broad patient population. For patients with a
chronic pulmonary condition, many hours per day may be dedicated to a variety
of treatments. The SmartVest System provides effective airway clearance therapy
in a comfortable and portable design which allows patients greater independence
and speed of treatment. Building from a foundation of product quality, as well
as our dedication to customer service, our goal is to be a consistent innovator
in providing airway clearance therapy to patients with compromised pulmonary
function.

Because
sale of the SmartVest System is by physicians prescription only, we market to
health care professionals, such as doctors, nurses, respiratory therapists, and
clinic coordinators. However, with respect to both our in-home and
institutional products, the health care professionals decisions may be based
on preferences expressed by patients. Therefore, we believe that it is also
important to market our products to patients and caregivers. In addition,
because the availability of reimbursement is an important consideration for
health care professionals and patients, we must also prove the effectiveness of
our product to public and private insurance providers.

Our
SmartVest System is currently prescribed to patients who suffer from cystic
fibrosis (CF), chronic obstructive pulmonary disease (COPD),
bronchiectasis, neuro-muscular disorders or post-surgical complications and
patients who are ventilator dependent or have other conditions involving excess
secretion and impaired mucus transport. When we entered the market in 2000, we
focused on providing our product to CF patients because we felt those
individuals could greatly benefit from treatment from our HFCWO system and it
was the indication most likely to qualify for reimbursement at that time. We
expect that the CF patient population will remain an important customer
population in the future but seek to continuously expand our product offerings
to a broader patient population, which now includes post-surgical and intensive
care patients at risk of developing pneumonia, patients with end-stage
neuromuscular disease, and ventilator-dependent patients. We believe that our
greatest opportunities for growth are in emerging areas of application, such as
COPD, bronchiectasis, neuro-muscular disorders, and acute care. We also believe
that international populations present a key market opportunity, as HFCWO is
not yet a prevalent form of therapy outside of the U.S.

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When
evaluating market expansion for the SmartVest System, it is important to
understand the needs of the patients requiring airway clearance therapy and, in
some instances, their care providers. The essential requirements that make a
patient a candidate for airway clearance therapy are compromised respiratory
function with a need to:

| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | secure airway clearance
 therapy on a cost-effective long-term basis, confidently and with relative
 ease;
| |   |                                                                                                           
| |  | maintain and/or improve
 pulmonary status;                                                                
| |   |                                                                                                           
| |  | mobilize secretions
 several times per day; and                                                           
| |   |                                                                                                           
| |  | carry out activities of
 daily living.                                                                    

The
SmartVest System is designed to meet the individual patients needs by
providing a therapy that is efficient, is easy to administer, and can be
performed independently. Electromeds established marketing and product support
services provide education, training, and follow-up with the patient population
to insure the product is integrated into their daily treatment regimen. We
believe advantages of the SmartVest System to the independent patient include:

| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | usually can be reimbursed
 by private insurance, by federal or state government programs or combinations
 of the foregoing;
| |   |                                                                                                                            
| |  | consistent treatments at
 home;                                                                                            
| |   |                                                                                                                            
| |  | independence from a
 dedicated caregiver;                                                                                  
| |   |                                                                                                                            
| |  | portability;                                                                                                               
| |   |                                                                                                                            
| |  | improved comfort during
 therapy; and                                                                                      
| |   |                                                                                                                            
| |  | improved self-image.                                                                                                       
| |   |                                                                                                                            

Cystic Fibrosis

CF
is a genetic defect that disrupts chloride (salt) transfer in and out of cells,
causing the normal secretions from the exocrine glands to become very thick and
sticky, eventually blocking ducts of the glands in the pancreas, lungs and
liver. The thick mucus accumulates in the lungs respiratory tracts, causing
chronic infections, scarring, and decreased vital capacity. Normal coughing is
often not sufficient to dislodge these secretions. Cystic fibrosis symptoms
usually appear in early childhood. The median life expectancy for CF patients
in the U.S. is approximately thirty-seven years, although some patients live
into their fifties and beyond.

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Approximately
30,000 people in the U.S. currently have cystic fibrosis, with an estimated
1,000 new cases diagnosed each year. We estimate that during our 2010 fiscal
year, sales to CF patients comprised approximately 19% of our net revenue,
although overlap in patient populations makes it difficult to attribute revenue
to any particular condition with certainty.

All
patients with cystic fibrosis require respiratory therapy as a daily part of
their care regimen. Traditionally, care providers perform Chest Physical
Therapy (CPT) one to four times per day. CPT consists of a patient lying in
one of twelve positions (most with the head pointed downward) while a caregiver
claps or pounds on the chest and back over each lobe of the lung. To treat
all areas of the lung in all twelve positions requires pounding for 30 to 45
minutes along with inhalation therapy. CPT clears the secretions by shaking
loose airway secretions through chest percussions and draining the loosened
secretions towards the mouth. Active coughing is required to ultimately remove
the loosened secretions.

The
SmartVest System provides a convenient means to mobilize secretions. Although
some patients may prefer CPT based on their preference to avoid the
reimbursement process for the SmartVest System, the necessity to learn to use
the system and adjust to a new treatment method, and the potential that the
patient may temporarily be without the equipment if it needs to be repaired,
many patients feel that CPT limits their independence by requiring the presence
and assistance of a second person. Attending college, working a job, traveling
on business, and having a normal social life are all adversely impacted by the
need for CPT. Although some older patients can learn to perform some elements
of CPT on themselves, many adults do not, and must forego regular CPT in order
to meet the requirements of school and employment with concomitant risk to
their health. Moreover, CPT is a physically exhausting process for both the
patient and the caregiver. Patient and caregiver non-compliance with prescribed
protocols is a well-recognized problem that diminishes the effectiveness of
this method. CPT effectiveness is also highly technique sensitive and degrades
as the giver becomes tired.

Bronchiectasis

Bronchiectasis
is a chronic lung condition characterized by abnormal widening of the bronchial
tubes, or, as defined by Medicare, a productive cough that occurs more than
twice per year or lasts longer than six months. In a patient with
bronchiectasis, the bronchial tubes are damaged by the abnormal widening, which
impairs their ability to clear mucus from the lungs and causes a chronic cough.
Bronchiectasis may affect multiple areas of one or both lungs. The condition is
often caused by inflammation and infection of the airways, for example due to
bacterial lung infections (chronic bronchitis or pneumonia) or inhaling foreign
objects. Cystic fibrosis causes about half of all bronchiectasis in the U.S.
The effects of bronchiectasis include excessive coughing, shortness of breath,
fatigue, and recurring pneumonias. Depending on the severity of a patients
condition, treatments range from bronchodilator medications (inhalers),
antibiotics, daily CPT and drainage, or surgical removal of the affected lung
tissue. We believe that our success in the CF market suggests that our
SmartVest System can provide effective treatment to patients with
bronchiectasis, as clearing the airways of secretions is central to the
treatment of both conditions. We estimate that during our 2010 fiscal year,
sales to bronchiectasis patients comprised approximately 39% of our net
revenue, although overlap in patient populations makes it difficult to
attribute revenue to any particular condition with certainty.

Chronic Obstructive
Pulmonary Disease

COPD
is a progressive disease that, over time, makes it more and more difficult for
a patient to breathe. According to statistics published by the World Health
Organization in November 2008, COPD is the fourth leading cause of death in the
world, and some experts expect that it will be the largest cause of disability
and death due to respiratory disease in the year 2020.

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People
with COPD may have chronic inflammation of the bronchial tubes, emphysema or,
more likely, both. In emphysema, the walls between the air sacs in the lungs
are damaged, causing them to lose their shape and become deflated. This damage
can also destroy the walls of the air sacs, leading to fewer and larger air
sacs instead of many tiny ones. In chronic obstructive bronchitis, the lining
of the airways is constantly irritated and inflamed. This causes the lining to
thicken. The patients immune system reacts by increasing secretions, making it
difficult to breathe. Thus, patients with COPD slowly suffocate over a period
of years. Using auxiliary muscles, people can inhale with considerable effort
but are unable to exhale. Even a mild case of COPD can have an impact on the
heart. Heart failure is also associated with severe COPD.

COPD
has no cure, and traditional treatments are inconvenient for the patient and
have limited effectiveness. These treatments consist of inhaled dilator and
steroid medications, physical therapy exercises, major surgery, such as a lung transplant
or lung volume reduction surgery, and oxygen therapy, either constantly through
nasal prongs or for several hours per day through a mask. For some patients,
the primary course of action is merely to manage the risks and complications
that result from the disease, such as by obtaining pneumonia and influenza
vaccines, since infections may suddenly increase the severity of COPD. We
believe that the combination of excess secretions and the inability to forcibly
exhale to clear the lungs make COPD patients ideal candidates for our airway
clearance therapy.

Neuro-Muscular
Diseases

Neuro-muscular
diseases include muscular dystrophy, spinal muscular atrophy, and multiple
sclerosis. Patients with neuro-muscular diseases have difficulty breathing, as
well as difficulty clearing their lungs of accumulated mucus. The conditions
often cause a patients diaphragm muscles to deteriorate and lead to poor
spinal alignment, each of which impairs the patients ability to fully inhale.
In addition, poor muscle coordination makes it difficult for the patient to
forcefully exhale or cough. Due to this difficulty, patients with
neuro-muscular diseases have an exceptionally high risk of developing serious
secondary complications, such as pneumonia and respiratory failure. Secretion
management is a critical aspect of the respiratory care of these patients. We
believe that our SmartVest System aids in producing effective coughs, and
thereby improves breathing and reduces the risk of infection.

New Markets

Acute
Care

The
acute care market includes ventilator-dependent patients and post-surgical
patients at risk for pulmonary complications. Patients at risk include smokers,
those with a history of lung disease, asthma, or chronic bronchitis, the
overweight, the elderly, those immobilized by illness or injury, and those who
have an adverse reaction to anesthesia. Specific problems may include
pneumonia, infection, atelectasis (collapsed lung), and/or respiratory failure
all of which increase mucus retention in the lungs.

We
have worked with health care professionals to create products for acute care
patients, including our Single Patient Use Vest, or SPUV, and our SmartVest
Wrap. We market both of these products to health care providers, particularly
those working in intensive care units. Hospitals issue the SPUV or SmartVest
Wrap to one patient for the duration of his or her hospital stay. Both products
facilitate continuity of care, because they introduce the patient to our
product line and may encourage use of the home care SmartVest System, which can
be provided to the chronic condition patient upon discharge. Both products
provide full coverage pulsation. The SPUV is a full-sized vest that is often
used for patients undergoing institutional treatment who are already accustomed
to using a SmartVest System. The SmartVest Wrap, which we introduced in 2007,
is lightweight, convenient and well-suited for patients recovering from surgery
and short-term illnesses. We believe that the lightweight nature of the
SmartVest Wrap makes it easy for the health care professional to operate. In
addition, we believe that our ability to provide a relatively more comfortable
therapy alternative to patients results in a higher level of patient cooperation
and consistent use.

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Other
Indications

The
benefits of airway clearance therapy using the SmartVest System are not
disease-specific. They apply to a broad range of conditions characterized by
lung congestion. One currently underserved group of patients are those with
underlying medical conditions and circumstances, such as severe down syndrome,
demobilizing injuries and severe muscular distrophy. Patients with severe
underlying conditions often suffer from multiple physical problems and may be
non-ambulatory. Their inability to move predisposes them to lung congestion,
which often progresses to more serious medical conditions such as pneumonia. We
believe these patients could improve their lung functionality and reduce their incidence
of infection by using airway clearance therapy with the SmartVest System, and
that the consistently higher oxygen levels that result from improvements to
breathing could offer ancillary benefits for their conditions.

Marketing, Sales and Distribution

We
believe that we can achieve future earnings and sales growth through expanding
and repositioning our domestic sales staff, focusing on continuing education
opportunities and industry relationships, building distributor relationships in
Europe and Asia, and maintaining leadership in product innovation. Each of
these objectives is described in more detail above in the section entitled
Growth Strategy.

Because
sale of the SmartVest System is by physicians prescription only, we focus our
marketing efforts on physicians and health care professionals such as
physicians assistants, nurses, nurse practitioners, and respiratory
therapists, as well as directly to their patients. In addition to increasing
the visibility and acceptance of our products through participating in medical
conferences and maintaining industry contacts, as explained in more detail
above in the section entitled Business StrengthsIndustry Contacts, we have a
designated Marketing Department and place advertisements in leading medical
magazines and journals in the U.S. and Europe. We also believe that the
Internet has provided us with a marketing benefit in recent years, as several
overseas distributors have contacted us after visiting our website.

In
addition to distributors overseas, as explained in more detail below under the
heading Our MarketsInternational Marketing, we have established our own
sales force in the U.S., nearly all of whom are respiratory therapists. Each
sales representative, or Clinical Area Manager (CAM), is responsible for
introducing our products, principally the SmartVest System, to clinics and
hospitals within a specific geographical area, and are also able to provide
training and continued support to customers. As of June 30, 2010, we had 20
total sales representatives, including a national sales manager, 3 regional
sales managers, and 16 clinical area managers. Collectively, our sales force
covers the entire United States and portions of Canada, which we have divided
into West, Midwest, and East regions. Each clinical area manager is assigned to
a particular territory within one of the three regions. We have also developed
a network of over 300 respiratory therapists and health care professionals to
assist with training patients across the U.S. on a non-exclusive independent
contractor basis. We believe that the professional understanding of the
Clinical Area Managers and trainers demonstrates our commitment to customer
service and facilitates sales. We expect that with expanded funding, our
current and future Clinical Area Managers can capture additional market share.

International
Marketing

The
international market for HFCWO therapy devices is emerging and we believe
represents a major growth opportunity for us. In fiscal 2010, our international
sales comprised approximately 4.5% of net revenue. Internationally, we have
made sales in more than ten countries. In addition to sales made in Canada, the
principal countries in which we have made sales internationally, and the
countries in which our principal distributors are located, are Italy, Spain and
Japan. We are actively identifying distributors and other sales opportunities.

Our historical
practice and continued intent includes developing long-term relationships with
distributors who have knowledge and experience in serving respiratory
physicians and patients in the host country. Units are sold at a consistent
price with payment made directly from the distributor. For all international
sales, our Quality Assurance Department and Chief Financial Officer monitor
pricing, payments and conforming regulatory practice. Our Chief Executive
Officer and Marketing Director oversee the growth and performance of
international sales.

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We
obtained ISO 9001 Certification in January 2005, which provides assurance to
our international distributors and customers that our products conform with
uniform standards for manufacturing quality and that our business meets certain
professional standards. Securing certification from the International
Organization for Standardization (ISO) provides assurance across national
boundaries that the goods imparted are of a reliable and predictable quality,
consistent with the representations of the manufacturer.

We
have also obtained clearance to use the European Union CE Mark on our products.
The CE Mark is required for medical device sales in countries within the
European Economic Area, which includes the twenty-seven member countries of the
European Union as well as Iceland, Liechtenstein, Norway, Switzerland, and
Turkey, and other European countries that may adopt EU standards voluntarily.
We also require all of our distributors to comply with their home country
regulations. We originally obtained clearance to use the CE Mark in April 2005.
Renewal is required every five years, and our notified body performs an annual
audit to ensure that we are in compliance with all applicable regulations. We
have maintained our CE Mark in good standing since originally receiving it and
most recently renewed it in January 2010.

Competition

High
Frequency Chest Wall Oscillation (HFCWO) was first developed for CF patients
at the University of Minnesota. The purpose of HFCWO is to provide more
effective mucus clearance in a form that could be performed independently of a
caregiver. The original technology was licensed to American Biosystems, Inc.
(now Advanced Respiratory, Inc. (ARI), part of Hill-Rom Holdings, Inc., a
publicly traded company) which, until the introduction of our original MedPulse
Respiratory Vest System® in 2000, was the only manufacturer of this technology.
All of ARIs products use a two-hose, closed system, in contrast to the
single-hose, flow-through system that we designed, which we believe provides greater
ease of use and patient comfort. In 2005, Respiratory Technologies, Inc., a
privately held company doing business as RespirTech, received FDA clearance to
market their inCourage system (the inCourage System), which includes a HFWCO
vest. Like our SmartVest System, ARIs The Vest and RespirTechs inCourage
System are cleared for market by the FDA.

From
a clinical performance perspective, all HFCWO products meet a common standard
of substantial equivalence. As a result, features and benefits such as number
of hoses required to deliver the therapy (one hose versus two hoses),
construction quality, appearance of the generator, reputation for patient
services, and sales effectiveness of field personnel have become key variables.
We believe that the product features of our SmartVest System enable us to
compete effectively, particularly when health care professionals, patients, and
caregivers are provided with demonstrations of product choices prior to
committing to a specific product. We often provide demonstration units to
encourage such comparisons. Unlike our competitors products, the SmartVest
System has a single-hose, flow-through system design and an adjustable vest
made from soft, breathable and washable fabric. We use Velcro in our patented
vest to provide a tailored fit, as opposed to an inflatable fit model. In
addition to product features, our focus on providing exemplary customer
training and service, along with our commitment to engage and retain highly
motivated employees and contractors, many of whom are medical professionals,
provides a valuable competitive advantage.

Alternative
products for administering pulmonary therapy include:

| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Positive Expiratory
 Pressure (PEP) mask, which provides backpressure into the lungs on
 expiration to keep respiratory tracts open longer to drain;

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| |   |                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Flutter® (Scandipharm), a tube which vibrates
 on expiration;                                                                                            
| |   |                                                                                                                                                              
| |  | Acapella® Vibratory PEP
 Therapy System (Smiths Medical), a handheld device that combines PEP with
 oscillations;                                            
| |   |                                                                                                                                                              
| |  | Intrapulmonary Percussive
 Ventilation Device, generally comprised of a ventilator that combines
 positive air pressure with nebulisation as appropriate; and
| |   |                                                                                                                                                              
| |  | Traditional Chest Physical
 Therapy (CPT), which is usually performed one to four times per day.                                                           
| |   |                                                                                                                                                              

Physicians
may prescribe some or all of these devices and techniques, depending upon each
patients health status, severity of disease, compliance, or personal
preference. We believe our primary competitive advantage over alternative
treatments is patient comfort, ease of use, and the effectiveness of HFCWO
treatment as compared to CPT and other alternative treatments. Because HFCWO is
not technique dependent, as compared to most other pulmonary therapy
products, therapy begins automatically once power is provided and remains
consistent and controlled for the duration of the session. We strive to make
the SmartVest System an increasingly attractive and comfortable form of HFCWO
therapy. We believe that HFCWO therapy generally, and our SmartVest System in
particular, produces less interference with daily activities, which increases
the likelihood of regular use. We believe these advantages encourage physicians
to prescribe and patients to request the SmartVest System for pulmonary
therapy. Reimbursement for the diverse patient populations for each of these
pulmonary therapies varies greatly because a patients medical care costs are
typically addressed by a combination of private insurance and government
benefit schedules, as well as state health care policies and programs.

Research and Development

We
have demonstrated our commitment to product development by introducing several
new products and product enhancements since we first entered the market in
2000. In addition to the 19 U.S. patents and 5 foreign patents that we
currently hold, we have a number of pending patent applications domestically
and internationally.

As
of June 30, 2010, our research and development staff consisted of three
full-time employee engineers. We also receive engineering support from several
consultants, including Mr. Craig Hansen, pursuant to an agreement with Hansen
Engine Corporation. See Part III, Item 13, Certain Relationships and Related
Transactions, and Director Independence. Our team, the majority of whom have
experience in respiratory therapy and medical device development, has a
demonstrated record of developing new products which receive the appropriate
product approvals and regulatory clearances, with our products having been
approved or cleared in the U.S., Canada, and the member countries of the
European Economic Area.

During
the fiscal years ended June 30, 2010 and 2009 we incurred research and
development expenses of $601,000 and $358,000, respectively. As a result of our
expected investments in enhancing the SmartVest System, we expect the amount we
spend on research and development to increase in the future to approximately 5%
of revenue.

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Intellectual Property

As
of June 30, 2010, we held 19 issued U.S. patents and 5 foreign patents covering
the SmartVest System and its underlying technology, and had 33 pending U.S. and
foreign patent applications. The pending U.S. patent applications primarily
relate to additional aspects of the underlying technology for the SmartVest
System and the pending foreign patent applications correspond to our existing
U.S. patents and pending U.S. patent applications. We believe it will take
several years, or possibly longer, for pending patent applications to result in
issued patents, if at all. Our first U.S. patent expires in 2013 and in Canada
in 2016.

Our
patents and patent applications offer coverage in the field of air pressure
pulse delivery to a human in support of airway clearance. The following table
provides information about our issued U.S. patents:

|                    |  |       |                                                                |        |                   
|------------------- |  | ----- | -------------------------------------------------------------- | ------ | ------------------
|U.S. PATENT
 NUMBER |  | TITLE |                                                                | ISSUED
|5,453,081           |  |       | Pulsator                                                       |        | September 26, 1995
|                    |  |       |                                                                |        |                   
|5,569,170           |  |       | Pulsator                                                       |        | October 29, 1996  
|                    |  |       |                                                                |        |                   
|6,254,556           |  |       | Repetitive Pressure Pulse
 Jacket                              |        | July 3, 2001      
|                    |  |       |                                                                |        |                   
|D456,591            |  |       | Human Body Pulsating
 Jacket                                   |        | May 7, 2002       
|                    |  |       |                                                                |        |                   
|D461,897            |  |       | Human Body Respiratory
 Vest                                   |        | August 20, 2002   
|                    |  |       |                                                                |        |                   
|6,488,641           |  |       | Body Pulsating Apparatus                                       |        | December 3, 2002  
|                    |  |       |                                                                |        |                   
|D469,876            |  |       | Human Respiratory Bladder                                      |        | February 4, 2003  
|                    |  |       |                                                                |        |                   
|6,547,749           |  |       | Body Pulsating Method and
 Apparatus                           |        | April 15, 2003    
|                    |  |       |                                                                |        |                   
|6,605,050           |  |       | Body Pulsating Jacket                                          |        | August 12, 2003   
|                    |  |       |                                                                |        |                   
|D478,989            |  |       | Supine Respiratory Vest                                        |        | August 26, 2003   
|                    |  |       |                                                                |        |                   
|6,676,614           |  |       | Vest for Body Pulsating
 Method and Apparatus                  |        | January 13, 2004  
|                    |  |       |                                                                |        |                   
|D531,728            |  |       | Combined Human Body Pulsator
 and Movable Pedestal             |        | November 7, 2006  
|                    |  |       |                                                                |        |                   
|D547,718            |  |       | Air Pulsating Generator                                        |        | July 31, 2007     
|                    |  |       |                                                                |        |                   
|7,278,978           |  |       | Respiratory Vest with
 Inflatable Bladder                      |        | October 9, 2007   
|                    |  |       |                                                                |        |                   
|7,374,550           |  |       | Respiratory Vest for
 Repetitive Pressure Pulses               |        | May 20, 2008      
|                    |  |       |                                                                |        |                   
|D585,991            |  |       | Combined Air Pulsator and
 Movable Pedestal                    |        | February 3, 2009  
|                    |  |       |                                                                |        |                   
|7,537,575           |  |       | Body Pulsating Method and
 Apparatus                           |        | May 26, 2009      
|                    |  |       |                                                                |        |                   
|7,713,219           |  |       | Combined Air Pulsator and
 Movable Pedestal                    |        | May 11, 2010      
|                    |  |       |                                                                |        |                   
|7,736,324           |  |       | Portable Human Body
 Pulsating Apparatus Mounted on a Pedestal |        | June 15, 2010     

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We
have also received the following U.S. trademark and service mark registrations:
MEDPULSE, MEDPULSE RESPIRATORY VEST SYSTEM, SMARTVEST, SMARTVEST WRAP, SMARTWRAP,
FACT, SOFT START, TRIMLINE, and CREATING SUPERIOR CARE THROUGH INNOVATION.

We
generally pursue patent protection for patentable subject matter in our
proprietary devices in foreign countries in which we make regular sales. We
have been granted patent protection in Canada, New Zealand and South Africa. We
have additional patent applications pending in Canada, Japan, and South Korea
and with the European Patent Organization, whose member states include Spain,
Croatia, Greece, Italy, Portugal, and Romania.

In
addition to our patent and trademark protected intellectual property, we seek
to protect proprietary information and know-how through confidentiality and
non-competition provisions in the agreements with our executives and employees.
We cannot provide assurance that these persons will abide by the terms of these
agreements. In addition, despite measures taken to protect our intellectual
property, unauthorized parties might copy aspects of our products or obtain and
use information that we regard as proprietary.

We
intend to continue expanding our intellectual property portfolio, and
particularly our patent position, as our business grows. However, our patent
applications may not result in issued patents, and we cannot assure you that
any patents that have been issued or might be issued will be broad enough to
prevent competitors from emulating our products, or that all of our patents
will be upheld if asserted against third parties, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.

Our
industry is characterized by the existence of a large number of patents and
frequent litigation based on assertions of patent infringement. For a
description of litigation relating to our intellectual property, please refer
to Part I, Item 3 of this Report, entitled Legal Proceedings.

Manufacturing

Our
headquarters in New Prague, Minnesota include a dedicated manufacturing and
engineering facility of more than 10,000 square feet. Our site has been
regularly audited by the FDA, in accordance with FDA practices, and we maintain
our operations in a manner consistent with FDA requirements for a medical
device manufacturer. Our manufacturing processes emphasize simplicity,
cost-effectiveness, and a capacity to realize increases in production volume
with escalation in demand. All employees are responsible for maintaining
specific manufacturing and quality standards, which are monitored by our
quality assurance manager under an extensive system designed to satisfy FDA and
ISO standards.

Electromed
staff is responsible for manufacturing each SmartVest System. While components
are outsourced based upon detailed specifications, each SmartVest System is
assembled, tested, and approved for final shipment at our manufacturing site in
New Prague, Minnesota, under careful control consistent with FDA, Underwriters
Laboratory (UL), and ISO standards. While all third-party vendors present
some degree of risk of supply or impairment issues, many of our vendors are
located within 100 miles of our headquarters, which enables us to closely
monitor the supply chain. We maintain at least a two-month supply of all of our
critical components, and the materials
used in the SmartVest System are generally available from a number of
suppliers.

A
rigorous quality standard is applied to components received from vendors. Any
adverse findings result in the quarantine of any out of specification
components. Before a SmartVest System is shipped to a patient, rigorous testing
is again applied to match the performance of the air pulse generator with the
particular vest size stipulated for the patient.

Seasonality

Our
business is not materially affected by seasonality.

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Product Warranties

We
provide a warranty on the SmartVest System that covers the cost of replacement
parts and labor, or a new SmartVest System in the event we determine a full
replacement is necessary. For SmartVest Systems initially purchased and
currently located in the United States and Canada, we provide a lifetime
warranty to the individual patient for whom the system is prescribed. For
products sold to patients in Greece, we provide a five-year warranty. For sales
to institutions within the United States and Canada, and for all other sales to
individuals and institutions made outside of the United States and Canada, we
provide a three-year warranty. Our warranties provide that if a newer model of
our systems has been developed and sold between the time of purchase of the
original system and we determine the need for replacement, we may replace the
system with a newer model at our discretion.

Third-Party Reimbursement

Much
of our growth is dependent on continued acceptance of HFCWO technology by
third-party payers. In the U.S., individuals who use the SmartVest System will
generally rely on third-party payers, including private payers and governmental
payers such as Medicare and Medicaid, to cover and reimburse all or part of the
cost of using the SmartVest System. Reimbursement for HFCWO therapy and our
SmartVest System varies among public and private insurance providers.

Most
patients are able to qualify for reimbursement and payment from Medicare,
Medicaid, private insurance or combinations of the foregoing. We believe that
subsequent generations of HFCWO products will also qualify for reimbursement
under Medicare Plan B and most major health plans. However, some third-party
payers must also approve coverage for new or innovative devices or therapies
before they will reimburse health care providers who use the medical devices or
therapies. In addition, we face the risk that new or modified products could
have a lower reimbursement rate, or that the levels of reimbursement currently
available for our existing products could decrease, which would hamper our
ability to market and sell that product. Consequently, our sales will continue
to depend in part on the availability of coverage and reimbursement from
third-party payers, even though our devices may have been cleared for
commercial distribution by the FDA. The manner in which reimbursement is sought
and obtained varies based upon the type of payer involved and the setting in
which the procedure is furnished. The nature of any future legislation is
uncertain, making it difficult for us to predict the impact of cost-containment
trends on operating results.

A
key element in our customer support strategy has been achieved by establishing
an effective Reimbursement Department to seek insurance authorization and
process claims on behalf of the patient. The skill and knowledge gained and
offered by our Reimbursement Department is an important factor in building our
revenue and serving patients financial interests. Our payment terms allow
patients to acquire the SmartVest System over a period of 1 to 15 months, which
is consistent with reimbursement procedures followed by Medicare and other
third parties. The amount we receive for any single unit is based on
reimbursement schedules and may vary based on a number of factors, including
Medicare and third-party reimbursement processes and policies. The patient
maintains the risk of reimbursement to the Company in the event of non-payment
by third-party payers.

Payments
for overseas sales are made directly by the distributor, and we are not
involved in the reimbursement process. Overseas sales were approximately 4.5%
of our net revenue in fiscal 2010, as explained in more detail below under the
heading International Marketing.

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Governmental Regulation

Medicare and
Medicaid

Recent
government and private sector initiatives in the U.S. and foreign countries are
aimed to limit the growth of health care costs, including price regulation,
competitive pricing, coverage and payment policies, comparative effectiveness
of therapies, technology assessments, and managed-care arrangements, and are
causing the marketplace to put increased emphasis on the delivery of more
cost-effective medical devices. Government programs, including Medicare and
Medicaid, have attempted to control costs by limiting the amount of
reimbursement they will pay for particular procedures or treatments,
restricting coverage for certain products or services, and implementing other
mechanisms designed to constrain utilization and contain costs. In addition,
many private insurance programs look to Medicare as a guideline in setting
their coverage policies and payment amounts. This has created an increasing
level of price sensitivity among customers. If we develop new or modified
products that have a lower reimbursement rate, or the levels of reimbursement
currently available for our existing products decrease, demand for our products
would be affected. We believe, however, that HFCWO can reduce the risk of
secondary complications and required hospitalizations from excess secretion,
and is therefore a cost-effective alternative to traditional treatments. We
expect that the cost-saving aspects of the SmartVest System will increase in
importance as cost control measures become more prevalent in the health care
industry.

FDA Requirements

We
have received clearance from the U.S. Food and Drug Administration to market
our products, including the SmartVest System, as a powered percussor. Since
inception, management has retained the necessary clinical, medical and legal
expertise to support required clearances and approvals to market our products.
On April 7, 2004, our Model 2000ez SMARTVEST was cleared to market by the FDA
pursuant to a 510(k) submission.

Our
medical devices are subject to regulation by numerous government agencies,
including the FDA and comparable foreign agencies. To varying degrees, each of
these agencies requires us to comply with laws and regulations governing the
development, testing, manufacturing, labeling, marketing, and distribution of
our medical devices. A full-time quality assurance manager as well as a
consulting regulatory and clinical expert provide detailed oversight of their
respective areas of responsibility.

Premarket
Clearance and Approval Requirements

All
of our current products have been cleared for sale in the U.S. by the FDA under
the premarket notification (510(k) clearance process). However, unless an
exemption applies, if we develop new medical devices or modifications to
existing products that would affect the products safety or effectiveness, we
must obtain FDA clearance before marketing the new or modified product in the
U.S., either through the 510(k) clearance process or the more complex Premarket
Approval Application (PMA) process.

The
510(k) clearance process would be available if we could demonstrate that our
new medical device is substantially equivalent to a legally marketed medical
device. In this process, we would be required to submit data that supports our
equivalence claim. While human clinical data has not been routinely required
for 510(k) products in the past, the FDA is increasingly requiring it for new
technologies. If human clinical data is required, it must be gathered in
compliance with FDA investigational device exemption regulations. We must
receive an order from the FDA finding substantial equivalence to another
legally marketed medical device before we can commercially distribute the new
medical device. Modifications to cleared medical devices can be made without
using the 510(k) process if the changes do not significantly affect safety or
effectiveness. A very small number of our devices are exempt from pre-market
review.

The
second, more rigorous process, known as pre-market approval (PMA), would
require us to independently demonstrate that the new medical device is safe and
effective. We would do this by collecting data regarding design, materials,
bench and animal testing, and human clinical data for the medical device. The
FDA will authorize commercial release if it determines there is reasonable
assurance that the medical device is safe and effective. This determination is
based on benefit outweighing risk for the population intended to be treated
with the device. This process is much more detailed, time-consuming and
expensive than the 510(k) clearance process.

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510(k)
Clearance Pathway

When
a 510(k) clearance is required, we will be required to submit a 510(k)
demonstrating that our proposed device is substantially equivalent to a
previously cleared 510(k) device or a device that was in commercial
distribution before May 28, 1976 for which the FDA has not yet called for the
submission of PMAs. In cases where no predicate is available, we can request a
de novo classification of the product. If the FDA classifies the device as
substantially equivalent to a predicate device, we will receive an order that
allows us to market the device.

Any
modification to a 510(k)-cleared device that would constitute a major change in
its intended use, or any change that could significantly affect the safety or
effectiveness of the device, requires a new 510(k) clearance and may even, in
some circumstances, require a PMA, if the change raises complex or novel
scientific issues or the product has a new intended use.

There
is no guarantee that the FDA will grant 510(k) clearance to new or modified
products that we develop in the future. Failure to obtain such clearances or
approvals could adversely affect our ability to grow our business. Delays in
receipt or failure to receive clearances or approvals, the loss of previously
received clearances or approvals, or the failure to comply with existing or
future regulatory requirements could have a material adverse effect on our
business.

Clinical
Trials

We
were able to obtain FDA clearance by demonstrating substantial equivalence to
preexisting products, and therefore new clinical trials were not required to
obtain FDA clearance for our current products. However, clinical trials are
increasingly required for 510(k) clearance and therefore may be required to
obtain FDA clearance for future products. If the device presents a significant
risk, as defined by the FDA, to human health, the FDA requires the device
sponsor to file an investigational device exemption (an IDE) application with
the FDA and obtain IDE approval prior to commencing the human clinical
trials. Such trials generally require an IDE application approved in
advance by the FDA for a specified number of patients and study sites, unless
the product is deemed a non-significant risk device eligible for more
abbreviated IDE requirements.

Clinical
trials are subject to extensive monitoring, recordkeeping and reporting
requirements. Clinical trials must be conducted under the oversight of an
institutional review board (IRB) for the relevant clinical trial sites and
must comply with FDA regulations, including but not limited to those
relating to good clinical practices. To conduct a clinical trial, we also are
required to obtain the patients informed consent in form and substance that
complies with both FDA requirements and state and federal privacy and human
subject protection regulations. If the clinical trial is not performed in
accordance with the FDAs IDE regulations, the FDA could seek an enforcement
action against the sponsor and the investigators. In addition, the sponsor, the
FDA or the IRB could suspend a clinical trial at any time for various reasons,
including a belief that the risks to study subjects outweigh the anticipated
benefits. Even if a trial is completed, the results of clinical testing may not
adequately demonstrate the safety and efficacy of the device or may otherwise
not be sufficient to obtain FDA clearance to market the product in the U.S.
Similarly, in Europe the clinical study must be approved by a local ethics
committee and in some cases, including studies with high-risk devices, by the
ministry of health in the applicable country.

Pervasive
and Continuing Regulation

After
a device is placed on the market, numerous regulatory requirements apply. These
include:

| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | product listing and
 establishment registration, which helps facilitate FDA inspections and other
 regulatory action;

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| |   |                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Quality System Regulation
 (QSR), which is the medical device term for good manufacturing practices,
 requires manufacturers, including third-party manufacturers, to follow
 stringent design, testing, control, documentation and other quality assurance
 procedures during all aspects of the manufacturing process;                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | labeling regulations and
 FDA prohibitions against the promotion of products for uncleared, unapproved
 or off-label use or indication;                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | clearance of product
 modifications that could significantly affect safety or efficacy or that
 would constitute a significant change in the safety or efficacy of our
 cleared devices;                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | medical device reporting
 regulations, which require that manufacturers comply with FDA requirements to
 report if their device may have caused or contributed to a death or serious
 injury, or has malfunctioned in a way that would likely cause or contribute
 to a death or serious injury if the malfunction of the device or a similar
 device were to recur;
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | post-approval or
 post-clearance restrictions or conditions, including post-approval or
 post-clearance study commitments;                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | post-market surveillance
 regulations, which apply when necessary to protect the public health or to
 provide additional safety and effectiveness data for the device; and                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                     
| |  | the FDAs recall
 authority, whereby it can ask, or under certain conditions order, device
 manufacturers to recall from the market a product that is in violation of
 governing laws and regulations.                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                     

Advertising
and promotion of medical devices, in addition to being regulated by the FDA,
are also regulated by the Federal Trade Commission and by state regulatory and
enforcement authorities. Recently, promotional activities for FDA-regulated
products of other companies have been the subject of enforcement action brought
under health care reimbursement laws and consumer protection statutes. In addition,
under the federal Lanham Act and similar state laws, competitors and others can
initiate litigation relating to advertising claims. In addition, we are
required to meet regulatory requirements in countries outside the U.S., which
can change rapidly with relatively short notice. If the FDA determines that our
promotional materials or training constitutes promotion of an unapproved or
uncleared use, it could request that we modify our training or promotional
materials or subject us to regulatory or enforcement actions, including the
issuance of an untitled letter, a warning letter, injunction, seizure, civil
fine or criminal penalties. It is also possible that other federal, state or
foreign enforcement authorities might take action if they consider our
promotional or training materials to constitute promotion of an unapproved use,
which could result in significant fines or penalties under other statutory
authorities, such as laws prohibiting false claims for reimbursement. In that
event, our reputation could be damaged and adoption of the products would be
impaired.

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Furthermore,
we could face product recalls, FDA enforcement actions, and user lawsuits if
any of our products are found to pose a risk of injury or otherwise be
defective. We believe that our products pose a low risk of
injury because they are non-invasive, and we maintain an active training
program that we expect would provide early identification of any product
defects. Nevertheless, our products could be subject to voluntary recall if we
or the FDA determine, for any reason, that our products pose a risk of injury
or are otherwise defective. Moreover, the FDA can order a mandatory recall if
there is a reasonable probability that our device would cause serious adverse
health consequences or death.

The
FDA has broad post-market and regulatory enforcement powers. Our facilities
have been and will continue to be subject to unannounced inspections by the FDA
to determine our level of compliance with the QSR and other regulations.
Failure by us or by our suppliers to comply with applicable regulatory
requirements can result in enforcement action by the FDA or other regulatory
authorities, which may result in sanctions including, but not limited to:

| |   |                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |  | warning letters or
 untitled letters;                                                                                                           
| |   |                                                                                                                                                 
| |  | fines and civil penalties;                                                                                                                      
| |   |                                                                                                                                                 
| |  | unanticipated expenditures
 to address or defend such actions;                                                                                  
| |   |                                                                                                                                                 
| |  | delays in clearing or
 approving, or refusal to clear or approve, our products;                                                                 
| |   |                                                                                                                                                 
| |  | withdrawal or suspension
 of approval or clearance of our products or those of our third-party
 suppliers by the FDA or other regulatory bodies;
| |   |                                                                                                                                                 
| |  | product recall or seizure;                                                                                                                      
| |   |                                                                                                                                                 
| |  | orders for physician
 notification or device repair, replacement or refund;                                                                     
| |   |                                                                                                                                                 
| |  | injunctions; and                                                                                                                                
| |   |                                                                                                                                                 
| |  | criminal prosecution.                                                                                                                           

Fraud and Abuse Laws

Federal
health care laws apply when we or customers submit claims for items or services
that are reimbursed under Medicare, Medicaid or other federally-funded health
care programs. The principal federal laws include: the False Claims Act which
prohibits the submission of false or otherwise improper claims for payment to a
federally-funded health care program; the Anti-Kickback Statute which prohibits
offers to pay or receive remuneration of any kind for the purpose of inducing
or rewarding referrals of items or services reimbursable by a federal health
care program; and health care fraud statutes that prohibit false statements and
improper claims with any third-party payer. There are often similar state false
claims, anti-kickback, and
anti-self referral and insurance laws that apply to state-funded Medicaid and
other health care programs and private third-party payers. In addition, the
U.S. Foreign Corrupt Practices Act can be used to prosecute companies in the
U.S. for arrangements with physicians, or other parties outside the U.S. if the
physician or party is a government official of another country and the
arrangement violates the law of that country.

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The
laws applicable to us are subject to change, and to evolving interpretations.
If a governmental authority were to conclude that we are not in compliance with
applicable laws and regulations, we and our officers and employees could be
subject to severe criminal and civil penalties including substantial penalties,
fines and damages, and exclusion from participation as a supplier of product to
beneficiaries covered by Medicare or Medicaid.

The
Federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting,
offering, receiving or providing remuneration, directly or indirectly, in
exchange for or to induce either the referral of an individual, or the
furnishing or arranging for a good or service, for which payment may be made
under a federal health care program such as Medicare or Medicaid. The
definition of remuneration has been broadly interpreted to include anything
of value, including for example gifts, improper discounts, the furnishing of
free supplies, equipment or services, credit arrangements, payments of cash and
waivers of payments. Several courts have interpreted the statutes intent
requirement to mean that if any one purpose of an arrangement involving
remuneration is to induce referrals of federal health care covered business,
the statute has been violated. Penalties for violations include criminal
penalties and civil sanctions such as fines, imprisonment and possible
exclusion from Medicare, Medicaid and other federal health care programs. In
addition, some anti-kickback allegations have been claimed to violate the
Federal False Claims Act, discussed in more detail below.

The
Anti-Kickback Statute is broad and prohibits many arrangements and practices
that are lawful in businesses outside of the health care industry. Recognizing
that the Anti-Kickback Statute is broad and may technically prohibit many
innocuous or beneficial arrangements, Congress authorized the Office of
Inspector General of the U.S. Department of Health and Human Services, or
OIG, to issue a series of regulations, known as safe harbors. These safe
harbors, issued by the OIG beginning in July 1991, set forth provisions
that, if all their applicable requirements are met, will assure health care
providers and other parties that they will not be prosecuted under the
Anti-Kickback Statute. The failure of a transaction or arrangement to fit
precisely within one or more safe harbors does not necessarily mean that it is
illegal or that prosecution will be pursued. However, conduct and business
arrangements that do not fully satisfy each applicable safe harbor may result
in increased scrutiny by government enforcement authorities such as the OIG.

Many
states have adopted laws similar to the Anti-Kickback Statute. Some of these
state prohibitions apply to referral of patients for health care items or
services reimbursed by any source, not only the Medicare and Medicaid programs.

Government
officials have focused their enforcement efforts on marketing of health care
services and products, among other activities, and recently have brought cases
against companies, and certain sales, marketing and executive personnel, for
allegedly offering unlawful inducements to potential or existing customers in
an attempt to procure their business.

Another
development affecting the health care industry is the increased use of the
Federal Civil False Claims Act and, in particular, actions brought pursuant to
the False Claims Acts whistleblower or qui
tam provisions. The False Claims Act imposes liability on any
person or entity who, among other things, knowingly presents, or causes to be
presented, a false or fraudulent claim for payment by a federal health care
program. The qui tam provisions of the False Claims Act allow a private
individual to bring actions on behalf of the federal government alleging that
the defendant has submitted a false claim to the federal government and to
share in any monetary recovery. In recent years, the number of suits brought
against health care providers by private individuals has increased
dramatically. In addition, various states have enacted false claim laws
analogous to the Civil False Claims Act, although many of these state laws
apply where a claim is submitted to any third-party payer and not merely a
federal health care program.

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When
an entity is determined to have violated the False Claims Act, it may be
required to pay up to three times the actual damages sustained by the
government, plus civil penalties of between $5,500 to $11,000 for each separate
false claim. There are many potential bases for liability under the False
Claims Act. Liability arises, primarily, when an entity knowingly submits, or
causes another to submit, a false claim for reimbursement to the federal
government. The False Claims Act has been used to assert liability on the basis
of inadequate care, kickbacks and other improper referrals, and improper use of
Medicare numbers when detailing the provider of services, in addition to the
more predictable allegations as to misrepresentations with respect to the
services rendered. In addition, companies have been prosecuted under the False
Claims Act in connection with alleged off-label promotion of products. Our
future activities relating to the reporting of wholesale or estimated retail
prices for our products, the reporting of discount and rebate information and
other information affecting federal, state and third-party reimbursement of our
products, and the sale and marketing of our products, may be subject to
scrutiny under these laws. We are unable to predict whether we would be subject
to actions under the False Claims Act or a similar state law, or the impact of
such actions. However, the costs of defending such claims, as well as any
sanctions imposed, could significantly affect our financial performance.

HIPAA and Other
Fraud and Privacy Regulations

Among
other things, the Health Insurance Portability and Accountability Act of 1996,
or HIPAA, created two new federal crimes: health care fraud and false
statements relating to health care matters. The HIPAA health care fraud statute
prohibits, among other things, knowingly and willfully executing, or attempting
to execute, a scheme to defraud any health care benefit program, including
private payers. A violation of this statute is a felony and may result in
fines, imprisonment and/or exclusion from government-sponsored programs. The
HIPAA false statements statute prohibits, among other things, knowingly and
willfully falsifying, concealing or covering up a material fact or making any
materially false, fictitious or fraudulent statement or representation in
connection with the delivery of or payment for health care benefits, items or
services. A violation of this statute is a felony and may result in fines
and/or imprisonment.

In
addition to creating the two new federal health care crimes, regulations
implementing HIPAA also establish uniform standards governing the conduct of
certain electronic health care transactions and protecting the security and
privacy of individually identifiable health information maintained or
transmitted by health care providers, health plans and health care
clearinghouses, which are referred to as covered entities. Three standards
have been promulgated under HIPAAs regulations: the Standards for Privacy of
Individually Identifiable Health Information, which restrict the use and
disclosure of certain individually identifiable health information, the
Standards for Electronic Transactions, which establish standards for common
health care transactions, such as claims information, plan eligibility, payment
information and the use of electronic signatures, and the Security Standards,
which require covered entities to implement and maintain certain security
measures to safeguard certain electronic health information. Because we provide
our products directly to patients and bill third-party payers such as Medicare,
Medicaid, and insurance companies, we are a covered entity and must comply
with these standards. The government intended this legislation to reduce
administrative expenses and burdens for the health care industry; however, our
compliance with certain provisions of these standards entails significant costs
for us. Although the HIPAA regulations allow disclosure to medical device
companies for purposes of complying with FDA regulations, treatment, and
payment, HIPAA may have a chilling effect on disclosure in some cases, limiting
information that is available to us.

In
addition to federal regulations issued under HIPAA, some states have enacted
privacy and security statutes or regulations that, in some cases, are more
stringent than those issued under HIPAA. In those cases, it may be necessary to
modify our planned operations and procedures to comply with the more stringent
state laws. If we fail to comply with applicable state laws and regulations, we
could be subject to additional sanctions.

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Environmental Laws

We
are also subject to various environmental laws and regulations both within and
outside the U.S. Like other medical device companies, our operations involve
the use of substances regulated under environmental laws, primarily
manufacturing and sterilization processes. To the best of our knowledge at this
time, we do not expect that compliance with environmental protection laws will
have a material impact on our consolidated results of operations, financial
position, or cash flows.

Employees

As
of June 30, 2010, we employed 70 total employees, 66 of which are full-time
employees. Of our 70 employees, more than 30% are respiratory therapists who
are licensed by the appropriate state professional organization, including all
of the employees in our Patient Services Department and nearly all of our sales
representatives. In addition, we retain as independent contractors several
expert consultants, who assist with quality assurance, product development,
marketing, and international opportunities. We also retain over 300 respiratory
therapists and health care professionals on a non-exclusive independent contractor
basis to provide training to our customers in the U.S. Approximately 75% of
these independent contractors are credentialed by the National Board for
Respiratory Care as either Certified Respiratory Therapists or Registered
Respiratory Therapists. The remainder of these respiratory therapists are
licensed at the state level in fields such as respiratory care, nursing,
physical therapy and occupational therapy. We believe that providing our
customers with the opportunity to obtain support and training from health care
professionals underscores our commitment to professional service and high
quality.

None
of our employees is covered by a collective bargaining agreement. We believe
our relations with our employees are good.

Executive Officers of the Registrant

Set
forth below are the names, titles, periods of service, and business experience
of our executive officers.

|                 |  |    |     |                                       |       | 
|---------------- |  | -- | --- | ------------------------------------- | ----- | 
|Name             |  |    | Age |                                       | Title | 
|                 |  |    |     |                                      
|Robert D. Hansen |  | 70 |     | Chairman and Chief
 Executive Officer
|                 |  |    |     |                                      
|Terry Belford    |  | 59 |     | Chief Financial Officer              
|                 |  |    |     |                                      

Robert D. HansenChairman and Chief Executive
Officer

Mr.
Hansen co-founded Electromed in 1992 and is responsible for the strategic
direction and development of the Company. Mr. Hansen is also a co-founder and
is President and Chief Executive Officer of Hansen Engine Corporation, a
research and development company that provides research and development
services to Electromed. Mr. Hansen joined Hansen Engine Corporation in January
1983 and has over forty years of business leadership and investment industry
experience. Mr. Hansen devotes approximately 5% of his time attending to
matters related to Hansen Engine Corporation where he is primarily responsible
for corporate governance matters through his service as a member of Hansen
Engine Corporations board of directors. He was also the founder and CEO of
LockerMate Corporation until January 1995. Mr. Hansen received a BA Degree from
Dana College (1964), Masters of Arts Degree from the University of Cincinnati in
U.S. History (1966), and a Masters of Divinity Degree (1976) from Luther Theological
Seminary. He completed additional graduate studies in U.S. economic history and
foreign policy at the University of Cincinnati. In 1996, Mr. Hansen was awarded
a Mini-MBA in Managing Growing Companies from the University of St. Thomas.
Among other attributes, skills, experiences and qualifications, our Board
believes that Mr. Hansens history with Electromed and management and
investment industry experience allow him to make a valuable contribution as a
director. Mr. Hansen is the brother of Craig Hansen, one of our directors.

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Terry M. Belford, CPA, CMAChief Financial
Officer

Mr.
Belford joined Electromed in January 2004 as its Chief Financial Officer.
Before joining Electromed, Mr. Belford worked for ten years as an independent
accountant and consultant, serving clients in the distributing, importing, and
manufacturing industries. Prior to that he served for several years as a
controller and chief financial officer for both established and start-up
companies in the above mentioned industries. Mr. Belford earned a Bachelor of
Science degree from the University of Missouri and also holds both CPA and CMA
designations. He is a member of the American Institute of Certified Public
Accountants, the Minnesota Society of Certified Public Accountants and the
Institute of Certified Management Accountants.

Item 1A. Risk
Factors.

As
a smaller reporting company, we are not required to provide disclosure pursuant
to this item.

Item 1B.
Unresolved Staff Comments.

As
a smaller reporting company, we are not required to provide disclosure pursuant
to this item.

Item 2.
Properties.

We
own our principal headquarters and manufacturing facilities, consisting of
approximately 24,000 total square feet, which are located on an approximately
2.3 acre parcel at 500 Sixth Avenue NW, New Prague, Minnesota 56071 and 502
Sixth Avenue NW, New Prague, Minnesota 56071. Management considers the current
facilities to be satisfactory for our growth plans. In addition, we believe
there is sufficient space within the lot in New Prague for additions to the
most recently constructed building.

Our
site has been regularly audited by the FDA, in accordance with FDA practices,
and we maintain our operations in a manner consistent with FDA requirements for
a medical device manufacturer. Our manufacturing processes are maintained in
such a way as to emphasize simplicity, cost-effectiveness, and a capacity to realize
increases in production volume with escalation in demand.

Item 3. Legal
Proceedings.

Our
industry is characterized by the existence of a large number of patents and
trademarks and frequent litigation based on assertions of patent and trademark
infringement. Hill-Rom Services, Inc., ARI, Hill-Rom Company, Inc. and Hill-Rom
Services Pte. Ltd. (collectively, Hill-Rom), subsidiaries of Hill-Rom
Holdings, Inc., brought an action on August 21, 2009, against us in the
Southern District of Indiana alleging that our use of the term SmartVest
infringes on its alleged trademarks The Vest and Vest. We answered the
allegations and brought counter-claims against Hill-Rom alleging, among other
things, defamation and libel. On September 16, 2010, we reached
a settlement in principle with respect to our litigation with Hill-Rom.
The terms of the settlement are confidential. We expect to enter a definitive
settlement agreement within the next month and anticipate that a stipulation of
dismissal will be filed at that time. The Company has no plans to change its
use of the SmartVest marks.

In
addition to the foregoing, we may be party to legal actions, proceedings, or
claims in the ordinary course of business. Corresponding costs are accrued when
it is more likely than not that loss will be incurred and the amount can be
precisely or reasonably estimated. We are not aware of any undisclosed actual or
threatened litigation that would have a material adverse effect on our
financial condition or results of operations.

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Item 4. (Removed
and Reserved).

PART II

Item 5. Market
for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.

Market Information

Our
common stock began trading on the NASDAQ Capital Market on August 13, 2010
under the symbol ELMD in connection with our initial public offering. Our
stock was not publicly traded during fiscal 2010.

As
of June 30, 2010, there were 198 registered holders of our common stock.

Dividends

We
have never paid cash dividends on any of our securities. We currently intend to
retain any earnings for use in operations and do not anticipate paying cash
dividends in the foreseeable future. Currently, the agreement governing our
credit facility restricts our ability to pay cash dividends.

Recent Sales of Unregistered Equity
Securities

In
August 2009, we issued an aggregate of 13,733 shares of common stock to 19
accredited investors pursuant to warrant exercises, for aggregate cash
consideration of approximately $34,333.

In
August 2009, we issued 5,000 shares of common stock to an employee pursuant to
a warrant exercise, for aggregate cash consideration of $15,000.

In
September 2009, we issued 5,000 shares of common stock to a service provider
in exchange for services.

In
December 2009 and January 2010, we issued warrants to purchase an aggregate of
10,000 shares of common stock to 2 employees. The warrants vest in full one
year from the date of issuance, have a four-year term and have an exercise
price of $4.50 per share.

In
November 2009, we issued 12,000 shares of common stock to an employee pursuant
to a warrant exercise, for cash consideration of $24,000.

From
April 2010 to June 2010, we issued warrants to purchase an aggregate of 15,000
shares of common stock to 3 employees. The warrants vest in full one year from
the date of issuance, have a four-year term and have an exercise price of $4.50
per share.

In
June 2010, we issued 100,000 shares of common stock to an employee pursuant to
a warrant exercise, for cash consideration of $300,000.

In
June 2010, we issued 5,000 shares of common stock to a service provider
pursuant to a warrant exercise, for cash consideration of $17,500.

Purchase of Equity Securities by the Company

None.

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Use of Proceeds

We
completed our initial public offering of shares of common stock, $0.01 par value
(the Offering) during the first quarter of our 2011 fiscal year. The
effective date of our registration statement relating to the Offering, filed on
Form S-1 under the Securities Act of 1933 (File No. 333-166470), was August 12,
2010. A total of 1,700,000 shares of our common stock were registered and sold
in the Offering. In addition, we granted Feltl and Company, Inc. (Feltl), the
underwriter of the Offering, warrants to purchase up to 170,000 additional
shares of our common stock at a price of $4.80 per share and an over-allotment
option to purchase 255,000 shares at $4.00 per share, less an underwriting
discount of $0.30 per share. On September 23, 2010, Feltl provided notice of
its intent to acquire 200,000 additional shares of our common stock
pursuant to exercise of its over-allotment option. As a result of this
exercise, Feltl will also receive warrants to purchase up to 20,000 additional
shares of our common stock.

The
aggregate offering price of our securities sold, including the shares sold to
Feltl upon exercise of its overallotment option, equals $7,600,000. The
aggregate underwriting discount for shares sold in the offering and
pursuant to the overallotment option equals $570,000, none of which was or will
be paid to our affiliates. We incurred approximately $1,040,000 of offering
costs in connection with the Offering. We expect to receive net proceeds from
this Offering of approximately $5,990,000. We have used $500,000 to reduce the
amount of our existing indebtedness under our credit facility with U.S. Bank,
National Association. We have used and intend to use the remainder of the
proceeds from the offering to add employees to our Reimbursement, Patient
Services and Administrative Departments; add members to our sales force and
further develop our focus on institutional sales; continue our research and
development efforts; and for general corporate purposes, including to finance
equipment purchases and other capital expenditures in the ordinary course of
business and to satisfy working capital needs.

Item 6. Selected
Financial Data.

As
a smaller reporting company, we are not required to provide disclosure pursuant
to this item.

Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements and the
accompanying notes included elsewhere in this Report. The forward-looking
statements include statements that reflect managements beliefs, plans,
objectives, goals, expectations, anticipations and intentions with respect to
our future development plans, capital resources and requirements, results of
operations, and future business performance. Our actual results could differ
materially from those anticipated in the forward-looking statements included in
this discussion as a result of certain factors, including, but not limited to,
those discussed in the section entitled Information Regarding Forward-Looking
Statements immediately preceding Part I of this Report.

Overview

Electromed,
Inc. was incorporated in 1992. We are engaged in the business of providing
innovative airway clearance products applying High Frequency Chest Wall Oscillation
(HFCWO) technologies in pulmonary care for patients of all ages.

We
manufacture, market and sell products that provide HFCWO, including the
SmartVest® Airway Clearance System (SmartVest System) and related products,
to patients with compromised pulmonary function. Our products are sold for both
the home health care market and the institutional market for use by patients in
hospitals, which we refer 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 repeated episodes of pneumonia. Additionally, we
offer our products 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.

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Because
sale of the SmartVest System is by a physicians prescription only, we focus
our marketing efforts on physicians as well as directly to patients. In
addition to distributors overseas, we have established our own domestic sales
force, nearly all of whom are respiratory therapists, who we believe are able
to provide superior support and training to our customers. In addition, we have
non-exclusive independent contractor arrangements with over 300 respiratory
therapists and health care professionals who also provide education and
training to our customers. Further, although the reimbursement process is
subject to many contingencies, the SmartVest System is often eligible for
reimbursement from major private insurance providers, HMOs, state Medicaid
systems, and the federal Medicare system, which is an important consideration
for patients considering an HFCWO course of therapy. We believe that our
SmartVest System has created a solid foundation to support our entry into larger
markets for airway clearance therapy.

The
SmartVest System may be reimbursed under the Medicare-assigned billing code for
High Frequency Chest Wall Oscillation devices if the patient has cystic
fibrosis, bronchiectasis (including chronic bronchitis or COPD that has
resulted in a diagnosis of bronchiectasis), or any one of certain enumerated
neuro-muscular diseases, and can demonstrate that another less expensive
physical or mechanical treatment did not adequately mobilize retained secretions.
Private payers consider a variety of sources, including Medicare, as guidelines
in setting their coverage policies and payment amounts.

We
have been generating revenue from the sale of our SmartVest System or its
predecessor products since 2000 and have generated net income since the fiscal
year ended June 30, 2006. For the fiscal year ended June 30, 2010, we generated
revenue of approximately $14,300,000 and net income of approximately $916,000.
Our sales growth rate was 10.0% for the 2010 fiscal year compared to the 2009
fiscal year and was 48.5% for the 2009 fiscal year compared to the 2008 fiscal
year. Management believes the decrease in net income in dollars and as a
percentage of revenues was primarily the result of certain events that restricted
managements available time to recruit additional sales representatives and
distributors, combined with increased expenditures on sales and marketing and
increased research and development expense. The events that drew the focus of
management included a 60-day suspension in all of Medicare reimbursements
(which was favorably resolved on December 4, 2009), securing a new bank
financing facility, and the Companys initial public offering. Management was
also required to address a trademark lawsuit initiated by a competitor (see
Part I, Item 3, Legal Proceedings).

Critical Accounting Policies and Estimates

During
the preparation of our consolidated financial statements, we are required to
make estimates, assumptions and judgments that affect reported amounts. Those
estimates and assumptions affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities, and the
reported revenues and expenses. We update these estimates, assumptions and
judgments as appropriate, which in most cases is at least quarterly. We use our
technical accounting knowledge, cumulative business experience, judgment and
other factors in the selection and application of our accounting policies.
While we believe the estimates, assumptions and judgments we use in preparing
our consolidated financial statements are appropriate, they are subject to
factors and uncertainties regarding their outcome and therefore, actual results
may materially differ from these estimates. The following is a summary of our
primary critical accounting policies and estimates. Please also refer to Note 1
to the Consolidated Financial Statements, included in Part II, Item 8 of this
Report.

Revenue Recognition
and Allowance for Doubtful Accounts

Revenues
from direct patient sales are recorded at the amount to be received from
patients under their arrangements with third-party payers, including private
insurers, prepaid health plans, Medicare and Medicaid. In addition, we record
an estimate for selling price adjustments which often arise from changes in a
patients insurance coverage, changes in a patients state of domicile,
insurance company coverage limitations or patient death. We periodically review
originally billed amounts and our collection history and make changes
to the estimation process by considering any changes in recent collection or
sales allowance experience, but have not made material adjustments to
previously recorded revenues and receivables.

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Other
than the installment sales as discussed below, we expect to receive payment on
the vast majority of accounts receivable within one year and therefore classify
all receivables as current assets. However, in some instances, payment for
direct patient sales can be delayed or interrupted resulting in a small portion
of collections occurring later than one year. In the event receivables are
expected to be paid over longer intervals than one year, we recognize revenue
under the installment method.

Certain
third-party reimbursement agencies pay us on a monthly installment basis, which
can span from 18 to 60 months in the cases of Wisconsin, New York and Texas
Medicaid, which constitute the majority of our installment method sales. Due to
the length of time over which reimbursement is received, we believe that the
inherent uncertainty of collection due to external factors noted above
precludes us from making a reasonable estimate of revenue at the time the
product is shipped. In certain circumstances, the patient must periodically
attest that the unit continues to be utilized as a prerequisite to continued
reimbursement coverage. Therefore, we believe the installment method is
appropriate for these sales. If the third party reimbursement agency
discontinues payment and we determine no further payments will be made from the
patient, the carrying value of the account receivable is written off as a
period adjustment against the previously recognized sales. Under the
installment method, we do not record accounts receivable or revenue at the time
of product shipment. We defer and amortize the costs associated with the sale
and, as each installment is received, that amount is recognized as revenue.
Deferred costs associated with the sale are amortized to cost of revenue
ratably over the estimated period in which collections are scheduled to occur.

Accounts
receivable are also net of an allowance for doubtful accounts, which are
accounts from which payment is not expected to be received although product was
provided and revenue was earned. Management determines the allowance for
doubtful accounts by regularly evaluating individual customer receivables and
considering a customers financial condition and credit history. Receivables
are written off when deemed uncollectible. Recoveries of receivables previously
written off are recorded when received.

We
request that customers return to us previously-sold units that are no longer in
use, in order to limit the possibility that such units would be resold by
unauthorized parties or used by individuals without a prescription. The
customer is under no obligation to return the product; however, we do reclaim
the majority of previously sold units upon the discontinuance of patient usage.
We have not obtained certification to recondition and resell returned units.
Returned units are primarily used for warranty replacement parts and
demonstration equipment. Returned products do not have significant value to us
as the costs of becoming certified to resell, reclamation and reconditioning
typically exceed the costs of producing a new unit.

Valuation of
Long-lived and Intangible Assets

Long-lived
assets, such as property and equipment and finite-life intangible assets are
evaluated for impairment whenever events or changes in circumstances indicate
the carrying value of an asset may not be recoverable. In evaluating
recoverability, the following factors, among others, are considered: a
significant change in the circumstances used to determine the amortization
period, an adverse change in legal factors or in the business climate, a
transition to a new product or service strategy, a significant change in
customer base, and a realization of failed marketing efforts. The
recoverability of an asset is measured by a comparison of the unamortized
balance of the asset to future undiscounted cash flows. If we believe the
unamortized balance is unrecoverable, we would recognize an impairment charge
necessary to reduce the unamortized balance to the estimated fair value of the
asset. The amount of such impairment would be charged to operations at the time
of determination.

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Property
and equipment are stated at cost less accumulated depreciation. We use the
straight-line method for depreciating property and equipment over their estimated
useful lives, which range from 3 to 39 years. Our finite-life intangibles
consist of patents and trademarks and their carrying costs include the original
cost of obtaining the patents, periodic renewal fees, and other costs
associated with maintaining and defending
patent and trademark rights. Patents and trademarks are amortized over their
estimated useful lives, generally 15 and 12 years using the straight-line
method. During the year ended June 30, 2010 we incurred legal defense costs associated
with a trademark infringement lawsuit filed against us (see Note 9 to the
Consolidated Financial Statements included in Part II, Item 8 of this Report).
Such legal defense costs are being capitalized and amortized over the remaining
useful life of the trademark. In the event we are unsuccessful in defending our
trademark, such capitalized legal defense costs of approximately $880,000 as of
June, 2010 will be immediately expensed. We expect future amortization expense
to increase as we incur additional costs associated with our patents and
trademarks, including the trademark defense costs.

Allowance for Excess
and Slow-moving Inventory

An
allowance for potentially slow-moving or excess inventories is made based on
our analysis of inventory levels on hand and comparing it to expected future
production requirements, sales forecasts and current estimated market values.

Income Taxes

We
recognize deferred tax assets and liabilities based on the differences between
the financial statement carrying amounts and the tax basis of assets and
liabilities. We provide a valuation allowance for deferred tax assets if we
determine, based on the weight of available evidence, that it is more likely
than not that some or all of the deferred tax assets will not be realized.

Warranty Reserve

We
provide a lifetime warranty on products sold to patients in the United States
and Canada, a three-year warranty for institutional sales within the United
States and Canada, a five-year warranty on products sold to patients in Greece,
and a three-year warranty on all other sales to individuals and institutions
outside of the United States and Canada. We estimate, based upon a review of
historical warranty claim experience, the costs that may be incurred under our
warranty policies and record a liability in the amount of such estimate at the
time a product is sold. The warranty cost is based upon future product
performance and durability, and is estimated largely based upon historical
experience. We estimate the average useful life of our products to be
approximately five years. Factors that affect our warranty liability include
the number of units sold, historical and anticipated rates of warranty claims,
the product useful life, and cost per claim. At our discretion, based upon the
cost to either repair or replace a product, we have occasionally replaced such
products covered under warranty with a new model. We periodically assess the
adequacy of our recorded warranty liability and make adjustments to the accrual
as claim data and historical experience warrant.

Share-Based
Compensation

Share-based
payment awards consist of warrants issued to employees for services, and to
nonemployees in lieu of cash payment for products or services. Expense is
estimated using the Black-Scholes pricing model at the date of grant and the
portion of the award that is ultimately expected to vest is recognized on a
straight-line basis over the requisite service or vesting period of the award.
In determining the fair value of our share-based payment awards, we make
various assumptions when using the Black-Scholes pricing model including
expected risk free interest rate, stock price volatility, life and forfeitures.

Results of Operations

Fiscal Year Ended
June 30, 2010 Compared to Fiscal Year Ended June 30, 2009

Revenues

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

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|                                  |  |                               |        |  |                      |   |        |  |  |    |       |   |  |  |       |   
|--------------------------------- |  | ----------------------------- | ------ |  | -------------------- | - | ------ |  |  | -- | ----- | - |  |  | ----- | --
|                                  |  | Twelve
 Months Ended June 30, |        |  | Increase
 (Decrease) |  
|                                  |  | 2010                          |        |  | 2009                 |   |        | 
|Total
 Revenue                    |  | $                             | 14,304 |  |                      | $ | 12,999 |  |  | $  | 1,305 |   |  |  | 10.0  | % 
|                                  |  |                               |        |  |                      |   |        |  |  |    |       |   |  |  |       |   
|Home Care
 Revenue                |  | $                             | 13,109 |  |                      | $ | 11,651 |  |  | $  | 1,458 |   |  |  | 12.5  | % 
|                                  |  |                               |        |  |                      |   |        |  |  |    |       |   |  |  |       |   
|International
 Revenue            |  | $                             | 647    |  |                      | $ | 919    |  |  | ($ | 272   | ) |  |  | (29.6 | %)
|                                  |  |                               |        |  |                      |   |        |  |  |    |       |   |  |  |       |   
|Government/Institutional
 Revenue |  | $                             | 548    |  |                      | $ | 429    |  |  | $  | 119   |   |  |  | 27.7  | % 
|                                  |  |                               |        |  |                      |   |        |  |  |    |       |   |  |  |       |   

Home
Care Revenue. Our home care revenue increased by 12.5% or approximately
$1,458,000 in fiscal 2010 compared to fiscal 2009. This primarily resulted from
a 17% increase in referrals, from 1,773 in 2009 to 2,076 in 2010, and a 19%
increase in approvals, from 1,108 in 2009 to 1,323 in 2010. We attribute this
increase primarily to an increase in productivity by our existing sales staff
as they continued to expand and strengthen their relationships with customers.
In addition, we employed approximately 36% more sales representatives as of
June 30, 2010 as compared to June 30, 2009. The increase to our sales force
facilitated higher revenues through deeper penetration of the market.

International
Revenue. International
revenue decreased by 29.6% in fiscal 2010, or $272,000. Revenue from sales in
Greece was down by $193,000, from $206,000 in fiscal 2009 to $13,000 in 2010,
and revenue from sales in Spain was down by $59,000, from $123,000 in 2009 to
$64,000 in 2010. This reflects the reductions in health care spending
instituted by those governments concerning purchases of medical devices.
Revenue from sales in Japan also decreased by $89,000, from $217,000 in 2009 to
$128,000 in 2010. Revenue from sales in Italy increased by $92,000, to $315,000
in 2010 compared to $223,000 in 2009, as our distributor continued to make
inroads into that market.

Government/Institutional
Revenue. Revenue
from government institutions increased to approximately $124,000 in fiscal
2010, compared to approximately $116,000 in fiscal 2009. Institutional revenue
rose by $111,000, to approximately $424,000 in 2010 compared to approximately
$313,000 in 2009, reflecting increased sales to hospital group purchasing
organizations resulting from targeted sales and marketing efforts. Revenue from
institutional sales of the SmartVest Wrap increased by $79,000, to
approximately $169,000 in fiscal 2010 compared to approximately $90,000 in
fiscal 2009 reflecting the popularity and acceptance of that product. We
believe the SmartVest Wrap, along with our Single Patient Use Vest, provide
synergies with our home care SmartVest System, because they introduce the
hospital patient to our product line and make it more likely that patients will
continue to use our products for subsequent in-home care.

Gross Profit

Gross
profit increased to $10,600,000, or 74.1% of net revenues, for the fiscal year
ended June 30, 2010, from approximately $9,700,000 million, or 74.3% of net
revenues, for the fiscal year ended June 30, 2009. The increase in gross profit
resulted primarily from the increase in sales volume.

Operating expenses

Selling,
general and administrative expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2010 were
approximately $8,200,000, compared to approximately $6,800,000 for the same
period in the prior year. Travel, meals and entertainment, and trade show
expenses were $209,000 higher in fiscal 2010 than in 2009,
an increase of 22%. This increase reflects the 23% increase in the average
number of sales representatives in 2010 compared to 2009. SG&A payroll and
compensation related expenses increased by 21%, or approximately $664,000, to
$3,790,000 million in fiscal 2010, compared to $3,126,000 in fiscal 2009. This
increase reflects a 34% increase in total employees from an average of 44
employees in 2009 compared to an average of 59 employees in 2010. Health
insurance costs for SG&A employees rose by $146,000, or 43%, to $484,000 in
2010, compared to $338,000 in 2009. This increase resulted from a combination
of a 15% rate increase, and an increase in the number of employees
participating in the health insurance plan. Advertising and marketing expenses
for the fiscal year ended June 30, 2010 increased $237,000 to approximately
$904,000 in fiscal 2010 from $667,000 in fiscal 2009, or approximately 35.5%.
These expenditures related to providing marketing support to a larger sales
team.

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Research
and development expenses.Research and development expenses were approximately
$601,000 and $358,000 for the fiscal years ended June 30, 2010 and 2009,
respectively. The increase was related to various research projects that began
in fiscal 2009 and related to system design and performance, development of new
colored therapy garments and a new disposable hose for the SmartVest System.
Research and development costs in 2010 were 4.2% of revenue, as a result of our
continued investments in enhancing our products. We expect research and
development expense to increase to approximately 5% or greater of revenue in
the future.

Interest
expense

Interest
expense decreased to approximately $263,000 in fiscal 2010, compared to
$270,000 in fiscal 2009. The decrease was due to a combination of a decrease in
average debt outstanding due to payments on term loans and lower average
interest rates on outstanding debt, offset by amortization of loan charges of
approximately $53,000 in fiscal 2010 compared to approximately $10,000 of loan
charges in fiscal 2009.

Income tax expense

Income
tax expense was approximately $599,000 in fiscal 2010, compared to
approximately $830,000 in the 2009 fiscal year. In fiscal 2010, our income tax
expense was down as a result of lower pre-tax income. The effective income tax
rate in 2010 was approximately 39.5% compared to approximately 38.5% in 2009.
The increase in the effective rate was due to increases in non-deductible
expenses as a percentage of pre-tax income in 2010 over 2009.

Net income

Net
income for the twelve months ended June 30, 2010 was approximately $916,000, or
6.4% of revenues, compared to approximately $1,333,000, or 10.3% of revenues,
in the same period in fiscal 2009. The decrease in net income in dollars and as
a percentage of revenues was primarily the result of certain events that
restricted managements available time to recruit additional sales representatives
and distributors, combined with increased expenditures on sales and marketing
and increased research and development expense, as noted above. The events that
drew the focus of management included a 60-day suspension of all Medicare
reimbursements (which was favorably resolved on December 4, 2009), the of
securing a new bank financing facility, and the Companys initial public
offering. Management was also required to address a trademark lawsuit initiated
by a competitor (see Part I, Item 3, Legal Proceedings).

Liquidity and Capital Resources

Cash Flows and
Sources of Liquidity

We
currently have a credit facility with U.S. Bank, National Association (U.S.
Bank) that provides for a $3,500,000 revolving line of credit and $2,520,000
in term debt. A $1,520,000 term loan bears interest at 5.79% (Term Loan A).
The remaining $1,000,000 term loan bears interest at 4.28% (Term Loan B). The
operating line of credit has an interest rate of LIBOR plus 2.75%. The amount
eligible for borrowing on our line of credit is limited to 60 percent of
eligible accounts receivable less the outstanding balance on our Term Loan
B. The operating line of credit requires monthly payments of interest due and
has a maturity date of November 30, 2010, which we expect will be renewed. Term
Loan A requires monthly payments of principal and interest of approximately
$10,700 and has a maturity date of December 9, 2014. Term Loan B requires
monthly payments of principal and interest of approximately $29,600 and has a
maturity date of December 9, 2012. Our obligations under the U.S. Bank credit
facility are secured by substantially all of our assets and are guaranteed by
our wholly-owned subsidiary, Electromed Financial, LLC. As of June 30, 2010, we
had $1,768,000 outstanding on the operating line of credit and $2,309,000
outstanding on the term debt for a total outstanding under the U.S. Bank credit
facility of $4,077,000. As of June 30, 2010, we had net unused availability of
$883,000 under our line of credit.

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The
agreement governing the credit facility contains certain covenants that
restrict our ability to, among other things, pay cash dividends, incur
indebtedness or liens, change Chief Executive Officer or Chief Financial
Officer, merge or consolidate with any person, or sell, lease, assign, transfer
or otherwise dispose of any assets other than in the ordinary course of
business. The agreement also contains financial covenants that require
maintenance of certain fixed charge and cash flow leverage ratios.

Subsequent
to the end of our 2010 fiscal year, on August 13, 2010, we completed an initial
public stock offering (IPO) of 1,700,000 shares of common stock, par value
$0.01 per share, at an offering price of $4.00 per share. In addition, we
received notice on September 23, 2010 that the underwriter in the IPO would
acquire an additional 200,000 pursuant to exercise of a portion of its
over-allotment option. After deducting the payment of underwriting discounts
and commissions and offering expenses, we expect the net proceeds from the sale
of shares in our IPO and pursuant to the over-allotment option to be
approximately $5,990,000. The terms of the U.S. Bank credit facility require us
to immediately prepay the outstanding loan amounts to the extent of net
proceeds received from any equity offering. Management discussed this
requirement with U.S. Bank prior to closing the IPO. U.S. Bank agreed to waive
this requirement in connection with the IPO and granted a formal waiver on
September 23, 2010, as discussed in Note 11 to the Consolidated Financial
Statements, contained in Part II, Item 8 of this Report.  See Part II, Item 5, Market for
Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities, for a discussion of our use of the IPO proceeds.

Cash
Flows from Operating Activities

For
the fiscal year ended June 30, 2010, our net cash provided by operating
activities was approximately $608,000. Cash flows provided by operations were
primarily a result of net income adjusted for non-cash expenses offset by
approximately $229,000, $292,000 and $111,000 increases in accounts receivable,
inventories, prepaid expenses and other current assets, respectively.

For
the fiscal year ended June 30, 2009, our net cash used by operating activities
was approximately $1,158,000. Our cash flows used by operations were primarily
the result of a decrease in accounts payable and accrued liabilities of
approximately $571,000 and an increase in accounts receivable of approximately
$2,419,000, driven by the increase in sales and timing differences associated
with collection of those sales, offset by net income adjusted for noncash
expenses.

Cash
Flows from Investing Activities

For
the fiscal year ended June 30, 2010 cash used in investing activities was
approximately $909,000. During the fiscal year ended June 30, 2010, we paid
approximately $515,000 in costs related to defending our SmartVest trademark,
$270,000 for purchases of property and equipment, and $125,000 for the purchase
of the minority interest in Electromed Financial, LLC.

For
the fiscal year ended June 30, 2009, cash used for investing activities was
$712,000. Cash of approximately $649,000 was used for expanding and equipping
our new manufacturing building and approximately $62,000 was used for payment
of patent costs.

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Cash Flows From Financing
Activities

For
the fiscal year ended June 30, 2010, cash provided by financing activities was
approximately $550,000. Short- and long-term borrowings during the period,
which includes borrowings under our U.S. Bank credit facility, were
approximately $4,288,000. The proceeds from the U.S. Bank credit facility were
primarily used to pay off the principal balance of existing debt. Proceeds from
the issuance of common stock were approximately $391,000. Offsetting the cash
provided by financing activities were principal payments on long-term debt of
approximately $3,649,000 and payments of $418,000 of deferred costs associated
with our public stock offering.

For
the fiscal year ended June 30, 2009, cash provided by financing activities was
approximately $790,000. Cash provided by financing activities was primarily
from long-term borrowings of approximately $1,027,000 and proceeds from the
issuance of common stock of approximately $364,000. Partially offsetting the
cash provided by financing activities were principal payments on long-term debt
of $641,000.

Adequacy of Capital
Resources

For
fiscal 2010 and 2009, we spent approximately $270,000 and $649,000 on property
and equipment, respectively. We currently expect to finance equipment purchases
with borrowings under our credit facility and cash flow from operations. We may
need to incur additional debt if we have an unforeseen need for additional
capital equipment or if our operating performance does not generate adequate
cash flow.

For
the twelve months ended June 30, 2010, we incurred and capitalized
approximately $880,000 of legal defense costs associated with our trademark
lawsuit. We reached a settlement in principle with respect to this lawsuit on
September 16, 2010. We expect to continue to incur costs in connection with
finalizing the settlement agreement. For additional information, see Part I,
Item 3, Legal Proceedings.

In
connection with the employment agreements we entered into with our Chief
Executive Officer and Chief Financial Officer on January 1, 2010, we may be
required to make cash payments to these officers if they resign following a
change in control or are terminated at any time without cause. With respect to
a resignation upon a change in control, the amount of the severance payment
would be equal to two times the annual base salary then in effect. With respect
to a termination without cause, the amount of the severance payment would be
equal to the base salary of the executive then in effect. In each instance, the
executive would also be entitled to a pro rata portion of any earned but unpaid
incentive compensation at the time of termination, the severance would be
payable in a lump sum within 60 days of the separation event, and the executive
would, in order to receive the severance and continued benefits, be required to
sign a release of claims against us, return all property owned by Electromed
and agree not to disparage us.

The
terms of the U.S. Bank credit facility require us to immediately prepay the
outstanding loan amounts the the extent of net proceeds received from any
equity offering. Management discussed this requirement with with U.S. Bank
prior to closing the initial public offering. U.S. Bank agreed to waive this
requirement in connection with the initial public offering and granted a formal
waiver in September 2010, as discussed in Note 11 to the Consolidated Financial
Statements, contained in Part II, Item 8 of this Report.

Based
on our current operational performance, we believe our cash flow from
operations, available cash and available borrowings under the existing credit
facility will adequately provide our liquidity needs for, at a minimum, the
next twelve months.

Certain Information Concerning Off-Balance
Sheet Arrangements

We
have no off-balance sheet arrangements.

- 36 -

---



Table of Contents

New Accounting Pronouncements

For
recently issued accounting pronouncements, see Note 1 to the Consolidated
Financial Statements, included in Part II, Item 8 of this Report.

Item 7A. Quantitative and Qualitative
Disclosures About Market Risk.

As a smaller
reporting company, we are not required to provide disclosure pursuant to this
item.

Item 8.
Financial Statements and Supplementary Data.

Index to Financial Statements

|                                                           |  |     
|---------------------------------------------------------- |  | ----
|                                                           |  | Page
|                                                           |  |     
|Report of Independent Registered Public
Accounting Firm    |  | F-1 
|                                                           |  |     
|Consolidated Balance Sheets                                |  | F-2 
|                                                           |  |     
|Consolidated Statements of Income                          |  | F-3 
|                                                           |  |     
|Consolidated Statements of Changes in Stockholders
Equity |  | F-4 
|                                                           |  |     
|Consolidated Statements of Cash Flows                      |  | F-5 
|                                                           |  |     
|Notes to Consolidated Financial statements                 |  | F-7 

- 37 -

---



Table of Contents

Report of Independent Registered Public Accounting
Firm

To the
Board of Directors and Stockholders
Electromed, Inc. and Subsidiary

We have
audited the accompanying consolidated balance sheets of Electromed, Inc. and
Subsidiary as of June 30, 2010 and 2009, and the related consolidated
statements of income, stockholders equity, and cash flows for the years then
ended. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Electromed, Inc.
and Subsidiary as of June 30, 2010 and 2009, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.

Minneapolis,
MinnesotaSeptember 28,
2010

F-1

---



Table of Contents

Electromed, Inc.
and Subsidiary
Consolidated Balance Sheets
June 30, 2010 and 2009

|                                                                                                                                   |  |         |            |      |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | ------- | ---------- | ---- | - | ---------- | -
|                                                                                                                                   |  | June 30 |           
|                                                                                                                                   |  | 2010    |            | 2009 |  
|Assets                                                                                                                             |  |         |            |      |   |            |  
|Current Assets                                                                                                                     |  |         |            |      |   |            |  
|Cash                                                                                                                               |  | $       | 610,727    |      | $ | 361,916    |  
|Accounts receivable (net of allowances for
doubtful accounts of $45,000)                                                           |  |         | 6,577,002  |      |   | 6,348,146  |  
|Inventories                                                                                                                        |  |         | 1,470,775  |      |   | 1,178,689  |  
|Prepaid expenses and other current assets                                                                                          |  |         | 269,193    |      |   | 167,272    |  
|Deferred income taxes                                                                                                              |  |         | 514,000    |      |   | 357,000    |  
|Total current assets                                                                                                               |  |         | 9,441,697  |      |   | 8,413,023  |  
|Property and equipment, net                                                                                                        |  |         | 2,688,941  |      |   | 2,731,269  |  
|Finite-life intangible assets, net                                                                                                 |  |         | 1,055,776  |      |   | 228,783    |  
|Deferred common stock offering costs                                                                                               |  |         | 828,034    |      |   | -          |  
|Other assets                                                                                                                       |  |         | 128,789    |      |   | 88,023     |  
|Total assets                                                                                                                       |  | $       | 14,143,237 |      | $ | 11,461,098 |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Liabilities and Stockholders Equity                                                                                               |  |         |            |      |   |            |  
|Current Liabilities                                                                                                                |  |         |            |      |   |            |  
|Revolving line of credit                                                                                                           |  | $       | 1,768,128  |      | $ | -          |  
|Current maturities of long-term debt                                                                                               |  |         | 397,886    |      |   | 392,251    |  
|Accounts payable                                                                                                                   |  |         | 1,239,827  |      |   | 426,320    |  
|Accrued compensation                                                                                                               |  |         | 665,083    |      |   | 541,125    |  
|Warranty reserve                                                                                                                   |  |         | 363,277    |      |   | 292,254    |  
|Other accrued liabilities                                                                                                          |  |         | 60,308     |      |   | 111,879    |  
|Income taxes payable                                                                                                               |  |         | 7,789      |      |   | 334,031    |  
|Total current liabilities                                                                                                          |  |         | 4,502,298  |      |   | 2,097,860  |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Long-term debt, less current maturities                                                                                            |  |         | 2,033,325  |      |   | 3,167,496  |  
|Deferred income taxes                                                                                                              |  |         | 145,000    |      |   | 137,000    |  
|Total liabilities                                                                                                                  |  |         | 6,680,623  |      |   | 5,402,356  |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Commitments and Contingencies (Note 9)                                                                                             |  |         |            |      |   |            |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Stockholders Equity                                                                                                               |  |         |            |      |   |            |  
|Electromed, Inc. stockholders equity:                                                                                             |  |         |            |      |   |            |  
|Common stock, $0.01 par value; authorized:
10,000,000 shares; issued and outstanding: 6,187,885 and 6,047,152 shares,
respectively |  |         | 61,879     |      |   | 60,472     |  
|Additional paid-in capital                                                                                                         |  |         | 6,685,362  |      |   | 6,201,636  |  
|Retained earnings (deficit)                                                                                                        |  |         | 797,873    |      |   | (118,465   | )
|                                                                                                                                   |  |         |            |      |   |            |  
|Common stock subscriptions receivable for
shares outstanding of 48,500 and 53,500 respectively                                     |  |         | (82,500    | )    |   | (91,500    | )
|                                                                                                                                   |  |         |            |      |   |            |  
|Total Electromed, Inc. stockholders equity                                                                                        |  |         | 7,462,614  |      |   | 6,052,143  |  
|Noncontrolling interest                                                                                                            |  |         | -          |      |   | 6,599      |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Total stockholders equity                                                                                                         |  |         | 7,462,614  |      |   | 6,058,742  |  
|                                                                                                                                   |  |         |            |      |   |            |  
|Total liabilities and stockholders equity                                                                                         |  | $       | 14,143,237 |      | $ | 11,461,098 |  

See Notes to Consolidated Financial
Statements.


F-2


---



Table of Contents

Electromed, Inc.
and Subsidiary
Consolidated Statements of Income
Years Ended June 30, 2010 and 2009

|                                                                           |  |                     |            |      |   |            |  
|-------------------------------------------------------------------------- |  | ------------------- | ---------- | ---- | - | ---------- | -
|                                                                           |  | Years Ended June 30 |           
|                                                                           |  | 2010                |            | 2009 |  
|                                                                           |  |                     |            |      |   |            |  
|Net revenues                                                               |  | $                   | 14,303,848 |      | $ | 12,998,627 |  
|Cost of revenues                                                           |  |                     | 3,707,509  |      |   | 3,340,041  |  
|Gross profit                                                               |  |                     | 10,596,339 |      |   | 9,658,586  |  
|                                                                           |  |                     |            |      |   |            |  
|Operating expenses                                                         |  |                     |            |      |   |            |  
|Selling, general and administrative                                        |  |                     | 8,199,386  |      |   | 6,845,106  |  
|Research and development                                                   |  |                     | 600,986    |      |   | 357,871    |  
|Total operating expenses                                                   |  |                     | 8,800,372  |      |   | 7,202,977  |  
|Operating income                                                           |  |                     | 1,795,967  |      |   | 2,455,609  |  
|                                                                           |  |                     |            |      |   |            |  
|Interest expense, net of interest income of
$6,417 and $8,746 respectively |  |                     | 263,431    |      |   | 270,446    |  
|Net income (loss) before income taxes                                      |  |                     | 1,532,536  |      |   | 2,185,163  |  
|                                                                           |  |                     |            |      |   |            |  
|Income tax expense                                                         |  |                     | (599,000   | )    |   | (830,000   | )
|Net income                                                                 |  |                     | 933,536    |      |   | 1,355,163  |  
|Less: Net income attributable to
noncontrolling interest                   |  |                     | (17,198    | )    |   | (22,257    | )
|Net income attributable to Electromed, Inc.                                |  | $                   | 916,338    |      | $ | 1,332,906  |  
|                                                                           |  |                     |            |      |   |            |  
|Earnings per share attributable to
Electromed, Inc. common shareholders:   |  |                     |            |      |   |            |  
|Basic                                                                      |  | $                   | 0.15       |      | $ | 0.22       |  
|Diluted                                                                    |  |                     | 0.15       |      |   | 0.22       |  
|                                                                           |  |                     |            |      |   |            |  
|                                                                           |  |                     |            |      |   |            |  
|Weighted-average Electromed, Inc. common
shares outstanding:               |  |                     |            |      |   |            |  
|Basic                                                                      |  |                     | 6,081,030  |      |   | 5,987,383  |  
|Diluted                                                                    |  |                     | 6,114,919  |      |   | 6,020,458  |  

See Notes to Consolidated Financial
Statements.


F-3


---



Table of Contents

Electromed, Inc. and Subsidiary 
Consolidated Statements
of Stockholders Equity 
Years Ended June 30, 2010 and 2009

|                                                                              |  |                  |           |                          |   |                             |   |                                    |           |                         |   |                          |   |   |          |   |   |         |   |   |           |  
|----------------------------------------------------------------------------- |  | ---------------- | --------- | ------------------------ | - | --------------------------- | - | ---------------------------------- | --------- | ----------------------- | - | ------------------------ | - | - | -------- | - | - | ------- | - | - | --------- | -
|                                                                              |  | Electromed, Inc. |           |                          |   |                             |   |                                    |          
|                                                                              |  | Common Stock     |           | AdditionalPaid-inCapital |   | Retained
Earnings
(Deficit) |   | CommonStockSubscriptionsReceivable |           | Noncontrolling
Interest |   | TotalStockholdersEquity |  
|                                                                              |  |                  |           |                          |   |                             |  
|                                                                              |  |                  |           |                          |   |                             |  
|                                                                              |  | Shares           |           | Amount                   |   |                             |   |                                    |           |                        
|                                                                              | 
|Balance at June 30, 2008                                                      |  |                  | 5,880,911 |                          | $ | 58,809                      |   | $                                  | 5,540,922 |                         | $ | (1,451,371               | ) | $ | (111,999 | ) | $ | 4,658   |   | $ | 4,041,019 |  
|Net income                                                                    |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | 1,332,906                |   |   | -        |   |   | 22,257  |   |   | 1,355,163 |  
|Sale of common stock                                                          |  |                  | 58,572    |                          |   | 586                         |   |                                    | 214,414   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 215,000   |  
|Issuance of common stock for exercise of warrants                             |  |                  | 49,669    |                          |   | 497                         |   |                                    | 148,507   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 149,004   |  
|Issuance of common stock
 for warrants exercised with subscription notes      |  |                  | 31,000    |                          |   | 310                         |   |                                    | 46,190    |                         |   | -                        |   |   | (46,500  | ) |   | -       |   |   | -         |  
|Issuance of common stock for acquisition of
 property and payment of services |  |                  | 30,000    |                          |   | 300                         |   |                                    | 104,700   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 105,000   |  
|Proceeds on subscription notes receivable                                     |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | -                        |   |   | 66,999   |   |   | -       |   |   | 66,999    |  
|Repurchase of common
 stock                                                   |  |                  | (3,000    | )                        |   | (30                         | ) |                                    | (6,330    | )                       |   | -                        |   |   | -        |   |   | -       |   |   | (6,360    | )
|Distributions paid to
 holders of noncontrolling interest                     |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | -                        |   |   | -        |   |   | (20,316 | ) |   | (20,316   | )
|Share-based compensation expense                                              |  |                  | -         |                          |   | -                           |   |                                    | 153,233   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 153,233   |  
|Balance at June 30, 2009                                                      |  |                  | 6,047,152 |                          |   | 60,472                      |   |                                    | 6,201,636 |                         |   | (118,465                 | ) |   | (91,500  | ) |   | 6,599   |   |   | 6,058,742 |  
|Net income                                                                    |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | 916,338                  |   |   | -        |   |   | 17,198  |   |   | 933,536   |  
|Issuance of common stock upon exercise of
 warrants                           |  |                  | 135,733   |                          |   | 1,357                       |   |                                    | 389,475   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 390,832   |  
|Issuance of common stock
 for payment of services                             |  |                  | 5,000     |                          |   | 50                          |   |                                    | 22,450    |                         |   | -                        |   |   | -        |   |   | -       |   |   | 22,500    |  
|Proceeds from subscription notes receivable                                   |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | -                        |   |   | 9,000    |   |   | -       |   |   | 9,000     |  
|Distributions paid to
 holders of noncontrolling
 interest                    |  |                  | -         |                          |   | -                           |   |                                    | -         |                         |   | -                        |   |   | -        |   |   | (18,417 | ) |   | (18,417   | )
|Share-based compensation
 expense                                             |  |                  | -         |                          |   | -                           |   |                                    | 168,895   |                         |   | -                        |   |   | -        |   |   | -       |   |   | 168,895   |  
|Income tax benefit related
 to exercise of stock
 warrants                    |  |                  | -         |                          |   | -                           |   |                                    | 22,526    |                         |   | -                        |   |   | -        |   |   | -       |   |   | 22,526    |  
|Purchase of noncontrolling
 interest in Electromed
 Financial, LLC            |  |                  | -         |                          |   | -                           |   |                                    | (119,620  | )                       |   | -                        |   |   | -        |   |   | (5,380  | ) |   | (125,000  | )
|Balance at June 30, 2010                                                      |  |                  | 6,187,885 |                          | $ | 61,879                      |   | $                                  | 6,685,362 |                         | $ | 797,873                  |   | $ | (82,500  | ) | $ | -       |   | $ | 7,462,614 |  

See Notes to Consolidated Financial
Statements.F-4

---



Table of Contents

Electromed, Inc. and Subsidiary 
Consolidated Statements of Cash Flows
Years Ended June 30, 2010 and 2009

|                                                                                             |  |                      |            |      |   |            |  
|-------------------------------------------------------------------------------------------- |  | -------------------- | ---------- | ---- | - | ---------- | -
|                                                                                             |  | Years Ended June 30, |           
|                                                                                             |  | 2010                 |            | 2009 |  
|Cash Flows
 From Operating Activities                                                        |  |                      |            |      |   |            |  
|Net income                                                                                   |  | $                    | 933,536    |      | $ | 1,355,163  |  
|Adjustments to reconcile net income to net
 cash provided by (used in) operating activities: |  |                      |            |      |   |            |  
|Depreciation                                                                                 |  |                      | 298,928    |      |   | 302,162    |  
|Amortization of finite-life intangible
 assets                                               |  |                      | 52,820     |      |   | 16,783     |  
|Amortization of debt issuance costs                                                          |  |                      | 53,404     |      |   | 9,638      |  
|Share-based compensation expense                                                             |  |                      | 168,895    |      |   | 153,233    |  
|Deferred income taxes                                                                        |  |                      | (149,000   | )    |   | 299,000    |  
|Loss on disposal of property and equipment                                                   |  |                      | 4,258      |      |   | 56,301     |  
|Issuance of common stock for payment of
 services                                            |  |                      | 22,500     |      |   | 35,000     |  
|Changes in operating assets and
 liabilities:                                                |  |                      |            |      |   |            |  
|Accounts receivable                                                                          |  |                      | (228,856   | )    |   | (2,418,665 | )
|Inventories                                                                                  |  |                      | (292,086   | )    |   | (329,181   | )
|Prepaid expenses and other assets                                                            |  |                      | (111,345   | )    |   | (66,562    | )
|Accounts payable and accrued liabilities                                                     |  |                      | (145,117   | )    |   | (570,578   | )
|Net cash provided by (used in) operating
 activities                                         |  |                      | 607,937    |      |   | (1,157,706 | )
|                                                                                             |  |                      |            |      |   |            |  
|Cash Flows
 From Investing Activities                                                        |  |                      |            |      |   |            |  
|Expenditures for property and equipment                                                      |  |                      | (269,616   | )    |   | (648,716   | )
|Purchase of noncontrolling interest in
 Electromed Financial, LLC                            |  |                      | (125,000   | )    |   | -          |  
|Expenditures for finite-life intangible
 assets                                              |  |                      | (514,505   | )    |   | (61,908    | )
|Net cash used in investing activities                                                        |  |                      | (909,121   | )    |   | (712,320   | )
|                                                                                             |  |                      |            |      |   |            |  
|Cash Flows
 From Financing Activities                                                        |  |                      |            |      |   |            |  
|Net borrowings on revolving line of credit                                                   |  |                      | 1,768,128  |      |   | -          |  
|Principal payments on long-term debt
 including capital lease obligations                    |  |                      | (3,648,744 | )    |   | (641,409   | )
|Proceeds from long-term debt                                                                 |  |                      | 2,520,000  |      |   | 1,027,399  |  
|Noncontrolling interest distributions paid                                                   |  |                      | (18,417    | )    |   | (20,316    | )
|Payments of deferred financing fees                                                          |  |                      | (75,780    | )    |   | (1,696     | )
|Proceeds from sales of common stock and
 warrant exercises                                   |  |                      | 390,832    |      |   | 364,004    |  
|Proceeds on subscription notes receivable                                                    |  |                      | 9,000      |      |   | 66,999     |  
|Income tax benefit related to exercise of
 stock warrants                                    |  |                      | 22,526     |      |   | -          |  
|Expenditures for deferred offering costs                                                     |  |                      | (417,550   | )    |   | -          |  
|Repurchase of common stock                                                                   |  |                      | -          |      |   | (6,360     | )
|Net cash provided by financing activities                                                    |  |                      | 549,995    |      |   | (790,317   | )
|Net increase (decrease) in cash and cash
 equivalents                                        |  |                      | 248,811    |      |   | (1,079,709 | )
|Cash                                                                                         |  |                      |            |      |   |            |  
|Beginning of period                                                                          |  |                      | 361,916    |      |   | 1,441,625  |  
|End of period                                                                                |  | $                    | 610,727    |      | $ | 361,916    |  

See Notes to Consolidated Financial
Statements. 
F-5

---



Table of Contents

Electromed, Inc. and Subsidiary 
Consolidated Statements of Cash Flows (Continued) 
Years Ended June 30, 2010 and 2009

|                                                                                     |  |                     |           |      |   |         | 
|------------------------------------------------------------------------------------ |  | ------------------- | --------- | ---- | - | ------- | 
|                                                                                     |  | Years Ended June 30 |          
|                                                                                     |  | 2010                |           | 2009 |  
|Supplemental
 Disclosures of Cash Flow Information                                   |  |                     |           |      |   |         | 
|Cash paid for interest                                                               |  | $                   | 227,454   |      | $ | 266,265 | 
|Cash paid for income taxes                                                           |  |                     | 1,052,640 |      |   | 192,703 | 
|                                                                                     |  |                     |           |      |   |         | 
|Supplemental
 Disclosures of Noncash Investing and Financing Activities              |  |                     |           |      |   |         | 
|Common stock issued for acquisition of
 property and equipment                       |  | $                   | -         |      | $ | 70,000  | 
|Reduction in basis of acquired building
 formerly under capital lease                |  |                     | 93,172    |      |   | -       | 
|Common stock issued for subscription notes                                           |  |                     | -         |      |   | 46,500  | 
|Accrued expenditures for finite-life
 intangible assets included in accounts payable |  |                     | 365,308   |      |   | -       | 
|Deferred common stock offering costs
 included in accounts payable                   |  |                     | 410,484   |      |   | -       | 
|Expenditures for property and equipment
 included in accounts payable                |  |                     | -         |      |   | 20,000  | 
|Property and equipment financed through
 capital leases                              |  |                     | 87,769    |      |   | 75,366  | 

See Notes to Consolidated Financial
Statements. 
F-6

---



Table of Contents

Electromed, Inc. and SubsidiaryNotes to Consolidated Financial Statements

Note 1.      Nature
of Business and Summary of Significant Accounting Policies

Nature of business:
Electromed, Inc. (the Company) develops, manufactures and markets innovative
airway clearance products which apply High Frequency Chest Wall Oscillation
(HFCWO) therapy in pulmonary care for patients of all ages. The Company markets
its products in the United States to the home health care and institutional
markets for use by patients in personal residences, hospitals and clinics. The
Company also sells internationally both directly and through distributors. The
Company had international sales of approximately $647,000 and $919,000 for the
years ended June 30, 2010 and 2009 respectively. Since its inception, the
Company has operated in a single industry segment: developing, manufacturing
and marketing medical equipment. As a result, the information disclosed herein
materially represents all of the financial information related to the Companys
operating segment.

Principles of consolidation and related party
transaction: The accompanying consolidated financial
statements include the accounts of Electromed, Inc. and its subsidiary,
Electromed Financial, LLC. Electromed Financial, LLC was established by the
Company to assist in raising capital from outside investors. The Company owned
95 percent of Electromed Financial, LLC through March 2, 2010, at which time
the Company acquired the remaining five percent of Electromed Financial, LLC
from a director of the Company for $125,000. Income related to the
noncontrolling interest in the subsidiary is reflected as noncontrolling
interest on the consolidated financial statements. All significant intercompany
accounts and transactions have been eliminated in consolidation.

A summary of the Companys significant
accounting policies follows:

Use of estimates:
Management uses estimates and assumptions in preparing the consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America. Those estimates and assumptions affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities, and the reported revenues and expenses. Actual results could
vary from the estimates that were used. 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, valuation allowance for deferred
income tax assets and warranty liability.

Revenue recognition:
The Company recognizes revenue when persuasive evidence of a sales arrangement
exists, delivery of goods occurs through the transfer of title and risks and
rewards of ownership, the selling price is fixed or determinable, and
collectability is reasonably assured. Revenues are primarily recognized upon
shipment.

Direct patient
sales are recorded at amounts to be received from patients under reimbursement
arrangements with third-party payers, including private insurers, prepaid
health plans, Medicare and Medicaid. In addition, the Company records an
estimate for selling price adjustments which often arise from changes in a
patients insurance coverage, changes in a patients domicile, insurance
company coverage limitations or patient death. Other than the installment sales
as discussed below, the Company expects to receive payment on the vast majority
of accounts receivables within one year and therefore has classified all
accounts receivable as current. However, in some instances, payment for direct
patient sales can be delayed or interrupted, resulting in a small portion of
collections occurring later than one year.

Certain
third-party reimbursement agencies pay the Company on a monthly installment
basis, which can span over several years. Due to the length of time over which
cash is collected and the inherent uncertainty of collectability with these
installment sales, the Company cannot make a reasonable estimate of revenue at
the time of sale and does not record accounts receivable or revenue at the time
of product shipment. Under the installment method, the Company defers and
amortizes the costs associated with the sale and, as each installment is
received, that amount is recognized as revenue. Deferred costs associated with
the sale are amortized to cost of revenue ratably over the estimated period in
which collections are scheduled to occur.

F-7

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Table of Contents

A summary of
sales made under the installment method are as follows:

|                                            |  |                     |         |      |   |         | 
|------------------------------------------- |  | ------------------- | ------- | ---- | - | ------- | 
|                                            |  | Years Ended June 30 |        
|                                            |  |                     |         |      |  
|                                            |  | 2010                |         | 2009 |  
|                                            |  |                     |         |      |  
|Revenue
 recognized under installment sales |  | $                   | 467,000 |      | $ | 299,000 | 
|                                            |  |                     |         |      |   |         | 
|Amortized
 cost of revenues recognized      |  |                     | 72,000  |      |   | 51,000  | 

Unrecognized
installment method sales were as follows:

|                                                                             |  |                     |         |      |   |         | 
|---------------------------------------------------------------------------- |  | ------------------- | ------- | ---- | - | ------- | 
|                                                                             |  | Years Ended June 30 |        
|                                                                             |  |                     |        
|                                                                             |  | 2010                |         | 2009 |  
|                                                                             |  |                     |         |      |  
|Estimated
 unrecognized sales, net of discounts                              |  | $                   | 708,000 |      | $ | 716,000 | 
|Unamortized costs of revenues included in
 prepaids and other current assets |  |                     | 111,000 |      |   | 94,000  | 

Shipping and handling expense:
Shipping and handling charges billed to customers are included as a cost in
arriving at gross profit. Shipping and handling charges incurred by the Company
are included in selling, general and administrative expenses and were $218,000
and $174,000 for the years ended June 30, 2010 and 2009 respectively.

Cash: The Company
maintains its cash in bank deposit accounts which, at times, may exceed
federally insured limits. The Company has not experienced any losses in these
accounts.

Accounts receivable:
The Companys receivable balance is comprised of amounts due from individuals,
institutions and distributors. Balances due from individuals are typically remitted
to the Company by third-party reimbursement agencies such as Medicare, Medicaid
and private insurance companies. Accounts receivable are carried at amounts
estimated to be received from patients under reimbursement arrangements with
third-party payers. Accounts receivable are also net of an allowance for
doubtful accounts. Management determines the allowance for doubtful accounts by
regularly evaluating individual customer receivables and considering a
customers financial condition and credit history. Receivable are written off
when deemed uncollectible. Recoveries of receivables previously written off are
recorded when received. The allowance for doubtful accounts was approximately
$45,000 as of June 30, 2010 and 2009.

Inventories:
Inventories, consisting of material, labor and manufacturing overhead are
stated at the lower of cost (first-in, first-out method) or market. Work in
process and finished goods are carried at standard cost, which approximates
actual cost, and includes materials, labor and allocated overhead. Standard
costs are reviewed at least quarterly by management, or more often in the event
circumstances indicate a change in cost has occurred. The reserve for
obsolescence is determined by analyzing the inventory on hand and comparing it
to expected production requirements.

Property and equipment:
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements and assets acquired under
capital leases are depreciated over the shorter of their estimated useful lives
or the remaining lease term. The Company retains ownership of demonstration
equipment in the possession of both inside and outside sales representatives,
who use the equipment in the sales process.

Finite-life intangible assets:
Finite-life intangible assets include patents and trademarks. These intangible
assets are being amortized on a straight-line basis over their estimated useful
lives, as described in Note 4.

F-8

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Table of Contents

Long-lived assets:
Long-lived assets, such as property and equipment and finite-life intangible
assets are evaluated for impairment whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. In evaluating
recoverability, the following factors, among others, are considered: a
significant change in the circumstances used to determine the amortization
period, an adverse change in legal factors or in the business climate, a
transition to a new product or service strategy, a significant change in
customer base, and a realization of failed marketing efforts. The
recoverability of an asset is measured by a comparison of the unamortized
balance of the asset to future undiscounted cash flows.

If the Company
believes the unamortized balance is unrecoverable, it would recognize an
impairment charge necessary to reduce the unamortized balance to the estimated
fair value of the asset. The amount of such impairment would be charged to
operations in the current period. The Company has not identified any indicators
of impairment associated with its long-lived assets.

Warranty liability:
The Company provides a lifetime warranty on its products to the prescribed
patient for sales within the United States and Canada, a five-year warranty on
its products to the prescribed patient for sales within Greece, and a
three-year warranty for all institutional sales and sales to individuals
outside the United States and Canada. The Company estimates the costs that may
be incurred under its warranty and records a liability in the amount of such
costs at the time the product is sold. Factors that affect the Companys
warranty liability include the number of units sold, historical and anticipated
rates of warranty claims, and cost per claim. The Company periodically assesses
the adequacy of its recorded warranty liability and adjusts the amounts as
necessary.

Changes in the
Companys warranty liability were approximately as follows:

|                                                     |  |                     |         |      |   |         |  
|---------------------------------------------------- |  | ------------------- | ------- | ---- | - | ------- | -
|                                                     |  | Years Ended June 30 |        
|                                                     |  | 2010                |         | 2009 |  
|Beginning
 warranty reserve                          |  | $                   | 292,000 |      | $ | 195,000 |  
|Accrual for products sold                            |  |                     | 146,000 |      |   | 162,000 |  
|Expenditures and costs incurred for
 warranty claims |  |                     | (75,000 | )    |   | (65,000 | )
|Ending
 warranty reserve                             |  | $                   | 363,000 |      | $ | 292,000 |  

Income taxes:
Deferred taxes are provided on a liability method whereby deferred tax assets
are recognized for deductible temporary differences and operating loss and tax
credit carryforwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax bases. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.

The Company
recognizes tax liabilities when the Company believes that certain positions may
not be fully sustained upon review by tax authorities. Benefits from tax
positions are measured at the largest amount of benefit that is greater than
fifty percent likely of being realized upon settlement. The current portion of
tax liabilities is included in other liabilities. To the extent that the final
tax outcome of these matters is different than the amounts recorded, such
differences impact income tax expense in the period in which such determination
is made. Interest and penalties, if any, related to accrued liabilities for
potential tax assessments are included in income tax expense.

Research and development:
Research and development costs include costs of research activities as well as
engineering and technical efforts required to develop new products or make
improvement to existing products. Research and development costs are expensed
as incurred.

Advertising costs:
Advertising costs are charged to expense when incurred. Advertising, marketing
and trade show costs for the years ended June 30, 2010 and 2009 were
approximately $527,000 and $642,000 respectively.

Share-based payments:
Share-based payment awards consist of warrants issued to employees for
services, and to nonemployees in lieu of payment for products or services.
Expense is estimated using the fair value of products or
services rendered or the Black-Scholes pricing model at the date of grant and
is recognized on a straight-line basis over the requisite service or vesting
period of the award.

F-9

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Table of Contents

Fair value of financial instruments:
The carrying values of cash, accounts receivable, accounts payable and accrued
expenses approximate their fair value due to the short-term nature of these
instruments. The carrying value of long-term debt is the remaining amount due
to debtors under borrowing arrangements. To estimate the fair value of debt,
the Company estimates the interest rate necessary to secure financing to
replace its debt. At June 30, 2010, the fair value of long-term debt was not significantly
different than its carrying value.

Basic and diluted earnings per share:
Basic per share amounts are computed by dividing net income attributable to
Electromed, Inc. by the weighted-average number of common shares outstanding.
Diluted per share amounts assume the conversion, exercise or issuance of all
potential common stock instruments unless their effect is anti-dilutive,
thereby reducing the loss per share or increasing the income per share (see
Note 7 for information on stock warrants).

Recently issued accounting pronouncements:
In June 2009, the FASB issued revised guidance for the consolidation of
variable interest entities. This amends the original guidance requiring an
enterprise to perform an analysis to determine whether the enterprises
variable interest or interests give it a controlling financial interest in a
variable interest entity (VIE). This analysis identifies the primary
beneficiary of a VIE as the enterprise that has both (a) the power to
direct the activities of a VIE that most significantly impact the entitys
economic performance, and (b) the obligation to absorb losses of the
entity that could potentially be significant to the VIE. Additionally, this new
guidance requires an enterprise to assess whether it has an implicit financial
responsibility to ensure that a VIE operates as designed when determining it
has the power to direct the activities of the VIE that most significantly
impact the entitys economic performance. This guidance is effective at the
beginning of the Companys 2011 fiscal year. This guidance is not expected to
have a material effect on the Companys consolidated financial statements.

Reclassifications:
Certain items in the fiscal 2009 financial statements have been reclassified to
be consistent with the classifications adopted for fiscal 2010. The fiscal 2009
reclassifications had no impact on previously reported net income and
stockholders equity.

Note
2.     Inventories

The components
of inventory at June 30, 2010 and 2009 are approximately as follows:

|                                |  |         |           |      |   |           |  
|------------------------------- |  | ------- | --------- | ---- | - | --------- | -
|                                |  | June 30 |          
|                                |  | 2010    |           | 2009 |  
|Parts
 inventory                |  | $       | 765,000   |      | $ | 759,000   |  
|Work in
 process                |  |         | 56,000    |      |   | 114,000   |  
|Finished
 goods                 |  |         | 680,000   |      |   | 336,000   |  
|Less:
 Reserve for obsolescence |  |         | (30,000   | )    |   | (30,000   | )
|Total                           |  | $       | 1,471,000 |      | $ | 1,179,000 |  

Note 3.     Property
and Equipment

Property and
equipment, including assets under capital leases, consisted of approximately
the following:

|                                    |  |                                 |      |         |            |   |   |           |  
|----------------------------------- |  | ------------------------------- | ---- | ------- | ---------- | - | - | --------- | -
|                                    |  | Estimated
 Useful
 Lives(Years) |      | June 30 |           
|                                    |  |                                 | 2010 |         | 2009       |  
|Building and
 building improvements |  | 15-39                           |      | $       | 1,892,000  |   | $ | 1,920,000 |  
|Land                                |  | N/A                             |      |         | 200,000    |   |   | 200,000   |  
|Land
 improvements                  |  | 15                              |      |         | 162,000    |   |   | 162,000   |  
|Equipment                           |  | 3-7                             |      |         | 921,000    |   |   | 755,000   |  
|Demonstration
 equipment            |  | 3                               |      |         | 507,000    |   |   | 396,000   |  
|Vehicles                            |  | 5                               |      |         | 35,000     |   |   | 35,000    |  
|                                    |  |                                 |      |         | 3,717,000  |   |   | 3,468,000 |  
|Less:
 Accumulated depreciation     |  |                                 |      |         | (1,028,000 | ) |   | (737,000  | )
|Total
 property and equipment       |  |                                 |      | $       | 2,689,000  |   | $ | 2,731,000 |  

F-10

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Table of Contents

Note 4.
     Finite-Life Intangible Assets

The carrying
value of patents and trademarks includes the original cost of obtaining the
patents, periodic renewal fees, and other costs associated with maintaining and
defending patent and trademark rights. Patents and trademarks are amortized
over their estimated useful lives, generally 15 and 12 years, respectively.
Accumulated amortization was $114,000 and $61,000 at June 30, 2010 and 2009,
respectively.

The activity
and balances of finite-life intangible assets were approximately as follows:

|                     |  |                     |           |      |   |         |  
|-------------------- |  | ------------------- | --------- | ---- | - | ------- | -
|                     |  | Years Ended June 30 |          
|                     |  | 2010                |           | 2009 |  
|Balance,
 beginning  |  | $                   | 229,000   |      | $ | 184,000 |  
|Additions            |  |                     | 880,000   |      |   | 62,000  |  
|Amortization expense |  |                     | (53,000   | )    |   | (17,000 | )
|Balance,
 ending     |  | $                   | 1,056,000 |      | $ | 229,000 |  

Based on the
carrying value at June 30, 2010, amortization expense is expected to be
approximately $93,000 annually.

Additions
during the year ended June 30, 2010 consisted primarily of legal defense costs
associated with a trademark infringement lawsuit filed against the Company (see
Note 9). Such defense costs are being capitalized by the Company and amortized
over the remaining useful life of the trademark. In the event the Company is
unsuccessful in defending this trademark, such capitalized legal defense costs
will be immediately expensed. The future amortization amount is expected to
change as the Company incurs additional costs associated with its patents and
trademarks, including the trademark defense costs.

Note
5.     Financing Arrangements

The Company
entered into a $3,500,000 revolving line of credit on December 9, 2009, which
expires on November 30, 2010, if not renewed. Advances are due at the
expiration date and are secured by substantially all Company assets. The amount
available for borrowing is limited to 60 percent of eligible accounts
receivable less the outstanding balance on the Companys 4.28% term note due
December 2012. Interest on advances accrues at LIBOR plus 2.75 percent and is
payable monthly. As of June 30, 2010, there was approximately $1,768,000
outstanding on the line of credit and $883,000 available for future borrowing.(a)

F-11

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Table of Contents

Long-term debt
consists of approximately the following as of June 30, 2010 and 2009:

|                                                                                                                                                                     |  |         |           |      |   |           | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | --------- | ---- | - | --------- | 
|                                                                                                                                                                     |  | June 30 |          
|                                                                                                                                                                     |  | 2010    |           | 2009 |  
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Mortgage note payable with bank, due in
 monthly installments of $10,706, including interest at 5.79%, remaining due
 December 2014, secured by land and building(a) |  | $       | 1,494,000 |      | $ | -         | 
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Term note payable with bank, due in monthly
 installments of $29,649, including interest at 4.28%, due December 2012,
 secured by substantially all assets(a)        |  |         | 815,000   |      |   | -         | 
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Capital lease obligations, due in varying
 monthly installments, including interest ranging from 8.99% to 12.07%, to
 July 2013, secured by equipment                |  |         | 122,000   |      |   | 78,000    | 
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Capital lease obligation for building,
 implied interest of 11.92%, terminated with the purchase of the building                                                     |  |         | -         |      |   | 654,000   | 
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Notes payable with bank, interest ranging
 from 6.75% to 9.0%, paid in full in fiscal 2010                                                                           |  |         | -         |      |   | 1,629,000 | 
|                                                                                                                                                                     |  |         |           |      |   |           | 
|Construction and mortgage notes payable
 with bank, interest at 6.0%, paid in full prior to December 31, 2009                                                        |  |         | -         |      |   | 1,198,000 | 
|Total                                                                                                                                                                |  |         | 2,431,000 |      |   | 3,559,000 | 
|Less: Current portion                                                                                                                                                |  |         | 398,000   |      |   | 392,000   | 
|Long-term debt                                                                                                                                                       |  | $       | 2,033,000 |      | $ | 3,167,000 | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | These
 instruments have certain financial and nonfinancial covenants which, among
 others, require the Company to maintain a minimum fixed charge coverage ratio
 and a maximum cash flow leverage ratio, and restrict the payment of dividends.
 Under the terms of the credit facility, the Company is required to
 immediately pay to the bank any net proceeds raised from an equity offering.
 The bank has agreed to waive this requirement as it relates to the initial
 public offering as discussed in Note 11.

Approximate
future maturities of long-term debt as of June 30, 2010 are as follows:

|                      |  |   |           | 
|--------------------- |  | - | --------- | 
|Year ending
 June 30: |  |   |           | 
|2011                  |  | $ | 398,000   | 
|2012                  |  |   | 429,000   | 
|2013                  |  |   | 239,000   | 
|2014                  |  |   | 50,000    | 
|2015                  |  |   | 1,315,000 | 
|Total                 |  | $ | 2,431,000 | 

Capital leases and related party transaction:
The Company has financed certain office equipment through capital leases. The
Company also had a building capital lease with a director of the Company
through December 2009, at which time the Company purchased the building for
approximately $555,000 using the proceeds from a new mortgage note with a bank.
The net carrying value of the capital lease obligation exceeded the purchase
price by approximately $93,000 which was recognized as a reduction in the net
book value of the acquired building, which had been capitalized at the
inception of the lease.

At June 30,
2010 and 2009, carrying value of assets under these capital leases are
approximately as follows:

|                                |  |         |         |      |   |         |  
|------------------------------- |  | ------- | ------- | ---- | - | ------- | -
|                                |  | June 30 |        
|                                |  | 2010    |         | 2009 |  
|Building                        |  | $       | -       |      | $ | 675,000 |  
|Fixtures and
 office equipment  |  |         | 181,000 |      |   | 96,000  |  
|Less:
 Accumulated depreciation |  |         | (38,000 | )    |   | (67,000 | )
|Total                           |  | $       | 143,000 |      | $ | 704,000 |  

Depreciation expense for these assets was $26,000 and
$29,000 for the years ended June 30, 2010 and 2009 respectively.

F-12

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Table of Contents

Approximate
future minimum payments under capital leases as of June 30, 2010 are as
follows:

|                                                                                   |  |   |         |  
|---------------------------------------------------------------------------------- |  | - | ------- | -
|Year ending
 June 30:                                                              |  |   |         |  
|                                                                                   |  |   |         |  
|2011                                                                               |  | $ | 71,000  |  
|2012                                                                               |  |   | 48,000  |  
|2013                                                                               |  |   | 18,000  |  
|Total                                                                              |  |   | 137,000 |  
|Less: Amount
 representing interest                                                |  |   | (15,000 | )
|Present
 value of future minimum lease payments (included in long term debt above) |  | $ | 122,000 |  

Note 6.     Common
Stock

Common stock issued for property and
services: In fiscal 2009, the Company issued 20,000
and 10,000 shares for land improvements and services with estimated fair values
of $70,000 and $35,000, respectively. During the year ended June 30, 2010, the
Company issued 5,000 shares for services valued at $22,500.

Common stock subscription receivables:
During fiscal 2008, the Company issued 47,333 shares of common stock to
unrelated third parties upon the exercise of outstanding warrants. The Company
agreed to accept subscription notes receivable from these individuals for a
total of approximately $112,000. For the year ended June 30, 2009, cash
collected on these notes was approximately $52,000.

During fiscal
2009, the Company issued 31,000 shares of common stock to an employee upon
exercise of outstanding warrants. The Company agreed to accept a subscription
note receivable from this individual for $46,500. For the year ended June 30,
2010 and 2009, cash collected on this note was approximately $9,000 and
$15,000, respectively. The Company revalued the warrants upon issuance of this subscription
note and recognized additional share-based expense of approximately $67,000 for
the year ended June 30, 2009.

Sales of common stock:
The Company from time to time has sold common stock to investors for cash.
During the year ended June 30, 2009, the Company sold 48,572 shares at $3.50
per share and 10,000 shares at $4.50 per share, for total cash proceeds of
approximately $215,000. All shares were sold to unrelated third-party
investors.

Note
7.     Share-Based Payments

Employee warrants:
The Company grants stock warrants to employees as long-term incentive
compensation. All warrants are granted at exercise prices equal to or greater
than the estimated fair market value of the Companys common stock, based upon
recent common stock sales transactions with independent third-party investors.
Warrants generally expire four to ten years from the grant date and vest over a
period of up to five years. Warrants have not been granted under a formal plan;
however, the number of warrants eligible for issuance is limited to the number
of authorized shares of the Companys common stock.

The Company
recognizes compensation expense related to share-based payment transactions in
the consolidated financial statements based on the estimated fair value of the
award issued. The fair value of each warrant is estimated using the
Black-Scholes pricing model at the time of award grant. The Company estimates
the expected life of warrants based on the expected holding period by the
warrant holder. The risk-free interest rate is based upon observed U.S.
Treasury interest rates for the expected term of the warrants. The Company
makes assumptions with respect to expected stock price volatility based upon
the volatility of similar companies. Forfeitures are estimated at the time of
grant and revised in subsequent periods if actual forfeitures differ from
initial estimates. Forfeitures are estimated based on the percentage of awards
expected to vest, taking into consideration the seniority level of the award
recipient.

Share-based compensation
expense for the years ended June 30, 2010 and 2009 was approximately $169,000
and $153,000 respectively.

F-13

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Table of Contents

The following
weighted-average assumptions were used to estimate the fair value of warrants
granted:

|                         |  |                     |        |      |  |        |  
|------------------------ |  | ------------------- | ------ | ---- |  | ------ | -
|                         |  | Years Ended June 30 |       
|                        
|                         |  | 2010                |        | 2009 | 
|                        
|Risk-free
 interest rate |  |                     | 1.45   | %    |  | 3.24   | %
|Expected
 life (years)   |  |                     | 4 - 10 |      |  | 4 - 10 |  
|Expected
 volatility     |  |                     | 46.0   | %    |  | 46.9   | %
|Expected
 dividends      |  |                     | 0      | %    |  | 0      | %

The following
table presents employee warrant activity for the years ended June 30, 2010 and
2009:

|                                       |  |                     |          |                                                 |  |                                      |      |                                                              |   |      |  |      |  | 
|-------------------------------------- |  | ------------------- | -------- | ----------------------------------------------- |  | ------------------------------------ | ---- | ------------------------------------------------------------ | - | ---- |  | ---- |  | 
|                                       |  | Number 
 of
 Shares |          | Weighted -
 Average
 Grant 
 Date
 Fair 
 Value |  | Weighted-
 Average
 Exercise 
 Price |      | Weighted-
 Average
 Remaining
 Contractual
 Life (in
 Years) |  
|Warrants
 outstanding at June 30, 2008 |  |                     | 272,000  |                                                 |  | $                                    | 1.32 |                                                              | $ | 2.64 |  | 1.14 |  | 
|Granted                                |  |                     | 307,800  |                                                 |  |                                      | 2.13 |                                                              |   | 3.55 |  | -    |  | 
|Exercised                              |  |                     | (31,000  | )                                               |  |                                      | 0.61 |                                                              |   | 1.50 |  | -    |  | 
|Canceled or forfeited                  |  |                     | (40,000  | )                                               |  |                                      | 1.06 |                                                              |   | 2.56 |  | -    |  | 
|Warrants
 outstanding at June 30, 2009 |  |                     | 508,800  |                                                 |  |                                      | 1.87 |                                                              |   | 3.27 |  | 6.03 |  | 
|Activity:                              |  |                     |          |                                                 |  |                                      |      |                                                              |   |      |  |      |  | 
|Granted                                |  |                     | 25,000   |                                                 |  |                                      | 1.68 |                                                              |   | 4.50 |  | -    |  | 
|Exercised                              |  |                     | (117,000 | )                                               |  |                                      | 1.77 |                                                              |   | 2.90 |  | -    |  | 
|Canceled or forfeited                  |  |                     | (25,000  | )                                               |  |                                      | 2.02 |                                                              |   | 2.60 |  | -    |  | 
|Warrants
 outstanding at June 30, 2010 |  |                     | 391,800  |                                                 |  |                                      | 1.87 |                                                              |   | 3.47 |  | 6.74 |  | 
|Warrants
 exercisable at June 30, 2010 |  |                     | 124,560  |                                                 |  |                                      | 1.51 |                                                              |   | 3.21 |  | 4.75 |  | 

For the years
ended June 30, 2010 and 2009 net cash proceeds from the exercise of employee
warrants was approximately $339,000 and $47,000 respectively. The Company
received an excess income tax benefit of approximately $23,000 in 2010 and no income
tax benefit in 2009 from the exercise of employee warrants.

At June 30,
2010, the Company had approximately $450,000 of unrecognized stock-based
compensation, which is expected to be recognized over a weighted-average period
of 3.2 years. The aggregate intrinsic value of warrants outstanding was
approximately $403,000, and the intrinsic value of warrants exercisable was
approximately $161,000 at June 30, 2010.

Warrants issued to non-employees for
services: In years prior to fiscal 2009, the Company
issued warrants to non-employees for services in lieu of cash payments. At June
30, 2010, the Company had warrants outstanding and exercisable to purchase
20,000 shares of common stock at a weighted-average exercise price of $3.00 per
share. These warrants expire at various dates through January 3, 2011.

All
outstanding warrants issued for services were granted prior to the 2009 fiscal
year. All services related to these warrants were completed prior to fiscal
2009. The Company has therefore recorded all share-based expense associated
with these services in prior years. During the year ended June 30, 2010, a
warrant to purchase 5,000 shares was exercised at an exercise price of $3.50
per share. There were no warrants forfeited during the year ended June 30,
2010. During the year ended June 30, 2009, there were 400,000 warrants
forfeited. The warrants canceled during the year ended June 30, 2009 were
forfeited as a result of a termination agreement with an independent sales
representative (see Note 9).

Warrants issued with convertible debt:
In years prior to fiscal 2009, the Company issued convertible notes payable to
certain individuals. In conjunction with the issuance of these convertible
notes, creditors also received warrants to purchase common stock for an
exercise price of $3.00 per share. At June 30, 2010, the Company had
approximately 83,000 warrants outstanding and exercisable at a weighted-average
exercise price of $3.00 per share. Approximately 38,000 warrants expire in
September 2012 and approximately 45,000 expire in September 2015. During the
years ended June 30, 2010 and 2009, warrant holders exercised 13,733 and 49,669
warrants at a weighted-average exercise price of $2.50 and $3.00 respectively.
There were no warrants forfeited and cancelled during the year ended June 30,
2010. During the year ended June 30, 2009, 62,338 warrants were forfeited and
canceled.

F-14

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Table of Contents

|        |             
|------- | ------------
|Note 8. | Income Taxes

Components of
the provision for (benefit from) income taxes for the years ended June 30, 2010
and 2009, are as follows:

|         |  |                     |          |      |   |         | 
|-------- |  | ------------------- | -------- | ---- | - | ------- | 
|         |  | Years Ended June 30 |         
|         |  | 2010                |          | 2009 |  
|Current  |  | $                   | 748,000  |      | $ | 531,000 | 
|Deferred |  |                     | (149,000 | )    |   | 299,000 | 
|Total    |  | $                   | 599,000  |      | $ | 830,000 | 

The total
income tax expense differs from the expected tax expense, computed by applying
the federal statutory rate to the Companys income before income taxes, as
follows:

|                                              |  |                     |         |      |   |         | 
|--------------------------------------------- |  | ------------------- | ------- | ---- | - | ------- | 
|                                              |  | Years Ended June 30 |        
|                                              |  | 2010                |         | 2009 |  
|Tax expense
 at statutory federal rate        |  | $                   | 515,000 |      | $ | 743,000 | 
|State income
 tax benefit, net of federal tax |  |                     | 55,000  |      |   | 75,000  | 
|Other
 permanent items                        |  |                     | 29,000  |      |   | 12,000  | 
|Income tax
 expense                           |  | $                   | 599,000 |      | $ | 830,000 | 

The
significant components of deferred income taxes are as follows:

|                                            |  |         |          |      |   |          |  
|------------------------------------------- |  | ------- | -------- | ---- | - | -------- | -
|                                            |  | June 30 |         
|                                            |  | 2010    |          | 2009 |  
|Deferred tax assets (liabilities):          |  |         |          |      |   |          |  
|Revenue recognition and accounts receivable |  | $       | 228,000  |      | $ | 221,000  |  
|Accrued liabilities                         |  |         | 296,000  |      |   | 200,000  |  
|Net operating loss carryforwards            |  |         | 2,000    |      |   | 31,000   |  
|Property and equipment                      |  |         | (195,000 | )    |   | (118,000 | )
|Finite-life intangible assets               |  |         | (60,000  | )    |   | (52,000  | )
|Investment in subsidiary                    |  |         | -        |      |   | (80,000  | )
|Warrants                                    |  |         | 110,000  |      |   | 82,000   |  
|Other                                       |  |         | (12,000  | )    |   | (64,000  | )
|Net deferred tax assets                     |  | $       | 369,000  |      | $ | 220,000  |  

The components
giving rise to the net deferred income tax assets described above have been
included in the accompanying consolidated balance sheets as follows:

|                         |  |         |          |      |   |          |  
|------------------------ |  | ------- | -------- | ---- | - | -------- | -
|                         |  | June 30 |         
|                         |  | 2010    |          | 2009 |  
|Current
 assets          |  | $       | 514,000  |      | $ | 357,000  |  
|Long-term
 liabilities   |  |         | (145,000 | )    |   | (137,000 | )
|Net deferred
 tax assets |  | $       | 369,000  |      | $ | 220,000  |  

The Company
has state net operating loss carryforwards at June 30, 2010, of approximately
$19,000 to reduce future income tax liabilities, which will begin to expire in
2024.

The Company
has evaluated its exposure to unrecognized tax benefits as of June 30, 2010 and
2009, and has estimated that there are no unrecognized benefits which would be
material to the consolidated financial statements. The Companys policy would
be to recognize accrued interest and penalties related to unrecognized tax
benefits as a component of income tax expense.

The Company is
subject to U.S. federal income tax as well as income tax of multiple state
jurisdictions. With limited exceptions, tax years prior to fiscal 2007 are no
longer open to federal, state and local examination by taxing authorities.

F-15

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Table of Contents

|        |                              
|------- | -----------------------------
|Note 9. | Commitments and Contingencies

Settlement of sales representation agreement:
In July 2008, the Company settled a lawsuit with an independent sales
representative organization. The terms of the settlement required the Company
pay all commissions
upon cash collection for sales through July 31, 2008, in accordance with the
original agreement. Approximately $28,000 and $71,000 of commissions related to
this independent sales representative organization were accrued in the
accompanying consolidated financial statements as of June 30, 2010 and 2009,
respectively. The period for which commissions would otherwise be payable to
the independent sales representative organization was reduced by three months
from October 31, 2008, to July 31, 2008. As a condition of the settlement, the
independent sales representative organization did not exercise and forfeited
their warrants for 400,000 shares of Company common stock, which had been
previously expensed. Additional conditions of the settlement included the
cancellation of a $1,000,000 contingent payment clause upon a change in control
of the Company and a requirement by the Company to repurchase 3,000 shares of
its common stock held by the independent sales representative organization for
$2.12 per share.

Litigation:
Subsidiaries of Hill-Rom Holdings, Inc., (collectively, Hill-Rom) brought an
action on August 21, 2009, against the Company alleging that the Companys use
of the term SmartVest infringes on its alleged trademark The Vest. The
Company answered the allegations and brought counter-claims against Hill-Rom
alleging, among other things, defamation and libel. For the year period ended
June 30, 2010, the Company incurred and capitalized costs of $880,000 in
defending this trademark. Subsequent to June 30, 2010 and through July 31, 2010
the Company incurred and capitalized approximately $27,000 in defending this
trademark.

In the
addition to the trademark matter discussed above, the Company is occasionally
involved in claims and disputes arising in the ordinary course of business. The
Company insures its business risks where possible to mitigate the financial
impact of individual claims, and establishes reserves for an estimate of any
probable cost of settlement or other disposition. In the opinion of management,
the ultimate disposition or resolution of these matters, if any, will not have
a material adverse effect on the Companys financial position, results of
operations, or liquidity.

401(k) profit sharing plan:
The Company has an employee benefit plan under Section 401(k) of the Internal
Revenue Code covering all employees who are 21 years of age or older and have
1,000 hours of service with the Company. The Company matches each employees
salary reduction contribution, not to exceed 4 percent of annual compensation.
Total employer contributions to this plan for the years ended June 30, 2010 and
2009 were approximately $125,000 and $108,000.

Employment Agreements:Effective
January 1, 2010, the Company entered into new employment agreements with its
chief executive officer and chief financial officer. These agreements provide
the officers, with among other things, one years salary upon a separation of
service without cause for termination. Also, in the event the employee resigns
within six months of a change in control, the chief executive officer and chief
financial officer are entitled to receive a severance equal to two years base
salary.

|         |                
|-------- | ---------------
|Note 10. | Related Parties

The Company
uses a related-party service provider, a director and minority shareholder of
which was the original inventor of the Companys product, to perform certain
outsourced research and development functions. The Companys chief executive
officer is also the president, chief executive officer and chairman of the
board of directors of the service provider and owns approximately 11% of that
entitys outstanding common stock. In addition, two members of the Companys
board of directors are directors and minority shareholders of the service
provider. The Company has an agreement with the service provider which provides
that the service provider will perform 80 hours per week of research and
development work in exchange for a monthly fee, in the amount of $25,000
through June 2010 and $30,000 through December 2010. For the years ended June
30, 2010 and 2009, expenses for these services totaled approximately $280,000
and $115,000 respectively, and such expenses are included in research and
development expense in the income statement.

Also see Notes
1 and 5 for additional related party transactions with Company directors.

F-16

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Table of Contents

|         |                  
|-------- | -----------------
|Note 11. | Subsequent Events

On August 13,
2010, The Company completed an initial public stock offering (IPO) of 1,700,000
shares of common stock at an offering price of $4.00 per share. In addition,
the Company received notice on September 23, 2010 that the underwriter in the
IPO would acquire an additional 200,000 pursuant to exercise of a portion of
its over-allotment option. After deducting the payment of underwriting
discounts, commissions and offering costs, the net proceeds from the sale of
shares in the IPO and pursuant to the over-allotment option will be
approximately $5,990,000. In connection with the IPO and the exercise of the
over-allotment option, the Company also issued to Feltl warrants to purchase up
to 190,000 additional shares of the Companys common stock at a price of $4.80
per share.

The changes to
the balance sheet adjusted for the IPO, over-allotment and subsequent $500,000 payment to the
revolving line of credit are as follows:

|                      |  |               |   |                       |  |  |  |   |            |  | 
|--------------------- |  | ------------- | - | --------------------- |  |  |  | - | ---------- |  | 
|                      |  | June 30, 2010 |  
|                      |  | Audited       |   | Proforma
 (Unaudited) | 
|                     
|Assets                |  |               | $ | 14,143,237            |  |  |  | $ | 19,634,039 |  | 
|                      |  |               |   |                       |  |  |  |   |            |  | 
|Liabilities           |  |               |   | 6,680,623             |  |  |  |   | 6,180,623  |  | 
|                      |  |               |   |                       |  |  |  |   |            |  | 
|Stockholders
 equity |  |               |   | 7,462,614             |  |  |  |   | 13,453,416 |  | 

Under the
terms of the Companys credit facility with U.S. Bank, the Company is required
to immediately pay to the bank any net proceeds raised from an equity offering.
The bank has agreed to waive this requirement as it relates to the initial
public offering.

F-17

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Table of Contents

|        |                                                                                        
|------- | ---------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on Accounting and
 Financial Disclosures.

None.

|         |                         
|-------- | ------------------------
|Item 9A. | Controls and Procedures.

Evaluation of Disclosure Controls and
Procedures

Our
principal executive officer and principal financial officer evaluated the
effectiveness of our disclosure controls and procedures, as defined in Rule
13a-15(e) or Rule 15d-15(e), as of the end of the period subject to this
Report. Based on this evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures were
effective to provide reasonable assurance that information required to be
disclosed by us in the periodic and current reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the periods specified by the Securities and Exchange Commissions rules and
forms.

Managements Report on Internal Control over
Financial Reporting and Auditor Attestation

This
annual report does not include a report of managements assessment regarding
internal control over financial reporting or an attestation report of the
Companys registered public accounting firm due to a transition period
established by rules of the Securities and Exchange Commission for newly public
companies.

Changes to Internal Control Over Financial
Reporting

There
were no changes in our internal control over financial reporting that occurred
during the fourth quarter of fiscal 2010 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.

|         |                   
|-------- | ------------------
|Item 9B. | Other information.

None.

Part III

|         |                                                         
|-------- | --------------------------------------------------------
|Item 10. | Directors, Executive Officers, and Corporate Governance.

Other
than the information included in this Annual Report on Form 10-K under the
caption Executive Officers of the Registrant, which is set forth at the end
of Part I, the information required by Item 10 is incorporated herein by
reference to the sections labeled Election of Directors, Corporate
Governance, Compliance With Section 16(a) of the Exchange Act, and Security
Ownership of Principal Shareholders, Directors, and Management in our
definitive proxy statement for our Fiscal 2011 Annual Meeting of Shareholders.

|         |                        
|-------- | -----------------------
|Item 11. | Executive Compensation.

The
information required by Item 11 is incorporated herein by reference to the
sections labeled Executive Compensation, Director Compensation, and
Corporate GovernancePersonnel and Compensation Committee in our definitive
proxy statement for our Fiscal 2011 Annual Meeting of Shareholders.

- 38 -

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Table of Contents

|         |                                                                                                 
|-------- | ------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and Management and
 Related Stockholder Matters.

The
beneficial ownership information required by Item 12 is incorporated herein by
reference to the section labeled Security Ownership of Principal Shareholders,
Directors, and Management in our definitive proxy statement for our Fiscal
2011 Annual Meeting of Shareholders.

Securities Authorized
for Issuance Under Equity Compensation Plans

The
following table provides information concerning our equity compensation plans
as of June 30, 2010:

|                                                           |  |  |                                                                               |  |  |                                                             |  |  |                                                                                                                                                        
|---------------------------------------------------------- |  |  | ----------------------------------------------------------------------------- |  |  | ----------------------------------------------------------- |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                           |  |  | Number of securities to 
 be issued upon exercise 
 of outstanding 
 warrants |  |  | Weighted-average 
 exercise price of 
 outstanding warrants |  |  | Number of securities 
 remaining available 
 for future issuance 
 under equity 
 compensation plans 
 (excluding securities 
 reflected in column (a))
|                                                           |  |  |                                                                               |  |  |                                                             |  |  |                                                                                                                                                        
|Plan Category                                              |  |  | (a)                                                                           |  |  | (b)                                                         |  |  | (c)                                                                                                                                                    
|                                                           |  |  |                                                                               |  |  |                                                             |  |  |                                                                                                                                                        
|Equity compensation plans not approved by security holders |  |  | 411,800                                                                       |  |  | $3.45 per share                                             |  |  | N/A(1)                                                                                                                                                 
|                                                           |  |  |                                                                               |  |  |                                                             |  |  |                                                                                                                                                        
|Total                                                      |  |  | 411,800                                                                       |  |  | $3.45 per share                                             |  |  | N/A(1)                                                                                                                                                 
|                                                           |  |  |                                                                               |  |  |                                                             |  |  |                                                                                                                                                        

(1)
Our Board has not presently authorized a pool of securities that would be
available for future issuance pursuant to equity compensation arrangements.
Other than as prohibited by any contractual restrictions to which we are
subject, the Board could authorize future equity grants on a case-by-case basis
as compensation to new employees, in an aggregate amount up to our
then-remaining number of authorized shares. We currently have 10,000,000
authorized shares of common stock. We would be required by Nasdaq rules to
obtain shareholder approval for most other forms of equity compensation
arrangements.


Currently,
we have no formal equity compensation plans in place. We have issued warrants for services in lieu of cash payments from time to time. The
warrants issued pursuant to these arrangements may be exercised upon payment of
the exercise price in cash and expire at various dates through November 2018.
The warrants contain standard antidilution provisions. Please see Note 7 to the
Consolidated Financial Statements, included in Part II, Item 8 of this Report.

|         |                                                                            
|-------- | ---------------------------------------------------------------------------
|Item 13. | Certain Relationships and Related Transactions, and Director
 Independence.

The
information required by Item 13 is incorporated herein by reference to the
sections labeled Corporate GovernanceIndependence and Certain Transactions
and Business Relationships in our definitive proxy statement for our Fiscal
2011 Annual Meeting of Shareholders.

|         |                                        
|-------- | ---------------------------------------
|Item 14. | Principal Accounting Fees and Services.

The
information required by Item 14 is incorporated herein by reference to the
sections labeled Ratification of the Appointment of McGladrey & Pullen,
LLP as the Companys Independent Registered Public Accountant FirmAudit Fees
in our definitive proxy statement for our Fiscal 2011 Annual Meeting of
Shareholders.

|         |                                         
|-------- | ----------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules.

| |     |                                         
| | --- | ----------------------------------------
| | (a) | Documents
 filed as part of this report.

- 39 -

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Table of Contents

| |     |                                                                                                                                 |                                                                                                                                                
| | --- | ------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Financial
 Statements. The following financial statements are included in Part II, Item
 8 of this Report:                     
| |     |                                                                                                                                
| |     |                                                                                                                                | Report of
 McGladrey & Pullen, LLP on Consolidated Financial Statements and
 Financial Statement Schedule as of June 30, 2010 and June 30, 2009
| |     |                                                                                                                                 |                                                                                                                                                
| |     |                                                                                                                                | Consolidated
 Balance Sheets as of June 30, 2010 and June 30, 2009                                                                             
| |     |                                                                                                                                 |                                                                                                                                                
| |     |                                                                                                                                | Consolidated
 Statements of Income for each of the two years in the period ended June 30,
 2010                                                
| |     |                                                                                                                                 |                                                                                                                                                
| |     |                                                                                                                                | Consolidated
 Statements of Stockholders Equity for each of the two years in the period
 ended June 30, 2010                                  
| |     |                                                                                                                                 |                                                                                                                                                
| |     |                                                                                                                                | Consolidated
 Statements of Cash Flows for each of the two years in the period ended June
 30, 2010                                            
| |     |                                                                                                                                 |                                                                                                                                                
| |     |                                                                                                                                | Notes to
 Consolidated Financial Statements                                                                                                    
| |     |                                                                                                                                 |                                                                                                                                                
| | (2) | Financial
 Statement Schedules. The following consolidated financial statement schedule
 is included in Item 8: Not applicable.
| |     |                                                                                                                                
| | (3) | Exhibits.
 See Exhibit Index to Form 10-K immediately following the signature page of
 this Form 10-K                        

- 40 -

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Table of Contents

SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

|                          |                                      
|------------------------- | -------------------------------------
|                          | ELECTROMED,
 INC.                    
|                          |                                      
|Date:
 September 28, 2010 | /s/ Robert
 D. Hansen                
|                          | Robert D.
 Hansen                    
|                          | Chairman and
 Chief Executive Officer

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.

Each
person whose signature appears below constitutes and appoints Robert D. Hansen
as the undersigneds true and lawful attorney-in fact and agent, with full
power of substitution and resubstitution, for the undersigned and in the
undersigneds name, place and stead, in any and all amendments to this Annual
Report on Form 10-K and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granted unto said attorney-in-fact and agent, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all said
attorney-in-fact and agent, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.

|                            |  |                                                                 |  |                   
|--------------------------- |  | --------------------------------------------------------------- |  | ------------------
|Signature                   |  | Title                                                           |  | Date              
|                            |  |                                                                 |  |                   
|/s/ Robert
 D. Hansen       |  | Co-Founder,
 Chairman and Chief Executive Officer               |  | September 28, 2010
|Robert D.
 Hansen           |  | (principal
 executive officer)                                  |  |                   
|                            |  |                                                                 |  |                   
|/s/ Terry M.
 Belford       |  | Chief
 Financial Officer                                        |  | September 28, 2010
|Terry M.
 Belford, CPA, CMA |  | (principal
 financial officer and principal accounting officer) |  |                   
|                            |  |                                                                 |  |                   
|/s/ Craig N.
 Hansen        |  | Co-Founder
 and Director                                        |  | September 28, 2010
|Craig N.
 Hansen            |  |                                                                 |  |                   
|                            |  |                                                                 |  |                   
|/s/ Dr. Noel
 D. Collis, MD |  | Director                                                        |  | September 28, 2010
|Dr. Noel D.
 Collis, MD     |  |                                                                 |  |                   

|                             |  |          |  |                   
|---------------------------- |  | -------- |  | ------------------
|/s/ Thomas
 M. Hagedorn      |  | Director |  | September 28, 2010
|Thomas M.
 Hagedorn          |  |          |  |                   
|                             |  |          |  |                   
|/s/ Dr.
 George H. Winn, DDS |  | Director |  | September 28, 2010
|Dr. George
 H. Winn, DDS     |  |          |  |                   

- 41 -

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Table of Contents

EXHIBIT INDEX
ELECTROMED, INC.
FORM 10-K

|                |  |                                                                                                                                                                        
|--------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
 Number |  | Description                                                                                                                                                            
|                |  |                                                                                                                                                                        
|3.1             |  | Articles of
 Incorporation of Electromed, Inc., as amended.(a)                                                                                                         
|                |  |                                                                                                                                                                        
|3.2             |  | Bylaws of
 Electromed, Inc.(a)                                                                                                                                         
|                |  |                                                                                                                                                                        
|10.1            |  | Credit
 Agreement, dated December 9, 2009, between Electromed, Inc. and U.S. Bank,
 N.A.(a)                                                                            
|                |  |                                                                                                                                                                        
|10.2            |  | $3,500,000
 Revolving Note, dated December 9, 2009, payable to U.S. Bank, N.A.(a)                                                                                      
|                |  |                                                                                                                                                                        
|10.3            |  | $1,520,000
 Term Loan A, dated December 9, 2009, payable to U.S. Bank N.A.(a)                                                                                          
|                |  |                                                                                                                                                                        
|10.4            |  | $1,000,000
 Term Loan B, dated December 9, 2009, payable to U.S. Bank N.A.(a)                                                                                          
|                |  |                                                                                                                                                                        
|10.5            |  | Security
 Agreement, dated December 9, 2009, between Electromed, Inc. and U.S. Bank
 N.A.(a)                                                                           
|                |  |                                                                                                                                                                        
|10.6            |  | Security
 Agreement, dated December 9, 2009, between Electromed Financial, LLC and U.S.
 Bank N.A.(a)                                                                  
|                |  |                                                                                                                                                                        
|10.7            |  | Pledge
 Agreement, dated December 9, 2009, between Electromed, Inc. and U.S. Bank
 N.A.(a)                                                                             
|                |  |                                                                                                                                                                        
|10.8            |  | Mortgage,
 Security Agreement, Assignment of Leases and Rents and Fixture Financing
 Statement, dated December 9, 2009, between Electromed, Inc. and U.S. Bank
 N.A.(a)
|                |  |                                                                                                                                                                        
|10.9            |  | Guaranty,
 dated December 9, 2009, between Electromed Financial, LLC and U.S. Bank, N.A.(a)                                                                            
|                |  |                                                                                                                                                                        
|10.10           |  | Environmental
 and ADA Indemnification Agreement dated December 9, 2009, between Electromed,
 Inc. and U.S. Bank N.A.(a)                                               

- 42 -

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Table of Contents

|      |  |                                                                                                                                                                                                                                                                                                        
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.11 |  | Form of
 Assignment of Patent Application.(b)                                                                                                                                                                                                                                                          
|      |  |                                                                                                                                                                                                                                                                                                        
|10.12 |  | Employment
 Agreement, dated January 1, 2010, between Electromed, Inc. and Robert D.
 Hansen.(a)**                                                                                                                                                                                                     
|      |  |                                                                                                                                                                                                                                                                                                        
|10.13 |  | Employment
 Agreement, dated January 1, 2010, between Electromed, Inc. and Terry Belford.(a)**                                                                                                                                                                                                         
|      |  |                                                                                                                                                                                                                                                                                                        
|10.14 |  | Non-Competition,
 Non-Solicitation, and Confidentiality Agreement dated January 1, 2010 between
 Electromed, Inc. and Robert D. Hansen.**(a)                                                                                                                                                           
|      |  |                                                                                                                                                                                                                                                                                                        
|10.15 |  | Non-Competition,
 Non-Solicitation, and Confidentiality Agreement dated January 1, 2010,
 between Electromed, Inc. and Terry Belford.**(a)                                                                                                                                                             
|      |  |                                                                                                                                                                                                                                                                                                        
|10.16 |  | Purchase
 Agreement, dated March 2, 2010, between Electromed, Inc. and Robert D.
 Hansen.(a)                                                                                                                                                                                                           
|      |  |                                                                                                                                                                                                                                                                                                        
|10.17 |  | Letter
 Agreement dated February 16, 2010, between Electromed, Inc. and Hansen Engine
 Technologies, Inc.(c)                                                                                                                                                                                           
|      |  |                                                                                                                                                                                                                                                                                                        
|10.18 |  | Form of
 warrant issued to investors, incorporated
 herein by reference to the exhibit 4.2 in Amendment 2, filed with the
 Commission on July 7, 2010, to Registration Statement on Form S-1, Reg. No.
 333-166470, filed with the Commission on May 3, 2010.                                          
|      |  |                                                                                                                                                                                                                                                                                                        
|10.19 |  | Form of
 warrant issued to employees and service providers, incorporated herein by reference to
 the exhibit 4.3 in Amendment 2, filed with the Commission on July 7, 2010, to
 Registration Statement on Form S-1, Reg. No. 333-166470, filed with the
 Commission on May 3, 2010.                    
|      |  |                                                                                                                                                                                                                                                                                                        
|10.20 |  | Form of
 warrant issued in connection with 7% Senior Secured Convertible Notes, incorporated herein by reference to
 the exhibit 4.4 in Amendment 2, filed with the Commission on July 7, 2010, to
 Registration Statement on Form S-1, Reg. No. 333-166470, filed with the
 Commission on May 3, 2010.
|      |  |                                                                                                                                                                                                                                                                                                        
|10.21 |  | Form of
 Underwriters Warrant, incorporated
 herein by reference to the exhibit 4.5 in Amendment 2, filed with the
 Commission on July 7, 2010, to Registration Statement on Form S-1, Reg. No.
 333-166470, filed with the Commission on May 3, 2010.                                                
|      |  |                                                                                                                                                                                                                                                                                                        
|10.22 |  | Letter
 Agreement, dated September 23, 2010, between Electromed, Inc. and U.S. Bank
 N.A.*                                                                                                                                                                                                             

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Table of Contents

|     |  |                                                                          
|---- |  | -------------------------------------------------------------------------
|21.1 |  | Subsidiaries
 of Electromed, Inc.*                                       
|     |  |                                                                          
|31.1 |  | Certification
 Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
|     |  |                                                                          
|31.2 |  | Certification
 Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
|     |  |                                                                          
|32.1 |  | Certification
 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
|     |  |                                                                          
|32.2 |  | Certification
 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

| |     |                                                                                                                                                                                                                           
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *   | Filed
 herewith                                                                                                                                                                                                           
| | **  | Management
 compensatory contract or arrangement.                                                                                                                                                                         
| | (a) | Incorporated
 herein by reference to the cited exhibit in Registration Statement on Form
 S-1, Reg. No. 333-166470, filed with the Commission on May 3, 2010.                                                             
| | (b) | Incorporated
 herein by reference to the cited exhibit in Amendment 1, filed with the
 Commission on June 17, 2010, to Registration Statement on Form S-1, Reg. No.
 333-166470, filed with the Commission on May 3, 2010.
| | (c) | Incorporated
 herein by reference to the cited exhibit in Amendment 2, filed with the
 Commission on July 7, 2010, to Registration Statement on Form S-1, Reg. No.
 333-166470, filed with the Commission on May 3, 2010. 

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