Electromed, Inc. (ELMD)

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 Annual Report on Form 10-K. The forward-looking statements
include statements that reflect management’s good faith 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 Annual Report on Form 10-K.

Overview

Electromed
develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.

14

We
manufacture, market and sell products that provide HFCWO, including the SmartVest System that includes our newest generation SmartVest
Clearway®, previous generation SmartVest SQL® and related products, to patients with compromised
pulmonary function. The SmartVest Clearway is an updated and modern approach to HFCWO focused on an enhanced patient experience
and proven patient outcomes. The product delivers effective 360o oscillatory pressure through our proprietary rapid
inflate-deflate technology which improves the patient’s ability to breathe deeply during therapy. SmartVest Clearway is
the smallest, and lightest generator on the market, and is designed with an intuitive touchscreen to simplify programing and everyday
use. Our products are sold in both the homecare market and the hospital market. The SmartVest SQL has been sold in the domestic
homecare market since 2014. In 2015, we launched the SmartVest SQL into hospital and certain international markets. In June 2017,
we announced the launch of the SmartVest SQL with SmartVest Connect™ wireless technology, which allows data connection between
physicians and patients to track therapy performance and collaborate in treatment decisions. In 2022, we launched the SmartVest
Clearway to adult pulmonary, pediatric and cystic fibrosis patients for use in the home. We have marketed the SmartVest System
and its predecessor products since 2000 to patients suffering from cystic fibrosis, bronchiectasis and repeated episodes of pneumonia.
Additionally, we offer our products to a patient population that includes neuromuscular disorders such as cerebral palsy, muscular
dystrophies, ALS, and patients with post-surgical complications or who are ventilator dependent or have other conditions involving
excess secretion and impaired mucus transport.

The
SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations
(“HMOs”), state Medicaid systems, and the federal Medicare system, which we believe is an important consideration
for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code (E0483) for HFCWO 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 neuromuscular 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 primarily employed a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage
insurance claims on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use
in their homes. This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional
durable medical equipment channel and capture both the manufacturer and distributor margins. We have engaged a limited number
of regional durable medical equipment distributors focused on respiratory therapies as an alternate sales channel.

Our
key growth strategies for fiscal 2025 are to accelerate our revenue growth by taking market share and expanding the addressable
population for the largest and fastest growing segments of the market: adult pulmonology/bronchiectasis. Actions to support accelerating
our revenue growth include the following:

Impacts
of Certain Macro-Economic Conditions and the Supply Chain on Our Business and Operations

We
observed increased lead times for certain components in our supply chain and increased material costs and shipping rates during
the second half of fiscal 2022 and all of fiscal 2023. The changes to our supply chain lead times resulted in a temporary interruption
that impacted product availability for certain customers beginning in September 2022 and continued through June 2023. In fiscal
2024, we experienced a return to normal supply chain lead times through renegotiated supplier agreements and improved long-term
material requirements planning. We expect that material costs and shipping rates will continue to be a challenge during fiscal
2025 relating to supply chain availability and inflationary trends in electronic components and may extend to other components.
In certain instances, we have purchased key materials in advance to ensure adequate future supply and mitigate the risk of potential
supply chain disruptions. It is possible that these macro-economic conditions could have a greater adverse impact on our supply
chain in the future, including impacts associated with preventative and precautionary measures taken by other businesses and applicable
governments. A reduction or further interruption in any of our manufacturing processes could have a material adverse effect on
our business. Any significant increases to our raw material or shipping costs could reduce our gross margins.

15

Critical
Accounting Estimates

During
the preparation of our financial statements, we are required to make estimates, assumptions and judgment that affect reported
amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets
and liabilities, and our reported revenues and expenses. We update these estimates, assumptions, and judgments as appropriate.
Some of our accounting policies and estimates require us to exercise significant judgment in selecting the appropriate assumptions
for calculating financial statements. Such judgments are subject to an inherent degree of uncertainty. Among other factors, these
judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information
from outside sources, as appropriate. The following is a summary of our primary critical accounting policies and estimates. See
also Note 1 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K.

Revenue
Recognition

Revenue
is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including consideration paid or payable to customers and significant
financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control
of a distinct good or service to a customer.

Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and
Deferred Costs,” or the requirements under other applicable accounting guidance are met.

The
Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the Company’s
SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost
of revenues.

We
request that customers return previously sold units that are no longer in use to us 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 are certified
to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold or used for demonstration
equipment and warranty replacement parts.

Inventory
Valuation

Inventories
are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are carried
at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. The reserve for obsolescence
is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated inventory to be returned
is based on the number of devices that have shipped that are expected to be returned prior to completion of the insurance reimbursement
process.

16

Warranty
Reserve

The
Company provides a lifetime warranty on its products to the prescribed patient for homecare sales within the U.S. and a one to
five-year warranty for all homecare distributor, hospital and other sales. 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 shipped. Factors that affect
the Company’s warranty reserve include the number of units shipped, historical and anticipated rates of warranty claims,
the product’s useful life and cost per claim. The Company periodically assesses the adequacy of its recorded warranty reserve
and adjusts the amounts as necessary.

Share-Based
Compensation

Share-based
payment awards consist of options to purchase shares of our common stock issued to employees, restricted stock awards, and performance-based
awards. Expense for options is estimated using the Black-Scholes pricing model at the date of grant and expense for restricted
stock is determined by the closing price on the day the grant is made. Expense is recognized on a graded vesting basis over the
requisite service or vesting period of the award, or at the time services are provided for non-employee awards. Expenses for performance-based
awards with market conditions is estimated using the Monte-Carlo pricing model at the date of grant and expense is recognized
on a straight-line basis. In determining the fair value of options and performance-based awards with market conditions, we make
various assumptions using the Black-Scholes and Monte-Carlo pricing models respectively, including expected risk-free interest
rate, stock price volatility, and life. See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report
on Form 10-K for a description of these assumptions.

Results
of Operations

Fiscal
Year Ended June 30, 2024 Compared to Fiscal Year Ended June 30, 2023

Revenues

Revenue
for the fiscal years ended June 30, 2024 and 2023 are summarized in the table below.

Homecare
Revenue. Homecare revenue increased by $5,558,000, or 12.6%, in fiscal 2024 compared to fiscal 2023. The increase in revenue
was due to an increase in direct sales representatives, higher quality referrals, and efficiencies recognized within our reimbursement
department. Efficiencies were due to recent investments aimed at increasing referral conversion rates and decreasing conversion
processing time resulting in recognizing revenue on more units in fiscal 2024.

Hospital
Revenue. Hospital revenue increased by $455,000, or 21.9%, in fiscal 2024 compared to fiscal 2023. Hospital revenue includes
sales to hospitals, rental companies and other institutions. The increase was primarily
due to an increase in sales representatives focused on the hospital market as well as increased capital and disposable demand.

Homecare
Distributor Revenue. Homecare distributor revenue increased by $234,000, or 14.5%, in fiscal 2024 compared to fiscal 2023.
The revenue increase in fiscal 2024 was due to increased demand from one of our primary homecare distribution partners. We sell
to a limited number of home medical equipment distributors, who in turn sell our SmartVest System in the U.S. homecare market.

17

Other
Revenue. Other revenue increased by $402,000, or 94.8%, in fiscal 2024 compared to fiscal 2023. The increase in other revenue
was primarily due to increased demand of international distributor purchases and purchases by customers that do not fall within
the other markets described above.

Gross
Profit

Gross
profit increased to $41,726,000 in fiscal 2024, or 76.3% of net revenues, from $36,519,000 or 76.0% of net revenues, in fiscal
2023. The increase in gross profit was primarily due to increased revenue in fiscal 2024, decreased shipping expenses and increased
material costs in the prior year to expedite inventory purchases which did not recur in the current year.

Operating
Expenses

Selling,
General and Administrative Expenses

Selling,
general and administrative (“SG&A”) expenses were $34,489,000 in fiscal 2024, representing an increase of $2,894,000
or 9.2% from $31,595,000 in fiscal 2023.

SG&A
payroll and compensation-related expenses including health insurance benefits and other compensation increased by $2,885,000,
or 14.0%, to $23,437,000 in fiscal 2024, compared to $20,552,000 in fiscal 2023. The increase
in the current year was primarily due to increases in share-based compensation, salaries, and incentive compensation related to
the higher average number of sales, sales support, marketing, and reimbursement personnel to process higher patient referrals.
We have also continued to provide regular merit-based increases for our employees and are regularly benchmarking our compensation
ranges including share-based compensation for new and existing employees to ensure we can hire and retain the talent needed to
drive growth in our business. Field sales employees totaled 62, of which 53 were direct sales, as of June 30, 2024, compared
to 55 as of June 30, 2023, of which 46 were direct sales. We expect to continue to expand our salesforce to align with our revenue
growth projections.

Travel,
meals and entertainment expenses increased $352,000, or 11.8%, to $3,342,000 for fiscal 2024 compared to $2,990,000 in fiscal
2023. The increase in the current year was primarily due to a higher average number of direct sales representatives, higher travel
costs, an increased number of sales territories and a mid-year sales meeting held in fiscal 2024.

Professional
and legal fees, including recruiting and insurance expenses, decreased by $456,000, or 8.6%, to $4,828,000 in fiscal 2024, compared
to $5,284,000 in fiscal 2023. Professional fees include services related to legal costs, shareowner services and reporting requirements,
information technology technical support and consulting fees. The decrease was primarily related to fiscal 2023 costs such as
legal and consulting costs associated with the termination of the Public Health Emergency for COVID-19, recruiting costs for multiple
senior leadership positions and legal fees related to a reimbursement project, all of which did not recur in fiscal 2024.

Total
discretionary marketing expenses increased by $452,000, or 43.7% to $1,487,000 in fiscal 2024, compared to $1,035,000 in fiscal
2023. The increase in the current year was primarily due to an investment in market research, direct-to-consumer and direct-to-physician
marketing.

Research
and Development Expenses

R&D
expenses decreased by $260,000, or 28.4%, to $656,000 in fiscal 2024 compared to $916,000 in fiscal 2023. The decrease in the
current year was primarily due to reduced costs associated with our SmartVest Clearway platform
development in the prior year which has now been launched into the Homecare and Hospital markets.

18

Interest
Income, net

Net
interest income was approximately $455,000 in fiscal 2024 compared to net interest income of $78,000 in fiscal 2023. The increase
in the current year was primarily due to increased savings rates on higher cash balances.

Income
Tax Expense

Income
tax expense in fiscal 2024 was $1,886,000, which includes a current tax expense of $2,457,000 and a deferred benefit of $571,000.
Estimated income tax expense includes a current federal and state tax benefit of approximately $103,000 related to the excess
tax benefit for fully vested stock options and non-qualified stock options that were exercised during the period.

Income
tax expense in fiscal 2023 was $920,000, which includes a current tax expense of $963,000 and a deferred benefit of $43,000. Estimated
income tax expense includes a current federal and state tax benefit of approximately $250,000 related to the excess tax benefit
for fully vested stock options and non-qualified stock options that were exercised during the period.

The
effective tax rates were 26.8% and 22.5% for fiscal 2024 and 2023, respectively. The effective tax rates differ from the statutory
federal rate because of state income taxes, R&D tax credits, and other permanent items that are non-deductible for tax purposes
relative to the amount of taxable income.

Net
Income

Net
income for fiscal 2024 was $5,150,000, compared to net income of $3,166,000 in fiscal 2023. The increase of $1,984,000, or 62.7%
in the current year net income was primarily due to revenue growth, decreased professional fees, and increased interest income.

Liquidity
and Capital Resources

Cash
Flows and Sources of Liquidity

Cash
Flows from Operating Activities

Net
cash provided by operating activities in fiscal 2024 was $9,067,000. Cash flows from operating activities consisted of net income
of $5,150,000, non-cash expenses of approximately $1,962,000, a decrease in prepaid expenses and other assets of $1,321,000,
a decrease in accounts receivable of $797,000, a decrease in inventories of $459,000 and an increase in accrued compensation of
$875,000. These cash flows from operating activities were offset by a decrease in accounts payable and accrued liabilities of
$1,206,000, an increase of $232,000 in contract assets and a decrease in income tax payable of $59,000.

Cash
Flows from Investing Activities

Net
cash used in investing activities in fiscal 2024 was approximately $395,000. Cash used in investing activities consisted of approximately
$287,000 in expenditures for property and equipment, which included approximately $62,000 for software and $225,000 for equipment,
and $108,000 in payments for patent and trademark costs.

Cash
Flows from Financing Activities

Net
cash provided by financing activities in fiscal 2024 was approximately $36,000, consisting of $311,000 received from the issuance
of common stock upon the exercise of options, partially offset by $275,000 used for our share repurchase program.

19

Adequacy
of Capital Resources

Our
primary working capital requirements relate to adding employees to our sales force and support functions, continuing infrastructure
investments, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred
in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately
$36,496,000 and available borrowings under our existing credit facility will provide sufficient liquidity to meet our anticipated
working capital and other liquidity needs for at least the next twelve months from the date of this report.

Effective
December 13, 2023, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on
the line of credit accrues at the prime rate (8.50% as of June 30, 2024) less 1.0% and is payable monthly. There was no outstanding
principal balance on the line of credit as of June 30, 2024, or June 30, 2023. The amount eligible for borrowing on the line of
credit is limited to the lesser of $2,500,000 or 57.0% of eligible accounts receivable, and the line of credit expires on December
18, 2025, if not renewed. As of June 30, 2024, the maximum $2,500,000 was available under the line of credit. Payment obligations
under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.

The
documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net
worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.

Any
failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result
in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring
prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated
or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may
not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.

During
fiscal 2024 and 2023, we spent approximately $287,000 and $1,648,000, respectively, on property and equipment. We currently expect
to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. 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 flows.

While
the impact of macroeconomic conditions and other factors such as inflation are difficult to predict, we believe our cash, cash
equivalents and cash flows from operations will be sufficient to meet our working capital, capital expenditure, operational cash
requirements for at least the next twelve months
from the date of this report.

Accounting
Standards Recently Issued But Not Yet Adopted by the Company

See
Note 1 of the Notes to our Financial Statements in this Annual Report on Form 10-K for information on new accounting standards
adopted in fiscal 2024 or pending adoption.

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 Annual Report on Form 10-K. The forward-looking statements
include statements that reflect management’s good faith 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 Annual Report on Form 10-K.

Overview

Electromed
develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.

We
manufacture, market and sell products that provide HFCWO, including the SmartVest System that includes our newest generation SmartVest
Clearway®, previous generation SmartVest SQL® and related products, to patients with compromised
pulmonary function. The SmartVest Clearway is an updated and modern approach to HFCWO focused on an enhanced patient experience
and proven patient outcomes. The product delivers effective 360o oscillatory pressure through our proprietary rapid
inflate-deflate technology which improves the patient’s ability to breathe deeply during therapy. SmartVest Clearway is
the smallest, and lightest generator on the market, and is designed with an intuitive touchscreen to simplify programing and everyday
use. Our products are sold in both the home health care market and the institutional market for use by patients in hospitals,
which we refer to as “institutional sales.” The SmartVest SQL has been sold in the domestic home care market since
2014. In 2015, we launched the SmartVest SQL into institutional and certain international markets. In June 2017, we announced
the launch of the SmartVest SQL with SmartVest Connect™ wireless technology, which allows data connection between physicians
and patients to track therapy performance and collaborate in treatment decisions. In 2022, we launched the SmartVest Clearway
with SmartVest Connect technology to adult pulmonary, pediatric and cystic fibrosis patients for use in the home. We have marketed
the SmartVest System and its predecessor products since 2000 to patients suffering from cystic fibrosis, bronchiectasis and repeated
episodes of pneumonia. Additionally, we offer our products to a patient population that includes neuromuscular disorders such
as cerebral palsy, muscular dystrophies, ALS, and patients with post-surgical complications or who are ventilator dependent or
have other conditions involving excess secretion and impaired mucus transport.

The
SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations
(“HMOs”), state Medicaid systems, and the federal Medicare system, which we believe is an important consideration
for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code (E0483) for HFCWO 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 neuromuscular 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.

14

We
employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims
on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes.
This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical
equipment channel and capture both the manufacturer and distributor margins. We have engaged a limited number of regional durable
medical equipment distributors focused on respiratory therapies as an alternate sales channel. Revenue through this channel was
3% of our total revenues in fiscal 2023.

Our
key growth strategies for fiscal 2024 are to accelerate our revenue growth by taking market share and expanding the addressable
population for the largest and fastest growing segments of the market: adult pulmonology/bronchiectasis. Actions to support accelerating
our growth include the following:

Impacts
of COVID-19 on Our Business and Operations

In
March 2020, the World Health Organization designated COVID-19 as a global pandemic, and the U.S. Department of Health and Human
Services designated COVID-19 as a public health emergency (“PHE”). In response to the COVID-19 pandemic and the U.S.
federal government’s declaration of a PHE, the Centers for Medicare & Medicaid Services (“CMS”) implemented
several temporary rule changes and waivers to allow prescribers to best treat patients during the period of the PHE. These waivers
became effective on March 1, 2020. Clinical indications and documentation typically required were not enforced for respiratory-related
products, including the SmartVest System (solely with respect to Medicare patients).

On
January 30, 2023, the Biden administration announced that the COVID-19 national and PHE declarations will end on May 11, 2023.
The CMS waiver was not extended and expired on May 11, 2023. We believe that we were able to mitigate the potential effects on
our net revenue resulting from the expiration of the CMS waiver by hiring additional employees to increase capacity and minimize
the average timeframe to convert a Medicare patient referral to approval and re-educating clinicians on Medicare requirements
for reimbursement of HFCWO.

We
did not receive any direct financial assistance from any government program during fiscal 2022 or fiscal 2023 in connection with
COVID-19 relief measures.

Impacts
of Certain Macro-Economic Conditions and the Supply Chain on Our Business and Operations

We
observed increased lead times for certain components in our supply chain and increased material costs and shipping rates during
the second half of fiscal 2022 and all of fiscal 2023. The changes to our supply chain lead times resulted in a temporary interruption
that impacted product availability for certain customers beginning in September 2022 and continuing through June 2023. We anticipate
that these increased lead times and temporary interruption of supply have the potential to continue through the first half of
fiscal 2024. If we are unable to procure components to meet our demand or if we extend delivery lead-times to our customers, there
may be an adverse impact to our revenue and, longer term, the potential of market share losses. We are taking actions to expedite
components and to identify and qualify alternate suppliers for certain components to minimize any impact to our revenue and customer
deliveries. We expect that material costs and shipping rates will remain elevated during the first half of fiscal 2024 relating
to supply chain availability and inflationary trends in electronic components and may extend to other components. In certain instances,
we have purchased key electronic materials in advance to ensure adequate future supply and mitigate the risk of potential supply
chain disruptions. It is possible that these macro-economic conditions could have a greater adverse impact on our supply chain
in the future, including impacts associated with preventative and precautionary measures taken by other businesses and applicable
governments. A reduction or further interruption in any of our manufacturing processes could have a material adverse effect on
our business. Any significant increases to our raw material or shipping costs could reduce our gross margins.

15

Critical
Accounting Estimates

During
the preparation of our financial statements, we are required to make estimates, assumptions and judgment that affect reported
amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets
and liabilities, and our reported revenues and expenses. We update these estimates, assumptions, and judgment as appropriate.
Some of our accounting policies and estimates require us to exercise significant judgment in selecting the appropriate assumptions
for calculating financial statements. Such judgments are subject to an inherent degree of uncertainty. Among other factors, these
judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information
from outside sources, as appropriate. The following is a summary of our primary critical accounting policies and estimates. See
also Note 1 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K.

Revenue
Recognition

Revenue
is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including consideration paid or payable to customers and significant
financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control
of a distinct good or service to a customer.

Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and
Deferred Costs,” or the requirements under other applicable accounting guidance are met.

The
Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the Company’s
SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost
of revenues.

We
request that customers return previously sold units that are no longer in use to us 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 are certified
to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold and continue
to be used for demonstration equipment and warranty replacement parts.

Inventory
Valuation

Inventories
are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are carried
at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. The reserve for obsolescence
is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated inventory to be returned
is based on how many devices that have shipped that are expected to be returned prior to completion of the insurance reimbursement
process.

16

Warranty
Reserve

The
Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and a three-year warranty
for all institutional sales and sales to individuals outside the U.S. 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 shipped. Factors that affect the Company’s
warranty reserve include the number of units shipped, historical and anticipated rates of warranty claims, the product’s
useful life and cost per claim. The Company periodically assesses the adequacy of its recorded warranty reserve and adjusts the
amounts as necessary.

Share-Based
Compensation

Share-based
payment awards consist of options to purchase shares of our common stock issued to employees. Expense for share-based payment
awards consist of options to purchase shares of our common stock issued to employees for services. Expense for options is estimated
using the Black-Scholes pricing model at the date of grant and expense for restricted stock is determined by the closing price
on the day the grant is made. Expense is recognized on a straight-line basis over the requisite service or vesting period of the
award, or at the time services are provided for non-employee awards. In determining the fair value of options, we make various
assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility, and life.
See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for a description of these
assumptions.

17

Results
of Operations

Fiscal
Year Ended June 30, 2023 Compared to Fiscal Year Ended June 30, 2022

Revenues

Revenue
for the fiscal years ended June 30, 2023 and 2022 are summarized in the table below.

Home
Care Revenue. Home care revenue increased by $5,941,000, or 15.6%, in fiscal 2023 compared to fiscal 2022. The revenue increase
compared to fiscal 2022 was primarily due to increases in referrals and approvals. The increase in referrals was primarily due
to an increase in direct sales representatives, increased sales representative productivity driven by increased clinic access
and patient flow, our sales team refining their selling process and clinic targeting methodology, and benefits of the CMS waiver
on the non-commercial Medicare portion of our home care revenue. Additionally, we benefitted from a Medicare allowable rate increase
that took effect on January 1, 2023. Annual Medicare rate increases for our device are linked closely to changes in the Urban
Consumer Price Index.

The
CMS waiver benefited the non-commercial Medicare portion of our home care revenue by increasing the number of referrals and the
approval percentage for previously non-covered diagnoses. We believe that our ongoing sales team execution, along with the return
to pre-COVID-19 levels of patient face-to-face engagement with physicians and clinic access for our sales team mitigated the fourth
quarter homecare revenue impact of the CMS waiver expiration on May 11, 2023.

Institutional
Revenue. Institutional revenue increased by $420,000, or 25.3%, in fiscal 2023 compared to fiscal 2022. Institutional revenue
includes sales to group purchasing organizations, rental companies and other institutions. The revenue increase was due to increased
capital purchases and stronger consumable volumes compared to fiscal 2022, as hospitals resumed utilization of HFCWO protocols
after reducing utilization early in the COVID-19 pandemic.

Home
Care Distributor Revenue. Home care distributor revenue increased by $144,000, or 9.8%, in fiscal 2023 compared to fiscal
2022. The revenue increase in fiscal 2023 was due to increased demand from one of our primary home care distribution partners.
We began selling to a limited number of home medical equipment distributors during our fiscal year ended June 30, 2020, who in
turn sell our SmartVest System in the U.S. home care market.

International
Revenue. International revenue decreased by $97,000, or 18.6%, in fiscal 2023 compared to fiscal 2022. International revenue
growth is not currently a primary focus for us, and our corporate resources are focused on supporting and maintaining our current
international distributors.

Gross
Profit

Gross
profit increased to $36,519,000 in fiscal 2023, or 76.0% of net revenues, from $31,442,000 or 75.5% of net revenues, in fiscal
2022. The increase in gross profit was primarily related to increases in domestic home care revenue including the Medicare allowable
rate increase that took effect in January 2023.

18

We
have a goal of improving our gross margin percentage over time due to cost savings initiatives associated with Clearway, supplier
optimization, and gaining operating leverage on higher volumes.

Operating
Expenses

Selling,
General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses were $31,595,000
in fiscal 2023, representing an increase of $4,481,000 or 16.5% from $27,114,000 in fiscal 2022.

SG&A
payroll and compensation-related expenses including health insurance benefits and other compensation increased by $2,629,000,
or 14.7%, to $20,552,000 in fiscal 2023, compared to $17,923,000 in fiscal 2022. The increase in the current year was primarily
due to a higher average number of sales, sales support and marketing personnel, increased reimbursement personnel to process higher
patient referrals, increased temporary resources to assist with systems infrastructure investments and increased incentive payments
on higher home care revenue. We have also continued to provide regular merit-based increases for our employees and are regularly
benchmarking our compensation ranges for new and existing employees to ensure we can hire and retain the talent needed to drive
growth in our business. Field sales employees totaled 55, of which 46 were direct sales, as of June 30, 2023, compared to 52 as
of June 30, 2022, of which 43 were direct sales. We expect to continue to expand our salesforce to align with our revenue growth
projections.

Professional
and legal fees, including recruiting and insurance expenses, increased by $859,000, or 19.4%, to $5,284,000 in fiscal 2023, compared
to $4,425,000 in fiscal 2022. Professional fees include services related to legal costs, shareowner services and reporting requirements,
information technology technical support and consulting fees. The increase in the current year was primarily due to an increased
investment in our system infrastructure and increased clinical study costs. We continue to make key investments in systems infrastructure
including implementing a new enterprise resource planning system, enhancing our customer relationship management system and further
optimizing of the revenue cycle management system that was implemented in June 2021. We expect these system infrastructure investments
will result in more efficient and scalable operational processes and provide enhanced analytics to drive business performance.

Total
discretionary marketing expenses increased by $211,000, or 25.6% to $1,035,000 in fiscal 2023, compared to $824,000 in fiscal
2022. The increase in the current year was primarily due to discretionary investment in market research, physician marketing,
and peer to peer education engagement strategies.

Travel,
meals and entertainment expenses increased $422,000, or 16.4%, to $2,990,000 for fiscal 2023 compared to $2,568,000 in fiscal
2022. The increase in the current year period was primarily due to an increase in headcount and our annual sales meeting expenses.

Research
and Development Expenses

R&D
expenses decreased by $440,000, or 32.4%, to $916,000 in fiscal 2023 compared to $1,356,000 in fiscal 2022. The decrease in the
current year was primarily due to reduced professional consulting costs associated with our next generation platform development
activities. R&D expenses were 1.9% of revenue in fiscal 2023 compared to 3.3% of revenue in fiscal 2022. We expect R&D
spending to be between 1.0% and 2.0% of revenue during fiscal 2024.

Interest
Income, net

Net
interest income was approximately $78,000 in fiscal 2023 compared to net interest income of $25,000 in fiscal 2022. The increase
in the current year was primarily due to higher interest rates earned on our cash deposits despite lower overall cash balances
in the current year.

Income
Tax Expense

Income
tax expense in fiscal 2023 was $920,000, which includes a current tax expense of $963,000 and a deferred benefit of $43,000. Estimated
income tax expense includes a current federal and state tax benefit of approximately $250,000 related to the excess tax benefit
for fully vested stock options and non-qualified stock options that were exercised during the period.

19

Income
tax expense in fiscal 2022 was $692,000, which included a current tax expense of $1,181,000 and a deferred benefit of $489,000.
Estimated income tax expense included a current federal and state tax benefit of approximately $12,000 related to excess tax benefit
for fully vested stock options and non-qualified stock options that were exercised during the period.

The
effective tax rates were 22.5% and 23.1% for fiscal 2023 and 2022, respectively. The effective tax rates differ from the statutory
federal rate because of state income taxes, R&D tax credits, and other permanent items that are non-deductible for tax purposes
relative to the amount of taxable income.

Net
Income

Net
income for fiscal 2023 was $3,166,000, compared to net income of $2,305,000 in fiscal 2022. The increase in current year net income
was primarily due to stronger home care and distributor revenue growth.

Liquidity
and Capital Resources

Cash
Flows and Sources of Liquidity

Cash
Flows from Operating Activities

Net cash provided by operating activities in fiscal 2023 was $1,315,000. Cash flows from operating activities consisted of net income of $3,166,000, non-cash expenses of approximately $1,278,000, a decrease in prepaid expenses of $202,000 an increase in tax payable of approximately $285,000 and a $696,000 increase in accounts payable and accrued liabilities, and accrued compensation. These cash flows from operating activities were offset by a $3,078,000 increase in accounts receivable, an increase in inventory of $1,033,000, and a $201,000 increase in contract assets. The increase in accounts receivable was primarily due to an increase in the Medicare portion of our home care business, which has a 13-month payment cycle. The increase in inventory was primarily due to an increase in raw materials associated with the launch of Clearway. Our cash receipt collection remains strong, with the three months ended June 30, 2023, period having the highest cash receipt collections in our company's history, building upon the prior record that was set in the previous quarter.

Cash
Flows from Investing Activities

Net
cash used in investing activities in fiscal 2023 was approximately $1,716,000. Cash used in investing activities consisted of
approximately $1,648,000 in expenditures for property and equipment, approximately $1,083,000 for software and $565,000 for equipment,
and $68,000 in payments for patent and trademark costs.

Cash
Flows from Financing Activities

Net
cash used in financing activities in fiscal 2023 was approximately $380,000, consisting of $153,000 used for our share repurchase
program and $310,000 for taxes paid on net share settlements of stock option exercises offset by $83,000 of cash provided by the
issuance of common stock upon exercise of options.

Adequacy
of Capital Resources

Our
primary working capital requirements relate to adding employees to our sales force and support functions, continuing infrastructure
investments, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred
in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately
$29,734,000 and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2024.

Effective
December 17, 2021, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on
the line of credit accrues at the prime rate (8.25% as of June 30, 2023) less 1.0% and is payable monthly. There was no outstanding
principal balance on the line of credit as of June 30, 2023 or June 30, 2022. The amount eligible for borrowing on the line of
credit is limited to the lesser of $2,500,000 or 57.0% of eligible accounts receivable, and the line of credit expires on December
18, 2023, if not renewed. As of June 30, 2023, the maximum $2,500,000 was available under the line of credit. Payment obligations
under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.

20

The
documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net
worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.

Any
failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result
in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring
prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated
or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may
not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.

During
fiscal 2023 and 2022, we spent approximately $1,648,000 and $1,425,000, respectively, on property and equipment. We currently
expect to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. 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 flows.

While
the impact of macroeconomic conditions and other factors such as inflation are difficult to predict, we believe our cash, cash
equivalents and cash flows from operations will be sufficient to meet our working capital, capital expenditure, operational cash
requirements for fiscal 2024.

Accounting
Standards Recently Issued But Not Yet Adopted by the Company

See
Note 1 of the Notes to our Financial Statements in this Annual Report on Form 10-K for information on new accounting standards
adopted in fiscal 2023 or pending adoption.

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 Annual Report on Form 10-K. The forward-looking statements
include statements that reflect management’s good faith 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 Annual Report on Form 10-K.

Overview

Electromed
develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.

We
manufacture, market and sell products that provide HFCWO, including the SmartVest System that includes our newest generation SmartVest
SQL® and previous generation SV2100 and related products, to patients with compromised pulmonary function. The SmartVest SQL
is smaller, quieter and lighter than our previous product with enhanced programmability, ease of use. Our products are sold in
both the home health care market and the institutional market for use by patients in hospitals, which we refer to as “institutional
sales.” The SmartVest SQL has been sold in the domestic home care market since 2014. In 2015, we launched the SmartVest
SQL into institutional and certain international markets. In June 2017, we announced the launch of the SmartVest SQL with SmartVest
Connect™ wireless technology, which allows data connection between physicians and patients to track therapy performance
and collaborate in treatment decisions. SmartVest Connect is currently available to pediatric and cystic fibrosis patients and
was made available to certain targeted adult pulmonary clinics starting in November 2017. Since 2000, we have marketed the SmartVest
System and its predecessor products to patients suffering from cystic fibrosis, bronchiectasis and repeated episodes of pneumonia.
Additionally, we offer our products to a patient population that includes neuromuscular disorders such as cerebral palsy, muscular
dystrophies, ALS, the combination of emphysema and chronic bronchitis commonly known as COPD, and patients with post-surgical
complications or who are ventilator dependent or have other conditions involving excess secretion and impaired mucus transport.

14

The
SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations
(“HMOs”), state Medicaid systems, and the federal Medicare system, which we believe is an important consideration
for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code (E0483) for HFCWO 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 neuromuscular 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
employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims
on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes.
This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical
equipment channel and capture both the manufacturer and distributor margins. We have engaged a limited number of regional durable
medical equipment distributors focused on respiratory therapies as an alternate sales channel. Revenue through this channel was
4% of our total revenues in fiscal 2022.

Our
key growth strategies for fiscal 2023 are to: accelerate our revenue growth by taking market share and expanding the addressable population for the largest and fastest growing
segments of the market: adult pulmonology/bronchiectasis. Actions to support accelerating our growth include the following:

Critical
Accounting Estimates

During
the preparation of our financial statements, we are required to make estimates, assumptions and judgment that affect reported
amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets
and liabilities, and our reported revenues and expenses. We update these estimates, assumptions, and judgment as appropriate.
Some of our accounting policies and estimates require us to exercise significant judgment in selecting the appropriate assumptions
for calculating financial statements. Such judgments are subject to an inherent degree of uncertainty. Among other factors, these
judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information
from outside sources, as appropriate. The following is a summary of our primary critical accounting policies and estimates. See
also Note 1 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K.

Impacts
of COVID-19 on Our Business and Operations

In
March 2020, the World Health Organization designated COVID-19 as a global pandemic, and the U.S. Department of Health and Human
Services designated COVID-19 as a public health emergency. The impact of the COVID-19 pandemic on our business remains uncertain,
and its effects on our operational and financial performance will depend in part on future developments, which cannot be reasonably
estimated at this time. Such future developments include, but are not limited to, the duration, scope and severity of the COVID-19
pandemic in geographic areas in which we operate or in which our patients live, actions taken to contain or mitigate its impact,
the impact on governmental healthcare programs and budgets, the development and distribution of treatments or vaccines, and the
resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and evolving situation, we are
unable to predict with confidence the likely impact of the COVID-19 pandemic on our future operations.

15

During
fiscal 2022, we experienced a reduction in the number of clinics allowing face-to-face access by our sales team although
not to the extent experienced in fiscal 2021 as the number of infections relating to the Omicron variant and related
subvariants of COVID-19 increased throughout most regions of the United States, and hospitals implemented additional
safety protocols. Our sales team continued to utilize a hybrid sales process of virtual and face-to-face clinician
interaction with strict adherence to specific clinic and healthcare system safety protocols, which we believe
allowed them to drive stronger referral growth compared to fiscal 2021. During the second half of fiscal 2022,
we observed an improvement in clinic access and patient flow compared to earlier in the fiscal year, which we
believe is likely a result of Omicron-related case reductions throughout most of the United States, contributing
to a record high number of monthly referrals for our company.

We
believe that the impact of the COVID-19 pandemic on our home care and institutional business will continue during at least the
beginning of fiscal 2023. Our home care revenue for fiscal 2022 has increased as compared to fiscal 2021; however, if COVID-19
infection rates increase and federal, state and local restrictions on commerce, stay-at-home orders or other restrictions on businesses
are reinstated, we believe that such measures could have a material adverse effect on our business.

We
observed increased changes to our supply chain timelines and increased material and shipping costs during the second half of fiscal
2022, but we did not experience any disruptions that materially impacted product availability for our customers. We anticipate
that increased material and shipping costs will continue during fiscal 2023 relating to supply chain availability and inflationary
trends in electronic components but may extend to other components as well. In certain instances, we have purchased key electronic
materials in advance to ensure adequate future supply and mitigate the risk of supply chain disruption. It is possible that the
COVID-19 pandemic could have a greater adverse impact on our supply chain in the future, including impacts associated with preventative
and precautionary measures taken by other businesses and applicable governments. A reduction or interruption in any of our manufacturing
processes could have a material adverse effect on our business. Any significant increases to our raw material or shipping costs
could reduce our gross margins.

We
have also taken measures to ensure the safety of our employees and to comply with applicable governmental orders. We consider
our business to be essential under applicable governmental orders, primarily due to our role in manufacturing and supplying needed
medical devices to patients with respiratory-related issues and have therefore continued to operate during the government restrictions
put in place in response to the pandemic.

In
response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, the CMS implemented
a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health
emergency. These waivers became effective on March 1, 2020. Clinical indications and documentation typically required will not
be enforced for respiratory-related products including the SmartVest System (solely with respect to Medicare patients). The minimum
documentation now requires a valid order and documentation of a respiratory-related diagnosis. Face-to-face and in-person requirements
for respiratory devices are being waived while the waiver is in place. The CMS waiver was recently extended in conjunction with
the extension of the federal public health emergency for an additional 90-day period beginning July 15, 2022.

We
did not receive any direct financial assistance from any government program during fiscal 2021 or fiscal 2022 in connection with
COVID-19 relief measures.

Revenue
Recognition

Revenue
is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including consideration paid or payable to customers and significant
financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control
of a distinct good or service to a customer.

Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and
Deferred Costs,” or the requirements under other applicable accounting guidance are met.

16

The
Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the Company’s
SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost
of revenues.

We
request that customers return previously sold units that are no longer in use to us 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 are certified to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold
and continue to be used for demonstration equipment and warranty replacement parts.

Inventory
Valuation

Inventories
are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are carried
at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. The reserve for obsolescence
is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated inventory to be returned
is based on how many devices that have shipped that are expected to be returned prior to completion of the insurance reimbursement
process.

Warranty
Reserve

The
Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and a three-year warranty
for all institutional sales and sales to individuals outside the U.S. 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 shipped. Factors that affect the Company’s
warranty reserve include the number of units shipped, historical and anticipated rates of warranty claims, the product’s
useful life and cost per claim. The Company periodically assesses the adequacy of its recorded warranty reserve and adjusts the
amounts as necessary.

Share-Based
Compensation

Share-based
payment awards consist of options to purchase shares of our common stock issued to employees. Expense for share-based payment
awards consist of options to purchase shares of our common stock issued to employees for services. Expense for options is estimated
using the Black-Scholes pricing model at the date of grant and expense for restricted stock is determined by the closing price
on the day the grant is made. Expense is recognized on a straight-line basis over the requisite service or vesting period of the
award, or at the time services are provided for non-employee awards. In determining the fair value of options, we make various
assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility, and life.
See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for a description of these
assumptions.

17

Results
of Operations

Fiscal
Year Ended June 30, 2022 Compared to Fiscal Year Ended June 30, 2021

Revenues

Revenue
for the fiscal years ended June 30, 2022 and 2021 are summarized in the table below (dollar amounts in thousands).

Home
Care Revenue. Home care revenue increased by $5,018,000, or 15.2%, in fiscal 2022 compared to fiscal 2021. The revenue increase
compared to fiscal 2021 was primarily due to increases in referrals and approvals. The increase in referrals was primarily due
to an increase in direct sales representatives, increased sales representative productivity driven by increased clinic access
and patient flow, our sales team refining their selling process and clinic targeting methodology, and benefits of the CMS waiver
on the non-commercial Medicare portion of our home care revenue. Additionally, we also benefitted from a Medicare allowable rate
increase that took effect on January 1, 2022. Annual Medicare rate increases for our device are linked closely to changes in the
Urban Consumer Price Index.

The
CMS waiver benefited the non-commercial Medicare portion of our home care revenue by increasing the number of referrals and the
approval percentage for previously non-covered diagnoses. We believe that our ongoing sales team execution, along with the expected
return to pre-COVID-19 levels of patient face-to-face engagement with physicians and clinic access for our sales team, has the
potential to mitigate the impact of a CMS waiver expiration, which is currently effective until October 2022.

Institutional
Revenue. Institutional revenue increased by $111,000, or 7.2%, in fiscal 2022 compared to fiscal 2021. Institutional revenue
includes sales to group purchasing organizations, rental companies and other institutions. The revenue increase was due to increased
capital purchases and stronger consumable volumes compared to fiscal 2021, as hospitals resumed utilization of HFCWO protocols
after reducing utilization early in the COVID-19 pandemic.

Home
Care Distributor Revenue. Home care distributor revenue increased by $911,000, or 161.8%, in fiscal 2022 compared to fiscal
2021. The revenue increase in fiscal 2022 was due to increased demand from one of our primary home care distribution partners.
We began selling to a limited number of home medical equipment distributors during our fiscal year ended June 30, 2020, who in
turn sell our SmartVest System in the U.S. home care market.

International
Revenue. International revenue decreased by $137,000, or 20.8%, in fiscal 2022 compared to fiscal 2021. International revenue
growth is not currently a primary focus for us, and our corporate resources are focused on supporting and maintaining our current
distributors. International sales are affected by the timing of international distributor purchases that can cause significant
fluctuations in reported revenue on a quarterly basis.

Gross
Profit

Gross
profit increased to $31,442,000 in fiscal 2022, or 75.5% of net revenues, from $27,305,000, or 76.4% of net revenues,
in fiscal 2021. The increase in gross profit was primarily related to increases in domestic home care revenue
including the Medicare allowable rate increase that took effect in January 2022. The decrease in gross profit
as a percentage of net revenue was driven by higher raw material and shipping costs as well as patient
training related expenses due to increase in face-to-face trainings.

18

We
believe as we continue to grow revenue, we will be able to leverage manufacturing costs, although there may be fluctuations on
a short-term basis related to increased material and shipping costs as well as average reimbursement based on the mix of referrals
during any given period. Factors such as diagnoses that are not assured of reimbursement, insurance programs with lower allowable
reimbursement amounts (for example, state Medicaid programs), whether an individual patient meets prerequisite medical criteria
for reimbursement, and continuation of the Medicare waiver currently in place may have an effect on average reimbursement received
on a short-term basis. We have a goal of improving our gross margin percentage over time due to lower product costs associated
with our next generation product, supplier optimization, and gaining operating leverage on higher volumes.

Operating
Expenses

Selling,
General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses were $27,114,000 in fiscal 2022, representing an increase of $4,671,000 or 20.8% from $22,443,000 in fiscal 2021.

SG&A
payroll and compensation-related expenses increased by $2,206,000, or 15.3%, to $16,640,000 in fiscal 2022, compared to $14,434,000
in fiscal 2021. The increase in the current year was primarily due to a higher average number of sales, sales support and marketing
personnel, increased reimbursement personnel to process higher patient referrals, increased temporary resources to assist with
systems infrastructure investments and increased incentive payments on higher home care revenue. We have also continued to provide
regular merit-based increases for our employees and are regularly benchmarking our compensation ranges for new and existing employees
to ensure we can hire and retain the talent needed to drive growth in our business. Field sales employees totaled 52, of which
43 were direct sales, as of June 30, 2022, compared to 46 as of June 30, 2021, of which 37 were direct sales.

Professional
and legal fees increased by $875,000, or 36.0%, to $3,308,000 in fiscal 2022, compared to $2,433,000 in fiscal 2021. Professional
fees include services related to legal costs, shareowner services and reporting requirements, information technology technical
support and consulting fees. The increase in the current year was primarily due to a shareholder activism matter, increased investment
in our system infrastructure and increased clinical study costs. Our shareholder activism matter concluded with a cooperation
agreement in September 2021. We continue to make key investments in systems infrastructure including implementing a new enterprise
resource planning (“ERP”) system, enhancing our customer relationship management system and further optimizing of
the revenue cycle management system that was implemented in June 2021. We expect these system infrastructure investments will
result in more efficient and scalable operational processes and provide enhanced analytics to drive business performance. We also
expect to continue investing in our on-going clinical studies in order to continue building the body of evidence around positive
outcomes from bronchiectasis patients using HFCWO and SmartVest therapy.

Total
discretionary marketing expenses decreased by $238,000, or 22.4% to $824,000 in fiscal 2022, compared to $1,062,000 in fiscal
2021. The decrease in the current year was primarily due to a shift to more cost-effective direct-to-consumer marketing investments.

Travel,
meals and entertainment expenses increased $734,000, or 41.2%, to $2,514,000 for fiscal 2022 compared to $1,780,000 in fiscal
2021. The increase in the current year period was primarily due to our sales team resuming closer-to-normal levels of travel compared
to the COVID-19 driven travel restrictions in the prior year and an increase in regional sales meetings that were cancelled in
the prior year due to COVID-19. The Company also held an in-person national sales meeting in August 2021 whereas the national
sales meeting was held virtually in fiscal 2021 due to COVID-19.

Recruiting
fees increased by $362,000 or 134.6% to $631,000 for fiscal 2022 compared to $269,000 in fiscal 2021. The increase in recruiting
fees is primarily due to increased recruiting for senior leadership and direct sales representative positions.

Insurance
expenses increased by $229,000 or 20.6% to $1,339,000 for fiscal 2022 compared to $1,110,000 in fiscal 2021. The increase in the
current year is primarily due to higher health insurance, director and officer insurance costs and cyber insurance costs.

19

Research
and Development Expenses

R&D
expenses decreased by $366,000, or 21.3%, to $1,356,000 in fiscal 2022 compared to $1,722,000 in fiscal 2021. The decrease in
the current year was primarily due to reduced professional consulting costs associated with our next generation platform development
activities. R&D expenses were 3.3% of revenue in fiscal 2022 compared to 4.8% of revenue in fiscal 2021. We expect R&D
spending to be between 2.0% and 3.0% of revenue during fiscal 2023, as we look to finalize our development and product testing
work in preparation for an anticipated fiscal year 2023 next generation product launch.

Interest
Income, net

Net
interest income was approximately $25,000 in fiscal 2022 compared to net interest income of $39,000 in fiscal 2021. The decrease
in the current year was primarily due to lower rates earned on our cash deposits and lower cash deposits in the bank compared
to prior fiscal periods.

Income
Tax Expense

Income
tax expense in fiscal 2022 was 692,000, which includes a current tax expense of $1,181,000 and a deferred benefit of $489,000.
Estimated income tax expenses include a discrete current tax benefit of approximately $37,000 related to exercised fully vested
stock options and a discrete current benefit of approximately $21,000 related to the excess tax benefit of non-qualified stock
options that were exercised during the period.

Income
tax expense in fiscal 2021 was $805,000, which included a current tax expense of $1,099,000 and a deferred benefit of $294,000.
Estimated income tax expense included a discrete deferred tax expense of approximately $81,000 related to unexercised fully vested
stock options that expired and a discrete current tax benefit of approximately $33,000 related to the excess tax benefit of non-qualified
stock options that were exercised during the period.

The
effective tax rates were 23.1% and 25.4% for fiscal 2022 and 2021, respectively. The effective tax rates differ from the statutory
federal rate due to the effect of state income taxes, R&D tax credits, and other permanent items that are non-deductible for
tax purposes relative to the amount of taxable income.

Net
Income

Net income
for fiscal 2022 was $2,305,000, compared to net income of $2,362,000 in fiscal 2021. The decrease in current year net income
was primarily due to increased strategic investments in SG&A, shareholder activism costs and higher product costs
partially offset by stronger home care and distributor revenue growth.

Liquidity
and Capital Resources

Cash
Flows and Sources of Liquidity

Cash
Flows from Operating Activities

Net
cash used in operating activities in fiscal 2022 was $686,000. Cash flows from operating activities consisted of net income of $2,305,000,
non-cash expenses of approximately $1,115,000, a $2,170,000 increase in accounts payable and accrued liabilities and a decrease in
contract assets of $107,000. These cash flows from operating activities were offset by a $4,020,000 increase in accounts receivable,
an increase in inventory of $1,072,000, and a $1,322,000 increase in prepaid expenses. The increase in accounts receivable was
primarily due to an increase in the Medicare portion of our home care business, which has a 13-month payment cycle. Three
distinct items have negatively impacted our operating cash flow in fiscal 2022, including tax payments on higher-than-expected
fiscal 2021 net income, increased payments to secure adequate supply of key raw material components, and a one-time payout of
accrued vacation balances as part of an enhancement to our paid time off policy. Our cash receipt collection remains strong,
with the three months ended June 30, 2022 period having the highest cash receipt collections in our company's history,
building upon the prior record that was set in the previous quarter.

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Cash
Flows from Investing Activities

Net
cash used in investing activities in fiscal 2022 was approximately $1,525,000. Cash used in investing activities consisted of
approximately $1,425,000 in expenditures for property and equipment, approximately $943,000 for software and $482,000 for
equipment, and $100,000 in payments for patent and trademark costs.

Cash
Flows from Financing Activities

Net
cash used in financing activities in fiscal 2022 was approximately $1,525,000, consisting of $1,448,000 used for our share repurchase
program and $77,000 for taxes paid on net share settlements of stock option exercises.

Adequacy
of Capital Resources

Our
primary working capital requirements relate to adding employees to our sales force and support functions, continuing infrastructure
investments, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred
in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately
$27,389,000 and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2023.

Effective
December 17, 2021, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on
the line of credit accrues at the prime rate (4.75% as of June 30, 2022) less 1.0% and is payable monthly. There was no outstanding
principal balance on the line of credit as of June 30, 2022 or June 30, 2021. The amount eligible for borrowing on the line of
credit is limited to the lesser of $2,500,000 or 57.0% of eligible accounts receivable, and the line of credit expires on December
18, 2023, if not renewed. As of June 30, 2022, the maximum $2,500,000 was available under the line of credit. Payment obligations
under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.

The
documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net
worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.

Any
failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result
in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring
prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated
or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may
not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.

During
fiscal 2022 and 2021, we spent approximately $1,425,000 and $287,000, respectively, on property and equipment. We currently expect
to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. 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 flows.

While
the impact of the COVID-19 pandemic and other factors such as inflation are difficult to predict, we believe our cash, cash equivalents
and cash flows from operations will be sufficient to meet our working capital, capital expenditure, operational cash requirements for
fiscal 2023.

Accounting
Standards Recently Issued But Not Yet Adopted by the Company

See
Note 1 of the Notes to our Financial Statements in this Annual Report on Form 10-K for information on new accounting standards
adopted in fiscal 2022 or pending adoption.

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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 Annual Report on Form 10-K. The forward-looking statements include statements that reflect management’s good faith 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 Annual Report on Form 10-K.

Overview

Electromed develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.

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We manufacture, market and sell products that provide HFCWO, including the SmartVest System and related products, to patients with compromised pulmonary function. The SmartVest SQL is smaller, quieter and lighter than our previous product (the SmartVest SV2100), with enhanced programmability, ease of use, wireless technology, and a personalized HFCWO therapy management portal for patients with compromised pulmonary function. Our products are sold in both the home health care market and the institutional market for use by patients in hospitals, which we refer to as “institutional sales.” The SmartVest SQL has been sold in the domestic home care market since 2014. In 2017, we launched the SmartVest SQL with SmartVest Connect wireless technology.

The SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations (“HMOs”), state Medicaid systems, and the federal Medicare system, which is an important consideration for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned billing code for HFCWO devices if the patient has cystic fibrosis, bronchiectasis (including chronic bronchitis or chronic obstructive pulmonary disease that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuromuscular 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 employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes. This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical equipment channel and capture both the manufacturer and distributor margins. We have engaged a limited number of regional durable medical equipment distributors focused on respiratory therapies as an alternate sales channel. Revenue through this channel was less than 2% of our total revenues in fiscal 2021.

Our key growth strategies for fiscal 2022 include the following:

Grow faster than the overall home care HFCWO market by taking market share and expanding the pool of physicians who prescribe the SmartVest System in the largest and fastest growing segments of the market: adult pulmonology/bronchiectasis;

Critical Accounting Policies and Estimates

During the preparation of our financial statements, we are required to make estimates, assumptions and judgments that affect reported amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets and liabilities, and our 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 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. See also Note 1 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K.

COVID-19 Pandemic and CARES Act Funding

In March 2020, the World Health Organization designated COVID-19 as a global pandemic. The COVID-19 pandemic created significant volatility, uncertainty and economic disruption that negatively impacted business in our industry starting in March 2020 and continuing to varying degrees throughout fiscal 2021.

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We consider our business to be essential under applicable governmental orders due primarily to our role in manufacturing and supplying needed medical devices to patients with respiratory related issues and remained fully operational for the duration of fiscal 2021.

We also took measures to ensure the safety of our employees and to comply with applicable governmental orders, including transitioning employees to remote work where possible, adhering to Centers for Disease Control (“CDC”) guidelines for mask wearing and social distancing, and implementing enhanced cleaning practices in the office. During the fourth quarter of fiscal 2021, as COVID-19 vaccines became more widely available in the United States, we reviewed our guidelines for corporate offices and manufacturing and adjusted our safety guidelines to align with CDC guidelines for mask wearing and social distancing. Additionally, we provided direction to employees on their work schedules, balancing business productivity and flexibility for employees and maintaining the highest level of safety in the workplace.

The home care market was impacted by COVID-19 primarily due to certain healthcare facilities and clinics restricting access to their clinicians, and patients reducing in-person visits to clinics for consultations and treatments. The degree of clinic access limitations and in-person patient visit reductions varied throughout fiscal 2021 based on multiple variables, including the number of daily COVID-19 cases occurring in key geographies, the degree of state and local government restrictions, and the availability and deployment of vaccines. During fiscal 2021, our sales team developed and utilized a hybrid selling approach that combined virtual and face-to-face clinician interactions, which helped mitigate the market disruption caused by COVID-19.

Our institutional business was negatively impacted by COVID-19 through fiscal 2021 as     hospitals and long-term care facilities adjusted their operating protocols and procurement management in response to the pandemic.  Limiting the spread of airborne particles was a priority in institutional settings during fiscal 2021, and airway clearance therapies usage, including HFCWO, induces coughing in patients.

In response to the negative impacts of the COVID-19 pandemic on our business, in April 2020 we initiated cost-containment measures, which included reducing discretionary and variable spend, such as travel, and the use of contractors, consultants, temporary help and employee furloughs in our manufacturing and general and administrative functions due to lower near-term demand for our products.  As our referral volumes returned to near pre-pandemic levels in July 2020, all furloughed employees returned to work by August 2020, and we continued to make all planned strategic investments in our business throughout fiscal 2021 in both selling, general and administrative (“SG&A”) and R&D.

We did not receive any direct financial assistance from any government program during fiscal 2021. We received a one-time $913,000 payment under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in the fourth quarter of fiscal 2020, which partially offset lower profitability related to the revenue decline caused by the COVID-19 pandemic during the period. The amount received from the CARES Act is subject to compliance with certain terms and conditions and reporting requirements, and such report may be audited by a federal agency for compliance with the program’s terms and conditions.

Overall, we believe that these and other responses by healthcare systems had a negative impact on our operating results and cash flows during the fourth quarter of fiscal 2020 and the first quarter of fiscal 2021, and then again in the third quarter of fiscal 2021 as Covid-19 cases and hospitalization spiked during that time period. We believe that we benefited during the most recent fiscal year from our sales organization adapting to innovations in contacting physicians, such as through virtual meetings, and from the waiver implemented by CMS in response to the public health emergency.

In response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, CMS implemented a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health emergency. These waivers were made retroactively effective to March 1, 2020 and were in place for the duration of fiscal 2021. Clinical indications and documentation typically required were not enforced for respiratory related products including the SmartVest System (solely with respect to direct Medicare covered patients) applicable for our home care prescriptions. The minimum documentation now requires a valid order and documentation of a respiratory related diagnosis. Face-to-face and in-person requirements for replacement respiratory devices are being waived during such period, both of which are currently scheduled to expire in October 2021. A temporary suspension of a 2% tax on Medicare payments was also initiated in May 2020 and has been extended through December 2021.

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The impact of the COVID-19 pandemic on our business remains uncertain and its effects on operational and financial performance will depend in part on future developments, which cannot be reasonably estimated at this time. Such future developments include, but are not limited to, the duration, scope and severity of the COVID-19 pandemic in geographic areas in which we operate or in which our patients live, actions taken to contain or mitigate its impact, the impact on governmental healthcare programs and budgets, the deployment of treatments or vaccines, and the resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and evolving situation, we are unable to predict with confidence the likely impact of the COVID-19 pandemic on our future operations.

Revenue Recognition and Allowance for Doubtful Accounts

We measure revenue based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer.

Individual promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement). If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and Deferred Costs,” or the requirements under other applicable accounting guidance are met.

We include shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of each SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost of revenues.

Accounts receivable are also net of an allowance for doubtful accounts, which are accounts from which payment is not expected to be received. 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 previously sold units that are no longer in use to us 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 are certified to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold and continue to be used for demonstration equipment and warranty replacement parts.

Valuation of Long-Lived and Intangible Assets

Long-lived assets, primarily 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 or asset group is measured by a comparison of the unamortized balance of the asset or asset group 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 group. The amount of such impairment would be charged to operations at the time of determination.

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 three 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, respectively, using the straight-line method.

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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.

Warranty Reserve

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 each home care SmartVest System initially purchased and currently located in the U.S. or Canada, we provide a lifetime warranty to the individual patient for whom the SmartVest System is prescribed. For sales to institutions within the U.S., and for all international sales, except Canadian home care, we provide a three-year warranty. 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 on future product performance and durability and is estimated largely based on historical experience. We estimate the average useful life of our products is approximately five years. Factors that affect our warranty liability include the number of units sold, historical and anticipated rates of warranty claims, the product’s 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 or refurbished model. We periodically assess the adequacy of our recorded warranty liability and adjust the accrual as claims data and historical experience warrant.

Share-Based Compensation

Share-based payment awards consist of options to purchase shares of our common stock issued to employees. Expense for options is estimated using the Black-Scholes pricing model at the date of grant. The portion of the option award that is ultimately expected to vest is recognized on a straight-line basis over the requisite service or vesting period of the award and adjusted upon completion of the vesting period. In determining the fair value of our share-based payment awards, we make various assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility, life and forfeitures. See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for a description of these assumptions.

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Results of Operations

Fiscal Year Ended June 30, 2021 Compared to Fiscal Year Ended June 30, 2020

Revenues

Revenue for the fiscal years ended June 30, 2021 and 2020 are summarized in the table below (dollar amounts in thousands).

Home Care Revenue. Home care revenue increased by 12.5%, or approximately $3,663,000, for fiscal 2021 compared to fiscal 2020.. The growth versus prior year was primarily driven by an increase in referrals and approvals. The increase in referrals compared to the prior year periods was due to the sales team adapting to a hybrid virtual and face-to-face selling model implemented to combat clinic access limitations due to the COVID-19 pandemic, benefits of the CMS waiver on the non-commercial Medicare portion of our home care revenue, and an increase in direct sales representatives.

The CMS waiver benefited the non-commercial Medicare portion of our home care revenue by increasing the number of referrals and the approval percentage for non-covered diagnoses. We believe that our ongoing sales team execution, along with the expected return to pre-COVID-19 levels of patient face-to-face engagement with physicians and clinic access for our sales team, has the potential to mitigate the impact of a CMS waiver expiration, which is currently effective until October 2021.

Institutional Revenue. Institutional revenue decreased by 22.6%, or approximately $451,000, in fiscal 2021 compared to fiscal 2020. Institutional revenue includes sales to group purchasing organizations, rental companies and other institutions. The decrease in the current year periods was primarily due to the continued impact of COVID-19 on hospital purchasing activity. Our institutional revenue increased each quarter throughout fiscal 2021 as hospital purchasing activity began returning to more standard operating procedures as were in place prior to COVID-19.

Home Care Distributor Revenue. Home care distributor revenue increased 30.9%, or approximately $133,000, for fiscal 2021 compared to fiscal 2020. The growth versus the prior year was driven by additional capital sales with our primary distributor. We began selling to home medical equipment distributors during fiscal 2020, who in turn sell our SmartVest System in the U.S. home care market.

International Revenue. International revenue decreased by 8.4%, or approximately $60,000, in fiscal 2021 compared to fiscal 2020. International revenue growth is not currently a primary focus for us, and our corporate resources are only focused on supporting and maintaining our current distributors.

Gross Profit

Gross profit increased to $27,305,000 during fiscal 2021, or 76.4% of net revenues, from $25,200,000, or 77.6% of net revenues, during fiscal 2020. The increase in gross profit was primarily related to increases in domestic home care revenue. The decrease in gross profit as a percentage of net revenue was driven by a higher warranty reserve adjustment, costs associated with discontinuing shipments of the SmartVest SV2100 in the United States, and limited cost increases to both raw materials and shipping costs, which was partially offset by a higher mix of home care revenue and a favorable mix of Medicare within the home care channel. The increase in the warranty reserve was driven by a combination of an increase in components included in the warranty calculation and higher repair costs for our SV2100 device repairs. There has not been an increase in product warranty returns for either our generators or vests.

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We believe as we continue to grow revenue, we will be able to leverage manufacturing costs, although there may be fluctuations on a short-term basis related to average reimbursement based on the mix of referrals during any given period. Factors such as diagnoses that are not assured of reimbursement, insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs), and whether an individual patient meets prerequisite medical criteria for reimbursement, may have an effect on average reimbursement received on a short-term basis We have a goal of improving our gross margin percentage over time due to lower product costs associated with our next generation product, supplier optimization, and gaining operating leverage on higher volumes.

Operating Expenses

Selling, General and Administrative Expenses. SG&A expenses increased by approximately $2,498,000, or 12.5%, to approximately $22,443,00 in fiscal 2021, compared to approximately $19,945,000 in fiscal 2020. During fiscal 2021, we invested in strategic SG&A investments that we believe will position the company for sustainable, long-term growth. Key strategic SG&A investments in fiscal 2021 included increased direct-to-consumer marketing, implementation of a new revenue cycle management system, strategic market analytics and commercial planning and new headcount positions in product marketing and clinical field support. We believe that these investments will provide the support to drive a successful sales force expansion plan beginning in fiscal 2022.

SG&A payroll and compensation-related expenses increased by $1,973,000, or 15.8%, to $14,434,000 in fiscal 2021, compared to $12,461,000 in fiscal 2020. The increase was primarily due to a higher average number of sales and marketing personnel, increased temporary resources to assist with systems infrastructure investments, increased compensation payments related to stronger home care revenue performance.

Professional and legal fees increased by $431,000, or 21.5%, to $2,433,000 in fiscal 2021, compared to $2,002,000 in fiscal 2020. These fees are primarily for services related to legal costs, shareowner services and reporting requirements, information technology technical support, and consulting fees for enhancing our market development strategy. The increase in the current year periods was primarily due to higher legal fees, annual fees associated with   a new human resources platform, increased investment in leadership development training, and fees associated with the implementation of our new revenue cycle management software.  We expect to make continued investments in our systems infrastructure over the next year, including an enterprise resource planning software implementation.

Total discretionary marketing expenses increased by $281,000, or 36.0% to $1,062,,000 in fiscal 2021, compared to $781,000 in fiscal 2020. The increase in the current year period was primarily due to a direct-to-consumer marketing campaign that began in May 2020 and investment in strategic market analytics and commercial planning activities.

Travel, meals and entertainment expenses decreased $164,000, or 8.4%, to $1,780,000 for fiscal 2021 compared to $1,944,000 in fiscal 2020. The decrease in the current year period was primarily due to travel reductions in connection with COVID-19, primarily in the first half of the fiscal year. Travel, meals and entertainment expenses returned to near pre-COVID-19 levels by the fourth quarter of fiscal 2021.

Research and Development Expenses. R&D expenses increased by $672,000, or 64.0%, to $1,722,000 in fiscal 2021 compared to $1,050,000 in fiscal 2020. R&D expenses were 4.8% of revenue in fiscal 2021 compared to 3.2% of revenue in fiscal 2020. The increase in the current year period was primarily due to professional consulting fees associated with our next generation platform development activities. We expect R&D spending to remain between 3.0% and 5.0% of revenue during fiscal 2022, as we look to finalize our development and product testing work in preparation for an anticipated fiscal year 2023 next generation product launch.

Government Stimulus Income. We did not record any government stimulus income in fiscal 2021. In fiscal 2020, we recorded $913,000 of government stimulus income related to general distribution funds received from the Provider Relief Fund established by the CARES Act for Medicare fee-for-service providers due to lost revenues resulting from the COVID-19 pandemic.

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Interest Income, net

Net interest income was approximately $39,000 during fiscal 2021 compared to net interest income of $121,000 in fiscal 2020. The decrease in net interest income was primarily driven by lower interest rates in fiscal 2021 as compared to fiscal 2020.

Other Expense, net

Net other expense was approximately $12,000 during fiscal 2021 compared to net other expense of zero in fiscal 2020.  Net other expenses represent costs related to our June 2021 data security incident of $187,000, net of related insurance reimbursement of $175,000.

Income Tax Expense

Income tax expense during fiscal 2021 was $805,000, which includes a current tax expense of $1,099,000 and a deferred benefit of $294,000. Estimated income tax expense includes a discrete deferred tax expense of approximately $81,000 related to unexercised fully vested stock options that expired and a discrete current tax benefit of approximately $33,000 related to the excess tax benefit of non-qualified stock options that were exercised during the period.

In fiscal 2020, we recorded a current income tax expense of $1,078,000, which includes a current tax expense of $1,204,000 and a deferred benefit of $126,000. Estimated income tax expense for fiscal 2021 included a discrete current tax benefit of approximately $358,000 related to the excess tax benefit of non-qualified stock options that were exercised during the period.

The effective tax rates were 25.4% and 20.6% for fiscal 2021 and 2020, respectively. The effective tax rates differ from the statutory federal rate due to the effect of state income taxes, R&D tax credits, and other permanent items that are non-deductible for tax purposes relative to the amount of taxable income.

Net Income

Net income for fiscal 2021 was $2,362,000, compared to net income of $4,161,000 in fiscal 2020. The decrease in the current year period was driven by increased strategic investments in SG&A and R&D and a lower gross margin percentage, partially offset by stronger home care revenue performance. Fiscal year 2021 does not include any government stimulus income, compared to $913,000 of government income received under the CARES Act in fiscal 2020.

Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

Cash Flows from Operating Activities

Net cash provided by operating activities in fiscal 2021 was $3,077,000. Cash flows from operating activities consisted of net income of $2,362,000, non-cash expenses of approximately $1,340,000, a $1,284,000 increase in accounts payable and accrued liabilities, a decrease in inventory of $971,000, a decrease in contract assets of $510,000 and a $151,000 decrease in prepaid expenses. These cash flows from operating activities were partially offset by a $4,091,000 increase in accounts receivable. The increase in accounts receivable was primarily due to an increase in the Medicare portion of our home care business, which has a 13-month payment cycle.

Cash Flows from Investing Activities

Net cash used in investing activities in fiscal 2021 was approximately $448,000. Cash used in investing activities consisted of approximately $287,000 in expenditures for property and equipment and $161,000 in payments for patent and trademark costs.

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Cash Flows from Financing Activities

Net cash used in financing activities in fiscal 2021 was approximately $1,219,000, consisting of $1,124,000 used for our share repurchase program and $141,000 for taxes paid on behalf of employees stock options that were exercised on a net basis during the period, partially offset by $46,000 of proceeds received from stock options exercised during the period.

Adequacy of Capital Resources

Our primary working capital requirements relate to adding employees to our sales force and support functions, continuing R&D efforts, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately $27,065,000 and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2022.

Effective December 16, 2020, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on the line of credit accrues at the prime rate (3.25% as of June 30, 2021) less 1.00% and is payable monthly. There was no outstanding principal balance on the line of credit as of June 30, 2021 or June 30, 2020. The amount eligible for borrowing on the line of credit is limited to the lesser of $2,500,000 or 57.00% of eligible accounts receivable, and the line of credit expires on December 18, 2021, if not renewed. As of June 30, 2021, the maximum $2,500,000 was available under the line of credit. Payment obligations under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.

The documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.

Any failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these assets.

During fiscal 2021 and 2020, we spent approximately $299,000 and $844,000, respectively, on property and equipment. We currently expect to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. 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 flows.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Accounting Standards Recently Issued But Not Yet Adopted by the Company

In December 2019, the Financial Accounting Standards Board issued Accounting Standards Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The new guidance also improves consistent application of and simplifies U.S. generally accepted accounting principles for other areas of Topic 740 by clarifying and amending the existing guidance. The guidance is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company is currently evaluating the effect of the new guidance.