Electromed, Inc. - Quarter Report: 2013 March (Form 10-Q)

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

          Some of the statements in this report may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 that reflect our current view on future events, future business, industry and other conditions, our future performance, and our plans and expectations for future operations and actions. In some cases, you can identify forward-looking statements by the following words: anticipate, believe, continue, could, estimate, expect, intend, may, ongoing, plan, potential, predict, project, should, will, would, or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Our forward-looking statements in this report primarily relate to the following: our ability to restructure and comply with the covenants in our existing credit facility; our exploration of additional international markets; our beliefs regarding gross profit margin trends; our expectations with respect to insurance coverage of certain expenses relating to ongoing litigation; our expectations regarding planned cost reductions; our expectations regarding leveraging manufacturing costs and its effect on gross profit percentage; our planned growth strategies and the impact of our business strategy on revenues and earnings, including the expected contributions of new members of our sales staff; expected expenditures for research and development; our expectations regarding capital expenditures; and our beliefs regarding the sufficiency of working capital and our ability and intention to renew or obtain financing. These statements involve known and unknown risks, uncertainties and other factors that may cause our results or our industry’s actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management’s beliefs and assumptions, which in turn are based on currently available information.

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

Overview

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

          We manufacture, market and sell products that provide HFCWO, including the Electromed, Inc. SmartVest® Airway Clearance System (SmartVest System) and related products, to patients with compromised mucus clearance function. The products are sold for both the home health care market and the institutional market for use by patients in hospitals, which are referred to as “institutional sales.” For more than ten years, we have marketed the SmartVest System and its predecessor products to patients suffering from cystic fibrosis, bronchiectasis (including chronic bronchitis or chronic obstructive pulmonary disease (COPD) that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuro-muscular diseases, and can demonstrate that another less expensive physical or mechanical treatment did not adequately mobilize retained secretions. Additionally, we offer such products upon physician prescription to a patient population that includes post-surgical and intensive care patients, patients with end-stage neuromuscular disease, and ventilator-dependent patients. Our goal is to be a consistent innovator in providing HFCWO to patients with impaired pulmonary function.

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Critical Accounting Policies and Estimates

          Our significant accounting policies and estimates are disclosed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 1 to our Audited Consolidated Financial Statements, included in Part II, Item 8, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2012. The critical accounting policies used in the preparation of the financial statements as of and for the three and nine month periods ended March 31, 2013, have remained unchanged from June 30, 2012.

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

Results of Operations

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

          Revenues

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

		Three Months Ended March 31,						Increase (Decrease)
		2013			2012
Total Revenue		$	3,199		$	4,774		$	(1,575	)		(33.0	)%
Home Care Revenue		$	2,611		$	4,360		$	(1,749	)		(40.1	)%
International Revenue		$	215		$	165		$	50			30.3	%
Government/Institutional Revenue		$	373		$	249		$	124			49.8	%

          Home Care Revenue. Home care revenue was approximately $2,611,000 for the three months ended March 31, 2013, representing a decrease of approximately $1,749,000, or 40.1%, compared to the same period in 2012. The decrease in revenue was caused downward pressure on pricing and added administrative procedures implemented by third party payers in the insurance claims process, which has lengthened the approval process compared to the prior year. Additionally, one of the largest domestic third party payers has decentralized its contracting process. The decentralization has required additional time to complete the necessary reimbursement contracts with individual affiliates to maintain our national coverage with that payer. Certain contracts have been resolved during the quarter, although the final completion of this process will extend into fiscal year 2014.

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          International Revenue. International revenue was approximately $215,000 for the three months ended March 31, 2013, representing an increase of approximately $50,000, or 30.3%, compared to the same period in 2012. This increase resulted primarily from an increase in revenue to the Middle East. During the quarter ended March 31, 2013, we hired a new international sales manager, which has facilitated exploring additional international opportunities.

          Government/Institutional Revenue. Government/institutional revenue was approximately $373,000 for the three months ended March 31, 2013, representing an increase of approximately $124,000, or 49.8%, compared to approximately $249,000 during the same period in 2012. This resulted from a $19,000 increase in revenue from the U.S. Department of Veterans Affairs and other government entities, which increased to approximately $69,000 for the three months ended March 31, 2013 from approximately $50,000 during the same period the prior year. Institutional revenue also contributed to the increase in government/institutional revenue, which increased to approximately $305,000 for the three months, ended March 31, 2013 from approximately $199,000 during the same period the prior year. The increase in government/institutional revenues are due to a renewed focus by the sales force and adding new pricing options in response to market conditions.

          Gross Profit

          Gross profit decreased to approximately $2,442,000 for the three months ended March 31, 2013, from approximately $3,369,000 in the same period in 2012. Gross profit as a percentage of revenue, however, increased to 76.3% for the three months ended March 31, 2013, from approximately 70.6% in the same period of 2012. The increase in gross profit percentage was primarily the result of higher than average reimbursement from the mix of referrals during the three month 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 the patient meets prerequisite medical criteria for reimbursement, affect average reimbursement received on a short-term basis. These factors tend to fluctuate on a quarterly basis. During the quarter ended March 31, 2013, the Company continued its focus on cost efficiencies which also affected the increase in gross profit percentage. We believe that future margins will trend at historical levels between 70% and 75%.

          Operating expenses

          Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses were approximately $3,034,000 for the three months ended March 31, 2013, representing an increase of approximately $129,000, or 4.4%, compared to SG&A expenses of approximately $2,905,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $1,586,000 for the three months ended March 31, 2013, representing an increase of approximately $154,000, or 10.8%, compared to approximately $1,432,000 in the same period the prior year. This increase primarily resulted from an increase in employees in the sales and reimbursement departments. Total SG&A employees increased by 10.3%, from 72 SG&A full-time equivalents (FTEs) for the three months ended March 31, 2012 to 80 SG&A FTEs during the same period in the current year. In addition, selling, general and administrative expenses increased approximately $44,000 as a result of the medical device tax that was implemented during the quarter ended March 31, 2013.

          Travel, meals and entertainment, and trade show expenses were approximately $360,000 for the three months ended March 31, 2013, representing a decrease of approximately $41,000, or 10.2%, compared to approximately $401,000 for the same period in the prior year. This decrease was primarily due to the elimination of industry training that was sponsored by Electromed, as well as eliminating costs related to tradeshows that do not fit our growth strategies.

          Advertising and marketing expenses for the three months ended March 31, 2013 were approximately $193,000, a decrease of approximately $84,000, or 30.3%, compared to approximately $277,000 in the same period the prior year. The decrease was related to bringing marketing leadership in-house, thus reducing our external marketing fees, as well as targeting more cost-effective advertising.

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          Patient training expenses for the three months ended March 31, 2013 were approximately $77,000, a decrease of approximately $57,000, or 42.5%, compared to approximately $134,000 in the same period the prior year. These decreases reflected the decreased volume of home care patient shipments for the three months ended March 31, 2013 compared to the same period in the prior year.

          Professional fees for the three months ended March 31, 2013 were approximately $320,000, an increase of approximately $129,000 compared to approximately $191,000 in the same period in the prior year. These fees are for services related to legal costs, reporting requirements, expenses related to information technology security and backup, and expenses for printing and other shareowner services. The increase in fees over the same period last year was primarily due to a shareholder’s proposal at our annual meeting and the resulting litigation. We have insurance for professional fees and expenses incurred in connection with the pending litigation and are working with our insurance carrier on coverage matters. While we believe that a majority of our fees and expenses incurred as a result of the litigation will be covered by insurance, there can be no guarantee of any specific coverage amount. 

          Research and development expenses. Research and development expenses were approximately $101,000 for the three months ended March 31, 2013, representing a decrease of approximately $137,000, or 57.6%, compared to approximately $238,000 in the same period the prior year. Research and development expenses for the three months ended March 31, 2013 were 3.2% of revenue, compared to 5.0% of revenue in the same period the prior year. As a percentage of revenue, management expects to spend up to 5.0% of revenue on research and development expenses over the long term.

          Interest expense

          Interest expense was approximately $30,000 for the three months ended March 31, 2013, representing a decrease of approximately $14,000, or 31.8%, compared to approximately $44,000 for the same period the prior year. The decrease resulted from a decrease in average debt outstanding.

          Income tax benefit (expense)

          Income tax benefit is estimated at approximately $292,000 for the three months ended March 31, 2013, compared to income tax expense of approximately $88,000 in the same period in the prior year. The effective tax rates for the three months ended March 31, 2013 and 2012 were 40.4% and 48.1%, respectively. On a quarterly basis, management estimates what its effective tax rate will be for the full fiscal year and records a quarterly income tax provision based on the anticipated rate. As the year progresses, the estimate is refined based on the facts and circumstances by each tax jurisdiction. The decrease in effective tax rate is related primarily to permanent differences including certain meals and entertainment expenses that are only 50% deductible for tax purposes. The Company’s estimate for the Federal Research and Development Tax Credit which was not extended until January 2013, by the U.S. Congress was recorded in the quarter ended March 31, 2013.

          Net income (loss)

          Net loss for the three months ended March 31, 2013 was approximately $431,000 compared to net income of approximately $95,000 for the same period in the prior year. The decrease in net income primarily resulted from a decrease in revenue partially offset by decreases in expenses. Management is focused on controlling costs more aggressively in the short term while implementing key strategies for growth, which includes a fully staffed and a realigned domestic sales force, updated branding including a new logo, website, and marketing material, and an HFCWO product and service innovation roadmap. Specifically, by customer group, our initiatives include:

	-	Homecare: increase lead generation with a greater tenured domestic sales force and adjustments to the Company’s selling process;
	-	Institutional: introduce additional pricing options while exploring distributor partnerships; and

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	-	International: hire an international sales manager to develop more distributors throughout Europe, Latin and South America and East Asia, while limiting exclusive distributors within a country.

Nine Months Ended March 31, 2013 Compared to Nine Months Ended March 31, 2012

          Revenues

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

		Nine Months Ended March 31,						Increase (Decrease)
		2013			2012
Total Revenue		$	11,086		$	14,944		$	(3,858	)		(25.8	)%
Home Care Revenue		$	9,511		$	13,790		$	(4,279	)		(31.0	)%
International Revenue		$	533		$	395		$	138			35.0	%
Government/Institutional Revenue		$	1,042		$	759		$	283			37.3	%

          Home Care Revenue. Home care revenue was approximately $9,511,000 for the nine months ended March 31, 2013, representing a decrease of approximately $4,279,000, or 31.0%, compared to the same period in 2012. The decrease in revenue was caused downward pressure on pricing and added administrative procedures implemented by third party payers in the insurance claims process which has lengthened the approval process compared to the prior year. Additionally, one of the largest domestic third party payers has decentralized its contracting process. The decentralization has required additional time to complete the necessary reimbursement contracts with individual affiliates to maintain our national coverage with that payer. Certain contracts have been resolved during the quarter, although the final completion of this process will extend into fiscal year 2014.

          International Revenue. International revenue was approximately $533,000 for the nine months ended March 31, 2013, representing an increase of approximately $138,000, or 35.0%, compared to the same period in 2012. This increase resulted primarily from an increase in revenues to the Middle East. During the quarter ended March 31, 2013 we hired a new international sales manager, which has facilitated exploring additional international opportunities.

          Government/Institutional Revenue. Government/institutional revenue was approximately $1,042,000 for the nine months ended March 31, 2013, representing an increase of approximately $283,000, or 37.3%, compared to approximately $759,000 during the same period in 2012. This resulted from a $250,000 increase in revenue from distributors, group purchasing organization (GPO) members, and other institutions, which increased to approximately $848,000 for the nine months ended March 31, 2013 from approximately $598,000 during the same period the prior year. Revenue from the U.S. Department of Veterans Affairs and other government entities increased by approximately $33,000, increasing to $194,000 for the nine months ended March 31, 2013 from $161,000 for the same period in 2012. The increase in government/institutional revenue was due to a renewed focus by the sales force and adding new pricing options in response to market conditions.

          Gross Profit

          Gross profit decreased to approximately $7,777,000, or 70.2% of net revenues, for the nine months ended March 31, 2013, from approximately $10,919,000, or 73.1% of net revenues, in the same period in 2012. The decrease in gross profit percentage was primarily the result of reduced leverage of manufacturing costs on lower revenue levels over the nine-month period.

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          Operating expenses

          Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses were approximately $8,851,000 for the nine months ended March 31, 2013, representing a decrease of approximately $584,000, or 6.2%, compared to SG&A expenses of approximately $9,435,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $4,380,000 for the nine months ended March 31, 2013, representing a decrease of approximately $173,000, or 3.8%, compared to approximately $4,553,000 in the same period the prior year. This decrease primarily resulted from lower commissions and overall management compensation as compared to the same period in the prior year. In addition, selling, general and administrative expenses increased approximately $44,000 as a result of the medical device tax that was implemented during the quarter ended March 31, 2013.

          Travel, meals and entertainment and trade show expenses were approximately $1,106,000 for the nine months ended March 31, 2013, representing a decrease of approximately $286,000, or 20.5%, compared to approximately $1,392,000 for the same period in the prior year. This decrease was primarily due to the elimination of industry training that was sponsored by Electromed, eliminating costs related to tradeshows that do not fit our growth strategies and reducing travel expenses among the sales force through improved travel planning.

          Advertising and marketing expenses for the nine months ended March 31, 2013 were approximately $527,000, a decrease of approximately $411,000, or 43.8%, compared to approximately $938,000 in the same period the prior year. The decrease was related to bringing marketing leadership in-house, thus reducing our external marketing fees, as well as targeting more cost-effective advertising.

          Professional fees for the nine months ended March 31, 2013 were approximately $947,000, an increase of approximately $202,000 compared to approximately $745,000 in the same period in the prior year. These fees are for services related to legal costs, reporting requirements, expenses related to information technology security and backup, one time consulting expenses, and expenses for printing and other shareowner services. The increase in fees over the same period last year was primarily due to a shareholder’s proposal at our annual meeting and the resulting litigation, as well as consulting fees related to upgrading our current information technology infrastructure. We have insurance for professional fees and expenses incurred in connection with the pending litigation and are working with our insurance carrier on coverage matters. While we believe that a majority of our fees and expenses incurred as a result of the litigation will be covered by insurance, there can be no guarantee of any specific coverage amount.

          Research and development expenses. Research and development expenses were approximately $312,000 for the nine months ended March 31, 2013, representing a decrease of approximately $394,000, or 55.8%, compared to approximately $706,000 in the same period the prior year. Research and development expenses for the nine months ended March 31, 2013 were 2.8% of revenue, compared to 4.7% of revenue in the same period the prior year. As a percentage of revenue, management expects to spend up to 5.0% of revenues on research and development expenses over the long term.

          Interest expense

          Interest expense was approximately $108,000 for the nine months ended March 31, 2013, representing a decrease of approximately $27,000, or 20.0%, compared to approximately $135,000 for the same period the prior year. The decrease resulted from a decrease in average debt outstanding.

          Income tax benefit (expense)

          Income tax benefit is estimated at approximately $564,000 for the nine months ended March 31, 2013 compared to income tax expense of approximately $283,000 in the same period in the prior year. The effective tax rates for the nine months ended March 31, 2013 and March 31, 2012 were 38.2% and 43.7%, respectively. On a quarterly basis, management estimates what its effective tax rate will be for the full fiscal year and records a quarterly income tax provision based on the anticipated rate. As the year progresses, the estimate is refined based on the facts and circumstances by each tax jurisdiction. The decrease in effective tax rate is related primarily to permanent differences including certain meals and entertainment expenses that are only 50% deductible for tax purposes.

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          Net income (loss)

          Net loss for the nine months ended March 31, 2013 was approximately $913,000 compared to net income of approximately $365,000 for the same period the prior year. The decrease in net income primarily resulted from a decrease in revenue partially offset by decreases in expenses. Management is focused on controlling costs more aggressively short term while implementing key strategies for growth which includes a fully staffed and a realigned domestic sales force, updated branding including a new logo, website, and marketing material, and an HFCWO product and service innovation roadmap. Specifically, by customer group, our initiatives include:

	-	Homecare: increased lead generation with a greater tenured domestic sales force and adjustments to the Company’s selling process;
	-	Institutional: introducing additional pricing options while exploring distributor partnerships; and
	-	International: hiring an international sales manager to develop more distributors throughout Europe, Latin and South America and East Asia, while limiting exclusive distributors within a country.

Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

          Cash Flows from Operating Activities

          For the nine months ended March 31, 2013, net cash provided by operating activities was approximately $990,000. Cash flows provided by operations consisted of approximately $913,000 in net loss, adjusted for non-cash expenses of approximately $627,000, offset by decreases in accounts receivable, inventories, and trade payables and accrued liabilities of $1,653,000, $251,000, and $5,000, respectively. In addition, prepaid expenses and other assets decreased by approximately $632,000.

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

          Cash Flows from Investing Activities

          For the nine months ended March 31, 2013, net cash used in investing activities was approximately $743,000. During this period we paid approximately $707,000 for purchases of property and equipment. We also paid approximately $36,000 for patent and trademark related costs.

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

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          Cash Flows from Financing Activities

          For the nine months ended March 31, 2013, net cash used in financing activities was approximately $1,445,000, which consisted of principal payments on long-term debt of $237,000 and payments on our revolving line of credit of $1,208,000.

          For the nine months ended March 31, 2012, net cash used in financing activities was approximately $258,000. We received approximately $52,000 from warrant exercises and receipts on subscription notes receivable, offset by principal payments on long-term debt of approximately $299,000 and payments of deferred financing fees of approximately $11,000.

Adequacy of Capital Resources

          Our primary working capital requirements relate to adding employees in our sales force and supporting functions; continuing research and development efforts; and for general corporate purposes, including to finance equipment purchases and other capital expenditures in the ordinary course of business and to satisfy working capital needs.

          Based on our current operational performance, we believe our cash and cash equivalents and available borrowings under the existing credit facility will provide adequate liquidity for the next year. However, we cannot guarantee that we will be able to procure additional financing upon favorable terms, if at all. During fiscal year 2013, we have obtained waivers of noncompliance or entered into amendments with our lender to modify certain covenants. Although the violations have been waived as of March 31, 2013, we believe we may be out of compliance with the covenants at June 30, 2013. 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 or preventing access to additional funds under the credit facility, or requiring prepayment of outstanding indebtedness under the credit facility. If the maturity of the indebtedness is accelerated, sufficient cash resources to satisfy the debt obligations may not be available and we may not be able to continue operations as planned. The indebtedness under the credit agreement is secured by a security interest in substantially all of our tangible and intangible assets of the Company. If we are unable to repay such indebtedness, the bank could foreclose on these assets.

          The Company is working with the bank to modify the covenants in the current debt agreement to be in compliance as of June 30, 2013. Given the Company’s ability to service its debt and its past relationship with its lender, the Company believes that it will be able to successfully restructure its covenants as of June 30, 2013.

          For the first nine months of fiscal years 2013 and 2012, we spent approximately $707,000 and $736,000 on property and equipment, respectively. In addition, we had approximately $145,000 of property and equipment purchases financed through accounts payable as of March 31, 2013. We currently expect to finance equipment purchases with borrowings under our credit facility and cash flows from operations. We may need to incur additional debt or equity financing if we have an unforeseen need for additional capital equipment or if our operating performance does not generate adequate cash flows.

          On November 8, 2011 we entered into an amended and restated credit facility with U.S. Bank, National Association (U.S. Bank), which was amended on December 30, 2011, May 14, 2012, September 21, 2012, November 13, 2012, February 13, 2013, and May 13, 2013 that provides for a revolving line of credit of $2,250,000, and $2,520,000 in term debt. A $1,520,000 Term Loan bears interest at 5.79% (Term Loan A). The remaining $1,000,000 term loan bore interest at 4.28% (Term Loan B) and was paid in full during October 2012. Interest on the operating line of credit accrues at LIBOR plus 3.50% (3.75% at March 31, 2013) and is payable monthly. The amount eligible for borrowing on the line of credit is limited to 60% of eligible accounts receivable. The line of credit will expire on December 31, 2013, if not earlier renewed. Term Loan A requires monthly payments of principal and interest of approximately $10,700 and has a maturity date of December 9, 2014. As of March 31, 2013, we had $560,000 outstanding on the operating line of credit and approximately $1,377,000 outstanding on Term Loan A for a total amount outstanding under the U.S. Bank credit facility of approximately $1,937,000. As of the most recent amendment date of May 13, 2013, we had $415,000 outstanding on the operating line of credit and net unused availability of $1,835,000. We are required to pay a fee of 0.125% per annum on unused portions of the revolving line of credit.

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          Our credit facility contains certain financial and nonfinancial covenants, which, among others, requires us to maintain a certain fixed charge coverage ratio and a maximum cash flow leverage ratio, and restricts the payment of dividends. We were in violation of certain financial covenants during the period ended March 31, 2013. On May 13, 2013, we entered into a Waiver and Fifth Amendment to our Credit Agreement with U.S. Bank (the “Waiver Agreement”). See Part II, Item 5 to this quarterly report for a description of the material terms of such Waiver Agreement. The Waiver and Fifth Amendment to Credit Agreement provides for adjustments to the revolving line of credit to $2,250,000.

Certain Information Concerning Off-Balance Sheet Arrangements

          We have no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

          Our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period subject to this Report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective.

Changes to Internal Control Over Financial Reporting

          There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

          Occasionally, we may be party to legal actions, proceedings, or claims in the ordinary course of business, including claims based on assertions of patent and trademark infringement. Corresponding costs are accrued when it is probable that loss will be incurred and the amount can be precisely or reasonably estimated.

          On December 7, 2012, we instituted a lawsuit in the District Court for Scott County, Minnesota against Eileen Manning, the proponent of a shareholder proposal at the Company’s 2012 Annual Meeting of Shareholders (the “Annual Meeting”) seeking to elect two individuals to the Company’s board of directors, and Robert D. Hansen, the Company’s former Chairman and Chief Executive Officer. The Company asserts that Ms. Manning, the owner of an entity that formerly provided marketing services to the Company, violated the proxy solicitation rules in connection with the nomination and election of directors at the Annual Meeting. Ms. Manning has asserted a counterclaim alleging that the Company has violated her rights as a shareholder by failing to count and certify the results of the election. The Company also asserts that Mr. Hansen violated his Separation Agreement and Release in connection with his actions relating to Ms. Manning’s proposal prior to and at the Annual Meeting and seeks declaratory relief and damages. Mr. Hansen has asserted a counterclaim alleging that the Company breached the Separation Agreement and Release by failing to make a payment under the agreement, as well as that the Company has violated his rights as a shareholder by failing to make the payment under the agreement. Ms. Manning has moved for summary judgment on her counterclaim, the Company opposed the motion, and it is currently under advisement. The Company has moved for summary judgment on its claim against Mr. Hansen for breach of the Separation Agreement. That motion will be heard by the Court on May 15, 2013. We have insurance for professional fees and expenses incurred in connection with the pending litigation and are working with our insurance carrier on coverage matters. While we believe that a majority of our fees and expenses incurred as a result of the litigation will be covered by insurance, there can be no guarantee of any specific coverage amount.

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Item 1A. Risk Factors

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

          None.

Item 3. Defaults Upon Senior Securities

          None.

Item 4. Mine Safety Disclosures

          None.

Item 5. Other Information

          On May 13, 2013, the Company entered into a Waiver and Fifth Amendment to Credit Agreement (the “Waiver Agreement”) with U.S. Bank National Association (the “Bank”), pursuant to which the Bank waived violation by the Company of its minimum EBITDA financial covenant under its Amended and Restated Credit Agreement with the Bank, dated as of November 7, 2011, as amended (the “Credit Agreement”). Among other things, the Credit Agreement, as amended prior to the Waiver Agreement, forbid the Company from permitting its EBITDA for the quarter ended March 31, 2013 to be less than negative $275,000.

          Pursuant to the Waiver Agreement, the Bank agreed to waive the specific covenant violation described above as an event of default under the Credit Agreement. In addition, the Waiver Agreement, among other things: (1) reduced the Bank’s commitment on our revolving line of credit from $2,500,000 to $2,250,000; (2) removed the minimum EBITDA covenant for the fiscal quarter ended June 30, 2013; (3) revised the Fixed Charge Coverage Ratio covenant to require a ratio of at least 1.15 to 1 for the quarter ended June 30, 2013 and successive periods in the aggregate thereafter; (4) amended the Company’s financial reporting covenants to provide for weekly delivery of 13-week cash flow forecasts; and (5) required the Company to engage a financial consultant to conduct a review of its financial statements and projections and deliver a report regarding the same to the Bank. The Company also released claims against the Bank, reasserted its representations and warranties under the Credit Agreement, and reaffirmed the Credit Agreement and related loan and security documents.

          The foregoing summary does not purport to be complete and is qualified in its entirety by reference to the full text of the Waiver Agreement, which is filed as Exhibit 10.3 to this quarterly report on Form 10-Q.

Item 6. Exhibits

          See attached exhibit index.

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SIGNATURES

          Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ELECTROMED, INC.
Date: May 15, 2013	/s/ Kathleen S. Skarvan
	Kathleen S. Skarvan, Chief Executive Officer
	(Principal Executive Officer)
	/s/ Jeremy T. Brock
	Jeremy T. Brock, Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX
ELECTROMED, INC.
FORM 10-Q

Exhibit Number		Description
3.1		Amendment No. 2 to Bylaws of Electromed (incorporated by reference to Exhibit 3.1 to the Company’s current report on Form 8-K filed with the SEC on April 2, 2013)
10.1		Waiver and Fourth Amendment to Credit Agreement by and between the Company and U.S. Bank, National Association, dated February 13, 2013 (incorporated by reference to Exhibit 10.3 to the Company’s quarterly report on Form 10-Q filed with the SEC on February 14, 2013)
10.2		Waiver and Fifth Amendment to Credit Agreement by and between the Company and U.S. Bank, National Association, dated May 13, 2013
31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended March 31, 2012, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) the Notes to Condensed Consolidated Financial Statements tagged as blocks of text.

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