Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q

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


For the quarterly period ended September 30, 2008



OR



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


For the transition period from _______ to ________



Commission File Number: 0-27605



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VASCULAR SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)



Minnesota
        41-1859679(State or other jurisdiction of incorporation or organization)
        (IRS Employer Identification No.)




6464 Sycamore Court

Minneapolis, Minnesota 55369

(Address of principal executive offices, including zip code)



(763) 656-4300

(Registrants telephone number, including area code)



Not Applicable

(Former name, former address and former

fiscal year, if changed since last report)



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesx
Noo



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

Large accelerated filero
        Accelerated filerxNon-accelerated filero
        Smaller Reporting Companyo




Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
 Exchange Act).Yeso
Nox



The registrant had 15,840,419 shares of common stock, $.01 par value per share, outstanding as of October 15, 2008.







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VASCULAR SOLUTIONS, INC.



TABLE OF CONTENTS



Page

PART I. FINANCIAL INFORMATIONItem 1.
        Financial Statements (Unaudited)
        2Consolidated Balance Sheets
        2Consolidated Statements of Operations
        3Consolidated Statements of Cash Flows
        4Notes to Unaudited Consolidated Financial Statements
        5Item 2.
        Managements Discussion and Analysis of Financial Condition and Results of Operations
        16Item 3.
        Quantitative and Qualitative Disclosures about Market Risk
        23Item 4.
        Controls and Procedures
        23PART II. OTHER INFORMATIONItem 1.
        Legal Proceedings
        24Item 1A.
        Risk Factors
        24Item 2.
        Unregistered Sales of Equity Securities and Use of Proceeds
        24Item 3.
        Defaults Upon Senior Securities
        24Item 4.
        Submission of Matters to a Vote of Security Holders
        24Item 5.
        Other Information
        24Item 6.
        Exhibits
        24






1

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Table of Contents

PART 1. FINANCIAL INFORMATION



Item 1.
        Financial Statements




VASCULAR SOLUTIONS, INC.

Consolidated Balance Sheets



September 30, 2008
        
        December 31, 2007(unaudited)
        
        (see note)AssetsCurrent assets:Cash and cash equivalents
        
        $
        5,598,000
        
        $
        5,286,000Restricted cash
        
        
        
        
        
        5,473,000Accounts receivable, net of reserves of $130,000 in both 2008 and 2007
        
        
        7,685,000
        
        
        7,363,000Inventories
        
        
        10,640,000
        
        
        8,307,000Prepaid expenses
        
        
        1,378,000
        
        
        810,000Total current assets
        
        
        25,301,000
        
        
        27,239,000Property and equipment, net
        
        
        3,709,000
        
        
        3,846,000Intangible assets, net
        
        
        193,000
        
        
        193,000Total assets
        
        $
        29,203,000
        
        $
        31,278,000Liabilities and shareholders equityCurrent liabilities:Accounts payable
        
        $
        2,813,000
        
        $
        2,021,000Accrued compensation.
        
        
        2,894,000
        
        
        2,766,000Accrued expenses
        
        
        1,306,000
        
        
        1,114,000Litigation provision
        
        
        
        
        
        5,219,000Current portion of long-term debt
        
        
        
        
        
        800,000Current portion of deferred revenue
        
        
        934,000
        
        
        789,000Total current liabilities
        
        
        7,947,000
        
        
        12,709,000Long-term liabilities:Long-term debt, net of current portion
        
        
        
        
        
        67,000Long-term deferred revenue, net of current portion
        
        
        5,276,000
        
        
        5,649,000Deferred tax liability
        
        
        32,000
        
        
        28,000Total long-term liabilities
        
        
        5,308,000
        
        
        5,744,000Shareholders equity:Common stock, $0.01 par value:Authorized shares  40,000,000Issued and outstanding shares  15,840,419  2008;15,606,656  2007
        
        
        158,000
        
        
        156,000Additional paid-in capital
        
        
        84,101,000
        
        
        82,456,000Other
        
        
        83,000
        
        
        96,000Accumulated deficit
        
        
        (68,394,000
        )
        
        (69,883,000
        )Total shareholders equity
        
        
        15,948,000
        
        
        12,825,000Total liabilities and shareholders equity
        
        $
        29,203,000
        
        $
        31,278,000




See accompanying notes.

Note:  The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date.



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VASCULAR SOLUTIONS, INC.



Consolidated Statements of Operations



Three Months EndedSeptember 30,
        
        Nine Months EndedSeptember 30,2008
        
        2007
        
        2008
        
        2007(unaudited)
        
        (unaudited)Revenue:Product revenue
        
        $
        15,089,000
        
        $
        12,529,000
        
        $
        43,698,000
        
        $
        37,617,000License and collaboration revenue
        
        
        376,000
        
        
        597,000
        
        
        1,120,000
        
        
        891,000Total revenue
        
        
        15,465,000
        
        
        13,126,000
        
        
        44,818,000
        
        
        38,508,000Product costs and operating expensesCost of goods sold
        
        
        5,130,000
        
        
        4,187,000
        
        
        15,071,000
        
        
        12,505,000Collaboration expenses.
        
        
        138,000
        
        
        358,000
        
        
        506,000
        
        
        358,000Research and development
        
        
        1,530,000
        
        
        1,160,000
        
        
        4,550,000
        
        
        3,998,000Clinical and regulatory
        
        
        792,000
        
        
        813,000
        
        
        2,402,000
        
        
        2,324,000Sales and marketing
        
        
        5,090,000
        
        
        4,838,000
        
        
        15,477,000
        
        
        14,451,000General and administrative
        
        
        1,037,000
        
        
        1,695,000
        
        
        3,771,000
        
        
        3,842,000Litigation
        
        
        
        
        
        74,000
        
        
        1,484,000
        
        
        5,764,000Thrombin qualification
        
        
        
        
        
        7,000
        
        
        
        
        
        136,000Total product costs and operating expenses
        
        
        13,717,000
        
        
        13,132,000
        
        
        43,261,000
        
        
        43,378,000Operating income (loss)
        
        
        1,748,000
        
        
        (6,000
        )
        
        1,557,000
        
        
        (4,870,000
        )Other income (expenses):Interest income.
        
        
        28,000
        
        
        126,000
        
        
        168,000
        
        
        324,000Interest expense
        
        
        (10,000
        )
        
        (35,000
        )
        
        (52,000
        )
        
        (120,000
        )Foreign exchange loss
        
        
        (22,000
        )
        
        
        
        
        (22,000
        )
        
        Income (loss) before income taxes
        
        
        1,744,000
        
        
        85,000
        
        
        1,651,000
        
        
        (4,666,000
        )Income tax expense
        
        
        (22,000
        )
        
        (70,000
        )
        
        (162,000
        )
        
        (158,000
        )Net income (loss)
        
        $
        1,722,000
        
        $
        15,000
        
        $
        1,489,000
        
        $
        (4,824,000
        )Net income (loss) per share  basic
        
        $
        0.11
        
        $
        0.00
        
        $
        0.10
        
        $
        (0.32
        )Net income (loss) per share  diluted
        
        $
        0.11
        
        $
        0.00
        
        $
        0.09
        
        $
        (0.32
        )




See accompanying notes.



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VASCULAR SOLUTIONS, INC.



Consolidated Statements of Cash Flows



Nine Months EndedSeptember 30,2008
        
        2007(unaudited)Operating activitiesNet income (loss)
        
        $
        1,489,000
        
        $
        (4,824,000
        )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation
        
        
        1,127,000
        
        
        1,014,000Stock-based compensation
        
        
        1,332,000
        
        
        1,076,000Deferred compensation expense
        
        
        9,000
        
        
        (3,000
        )Deferred tax liability
        
        
        4,000
        
        
        27,000Loss on disposal of fixed assets
        
        
        24,000
        
        
        6,000Change in allowance for doubtful accounts
        
        
        
        
        
        15,000Changes in operating assets and liabilities:Accounts receivable
        
        
        (315,000
        )
        
        (269,000
        )Inventories
        
        
        (2,327,000
        )
        
        (1,081,000
        )Prepaid expenses
        
        
        (567,000
        )
        
        66,000Accounts payable
        
        
        792,000
        
        
        447,000Accrued compensation and expenses
        
        
        (4,900,000
        )
        
        5,437,000Deferred revenue, net
        
        
        (229,000
        )
        
        6,529,000Net cash provided by (used in) operating activities
        
        
        (3,561,000
        )
        
        8,440,000Investing activitiesPurchase of property and equipment, net
        
        
        (1,013,000
        )
        
        (1,167,000
        )Cash deposits transferred from (to) restricted cash
        
        
        5,473,000
        
        
        (5,473,000
        )Net cash provided by (used in) investing activities
        
        
        4,460,000
        
        
        (6,640,000
        )Financing activitiesRepurchase of common shares
        
        
        (153,000
        )
        
        Payment on long-term debt
        
        
        (867,000
        )
        
        (600,000
        )Proceeds from the exercise of stock options, stock warrants and sale of stock, net of expenses
        
        
        468,000
        
        
        640,000Net cash provided by (used in) financing activities.
        
        
        (552,000
        )
        
        40,000Effect of exchange rate changes on cash and cash equivalents
        
        
        (35,000
        )
        
        36,000Increase in cash and cash equivalents
        
        
        312,000
        
        
        1,876,000Cash and cash equivalents at beginning of period
        
        
        5,286,000
        
        
        2,557,000Cash and cash equivalents at end of period
        
        $
        5,598,000
        
        $
        4,433,000Supplemental disclosure of cash flowCash paid for interest
        
        $
        59,000
        
        $
        125,000Cash paid for taxes
        
        $
        241,000
        
        $
        




See accompanying notes.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements



(1)
        Basis of Presentation




The accompanying unaudited financial statements of Vascular Solutions, Inc. (the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation have been included. The financial statements should be read in conjunction with the audited financial statements for the fiscal year ended December 31, 2007 included in the Annual Report on Form 10-K of the Company filed with the Securities and Exchange Commission. Interim results of operations are not necessarily indicative of the results to be expected for the full year
or any other interim periods.



(2)
        Stock-Based Compensation




The Company has various types of stock-based compensation plans. These plans are administered by the compensation committee of the Board of Directors, which selects persons to receive awards and determines the number of shares subject to each award and the terms, conditions, performance measures and other provisions of the award. Readers should refer to Notes 8 and 9 of the Companys consolidated financial statements in the Annual Report on Form 10-K for the fiscal year ended December 31, 2007, for additional information related to these stock-based compensation plans.



Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R,Share-Based Payment(SFAS 123R), which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. SFAS 123R is being applied on the modified prospective basis. Prior to the adoption of SFAS 123R, the Company accounted for its stock-based compensation plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations, and accordingly, recognized no compensation expense related to the stock-based plans.



The following amounts have been recognized as stock-based compensation expense in the Consolidated Statements of Operations:



Three Months EndedSeptember 30,
        
        Nine Months EndedSeptember 30,2008
        
        2007
        
        2008
        
        2007Stock-based compensation included in:Cost of goods sold
        
        $
        53,000
        
        $
        34,000
        
        $
        158,000
        
        $
        104,000Research and development
        
        
        74,000
        
        
        65,000
        
        
        161,000
        
        
        153,000Clinical and regulatory
        
        
        32,000
        
        
        23,000
        
        
        101,000
        
        
        67,000Sales and marketing
        
        
        156,000
        
        
        116,000
        
        
        451,000
        
        
        294,000General and administrative
        
        
        138,000
        
        
        179,000
        
        
        461,000
        
        
        458,000$
        453,000
        
        $
        417,000
        
        $
        1,332,000
        
        $
        1,076,000






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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



The Company uses the Black-Scholes option-pricing model to estimate the fair value of stock-based awards with the following weighted average assumptions:



September 30,2008
        
        2007Stock Options and Awards:Expected life (years)
        
        5.50
        
        5.50Expected volatility
        
        50
        %
        50
        %Dividend yield
        
        0
        %
        0
        %Risk-free interest rate
        
        2.75
        %
        4.50
        %Employee Stock Purchase Plan:Expected life (years)
        
        2.00
        
        2.00Expected volatility
        
        35
        %
        34
        %Dividend yield
        
        0
        %
        0
        %Risk-free interest rate
        
        2.02
        %
        4.38
        %




The Company calculates expected volatility for stock options and awards using historical volatility. The starting point for the historical period used is based on a material change in the Companys operations that occurred in the third quarter of 2003. The Company uses a 10% forfeiture rate for key employees and a 15% forfeiture rate for non-key employees for stock options and awards. The Company calculates expected volatility for employee stock purchase plan shares using historical volatility over a two-year period. A two-year period is used to coincide with the maximum two-year offering period under the employee stock purchase plan.



The Company has a stock option and stock award plan (the Stock Option Plan) which provides for the granting of stock options, restricted shares and alternative stock appreciation rights to employees, directors and consultants. Incentive stock options may be granted only to employees of the Company. Options which do not qualify as incentive stock options and awards of restricted shares may be granted to both employees and to non-employee directors and consultants. As of September 30, 2008, the Company has reserved 5,400,000 shares of common stock under the Stock Option Plan. Under the Stock Option Plan, stock options must be granted at an exercise price not less than the fair market value of the Companys common stock on the grant date. The options expire on the date determined by the Board of Directors but may not extend more than ten years from the grant date. The incentive stock
options generally become exercisable over a four-year period and the nonqualified stock options generally become exercisable over a two-year period. Unexercised options are canceled 90 days after termination, and unvested awards are canceled on the date of termination of employment and become available under the Stock Option Plan for future grants.



The holder of a restricted share award is generally entitled at all times on and after the date of issuance of the restricted shares to exercise the rights of a shareholder of the Company, including the right to vote the shares and the right to receive dividends on the shares. On February 1 and July 25, 2008, the Company granted additional restricted shares to employees under the Stock Option Plan. The restricted shares vest over a four-year period based on the continuation of employment.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



Restricted share activity is summarized as follows:



Shares Outstanding
        
        Weighted Average Grant Date Fair ValueBalance at December 31, 2007
        
        313,000
        
        $
        8.01Granted
        
        171,000
        
        
        6.05Vested
        
        (71,000
        )
        
        5.50Canceled
        
        (36,000
        )
        
        7.76Balance at September 30, 2008
        
        377,000
        
        $
        7.65




As of September 30, 2008, there was $1,109,000 of total unrecognized compensation costs related to the outstanding restricted shares, which is expected to be recognized over a weighted average period of 1.55 years.



Stock option activity is summarized as follows:



Plan OptionsOutstanding
        
        WeightedAverageExercisePrice
        
        AggregateIntrinsicValueBalance at December 31, 2007
        
        1,459,000
        
        $
        5.74Granted
        
        60,000
        
        
        6.36Exercised
        
        (59,000
        )
        
        2.01Forfeited
        
        (5,000
        )
        
        9.45Canceled
        
        (68,000
        )
        
        9.53Balance at September 30, 2008
        
        1,387,000
        
        $
        5.75
        
        $
        3,283,000Exercisable at September 30, 2008
        
        1,329,000
        
        $
        5.64
        
        $
        3,245,000




As of September 30, 2008, there was $67,000 of total unrecognized compensation costs related to the outstanding stock options,which is expected to be recognized over a weighted average period of 0.31 years. The total intrinsic value of options exercised was $115,000 and $291,000 for the three and nine months ended September 30, 2008.



At September 30, 2008, a total of 2,563,337 shares were available for grant under the Stock Option Plan.



As of September 30, 2008, there was $299,000 of total unrecognized compensation costs related to the employee stock purchase plan, which is expected to be recognized over a weighted average period of 0.70 years.





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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



(3)
        Net Income (Loss) per Share




In accordance with Statement of Financial Accounting Standards No. 128,Earnings Per Share,(SFAS 128), basic net income (loss) per share for the three and nine months ended September 30, 2008 and 2007 is computed by dividing net income (loss) by the weighted average common shares outstanding during the periods presented. Diluted net income per share is computed by dividing income by the weighted average number of common shares outstanding during the period, increased to include dilutive potential common shares issuable relating to outstanding restricted stock, and upon the exercise of stock options and awards that were outstanding during the period. For all net loss periods presented, diluted loss per share is the same as basic loss per share because the effect of outstanding restricted stock, options and warrants is antidilutive.



Weighted average common shares outstanding for the three and nine months ended September 30, 2008 and 2007 was as follows:



Three Months EndedSeptember 30,
        
        Nine Months EndedSeptember 30,2008
        
        2007
        
        2008
        
        2007(unaudited)
        
        (unaudited)Weighted average shares outstanding  basic
        
        15,580,748
        
        15,259,957
        
        15,517,182
        
        15,191,193Weighted average shares outstanding  diluted
        
        16,043,957
        
        15,843,850
        
        15,885,292
        
        15,191,193




(4)
        Comprehensive Income (Loss)




Comprehensive income (loss) for the Company includes net income (loss) and foreign currency translation. Comprehensive income (loss) for the three and nine months ended September 30, 2008 and 2007 was as follows:



Three Months EndedSeptember 30,
        
        Nine Months EndedSeptember 30,2008
        
        2007
        
        2008
        
        2007(unaudited)
        
        (unaudited)Net income (loss)
        
        $
        1,722,000
        
        $
        15,000
        
        $
        1,489,000
        
        $
        (4,824,000
        )Foreign currency translation adjustments
        
        
        (48,000
        )
        
        34,000
        
        
        (22,000
        )
        
        24,000Comprehensive income (loss)
        
        $
        1,674,000
        
        $
        49,000
        
        $
        1,467,000
        
        $
        (4,800,000
        )












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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



(5)
        Revenue Recognition




In the United States the Company sells its products directly to hospitals and clinics. Revenue is recognized in accordance with generally accepted accounting principles as outlined in the Securities and Exchange Commissions Staff Accounting Bulletin No. 104,Revenue Recognition(SAB 104), which requires that four basic criteria be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) the price is fixed or determinable; (iii) collectibility is reasonably assured; and (iv) product delivery has occurred or services have been rendered. The Company recognizes revenue as products are shipped based on FOB shipping point terms when title passes to customers. The Company negotiates credit terms on a customer-by-customer basis and products are shipped at an agreed-upon price. All product returns must be
pre-approved and, if approved, customers are subject to a 20% restocking charge.



Effective April 1, 2008 the Company entered into a five-year distribution agreement with Nicolai, GmbH. As a result of entering into this distribution agreement, the Company no longer maintains a direct sales force in Germany. In connection with this distribution agreement, the Company is expected to receive four installment payments of 125,000 Euros from Nicolai, GmbH. The first of these four installment payments was due upon execution of the agreement and was received on March 14, 2008. The second installment payment was earned on June 30, 2008 and was received by the Company on July 9, 2008. The third installment payment was earned on September 30, 2008 and was received by the Company on October 3, 2008. The installment payments are deferred and recognized ratably over the five-year term of the distribution agreement. The agreement also includes provisions requiring the Company to pay
Nicolai, GmbH specific amounts if the Company terminates the distribution agreement prior to the end of the five-year term. The Company does not intend to terminate the distribution agreement and, as such, has not recorded a liability relating to these potential future payments to Nicolai, GmbH.



In all international markets, the Company sells its products to international distributors which subsequently resell the products to hospitals and clinics. The Company has agreements with each of its distributors which provide that title and risk of loss pass to the distributor upon shipment of the products to the distributor. The Company warrants that its products are free from manufacturing defects at the time of shipment to the distributor. Revenue is recognized upon shipment of products to distributors following the receipt and acceptance of a distributors purchase order. Allowances are provided for estimated returns and warranty costs at the time of shipment.



The Company also generates revenues from license agreements and research collaborations and recognizes these revenues when earned. In accordance with Emerging Issues Task Force (EITF) Issue No. 00-21,Revenue Arrangements with Multiple Deliverables, for deliverables which contain multiple deliverables, the Company separates the deliverables into separate accounting units if they meet the following criteria: (i) the delivered items have a stand-alone value to the customer; (ii) the fair value of any undelivered items can be reliably determined; and (iii) if the arrangement includes a general right of return, delivery of the undelivered items is probable and substantially controlled by the seller. Deliverables that do not meet these criteria are combined with one or more other deliverables into one accounting unit. Revenue from each accounting
unit is recognized based on the applicable accounting literature, primarily Staff Accounting Bulletin (SAB) 104,Revenue Recognition.





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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued





In addition, the Company has reviewed the provisions of EITF Issue No. 07-01,Accounting for Collaborative Arrangements,and believes the adoption of this EITF will have no impact on the amounts recorded under these agreements.



In accordance with EITF Issue No. 00-10,Accounting for Shipping and Handling Fees and Costs, the Company includes shipping and handling revenues in net revenue, and shipping and handling costs in cost of sales.



(6)
        Restricted Cash




Under an investment management agreement with Wells Fargo Bank, N.A., effective June 19, 2007, the Company set aside $5,473,000 as restricted cash in connection with the judgment in the Diomed, Inc. litigation case as more fully discussed below in footnote 11, Commitments and Contingencies. Upon settlement of the lawsuit on April 8, 2008, a portion of the restricted cash was paid to the bankruptcy estate of Diomed and the remaining restricted cash was returned to the Company on June 10, 2008 and the account was closed.



(7)
        Inventories




Inventories are stated at the lower of cost (first-in, first-out method) or market. Appropriate consideration is given to deterioration, obsolescence and other factors in evaluating net realizable value. Inventories are comprised of the following:



September 30,2008
        
        December 31,2007(unaudited)Raw materials
        
        $
        4,772,000
        
        $
        4,119,000Work-in process
        
        
        934,000
        
        
        650,000Finished goods
        
        
        4,934,000
        
        
        3,538,000$
        10,640,000
        
        $
        8,307,000




(8)
        Credit Risk and Allowance for Doubtful Accounts




The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is regularly evaluated by the Company for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customers ability to pay. Accounts receivable over 60 days past due are considered past due. The Company does not accrue interest on past due accounts receivable. Receivables are written off only after all collection attempts have failed and are based on individual credit evaluation and the specific circumstances of the customer. At September 30, 2008 and December 31, 2007, the allowance for doubtful accounts was $100,000 and $90,000, respectively.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



All product returns must be pre-approved and, if approved, customers are subject to a 20% restocking charge. The Company analyzes the rate of historical returns when evaluating the adequacy of the allowance for sales returns, which is included with the allowance for doubtful accounts on our balance sheet. At September 30, 2008 and December 31, 2007, the sales and return allowance was $30,000 and $40,000, respectively.



Accounts receivable are shown net of the combined total of the allowance for doubtful accounts and allowance for sales returns of $130,000 at both September 30, 2008 and December 31, 2007.



(9)
        Concentrations of Credit and Other Risks




In the United States the Company sells its products directly to hospitals and clinics. In all international markets, the Company sells its products to distributors who, in turn, sell to medical clinics. Loss, termination or ineffectiveness of distributors to effectively promote the Companys products could have a material adverse effect on the Companys financial condition and results of operations.



With respect to accounts receivable, the Company performs credit evaluations of its customersand does not require collateral. No single customer represented greater than 10% of gross accounts receivable as of either September 30, 2008 or December 31, 2007. There have been no material losses on customer receivables.



Revenue by geographic destination as a percentage of total net revenue for the nine-month periods ended September 30, 2008 and 2007 was 87% in the United States and 13% in international markets for both periods. No single customer represented greater than 10% of the total net revenue for the nine months ended September 30, 2008 or 2007.



(10)
        Dependence on Key Suppliers




King Pharmaceuticals



The Company purchases certain key components from single-source suppliers. Any significant component delay or interruption could require the Company to qualify new sources of supply, if available, and could have a material adverse effect on the Companys financial condition and results of operations. The Company purchases its requirements for thrombin (a component in the D-Stat products) under a Thrombin-JMI Supply Agreement entered into with King Pharmaceuticals, Inc. (King) on January 9, 2007. Under the terms of the Thrombin-JMI Supply Agreement, King agrees to manufacture and supply thrombin to the Company on a non-exclusive basis. The Thrombin-JMI Supply Agreement does not contain any minimum purchase requirements. King agrees to supply the Company with such quantity of thrombin as the Company may order at a fixed price throughout the term of the Thrombin-JMI Supply Agreement as
adjusted for inflation, variations in potency and other factors. The Thrombin-JMI Supply Agreement has an initial term of 10 years, followed by successive automatic one-year extensions, subject to termination by the parties under certain circumstances, including: (i) termination by King without cause anytime after the fifth anniversary of the date of the Thrombin-JMI Supply Agreement upon five years prior written notice to the Company, and (ii) termination by the Company without cause anytime after the fifth anniversary of the date of the Thrombin-JMI Supply Agreement upon five years prior written notice to King provided that the Device Supply Agreement, which the Company also entered into with King on January 9, 2007, has expired on its terms or the parties have agreed to terminate it.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued





Sigma



On October 18, 2004, the Company entered into a supply agreement with Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc. (Sigma) for the supply of thrombin to the Company. Pursuant to the terms of the Sigma agreement, the Company agreed to pay certain development costs of Sigma to allow Sigma to manufacture thrombin for the Companys needs in manufacturing its hemostatic products. The payments were based on the achievement of certain milestones over a two-year period and all payment obligations have been fulfilled. The Sigma agreement terminates after ten years and is automatically extended for up to five additional successive one-year terms unless one party delivers notice of termination at least one year prior to the scheduled termination of the Sigma agreement. During the term of the agreement, Sigma

has agreed not to sell thrombin of the type developed for the Company under the agreement in or as a component of a hemostatic product for medical use. The Company does not have any minimum purchase requirements under the Sigma agreement; however, if the Company purchases less than three lots of thrombin in any year commencing in 2008, then (i) Sigma will be released from its agreement not to sell thrombin in or as a component of a hemostatic product for medical use and (ii) Sigma will have the right to terminate the agreement on 30 days notice.



(11)
        Commitments and Contingencies




Diomed Inc. Litigation



On March 4, 2004, the Company was named as the defendant in an intellectual property lawsuit brought by Diomed Inc. (Diomed) in the United States District Court for the District of Massachusetts (the Court). The complaint requested a judgment that sales of the Companys Vari-Lase® procedure kit and Vari-Lase laser console infringe on a single method patent (No. 6,398,777) held by Diomed and asked for relief in the form of an injunction that would prevent the Company from selling the Companys Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of the Companys products, and other costs, disbursements and attorneys fees. The trial commenced on March 12, 2007, and concluded on March 28, 2007 when the jury reached a verdict that the Company contributed to and induced infringement of Diomeds patent and
awarded monetary damages in the amount of $4,100,000, plus pre-judgment interest. To settle Diomeds claims for pre-judgment interest and for additional damages for sales not considered by the jury, the Company agreed to amend the judgment amount to $4,975,000 and accrued this amount together with additional costs and attorneys fees as of June 30, 2007 in the aggregate amount of $5,690,000. The jury concluded there was no willful infringement by the Company and therefore the award was not subject to treble damages or attorneys fees. On April 12, 2007 the Company converted all Vari-Lase sales to the Companys new Vari-Lase Bright TipTM fiber which features a proprietary ceramic distal tip that prevents even the possibility of the vein wall contact that was the requirement of Diomeds sole patent claim in the litigation. On June 20, 2007 the Company posted a supersedeas bond and appealed the jury verdict to the U.S. Court of Appeals for the Federal
Circuit in Washington, D.C. On July 2, 2007 the Court granted an injunction order that applies to endovenous laser therapy kits that were sold by the Company as of the trial date and any other kits that are not more than a mere colorable variation of such kits. Concerning the laser consoles, the injunction order applies only to Vari-Lase consoles of the type that were sold at the time of trial and that are not more than a mere colorable variation of such consoles and that are sold for use with the kits that are subject to the injunction. On July 11, 2007, Diomed moved for a finding that the Companys continued sale of laser consoles was in violation of the injunction. The Company filed a response to the motion and requested a hearing on the matter. On January 15, 2008, the Court denied Diomeds contempt motion and ruled that the Companys sale of laser consoles did not violate the injunction. On April 8, 2008, the Company announced that it entered into a settlement
agreement with Diomed. Pursuant to the settlement agreement, (i) on April 29, 2008, the Company made a one-time payment of $3,586,000 to Diomed, (ii) the Company and Diomed jointly dismissed the appeal with the United States Court of Appeals for the Federal Circuit, and (iii) Diomed provided to the Company a satisfaction of judgment, releasing the Company from the monetary obligations of the judgment imposed by the Court in its entirety.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued





Marine Polymer Technologies, Inc. Litigation



On May 11, 2005 the Company initiated a lawsuit for product disparagement and false advertising against Marine Polymer Technologies, Inc., a Delaware corporation (Marine Polymer). In the lawsuit, the Company alleged that Marine Polymer made defamatory and disparaging statements concerning the Companys D-Stat® Dry hemostatic bandage. The Company sought relief in the form of an injunction to enjoin Marine Polymer from continuing to defame and disparage the Companys products, damages as a result of such statements, and other costs, disbursements and attorneys fees. Marine Polymer brought a counter-claim against the Company including, among other claims, business defamation and product disparagement for statements allegedly made by the Company concerning Marine Polymers SyvekPatch®. Marine Polymer sought relief in the form of monetary
damages, costs, disbursements and attorneys fees. The trial commenced on March 24, 2008 in the United States District Court for the District of Massachusetts. At the conclusion of the trial on April 7, 2008 the jury returned a verdict in favor of the Company and against Marine Polymer for product disparagement concerning statements made regarding the safety of the Companys D-Stat Dry hemostat product. In its verdict, the jury found that Marine Polymers statements were false and disparaged the D-Stat Dry product and awarded the Company $4,500,000 in monetary damages. The jury rejected Marine Polymers counterclaims in their entirety. Following post trial motions, on June 30, 2008, the Court upheld the jury verdict, granted the Companys request for a permanent injunction against Marine Polymer for the statements that the jury found were false, and added prejudgment interest on the jury verdict award in the amount of $592,124. On July 14, 2008, Marine Polymer
filed a Notice of Appeal. On October 17, 2008, Marine Polymer filed an appeal brief in which it challenges the verdict in favor of the Companys claims. Marine Polymer in not appealing the Courts rejection of its counter claims against the Company.



VNUS®Medical Technologies Litigation



On October 13, 2005, the Company was named as one of three defendants in an intellectual property lawsuit brought by VNUS® Medical Technologies, Inc. (VNUS) in the United States District Court for the Northern District of California. The complaint requested a judgment that the Companys Vari-Lase procedure kit and Vari-Lase laser console infringe on four patents held by VNUS and asked for relief in the form of an injunction that would prevent the Company from selling the Companys Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of these products, and other costs, disbursements and attorneys fees. VNUS subsequently indicated that it was not pursuing its allegation of infringement concerning one of the four patents. On June 2, 2008, the Company entered into a settlement agreement with VNUS for the purpose of resolving the
lawsuit. Under the terms of the settlement agreement, (i) on June 4, 2008, the Company paid VNUS a royalty payment in the aggregate amount of $3,116,000 related to all Vari-Lase® products shipped within the United States through the end of the first quarter of 2008, (ii) the Company agreed to pay a quarterly royalty on all on-going U.S. shipments of Vari-Lase laser and kit products payable quarterly during the remaining life of the applicable patents, (iii) VNUS granted the Company a non-exclusive and non-sublicensable license to the applicable patents for use in endovenous laser therapy, and (iv) all litigation between the parties was dismissed.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued





From time to time, the Company is involved in legal proceedings arising in the normal course of business. As of the date of this report the Company is not a party to any legal proceeding not described in this section in which an adverse outcome would reasonably be expected to have a material adverse effect on the Companys results of operations or financial condition.



(12)
        Long-term Debt




On December 26, 2007, the Company modified and extended its secured asset-based loan and security agreement with Silicon Valley Bank dated December 31, 2003 (as previously amended December 28, 2006 and December 29, 2005), consisting of an operating line of credit and an equipment line of credit. The operating line of credit is a two-year, $10,000,000 facility with availability based primarily on eligible customer receivables and inventory. The interest rate is the greater of prime plus 0.5% or 7.25%. As of September 30, 2008, the Company had no outstanding balance against the operating line of credit. Based on the Companys eligible customer receivables, inventory and cash balances, $10,000,000 was available for borrowing as of September 30, 2008. The operating line of credit requires an annual fee of 0.25% of the average unused portion of the committed revolving line as determined by the bank.



The equipment line of credit was paid in full on July 9, 2008 and the Company no longer has the ability to borrow any additional funds under the equipment line of credit portion of the credit facility.



The credit facility includes three covenants: a minimum of $10,000,000 in tangible net worth, a minimum of $3,000,000 of unrestricted cash in deposit accounts with Silicon Valley Bank and an adjusted net income for each financial reporting period. The adjusted net income covenant requires an adjusted net income greater than $500,000 for each rolling three month period for the remaining term of the agreement. The amount required as a minimum tangible net worth will increase by an amount equal to the sum of 50% of the Companys quarterly net profit and all consideration received by the Company upon the issuance of equity securities. The minimum tangible net worth requirement at September 30, 2008 was $11,447,000. The Company was in compliance with all of the covenants as of September 30, 2008.



(13)
        Income Taxes




In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 48 (FIN 48),Accounting for Uncertainty in Income Taxes  an Interpretation of FASB Statement No.109, which clarifies the accounting for uncertain income tax positions. This interpretation prescribes a financial statement recognition threshold and measurement attribute for any tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Effective January 1, 2007, the Company adopted FIN 48. Upon adoption, the Company had $425,000 of unrecognized income tax benefits and the adoption of FIN 48 had no effect on
shareholders equity. The Company has recorded a FIN 48 reserve of $512,000 at both September 30, 2008 and December 31, 2007. The impact of tax related interest and penalties is recorded as a component of income tax expense. At September 30, 2008, the Company has recorded $-0- for the payment of tax related interest and there were no tax penalties or interest recognized in the statements of operations.



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VASCULAR SOLUTIONS, INC.

Notes to Unaudited Consolidated Financial Statements-Continued



(14)
        Products and Services




The following tables set forth, for the periods indicated, net revenue by product line along with

the percent change from the previous year:



Three Months Ended September 30,2008
        
        2007NetRevenue
        
        PercentChange
        
        NetRevenue
        
        PercentChangeHemostat products
        
        $
        5,777,000
        
        ( 4%
        )
        $
        6,012,000
        
        10%Extraction catheters
        
        
        3,842,000
        
        45%
        
        
        2,648,000
        
        16%Vein products
        
        
        2,425,000
        
        14%
        
        
        2,134,000
        
        15%Specialty catheters
        
        
        1,120,000
        
        53%
        
        
        734,000
        
        3%Access products
        
        
        1,620,000
        
        106%
        
        
        787,000
        
        88%Other
        
        
        305,000
        
        43%
        
        
        214,000
        
        ( 5%
        )Total product revenue
        
        $
        15,089,000
        
        21%
        
        $
        12,529,000
        
        14%License and collaboration
        
        
        376,000
        
        (37%
        )
        
        597,000
        
        100%Total revenue
        
        $
        15,465,000
        
        18%
        
        $
        13,126,000
        
        20%






Nine Months Ended September 30,2008
        
        2007NetRevenue
        
        PercentChange
        
        NetRevenue
        
        PercentChangeHemostat products
        
        $
        17,633,000
        
        (5%
        )
        $
        18,482,000
        
        14%Extraction catheters
        
        
        10,913,000
        
        34%
        
        
        8,115,000
        
        22%Vein products
        
        
        6,982,000
        
        17%
        
        
        5,965,000
        
        20%Specialty catheters
        
        
        3,398,000
        
        37%
        
        
        2,481,000
        
        10%Access products
        
        
        3,933,000
        
        107%
        
        
        1,898,000
        
        73%Other
        
        
        839,000
        
        24%
        
        
        676,000
        
        15%Total product revenue
        
        $
        43,698,000
        
        16%
        
        $
        37,617,000
        
        18%License and collaboration
        
        
        1,120,000
        
        26%
        
        
        891,000
        
        100%Total revenue
        
        $
        44,818,000
        
        16%
        
        $
        38,508,000
        
        21%






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




Overview



Vascular Solutions, Inc. (we, us or Vascular) is a medical device company focused on bringing clinically advanced solutions to interventional cardiologists and interventional radiologists worldwide. We were incorporated in the state of Minnesota in December 1996, and began operations in February 1997. Our main product lines consist of the following:




        Hemostat (blood clotting) products, principally consisting of the D-Stat Dry hemostat, a topical thrombin-based pad with a bandage used to control surface bleeding, and the D-Stat® Flowable, a thick yet flowable thrombin-based mixture for preventing bleeding in subcutaneous pockets,





        Extraction catheters, principally consisting of the Pronto® V3 extraction catheter, a mechanical system for the removal of soft thrombus from arteries,





        Vein products, principally consisting of the Vari-Lase® endovenous laser, a laser and procedure kit used for the treatment of varicose veins,





        Specialty catheters, consisting of a variety of catheters for clinical niches including the Langston® dual lumen catheters, Twin-Pass® dual access catheters, Gandras catheters, and Gopher support catheter and





        Access products, principally consisting of micro-introducer kits, the MICROElitesnare,  the Guardian®hemostasis valve, and guidewires used in connection with percutaneous access to the vasculature.




In 2000 we received FDA clearance for our first product, the Duett sealing device, which is used to seal the puncture site following catheterization procedures. In 2001, due to competitive developments in the sealing device market, we made the strategic decision to develop additional products and de-emphasize the promotion of our Duett sealing device. We have grown from net revenue of $6.2 million in 2000 solely from the Duett device to net revenue of $52.9 million in 2007, with 97% of our 2007 net revenue resulting from products other than the Duett device. This increase in revenue represents a compound annual growth rate of 36% and was driven by our commitment to the research and development of multiple new devices to diagnose and treat existing and new vascular conditions.



As a vertically-integrated medical device company, we generate ideas and create new interventional medical devices and then deliver these products directly to the physician through our direct domestic sales force and our international distribution network. We currently have in development several additional products that leverage our existing infrastructure to bring additional solutions to the interventional cardiologist and interventional radiologist.



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Results of Operations



The following table sets forth, for the periods indicated, certain items from our statements of operations expressed as a percentage of net revenue:



|                                           |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30, | 
|------------------------------------------ |  | ------------------------------- |  | ------------------------------ | 
|                                           |  | 2008                            |  | 2007                           | 
|Revenue:                                   |  |                                 |  |                                | 
|Product revenue                            |  | 98%                             |  | 95%                            | 
|License and collaboration revenue          |  | 2%                              |  | 5%                             | 
|Total revenue                              |  | 100%                            |  | 100%                           | 
|                                           |  |                                 |  |                                | 
|Product costs and operating expenses:      |  |                                 |  |                                | 
|Cost of goods sold                         |  | 33%                             |  | 32%                            | 
|Collaboration expenses                     |  | 1%                              |  | 3%                             | 
|Research and development                   |  | 10%                             |  | 9%                             | 
|Clinical and regulatory                    |  | 5%                              |  | 6%                             | 
|Sales and marketing                        |  | 33%                             |  | 37%                            | 
|General and administrative                 |  | 7%                              |  | 13%                            | 
|Litigation                                 |  |                                |  |                               | 
|Total product costs and operating expenses |  | 89%                             |  | 100%                           | 
|Operating income (loss)                    |  | 11%                             |  |                               | 
|Other income and expenses, net             |  |                                |  |                               | 
|Income (loss) before income taxes          |  | 11%                             |  |                               | 
|Income taxes                               |  |                                |  |                               | 
|Net income (loss)                          |  | 11%                             |  |                               | 



Three and nine months ended September 30, 2008, compared to three and nine months ended September 30, 2007



Net revenue increased 18% to $15,465,000 for the quarter ended September 30, 2008 from $13,126,000 for the quarter ended September 30, 2007. Approximately 87% of our net revenue for the quarter ended September 30, 2008 was earned in the United States and 13% of our net revenue was earned in international markets. Net revenue increased 16% to $44,818,000 for the nine months ended September 30, 2008 from $38,508,000 for the nine months ended September 30, 2007. Approximately 87% of our net revenue for the nine months ended September 30, 2007 was earned in the United States and 13% of our net revenue was earned in international markets.



Gross margin across all product lines declined to 66% for the quarter ended September 30, 2008from 67% for the quarter ended September 30, 2007, principally due to selling mix. We expect product gross margins to be in the range of 65% to 66% for the fourth quarter of 2008, subject to changes in our selling mix between our lower margin products such as the Vari-Lase products and our higher margin products such as the D-Stat Dry. Gross margin across all product lines declined to 66% for the nine months ended September 30, 2008 from 67% for the nine months ended September 30, 2007.



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Research and development expense for the third quarter of 2008 totaled $1,530,000, or 9.9% of revenue, compared to $1,160,000, or 8.8% of revenue, for the third quarter of 2007. Research and development expense for the nine months of 2008 totaled $4,550,000, or 10.2% of revenue, compared to $3,998,000, or 10.4% of revenue, for the nine months of 2007. The growth in research and development expenses resulted from additional new products moving through our development system in 2008. We expect our research and development expenses to be approximately 9% to 10% of revenue for the foreseeable future as we continue to plan on developing at least five new products each year.



Clinical and regulatory expense for the third quarter of 2008 totaled $792,000, or 5.1% of revenue, compared to $813,000, or 6.2% of revenue, for the third quarter of 2007. Clinical and regulatory expense for the nine months of 2008 totaled $2,402,000, or 5.4% of revenue, compared to $2,324,000, or 6.0% of revenue, for the nine months of 2007. We expect our clinical and regulatory expenses to remain fairly constant at approximately 5% to 6% of revenue for the foreseeable future as we continue our clinical study and regulatory approval activities for new products.



Sales and marketing expense for the third quarter of 2008 totaled $5,090,000, or 32.9% of revenue, compared to $4,838,000, or 36.9% of revenue, for the third quarter of 2007. Sales and marketing expense for the nine months of 2008 totaled $15,477,000, or 34.5% of revenue, compared to $14,451,000, or 37.5% of revenue, for the nine months of 2007. We have not materially increased the number of our U.S. field sales employees during 2008, as we believe we have substantially complete geographic coverage with 82 employees, and we do not expect to substantially increase this number through the end of 2009. As a result, we expect our sales and marketing expenses to be between 30% and 32% of revenue in the fourth quarter of 2008 and continue to decline during 2009 as a percent of revenue as our revenue increases.



General and administrative expense for the third quarter of 2008 totaled $1,037,000, or 6.7% of revenue, compared to $1,695,000, or 12.9% of revenue, for the third quarter of 2007. General and administrative expense for the nine months of 2008 totaled $3,771,000, or 8.4% of revenue, compared to $3,842,000, or 10.0% of revenue, for the nine months of 2007. The decrease was principally due to lower attorneys fees due to the completion of litigation matters during the second quarter of 2008. We expect general and administrative expenses to be approximately 6% to 7% of revenue for the foreseeable future.



Litigation expenses were $-0- for the quarter ended September 30, 2008, and $1,484,000 for the nine months ended September 30, 2008. During the quarter ended June 30, 2008 we recorded a litigation gain of $1,659,000 offset by a litigation expense of $3,116,000 following the settlement agreements reached with Diomed and VNUS, respectively. For a complete discussion of litigation matters, see Note 11 to the Unaudited Consolidated Financial Statements in Item 1 of Part 1 of this Form 10-Q.



Thrombin qualification expenses were $-0- for the quarter ended September 30, 2008 compared to $7,000 for the quarter ended September 30, 2007. Thrombin qualification expenses were $-0- for the nine months ended September 30, 2008 compared to $136,000 for the nine months ended September 30, 2007. On October 18, 2004, we entered into a supply agreement with Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc. (Sigma) for the supply of thrombin to us. Pursuant to the terms of the agreement, we agreed to pay certain development costs of Sigma necessary for Sigma to produce thrombin. The initial contract term ends after ten years and is automatically extended for up to five additional successive one-year terms unless one party delivers notice of termination at least one year prior to the scheduled termination of the agreement. During the term of the agreement, Sigma has
agreed not to sell thrombin of the type developed for us under the agreement in or as a component of a hemostatic product for medical use. We do not have any minimum purchase requirements under the agreement; however, if we purchase less than three lots of thrombin in any year commencing in 2008 then (i) Sigma will be released from its agreement not to sell thrombin in or as a component of a hemostatic product for medical use, and (ii) Sigma will have the right to terminate the agreement upon 30 days notice.



The Sigma contract was part of our plan to qualify a second source of thrombin (in addition to the Thrombin-JMI® Supply Agreement discussed in above Note 10 to the Unaudited Consolidated Financial Statements in Item 1 of Part 1 of this Form 10-Q) and to bring the new thrombin through the regulatory process to be used in our hemostatic products. We have purchased $1.7 million of thrombin from Sigma, of which we have expensed approximately $400,000 in our development work. We received regulatory approval in February 2008 allowing us to use the Sigma thrombin in our hemostat products sold in international markets. In the second quarter of 2008 we began using Sigma thrombin in the manufacture of our international hemostat products and have consumed $200,000 to date, resulting in approximately $1.1 million in inventory at September 30, 2008. We expect to consume the remaining
supply of Sigma thrombin in the manufacture of our hemostat products sold in international markets prior to its expiration.



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Interest income decreased to $28,000 for the quarter ended September 30, 2008 from $126,000 for the quarter ended September 30, 2007. Interest income decreased to $168,000 for the nine months ended September 30, 2008 from $324,000 for the nine months ended September 30, 2007. The decrease in interest income was primarily the result of lower cash balance following payments made in settlement of the Diomed litigation and VNUS litigation.



Interest expense decreased to $10,000 for the quarter ended September 30, 2008 from $35,000 for the quarter ended September 30, 2007. Interest expense decreased to $52,000 for the nine months ended September 30, 2008 from $120,000 for the nine months ended September 30, 2007. The decrease in interest expense was the result of repayment of our equipment line of credit, which occurred on July 9, 2008.



Foreign exchange loss increased to $22,000 for the quarter ended September 30, 2008 from $-0- for the quarter ended September 30, 2007. Foreign exchange loss increased to $22,000 for the nine months ended September 30, 2008 from $-0- for the nine months ended September 30, 2007. Effective April 1, 2008 we began to sell our products to one of our new international distributors at prices denominated in Euros. We also purchase a small number of inventory items at prices denominated in Euros. As a result, we are exposed to foreign exchange movements during the time between the shipment of the product and payment. We currently have terms of net 60 days with our distributor and net 30 with our vendors under the agreements providing for payments in Euros.



Income Taxes



Income tax expense was $22,000 for the quarter ended September 30, 2008, and $162,000 for the nine months ended September 30, 2008, primarily the result of federal and state alternative minimum tax (AMT). With the exception of the year ended December 31, 2007, we have not generated any significant pre-tax income. No provision or benefit for future federal and state income taxes has been recorded for net operating losses incurred in any period since our inception because the benefits may not be realized until we generate sustainable taxable income. We have established a valuation allowance in the amount of the full value of our federal net operating loss, federal and state research and development credits and foreign tax losses. The adoption of FIN 48has not impacted our operating results since we have historically established a valuation
allowance for the full value of our deferred assets. However, we established a FIN 48 reserve of $512,000 for the nine months ended September 30, 2008.



As of September 30, 2008, we had approximately $49.5 million of federal net operating loss carryforwards available to offset future taxable income which begin to expire in the year 2013. As of September 30, 2008, we also had federal and state research and development tax credit carryforwards of approximately $3.1 million which begin to expire in the year 2013. As of September 30, 2008, we also had a foreign tax loss carryforward of approximately $3.2 million, which does not expire. Under the United States Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances, including significant changes in ownership interests. Future use of our existing net operating loss carryforwards may be restricted due to changes in ownership or from future tax legislation. We performed a section 382 change in
ownership study during the third quarter of 2005 on our federal net operating loss carryforward, and concluded that, as of the date of the study, we would have no limitations on the net operating loss carryforward.



Liquidity and Capital Resources



We have financed substantially all of our operations since inception through the issuance of equity securities and sales of our products. Through September 30, 2008, we have sold capital stock generating aggregate net proceeds of approximately $80.4 million. At September 30, 2008, we had $5,598,000 in cash and cash equivalents on-hand, compared to $10,759,000 in cash and cash equivalents at December 31, 2007.



During the nine months ended September 30, 2008, we used $3,561,000 in cash for operating activities, we generated $4,460,000 in cash from investing activities, and we used $552,000 in cash for financing activities. Our cash usage for operating activities was primarily the result of payments made to Diomed and VNUS upon settlement of intellectual property litigation and for additional purchases of inventory. The majority of the cash generated by investing activities was the result of the transfer of $5,473,000 from restricted cash to cash upon the settlement of the litigation with Diomed. Capital expenditures of $1,013,000 were incurred, relating primarily to leasehold improvements as part of our facility expansion, additional manufacturing equipment and additional research and development equipment. Cash used in financing activities consisted of the repurchase of our shares for income tax
withholding purposes upon vesting of outstanding restricted share awards, repayment of our equipment line of credit, and proceeds received upon the exercise of outstanding stock options.



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Following the repayment of our equipment line of credit on July 9, 2008, our $10 million credit facility with Silicon Valley Bank consists of a revolving line of credit with a 24-month term that bears interest at the rate equal to the greater of prime plus 0.5% or 7.25% and is secured by a first security interest on all of our assets. The credit facility includes three covenants: a minimum of $10 million in tangible net worth, a minimum of $3 million of unrestricted cash in deposit accounts with Silicon Valley Bank and an adjusted net income for each financial reporting period. The adjusted net income covenant requires an adjusted net income greater than $500,000 for each subsequent rolling three month period for the remaining term of the agreement. The amount required as a minimum tangible net worth will increase by an amount equal to the sum of 50% of the Companys quarterly net
profit and all consideration received by us upon the issuance of equity securities. The minimum required tangible net worth was $11.4 million at September 30, 2008. We were in compliance with all of the covenants on September 30, 2008. As of September 30, 2008, we had no outstanding balance on the $10 million revolving line of credit and an availability of $10 million.



The following table summarizes our contractual cash commitments as of September 30, 2008:



Payments Due by PeriodContractual Obligations
        
        Total
        
        Less than1 year
        
        1 - 3 years
        
        3 - 5 years
        
        More than 5yearsFacility operating leases
        
        $
        5,617,000
        
        $
        749,000
        
        $
        1,547,000
        
        $
        1,639,000
        
        $
        1,682,000




We do not have any other significant cash commitments related to supply agreements, nor do we have any significant commitments for capital expenditures.



We currently anticipate that we will continue to experience positive cash flow from our operating activities for the foreseeable future. We currently believe that our working capital of $17.4 million at September 30, 2008 will be sufficient to meet all of our operating and capital requirements for the foreseeable future. However, our actual liquidity and capital requirements will depend upon numerous unpredictable factors, including the amount of revenues from sales of our existing and new products; the cost of maintaining, enforcing and defending our patents and other intellectual property rights; competing technological and market developments; developments related to regulatory and third party reimbursement matters; and other factors.



If cash generated from operations is insufficient to satisfy our cash needs, we may be required to raise additional funds. In the event that additional financing is needed, and depending on market conditions, we may seek to raise additional funds for working capital purposes through the sale of equity or debt securities. There is no assurance such financing will be available on terms acceptable to us or available at all.



Critical Accounting Policies



Managements Discussion and Analysis of Financial Condition and Results of Operations addresses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. The preparation of our financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate these estimates and judgments. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets
and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



We set forth below those material accounting policies that we believe are the most critical to an investors understanding of our financial results and condition and which require complex management judgment.



Inventory



We state our inventory at the lower of cost (first-in, first-out method) or market. The estimated value of excess, obsolete and slow-moving inventory as well as inventory with a carrying value in excess of its net realizable value is established by us on a quarterly basis through review of inventory on hand and assessment of future demand, anticipated release of new products into the market, historical experience and product expiration. Our stated value of inventory could be materially different if demand for our products decreased because of competitive conditions or market acceptance, or if products become obsolete because of advancements in the industry.



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Revenue Recognition



We recognize revenue in accordance with generally accepted accounting principles as outlined in the Securities and Exchange Commissions Staff Accounting Bulletin No. 104,Revenue Recognition(SAB 104), which requires that four basic criteria be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) the price is fixed or determinable; (iii) collectability is reasonably assured; and (iv) product delivery has occurred or services have been rendered. We recognize revenue as products are shipped based on FOB shipping point terms when title passes to customers. We negotiate credit terms on a customer-by-customer basis and products are shipped at an agreed upon price. All product returns must be pre-approved and, if approved, customers are subject to a 20% restocking charge.



We also generate revenue from license agreements and research collaborations and recognize this revenue when earned. In accordance with EITF Issue No. 00-21,Revenue Arrangements with Multiple Deliverables, for deliverables which contain multiple deliverables, we separate the deliverables into separate accounting units if they meet the following criteria: (i) the delivered items have a stand-alone value to the customer; (ii) the fair value of any undelivered items can be reliably determined; and (iii) if the arrangement includes a general right of return, delivery of the undelivered items is probable and substantially controlled by the seller. Deliverables that do not meet these criteria are combined with one or more other deliverables into one accounting unit. Revenue from each accounting unit is recognized based on the applicable accounting
literature, primarily SAB 104.



We analyze the rate of historical returns when evaluating the adequacy of the allowance for sales returns, which is included with the allowance for doubtful accounts on our balance sheet. At September 30, 2008, this reserve was $30,000 compared to $40,000 at December 31, 2007. If the historical data we use to calculate these estimates does not properly reflect future returns, revenue could be overstated.



Allowance for Doubtful Accounts



We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customers ability to pay. At September 30, 2008, this reserve was $100,000 compared to $90,000 at December 31, 2007. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.



Warranty Costs



We provide a warranty for certain products against defects in material and workmanship for periods of up to 24 months. We record a liability for warranty claims at the time of sale. The amount of the liability is based on the amount we are charged by our original equipment manufacturer to cover the warranty period. The original equipment manufacturer includes a one-year warranty with each product sold to us. We record a liability for the uncovered warranty period offered to a customer, provided the warranty period offered exceeds the initial one-year warranty period covered by the original equipment manufacturer. At September 30, 2008, this warranty provision was $31,000 compared to $34,000 at December 31, 2007. If the assumptions used in calculating the provision were to materially change, resulting in more defects than anticipated, an additional provision may be required.



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Income Taxes



The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient taxable income in the United States and, to a lesser extent, Germany, based on estimates and assumptions. We record a valuation allowance to reduce the carrying value of our net deferred tax asset to the amount that is more likely than not to be realized. For the quarter ended September 30, 2008, we recorded a $28.1 million valuation allowance and a $512,000 reserve related to our net deferred tax assets of $28.6 million as a result of FIN 48. In the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase net income in the period such determination is made. On a quarterly basis, we evaluate the realizability of our deferred tax assets and assess the requirement for a valuation allowance.



Stock-Based Compensation



We account for stock-based compensation in accordance with SFAS No. 123(R),Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends, estimating expected forfeiture rates, estimating expected stock volatility, estimating the expected term, estimating expected risk-free interest rates and determining illiquidity discount rates. If actual results differ significantly from these estimates and we materially change our estimates, stock-based compensation expense and our results of operations could be materially impacted.



Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995



The Private Securities Litigation Reform Act of 1995 (the Act) provides a safe harbor for forward-looking statements to encourage companies to provide prospective information about their business, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. We desire to take advantage of the safe harbor provisions with respect to any forward-looking statements we may make in this filing, other filings with the Securities and Exchange Commission and any public oral statements or written releases. The words or phrases will likely, is expected, will continue, is anticipated, believe, estimate, projected,
forecast, or similar expressions are intended to identify forward-looking statements within the meaning of the Act. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. In accordance with the Act, we identify the following important general factors which, if altered from the current status, could cause our actual results to differ from those described in any forward-looking statements: risks associated with our limited operating history, defense of patent infringement lawsuits, adoption of our new products, lack of profitability, lack of experience with a direct sales force, exposure to possible product liability claims, the development of new products by others, dependence on third party distributors in international markets, doing business in international markets,
limited manufacturing experience, the availability of third party reimbursement, actions by the FDA related to our products, the loss of key vendors, and those factors set forth under the heading Risk Factors in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2007. This list is not exhaustive, and we may supplement this list in any future filing with the Securities and Exchange Commission or in connection with the making of any specific forward-looking statement.



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Item 3.
        Quantitative and Qualitative Disclosures About Market Risk




Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivables. We maintain our accounts for cash and cash equivalents principally at two major banks and one investment firm in the United States. We have a formal written investment policy that limits our investments to investments in issuers evaluated as creditworthy. We have not experienced any losses on our deposits of our cash and cash equivalents.



With respect to accounts receivable, we perform credit evaluations of our customers and do not require collateral. There have been no material losses on accounts receivables.



In the United States we sell our products directly to hospitals
and clinics denominated in United States dollars. In Germany, through April 1, 2008 we sold our products to hospitals and clinics denominated in Euros.
Effective April 1, 2008, we began selling our products in Germany through our new distributor Nicolai, GmbH. The sale of our products to Nicolai is denominated
in Euros. Product revenue recognized on sales in Germany represented approximately 1.4% of our total product revenue for the nine months ended September 30,
2008. The exposure to currency exchange rates on this volume of product sales in Germany would be considered immaterial to our financial statements.



In all other international markets, we sell our products to independent distributors who, in turn, sell to medical clinics. We sell our product in these countries through independent distributors denominated in United States dollars. Loss, termination or ineffectiveness of distributors to effectively promote our product would have a material adverse effect on our financial condition and results of operations.



We do not believe our operations are currently subject to significant market risks for interest rates, foreign currency exchange rates, commodity prices or other relevant market price risks of a material nature. We expect to earn the remaining installment payment of 125,000 Euros pursuant to the terms of our distribution agreement with Nicolai, GmbH before the end of 2008. A change of 0.1 in the Euro exchange would result in an increase or decrease of approximately $45,500 in the amount of United States dollars we receive in the installment and payment on accounts receivable from Nicolai, GmbH. Under our current policies, we do not use foreign currency derivative instruments to manage exposure to fluctuations in the Euro exchange rate.



We currently have no indebtedness, but if we were to borrow amounts from our revolving credit line, we would be exposed to changes in interest rates. Advances under our revolving credit line bear interest at an annual rate indexed to prime. We will thus be exposed to interest rate risk with respect to amounts outstanding under the line of credit to the extent that interest rates rise. As we had no amounts outstanding on the line of credit at September 30, 2008, we have no exposure to interest rate changes on this credit facility. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. Additionally, we will be exposed to declines in the interest rates paid on deposited funds. A 1% decline in the current market interest rates paid on deposits would result in interest income being reduced by approximately $56,000 on an annual basis.



Item 4.
        Controls and Procedures




Evaluation of disclosure controls and procedures.



Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.



Changes in internal controls.



During the fiscal quarter ended September 30, 2008, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





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PART II. OTHER INFORMATION



Item 1.
        Legal Proceedings




The legal proceedings as described in Note 11 to Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q are incorporated into this Item 1 of Part II by reference.



Item 1A.
        Risk Factors




We do not have material changes to our risk factors as set forth under Item 1A of Part I of our most recently filed Form 10-K.



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




During the quarter ended September 30, 2008, we repurchased shares of common stock to satisfy income tax withholding obligations upon vesting of outstanding restricted share awards with employees.



Shares purchase activity for the third quarter of fiscal 2008 was as follows:



Date
        
        Total Number ofShares Purchased
        
        Price Paid per Share
        
        Total Number of Shares Purchased
as Part of a Publicly Announced Plans or Programs
        
        Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or ProgramsJuly 28, 2008
        
        1,634
        
        $7.08
        
        
        
        




Item 3.
        Defaults Upon Senior Securities




None.



Item 4.
        Submission of Matters to a Vote of Security Holders




None.



Item 5.
        Other Information




None



Item 6.
        Other Exhibits




ExhibitNumber
        
        Description3.1
        
        Amended and Restated Articles of Incorporation of Vascular Solutions, Inc. (incorporated by reference to Exhibit 3.1 to Vascular Solutions Form 10-Q for the quarter ended September 30, 2000).3.2
        
        Amended and Restated Bylaws of Vascular Solutions, Inc. (incorporated by reference to Exhibit 3.1 of Vascular Solutions Form 8-K dated October 19, 2007).4.1
        
        Specimen of Common Stock certificate (incorporated by reference to Exhibit 4.1 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).10.1
        
        Separation Agreement and General Release, dated August 15, 2008, between Deborah L. Neymark and Vascular Solutions, Inc. (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 8-K dated August 15, 2008).31.1
        
        Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
        
        Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
        
        Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
        
        Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.






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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.





VASCULAR SOLUTIONS, INC.Date:  October 21, 2008
        
        By:
        /s/ Howard RootHoward RootChief Executive Officer
 and Director(principal executive officer and dulyauthorized officer)




By:
        /s/ James HennenJames HennenChief Financial Officer(principal financial officer)




By:
        /s/ Timothy SlaytonTimothy SlaytonController(principal accounting officer)






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