UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K

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(Mark One)


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




For the fiscal year ended December 31, 2006

OR

o
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE 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)



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

Title of each class:
        Name of each exchange on which registered:Common Stock, par value $.01 per share
        The NASDAQ Global Market


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



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



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



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o



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



Indicate by check mark whether
 the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated
 filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
        Accelerated filer x
        Non-accelerated filer o




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



The aggregate market value of voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold on June 30, 2006 was $115,374,594.



As of January 26, 2007, the number of shares
outstanding of the registrants common stock was 15,335,931.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrants Proxy Statement for its 2007 Annual Meeting of Shareholders to be held on April 24, 2007 are incorporated by reference in Part III of this Annual Report on Form 10-K.







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PART I



ITEM 1. BUSINESS



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 we 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 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 catheter and Skyway® support catheters, and



        Access products, principally consisting of micro-introducers and guidewires used to gain 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 sales of $6.2 million in 2000 solely from the Duett device to net sales of $43.3 million in 2006, with 95% of our 2006 net sales coming from products other than the Duett device. This increase in revenue represents a compound annual growth rate of 32% 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. Additional products that we expect to gain regulatory clearance and market launch in the United States within the next 12 months include the following medical devices, each of which we believe addresses an annual market opportunity of between $1 million and $20 million:




        InnerChange micro-introducer catheter, a series of catheters that combines both a diagnostic catheter and a micro-introducer into a single product kit,



        Gopher catheter, a low profile metal catheter designed to be used principally in chronic total occlusion cases to provide improved passage through occlusions, and



        GuideLiner catheter, a specialty-purpose catheter designed to provide back-up support to the guide catheter in difficult coronary procedures.




When we develop versions of our products that have application outside of the interventional cardiology and interventional radiology markets where our direct sales force focuses, we attempt to enter into a strategic relationship with a distribution partner. Our current products and products in development that fit into this category consist of the following:



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        ThrombiGel®hemostat, a thrombin impregnated gelatin foam pad designed for use in controlling surgical bleeding,



        ThrombiGel Paste hemostat (in development), a thick suspension of gelatin, thrombin and water designed for use in controlling surgical bleeding, and



        Thrombix® 3x3 trauma bandage, a thrombin-based bandage designed for use in trauma indications.




In January 2007 King Pharmaceuticals, Inc. (King) acquired the worldwide license to the ThrombiGel, ThrombiGel Paste and Thrombix devices for use outside of the catheterization markets for an initial cash payment of $6 million and an additional $1 million milestone payment due upon the first commercial sale of ThrombiGel or Thrombix, and a second $1 million milestone payment upon the first commercial sale of ThrombiGel Paste. We agreed to manufacture the ThrombiGel and Thrombix devices for King, and King agreed to sell us thrombin used in all of our hemostatic products under ten year device and thrombin supply agreements that expire in 2017.



Interventional Cardiology and Interventional Radiology Industry Background



Over 60 million Americans have one or more types of cardiovascular diseasediseases of the heart and blood vessels. Cardiovascular disease is the number one cause of death in the United States and is replacing infectious disease as the worlds pre-eminent health risk. Advances in medicine have enabled physicians to perform an increasing number of diagnostic and therapeutic treatments of cardiovascular disease using minimally invasive methods, such as catheters placed inside the arteries, instead of highly invasive open surgery. Cardiologists and radiologists use diagnostic procedures, such as angiography, to confirm, and interventional procedures, such as angioplasty and stenting, to treat diseases of the coronary and peripheral arteries. Based on industry statistics, we estimate that cardiologists and radiologists performed over nine million diagnostic and interventional
catheterization procedures worldwide in 2006. Often times, these procedures are performed to remove blood clots or plaque which have been generated and deposited inside the patients artery and are an impediment to normal blood flow. The number of catheterization procedures performed is expected to grow by more than 5% each year for the next three years as the incidence of cardiovascular disease continues to increase. The overall interventional medical device market in 2006 exceeded $5 billion worldwide.



Each angiographic procedure using a catheter requires a puncture in an artery, usually the femoral artery in the groin area and sometimes the radial artery in the wrist of the patient to gain access for the catheter. The catheter then is deployed through an introducer sheath and into the vessel to be diagnosed or treated. Upon completion of the procedure and removal of the catheter, the physician must seal this puncture in the artery and the tissue tract that leads from the skin surface to the artery to stop bleeding. The traditional method for sealing the puncture site has been a manual process whereby a healthcare professional applies direct pressure to the puncture site, sometimes using a sand bag or a large C-clamp, for 20 minutes to an hour in order to form a blood clot. The healthcare professional then monitors the patient, who must remain immobile in order to prevent dislodging of
the clot, for an additional four to 48 hours.



Patients subjected to manual compression generally experience significant pain and discomfort during compression of the puncture site and during the period in which they are required to be immobile. Many patients report that this pain is the most uncomfortable aspect of the catheterization procedure. In addition, patients can develop a substantial coagulated mass of blood, or hemotoma, around the puncture site, limiting patient mobility for up to six weeks following the procedure. Finally, the need for healthcare personnel to provide compression and the use of hospital beds during the recovery period results in substantial costs to the institution, which, under virtually all current healthcare payment systems, are not separately reimbursed.



Until 1996, manual compression was used following virtually all catheterization procedures. In late 1995, the first vascular sealing device which did not rely on compression was introduced in the United States. In addition to invasive (below the skin surface) sealing devices, starting in 2000, non-invasive patches began to be used as an assist to manual compression following catheterizations. Non-invasive patches are used by physicians who (principally due to cost, complexity or risk of complications) do not wish to use invasive sealing devices, and for those patients who are contra-indicated for an invasive sealing device. Based on the number of catheterization procedures performed annually by cardiologists and radiologists, industry sources report that the total market opportunity for vascular sealing devices (invasive and non-invasive) is more than $1 billion annually.



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Hemostat Products



Our hemostat products utilize thrombin, a powerful bovine-derived blood clotting protein, to deliver a rapid seal of bleeding with a variety of shelf-stable product configurations. Through internal development we developed a proprietary manufacturing process to terminally sterilize our thrombin-based hemostats, which has resulted in our ability to create unique advantages in storage, shipping, preparation and application of our hemostat products.



Our most popular hemostat product is the D-Stat Dry. In September 2003 we received regulatory clearance and commenced sales of our D-Stat Dry hemostat bandage in the United States and international markets. The D-Stat Dry hemostat bandage is a version of our proprietary blood clotting substance that is lyophilized (freeze-dried) into a gauze pad and combined with an adhesive bandage for application. The D-Stat Dry is used as an adjunct to manual compression for managing bleeding after diagnostic catheterization procedures. We completed a 376-patient, five center randomized clinical study that demonstrated a 50% reduction in the median time-to-hemostasis when using the D-Stat Dry bandage compared to simple manual compression. In the third quarter of 2006 we received Food and Drug Administration (FDA) clearance of our claim that the D-Stat Dry reduces the time-to-hemostasis in diagnostic
catheterizations. We believe that the market for a hemostat pad in this indication has grown substantially since the first competitive patch was introduced in 2000, with a market size greater than $50 million in 2006.



We have developed additional configurations of the D-Stat Dry technology for specialized medical procedures. Our D-Stat Radial hemostat band is a specially-sized version of the D-Stat Dry that includes a compression band that allows it to be applied over the radial artery in the wrist. In approximately 5% of all catheterizations, the radial artery is used to gain arterial access in the wrist instead of the femoral artery in the groin. In these cases using the radial artery, the health care professional must control bleeding from the artery after the procedure. A variety of compression splints and tapes have been used for this purpose. The D-Stat Radial is the first device that contains an active blood clotting agent together with the compression collar for this purpose. We received regulatory clearance for the D-Stat Radial hemostat band in September 2003, and made manufacturing
improvements to the product before launching it in the United States in early 2004.



Our D-Stat Flowable hemostat, which we began selling worldwide in February 2002, is a thick yet flowable mixture of collagen, thrombin and diluent that can be delivered topically and into voids and open spaces to control active bleeding. The D-Stat Flowable hemostat can be used in a wide variety of interventional procedures as an adjunct to hemostasis. In December 2006 we received FDA approval of our premarket approval (PMA) supplement for the use of D-Stat Flowable in the prepectoral pockets created in pacemaker and implantable cardioverter defibrillator (ICD) implants. Our PMA supplement was supported by the results of our 269-patient Pocket Protector clinical study that demonstrated a 48% reduction in the incidence of clinically relevant hematomas through the use of D-Stat Flowable compared to the standard of care. We estimate that the U.S. market opportunity for this
prepectoral pocket indication is greater than 100,000 procedures or $10 million annually. We also believe that the D-Stat Flowable has applications for use following breast biopsy and liver biopsy procedures which are not approved but we intend to explore.



Our Duett sealing device is designed to provide a complete seal of the puncture site following catheterization procedures such as angiography, angioplasty and stenting. The Duett sealing device combines an easy-to-use balloon catheter delivery mechanism with a biological procoagulant mixture, which we believe offers advantages over both manual compression and competitive vascular sealing devices. We began selling our Duett sealing device in Europe in February 1998 and in the United States in June 2000. In the fourth quarter of 2001 we introduced the Diagnostic Duett version of the Duett sealing device, which utilizes a lower dose of procoagulant for the less-challenging diagnostic subset of catheterization procedures. Subsequently,  we made the decision to reduce our focus on growing the Duett product line in order to focus on increasing sales of our new products.



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At the end of the first quarter of 2004 we received regulatory clearance in the United States for the Thrombix 3x3 trauma bandage. The Thrombix bandage is a larger sized version of our D-Stat Dry designed for use in trauma indications, does not require mixing or special storage requirements and can be quickly applied to even severely bleeding wounds.



During the second quarter of 2005 we received regulatory clearance in the United States for the ThrombiGel hemostatic foam.  The ThrombiGel hemostatic product contains a gelatin foam pad (instead of the non-resorbable gauze pad in the D-Stat Dry) to provide a unique, premixed, sterile, gelatin/thrombin hemostat. An additional version of the ThrombiGel in development is the ThrombiGel Paste, which adds diluent to make a thick, adherent thrombin-based gel. We expect to pursue surgical indications for the use of ThrombiGel and ThrombiGel Paste in 2007.



Extraction Catheters



Our Pronto product consists of an extraction catheter with a proprietary distal tip and large extraction lumen that can be delivered into arteries to mechanically remove blood clots using simple vacuum suction. The Pronto extraction catheter was initially developed by Dr. Pedro Silva of Milan, Italy, who exclusively licensed the design to us in 2002. We received CE mark approval and commenced international sales of the Pronto in August 2003, and received FDA clearance in December 2003 and commenced sales in the United States in early 2004. In the fourth quarter of 2005 we launched the third generation design of the Pronto, named the Pronto V3. This new version of the Pronto incorporates several improvements that physicians have requested, and resulted in a substantial increase in Pronto sales in 2006. We believe that the market size for the removal of soft thrombus is greater than $100
million per year worldwide.



In October 2005 we announced the results of the DEAR-MI (Dethrombosis to Enhance Acute Reperfusion in Myocardial Infarction) clinical study by Dr. Pedro Silva. The DEAR-MI clinical study was a randomized evaluation of the use of the Pronto extraction for the removal of thrombus from patients presenting with ST elevated acute myocardial infarction admitted within 12 hours of symptom onset. The primary endpoints of the DEAR-MI study were a comparison of myocardial reperfusion according to ST-segment resolution and myocardial blush grade. The results showed thrombus aspiration with the Pronto was determined to be an independent predictor of myocardial reperfusion as measured by both ST resolution and mean blush grade. The FDA cleared the Pronto V3 catheter for specific use within the coronary system in December 2006.



We believe that there is market potential for additional sizes and configurations of extraction catheters, and to date, we have developed one additional line extension, the Pronto-Short. The Pronto-Short is a shorter and larger size of the original Pronto which is designed for use in clotted dialysis grafts and was launched in August 2005.



Vein Products



Our Vari-Lase endovenous laser products consist of a laser console, procedure kits and accessories used in the treatment of reflux of the great saphenous vein, commonly referred to as varicose veins. More than one million people in the United States seek treatment each year for varicose veins. Left untreated, varicose veins can result in serious clinical consequences, including limited mobility and venous stasis ulcers. Historically, an invasive surgical procedure known as vein stripping was the only treatment for severe varicose veins. While vein stripping is still performed on over 100,000 patients each year in the United States, since 2002 a non-surgical procedure using endovenous laser energy to treat and close the diseased vein has become the preferred alternative. Recent clinical data on endovenous laser therapy has demonstrated excellent clinical results and outstanding patient
satisfaction. During the fourth quarter of 2004 the Center for Medicare and Medicaid Services (CMS) published the Medicare Physicians Fee Schedule which established favorable reimbursement rates for the endovenous laser procedure starting January 1, 2005. Private insurance also has continued its favorable trend with coverage decisions which have caused more physicians to add this procedure to their practice.  We believe the current U.S. market size for treating varicose veins using endovenous therapy is greater than $80 million per year.



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The first product we launched in our vein product line was our Vari-Lase procedure kit in July 2003 in the United States. Our Vari-Lase procedure kit is custom-designed for the endovenous procedure, with features supporting ease-of-use and safety, and is compatible with the competitive laser consoles already in use for this procedure. In December 2003, we received FDA clearance for our Vari-Lase laser console, which we have manufactured to our specifications by MedArt Corporation, a subsidiary of Asah Medico, a leading Denmark-based medical laser manufacturer. During 2004 we developed and commenced sales of our Auto-Fill® syringe and procedure packs as accessory products to the vein product line. The Auto-Fill syringe is an easy fluid delivery system for local anesthesia. The procedure packs are complete sterile packs of accessories designed for vein procedures. In 2005 we
added additional vein products such as compression stockings.



Specialty Catheters



Specialty catheters consist of a variety of catheters designed to perform unique functions within clinical niches in interventional medicine. At the end of the third quarter of 2004 we received regulatory clearance in the United States for the Langston dual lumen pigtail catheter. The Langston catheter is used for the precise measurement of intravascular pressure gradients, primarily measured to diagnose aortic valve stenosis. We believe our Langston catheter is the only dual lumen pigtail catheter on the U.S. market that can be used for this intended indication. During 2005 we received approval for additional sizes and configurations of the Langston catheter product line. We believe the U.S. market opportunity for the Langston catheter product line is $10 million annually.



During 2006 we launched both the Twin-Pass dual access catheter and Skyway support catheter. The Twin-Pass is a two lumen catheter designed to be used in conjunction with steerable guidewires to access discrete regions of the coronary and peripheral arterial vasculature and for use during procedures utilizing two guidewires. The Skyway support catheter can be used in the support of guidewires during difficult lesion crossing procedures and in the exchange of guide wires in an interventional procedure. We believe that both of these products address market opportunities of between $1 million and $5 million annually within interventional cardiology.



Access Products



Access products are used to gain percutaneous access to the vasculature for a wide variety of arterial and venous procedures. We started selling access products in July 2003. Our access products include a full line of micro-introducer kits and a variety of specialty guidewires.



Other Products



We have developed and offer several additional clinical niche products, and additional products in international markets which are not yet approved in the United States. During the first quarter of 2005 we launched the MAX-Support abdominal retraction belt as a tape-free retraction system to expose the femoral artery puncture site in obese patients. During the second quarter of 2002 we acquired the Acolysis®ultrasound thrombolysis system. The Acolysis system uses ultrasound energy generated by the Acolysis controller that is delivered by the disposable Acolysis probe to lyse blood clots and plaque within the artery. The Acolysis controller and probes are sold only in international markets, where it has been sold principally for the treatment of peripheral vascular disease.



The amount of total revenue contributed by each of our product lines for the last three fiscal years is set forth in Item 7, Part II of this Form 10-K.



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Agreements with King Pharmaceuticals, Inc.



On and effective as of January 9, 2007, we entered into three agreements with King, consisting of the License Agreement, the Device Supply Agreement and the Thrombin JMI® Supply Agreement. King Pharmaceuticals Research and Development, Inc., a wholly-owned subsidiary of King (King R&D), is also a party to the License Agreement.



The effect of these three agreements is to forge a new relationship between us and King having essentially three components. First, King will exclusively sell through its direct sales force, and we will manufacture and supply to King, our Thrombix trauma bandage and ThrombiGel hemostat products and our ThrombiGel Paste hemostat product which is currently in development. Second, we will work with King to develop additional hemostat products to be sold by King outside of our direct sales forces call point of cardiac, peripheral and electrophysiology catheterization laboratories. Third, King will sell Thrombin-JMI® to us for use in the manufacture of our catheterization lab hemostatic products under a 10-year, fixed price arrangement.



Under the terms of the License Agreement, we granted to King and King R&D an exclusive, royalty-free, fully paid up, perpetual, worldwide right and license to all of our patents and know-how relating to the development, manufacture, use, sale, importation or other exploitation of our Thrombix trauma bandage, ThrombiGel 10, 40 and 100 hemostats, ThrombiGel Paste hemostat (the Products) and all future medical devices having application in the Field (as defined below) and intended to produce hemostasis by accelerating the clotting process of blood (a hemostat device). The Field is defined as all applications of hemostat devices in all areas other than catheterization laboratories (cardiac and peripheral), electrophysiology laboratories and holding and recovery rooms for such laboratories. Upon execution of the License Agreement, King paid us a one-time
payment of $6.0 million. No other payments are due from King to us under the License Agreement. Under the License Agreement, we are obligated to prosecute and maintain all of the patents licensed under the Agreement at our own expense. We also represent that there are no liens or claims currently existing on any of the licensed patents or know-how and covenant not to create, incur or permit to exist any such liens or claims in the future other than the liens and claims created by the License Agreement. The term of the License Agreement commenced on January 9, 2007 and continues until the later of the expiration of each licensed patent or Kings relinquishment of its license rights under the licensed know-how.



Under the terms of the Device Supply Agreement, we agreed to manufacture and supply the Products to King and King agreed to purchase the Products from us for Kings exclusive commercialization, distribution, sale and use of the Products in the Field. King does not have any minimum purchase obligations under the Device Supply Agreement. The Device Supply Agreement does not limit our ability to manufacture the Products for our own commercialization, distribution, sale and use outside of the Field. The transfer prices are fixed for each Product under the Device Supply Agreement and are adjusted for cost and inflation increases according to a market index. Upon the first commercial sale by King of a ThrombiGel hemostat or Thrombix bandage, King will make a one-time, non-refundable milestone payment to us of $1.0 million. Upon the first commercial sale by King of a ThrombiGel Paste hemostat
product, King will make a one-time, non-refundable milestone payment to us of $1.0 million. We have agreed to continue to perform the regulatory work necessary to obtain surgical approvals for the ThrombiGel and ThrombiGel Paste products, and King has agreed to reimburse us for our expenses in obtaining these approvals. If, after undertaking and completing the development and regulatory plans with respect to the products, such development and regulatory efforts have not resulted in regulatory approval for surgical use, we have agreed to make a one-time, non-creditable, non-refundable payment of $2.5 million to King if the FDA has not approved the ThrombiGel product for surgical use, and an additional $2.5 million if the FDA has not approved the ThrombiGel Paste product for surgical use. We believe the probability of paying the one-time payments is remote. Under the Device Supply Agreement, King also has certain rights of first refusal with respect to any hemostatic devices for use in
the Field that we may develop on our own or at the request of King. The Device 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 termination by King without cause anytime after the third anniversary of its execution upon two years prior written notice to us.



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Under the terms of the Thrombin JMI® Supply Agreement, King agreed to manufacture and supply thrombin to us on a non-exclusive basis. King agreed to supply us with such quantity of thrombin as we may order for use in devices not intended for sale by King in the Field at a fixed price throughout the term of the Thrombin JMI® Supply Agreement as adjusted for inflation, variations in potency and other factors. King has also agreed to provide thrombin to us under the Thrombin JMI® Supply Agreement at no cost for incorporation into Products and hemostat devices intended for sale in the Field by King. 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 (1) termination by King without cause
anytime after the fifth anniversary of its execution upon five years prior written notice to us and (2) termination by us without cause anytime after the fifth anniversary of its execution upon five years prior written notice to King provided that the Device Supply Agreement has expired on its terms or the parties have agreed to terminate it.



Business Strategy



Our primary objective is to establish ourselves as a leading supplier of clinically superior medical devices for substantial unique opportunities within interventional medicine. The key steps in achieving our primary objective are the following:




        Maintain and Improve our Clinically-Oriented Direct Sales Force in the United States.During the third quarter of 2000 we commenced sales of our products in the United States through a direct sales force of clinically trained account managers who train interventional cardiologists, radiologists and catheterization laboratory administrators on the use of our products. As our product lines have increased, we have increased the size of our sales force to cover the entire country.





        Expand our Existing Products to Our Existing Market.Starting in 2003 we have launched multiple new products in the United States through our existing direct sales force to our existing markets. Pursuing this multiple product strategy has generated material sales growth, and we believe that each of our product lines has the potential to generate continued sales growth during 2007 and beyond.





        Develop New Devices to be Sold Through our Direct Sales Force to our Existing Customers.We intend to continue to leverage our direct sales force by bringing additional products to the interventional physician. During 2007 we expect to launch three new material products in the United States  the InnerChange, Gopher and GuideLiner catheters, with additional products being developed for an expected 2008 launch.





        Explore Corporate Relationships to Augment our Direct Sales Force.In markets for our products beyond the interventional physician (such as occurred with our ThrombiGel, ThrombiGel Paste and Thrombix 3x3 products) and in other situations where synergistic sales can result, we intend to enter into corporate relationships to broaden our products reach and increase our revenues.




Sales, Marketing and Distribution



In the third quarter of 2000 we commenced sales of our Duett sealing device in the United States through our direct sales organization. As of December 31, 2006, our direct sales force consisted of approximately 82 employees who sell our entire line of interventional products. We believe that the majority of interventional catheterization procedures in the United States are performed in high volume catheterization laboratories, and that these institutions can be served by our focused direct sales force.



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As part of our sales strategy, our sales force is clinically trained and is able to train physicians and other healthcare personnel on the use of our products. We believe that effective training is a key factor in encouraging physicians to use interventional medical devices. We have created, and will continue to work to improve, an in-the-field training program for the use of all of our products. We also develop and maintain close working relationships with our customers to continue to receive input concerning our product development plans.



We are focused on building market awareness and acceptance of our products. Our marketing department provides a wide range of programs, materials and events that support our sales force. These include product training, conference and trade show appearances and sales literature and promotional materials. Members of our medical advisory board also aid in marketing our products by publishing articles and making presentations at physicians meetings and conferences.



Our international sales and marketing strategy has been to sell to interventional cardiologists and interventional radiologists through established independent distributors in major international markets, subject to required regulatory approvals. In Germany, we created our wholly-owned subsidiary Vascular Solutions GmbH to sell directly to customers in the German market beginning in the fourth quarter of 2000. In most of the other major developed markets our products are currently marketed through independent distributors. Under multi-year written distribution agreements with each of our independent distributors, we ship our products to these distributors upon receipt of purchase orders. Each of our independent distributors has the exclusive right to sell our products within a defined territory. These distributors also market other medical products,
although they have agreed not to sell directly competitive products. Our independent distributors purchase our products from us at a discount from list price and resell the device to hospitals and clinics. Sales to international distributors are denominated in United States dollars. The end-user price is determined by the distributor and varies from country to country.



New Product Development



Our research and development staff is currently focused on developing new products to sell to our existing customer base through our direct sales force and on developing next generation versions of our existing products. We incurred expenses of $4,578,000 in 2006, $3,789,000 in 2005 and $3,401,000 in 2004 for research and development activities. To further leverage our efficiencies, our research and development group continues to develop in-house capabilities to manufacture some of the components currently produced by outside vendors.



In addition to our normal research and development expenses, we incurred $2,802,000 in 2006, $1,620,000 in 2005 and $210,000 in 2004 in thrombin qualification expenses relating to our project to qualify a second source of thrombin. We do not expect to incur material additional expenses on the thrombin qualification project in 2007.



We expect our research and development activities to continue to expand to include evaluation of new concepts and products for the interventional cardiology and interventional radiology field. We believe that there are many potential new interventional products that would fit within the development, clinical, manufacturing and distribution network we have created for our existing products.



Manufacturing



We manufacture our products in our facilities located in the suburbs of Minneapolis, Minnesota. The catheter manufacturing and packaging processes occur under a controlled clean room environment. Our quality system, manufacturing facilities and processes have been certified to be compliant with the applicable European standards EN46001 and the succeeding EN13485 since July 1998. Our quality system was most recently audited by the FDA in March 2006 with no deficiencies noted.



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We purchase components from various suppliers and rely on single sources for several parts of our products. In September 1998 we entered into a ten year, sole-source supply agreement with our collagen supplier, Davol Inc., which provides for a fixed price based on volume purchases which is adjusted annually for increases in the Department of Labors employers cost index. We purchase our requirements for thrombin (a component in the Duett and in all of the D-Stat products) under a Purchase Agreement dated January 9, 2007 with a subsidiary of King Pharmaceuticals, Inc. The agreement provides for a fixed price with annual adjustments based on a producer price index tied to pharmaceuticals. The agreement has an initial term of ten years, followed by successive automatic one-year extensions starting in 2017. To date, we have not experienced any significant adverse effects resulting
from shortages of components.



The manufacture and sale of our products entails significant risk of product liability claims. Although we have product liability insurance coverage in an amount which we consider reasonable, it may not be adequate to cover potential claims. Any product liability claims asserted against us could result in costly litigation, reduced sales and significant liabilities and divert the attention of our technical and management personnel away from the development and marketing of our products for significant periods of time.



Competition



Competition in the interventional medical device industry is intense and dominated by very large and experienced companies such as Medtronic, Inc., Abbott Laboratories and Boston Scientific. We compete on the basis of our clinically differentiated products and focused opportunities within this interventional medical device market.



Our D-Stat Dry hemostatic bandage competes in the noninvasive topical patch market segment of sealing devices. These patches are applied directly over the puncture site and held in place with adjunctive manual compression for a period of 10-20 minutes. These patches include:



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        The Syvek® Patch, manufactured and marketed by Marine Polymer Technologies, Inc.


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        The Closur-P.A.D., manufactured by Scion Cardiovascular



        The Chito-Seal, distributed by Abbott Vascular, Inc. a division of Abbott Laboratories




The Pronto extraction catheter competes in the market segment for removal of thrombus from the arterial system. There are many companies that are selling or have developed products in this segment, including Possis Medical, Medtronic, Kensey Nash and ev3.



We are aware of five companies that sell a product for the endovenous laser treatment of varicose veins. These companies are AngioDynamics, biolitec, Dornier MedTech, CoolTouch and Diomed. Each of these companies products contains the same components for the therapy but differ in procedural training, laser wavelength, custom-designed features and customer support. In addition, VNUS® Medical Technologies sells a radiofrequency alternative to the laser for the treatment of varicose veins.



Our Duett sealing device principally competes with several vascular sealing devices and manual compression. The two principal competitive vascular sealing devices are:




        The Angio-Seal® device, sold by St. Jude Medical, Inc. and developed by Kensey Nash Corporation, seals the puncture site through the use of a collagen plug on the outside of the artery connected by a suture to a biodegradable anchor which is inserted into the artery.





        The StarClose and Closer devices, sold by Perclose, Inc., a subsidiary of Abbott Laboratories, seals the puncture site through the use of a staple and suture, respectively, that enables a physician to perform a minimally invasive replication of open surgery.




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There are many companies that are selling or have developed hemostats which compete generally with our D-Stat Flowable hemostat. Virtually all of these devices, however, are positioned as hemostats for the surgical market and are not designed specifically for use in interventional procedures.



In each of our product areas, we believe that several other companies are developing new devices. The medical device industry is characterized by rapid and significant technological changes as well as the frequent emergence of new technologies. There are likely to be research and development projects related to these market areas of which we are currently unaware. A new technology or product may emerge that results in a reduced need for our products or results in a product that renders our product noncompetitive.



Regulatory Requirements



United States



Our products are regulated in the United States as medical devices by the FDA under the Federal Food, Drug and Cosmetic Act. The FDA classifies medical devices into one of three classes based upon controls the FDA considers necessary to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls such as labeling, adherence to good manufacturing practices and maintenance of product complaint records, but are usually exempt from premarket notification requirements. Class II devices are subject to the same general controls and also are subject to special controls such as performance standards, and FDA guidelines, and may also require clinical testing prior to approval. Class III devices are subject to the highest level of controls because they are used in life-sustaining or life-supporting implantable devices. Class III devices require rigorous clinical
testing prior to their approval and generally require a premarket approval (PMA) or supplement application prior to their sale.



If a medical device manufacturer can establish that a device is substantially equivalent to a legally marketed Class I or Class II device, or to an unclassified device, or to a Class III device for which the FDA has not called for PMAs, the manufacturer may seek clearance from the FDA to market the device by filing a 510(k) premarket notification. The 510(k) notification must be supported by appropriate data establishing the claim of substantial equivalence to the satisfaction of the FDA. Following submission of the 510(k) notification, the manufacturer may not place the device into commercial distribution in the United States until an order is issued by the FDA.



Manufacturers must file an investigated device exemption (or IDE) application if human clinical studies of a device are required and if the FDA considers experimental use of the device to represent significant risk to the patient. The IDE application must be supported by data, typically including the results of animal and mechanical testing of the device. If the IDE application is approved by the FDA, human clinical studies may begin at a specific number of investigational sites with a maximum number of patients, as approved by the FDA. The clinical studies must be conducted under the review of an independent institutional review board to ensure the protection of the patients rights.



Generally, upon completion of these human clinical studies, a manufacturer seeks approval of a Class III medical device from the FDA by submitting a PMA application. A PMA application must be supported by extensive data, including the results of the clinical studies, as well as literature to establish the safety and effectiveness of the device.



Our Duett sealing device is classified as a Class III device and is subject to the PMA requirements. In May 1997, the FDA determined that the review of the Duett sealing device would be delegated to the Center for Devices and Radiological Health area of the FDA, with a consulting review by the Center for Biologic Evaluation and Research. During 1998 and 1999, we received approval of our IDE application to start our feasibility clinical study, filed our IDE Supplement to begin our multi-center clinical study, completed the SEAL multi-center clinical study and filed our PMA application with the FDA. In September 1999 our manufacturing facility was audited by the FDA, with no deficiencies or non-compliances noted by the inspector. In December 1999, we received the FDAs review letter of our PMA application, and we submitted an amendment to our PMA to the FDA in January 2000. On June 22,
2000, we received approval from the FDA of our PMA application to sell the Duett sealing device in the United States. Our D-Stat Flowable is dually classified as both a Class III and Class II device based on the three distinct indications for use that have been assigned to this product.



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Our D-Stat Dry, Pronto, Vari-Lase, specialty catheters and access products product lines require clearance of a 510(k) notification by the FDA prior to being sold in the United States. Each of the devices within these product lines was subject to a 510(k) notification which was determined to be substantially equivalent to a legally marketed predicate device by the FDA, thereby allowing commercial marketing in the United States.



Our ThrombiGel and ThrombiGel Paste (in-development) product lines are indicated for use as topical hemostats and as such, are classified as Class II products. Approval for expanded use as surgical hemostats will place these products into the Class III designation subject to the PMA requirements. On October 31, 2006, the FDA published a proposed rule to reclassify absorbable hemostatic devices from Class III to Class II. If implemented as written, approval of these products as absorbable hemostats would no longer require PMA approval and could be accomplished through the 510(k) process. There is no assurance that the proposed rule will be adopted as written and there is no firm date for a final decision on this action.



We also are subject to FDA regulations concerning manufacturing processes and reporting obligations. These regulations require that manufacturing steps be performed according to FDA standards and in accordance with documentation, control and testing standards. We also are subject to inspection by the FDA on an on-going basis. We are required to provide information to the FDA on adverse incidents as well as maintain a documentation and record keeping system in accordance with FDA guidelines. The advertising of our products also is subject to both FDA and Federal Trade Commission jurisdiction. If the FDA believes that we are not in compliance with any aspect of the law, it can institute proceedings to detain or seize products, issue a recall, stop future violations and assess civil and criminal penalties against us, our officers and our employees.



International



The European Union has adopted rules which require that medical products receive the right to affix the CE mark, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. As part of the CE mark compliance, manufacturers are required to comply with the European quality systems standards. We received the CE mark approval for our Duett sealing device and certification of our quality system in July 1998, and we received the CE mark approval for other select products within our product lines.



Our hemostatic products contain bovine-derived thrombin and are subject to additional regulatory review within the European Union to minimize the risk of exposure to viral and BSE pathogens. The regulations in this area continue to evolve and our products may be subject to additional regulatory scrutiny in the future.



International sales of our products are subject to the regulatory requirements of each country in which we sell. These requirements vary from country to country but generally are less stringent than those in the United States. We have obtained regulatory approvals where required for us to sell our products in those countries. Through our Japanese distributor, in 2005 we gained regulatory approval of our Pronto extraction catheters for commercial sale in Japan.



Third Party Reimbursement



In the United States, healthcare providers that purchase medical devices, generally rely on third-party payors, principally the Centers for Medicare and Medicaid Services or CMS (formerly the Health Care Financing Administration, or HCFA), and private health insurance plans, to reimburse all or part of the cost of therapeutic and diagnostic stent procedures. We believe that in the current United States reimbursement system, the cost of vascular sealing devices is incorporated into the overall cost of the catheter procedure. Our other products are subject to reimbursement rules depending on the specific medical procedure in which they are utilized.



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CMS and the AMA Current Procedure Terminology (CPT) panel finalized the implementation of reimbursement codes for the endovenous laser ablation procedure beginning in January 2005. This action cleared the way for a consistent means of billing the Medicare program for medically necessary vein treatments using laser technologies and resulted in a favorable reimbursement rate. Reimbursement for these procedures is now well-established, going forward, the reimbursement rate will be adjusted by the overall adjustments implemented by CMS for most therapeutic procedures beginning in 2007 and continuing through 2010.



Market acceptance of our products in international markets is dependent in part upon the availability of reimbursement from healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country. The main types of healthcare payment systems in international markets are government-sponsored healthcare and private insurance. Countries with government-sponsored healthcare, such as the United Kingdom, have a centralized, nationalized healthcare system. New devices are brought into the system through negotiations between departments at individual hospitals at the time of budgeting. In most foreign countries, there are also private insurance systems that may offer payments for alternative therapies.



Patents and Intellectual Property



We file patent applications to protect technology, inventions and improvements that are significant to the development of our business, and use trade secrets and trademarks to protect other areas of our business. We currently have 10 United States patents issued and 9 additional patents pending concerning our Duett sealing device, Pronto catheter, Langston dual lumen pigtail catheter and other specialty catheters, MAX-Support abdominal retraction belt, Vari-Lase product line and D-Stat Dry product. We also have pursued international patent applications.



The interventional medical device market in general, and the vascular sealing device and endovenous laser therapy fields in particular, are characterized by frequent and substantial intellectual property litigation. Two of our competitors in the endovenous laser therapy market (Diomed and VNUS) have brought separate intellectual property lawsuits against their competitors, including us. (See Legal Proceedings in Item 3 of Part I of this Form 10-K.)  The interpretation of patents involves complex and evolving legal and factual questions. Intellectual property litigation in recent years has proven to be complex and expensive, and the outcome of such litigation is difficult to predict.



We may become the subject of additional intellectual property claims in the future related to our products. Our defense of any intellectual property claims filed in the future, regardless of the merits of the complaint, could divert the attention of our technical and management personnel away from the development and marketing of our products for significant periods of time. The costs incurred to defend future claims could be substantial and adversely affect us, even if we are ultimately successful.



We also rely on trade secret protection for certain aspects of our technology. We typically require our employees, consultants and vendors for major components to execute confidentiality agreements upon their commencing services with us or before the disclosure of confidential information to them. These agreements generally provide that all confidential information developed or made known to the other party during the course of that partys relationship with us is to be kept confidential and not disclosed to third parties, except in special circumstances. The agreements with our employees also provide that all inventions conceived or developed in the course of providing services to us shall be our exclusive property.



We also register the trademarks and trade names through which we conduct our business. To date, we have registered the trademarks Acolysis®, Acolysis Probe®, Acolysis System®, Acolysis System Therapeutic Ultrasound Thrombolysis®, Auto-Fill®, D-Stat®, Langston®, Skyway®, Thrombix®, ThrombiGel®, Twin-Pass®, and Vari-Lase®, and we use the following trademarks Vascular Solutions DuettTM, ProntoTM, MAX-SupportTM, InnerChangeTM, HandyTM,
Thrombin-VSITM, GuidelinerTM, and the Duett stylized logo. We acquired the registered trademark Acolysis in connection with our acquisition of the Acolysis therapeutic ultrasound business in 2002. U.S. trademark registrations are generally for a term of 10 years, renewable every 10 years as long as the trademark is used in the regular course of trade.



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Employees



As of December 31, 2006, we had 210 full time employees. Of these employees, 49 were in manufacturing activities, 99 were in sales and marketing activities, 18 were in research and development activities, 28 were in regulatory, quality assurance and clinical research activities and 16 were in general and administrative functions. We have never had a work stoppage and none of our employees are covered by collective bargaining agreements. We believe our employee relations are good.



Executive Officers of the Registrant



Our executive officers as of January 31, 2007 are as follows:



Name
        Age
        PositionHoward Root
        46
        Chief Executive Officer and DirectorJames Hennen
        34
        Chief Financial Officer, Vice President of Finance and Corporate SecretaryDeborah Neymark
        50
        Vice President of Regulatory Affairs, Clinical Research and Quality SystemsJames Quackenbush
        48
        Vice President of ManufacturingFred Reuning
        51
        Vice President of Marketing




Howard Roothas served as our Chief Executive Officer and a director since he co-founded Vascular Solutions, Inc. in February 1997. From 1990 to 1995, Mr. Root was employed by ATS Medical, Inc., a mechanical heart valve company, most recently as Vice President and General Counsel. Prior to joining ATS Medical, Mr. Root practiced corporate law, specializing in representing emerging growth companies, at the law firm of Dorsey & Whitney for over five years. Mr. Root received his B.S. in Economics and J.D. from the University of Minnesota.



James Hennenhas served as our Chief Financial Officer since January 2004. Mr. Hennen served as our Controller & Director of Finance from February 2002 through December 2003. Prior to joining us, Mr. Hennen served in various accounting positions, most recently as International Controller with WAM!NET, Inc., a globally networked information technology company for media transfer, where he worked since December 1997. From October 1995 through December 1997, Mr. Hennen was a Senior Auditor for Ernst & Young, LLP. Mr. Hennen received a B.S. in Business/Accounting from the University of Minnesota. Mr. Hennen is a Certified Public Accountant.



Deborah Neymarkhas served as our Vice President of Regulatory Affairs, Clinical Affairs and Quality Systems since October 2000. Mrs. Neymark served as the Corporate Compliance Officer and Vice President of Regulatory Affairs, Clinical Research and Quality Systems for Empi, Inc. from October 1995 to October 2000. From May 1993 to October 1995, Mrs. Neymark was employed as a Regulatory Affairs Manager for Boston Scientifics Scimed division. Prior to May 1993, Mrs. Neymark held regulatory affairs, clinical research and quality assurance positions at Medtronic and Lifecore Biomedical. She received her B.S. in Biology from Valparaiso University.



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James Quackenbushhas served as our Vice President of Manufacturing since March 1999. Prior to joining us, Mr. Quackenbush served as Vice President of Manufacturing and Operations of Optical Sensors, Inc., a diagnostic medical device company, where he worked since October 1992. From March 1989 through October 1992, Mr. Quackenbush served as operations manager with Schneider USAs stent division. Prior to this time, he was an advanced project engineer with the 3M Medical Products Division. Mr. Quackenbush received a B.S. in Industrial Engineering from Iowa State University.



Fred Reuninghas served as our Vice President of Marketing since July 2005. Prior to joining us, Mr. Reuning worked at Smiths Medical, a medical device company, where he was Director of Marketing for the Vascular Access division from November 2001 to July 2005 and Senior Product Manager from January 2000 to November 2001. From 1987 to 2000, he worked for Novartis Nutrition, a medical nutrition company, in product management for medical devices with his last position as Group Manager, Medical Devices from November 1997 to December 1999. Mr. Reuning received a B.A. in history from Washington and Lee University and a M.A. in international studies from Johns Hopkins School of Advanced International Studies.



There are no family relationships among any of our executive officers.



Available Information



We make available free of charge
on or through our internet website at http://www.vascularsolutions.com our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) as soon as reasonably practicable
after we electronically file such material with, or furnish it to the SEC.



ITEM IA. RISK FACTORS



The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks occur, our business, financial condition or results of operations could be seriously harmed.



We will not be successful if the interventional medical device community does not adopt our new products



During the third quarter of 2000 we commenced sales of our first product in the United States, the Duett sealing device. In the second half of 2003, we received clearance to commence sales of four new interventional products in the United States. Our success will depend on the medical communitys acceptance of our new products. We cannot predict how quickly, if at all, the medical community will accept our new products, or, if accepted, the extent of their use. Our potential customers must:




        believe that our products offer benefits compared to the methodologies and/or devices that they are currently using;





        use our products and obtain acceptable clinical outcomes;





        believe that our products are worth the price that they will be asked to pay; and





        be willing to commit the time and resources required to change their current methodology.




Because we have only limited experience with sales of our new products, we have no ability to predict the level of growth in sales of these products. If we encounter difficulties in growing our sales of our new medical devices in the United States, our business will be seriously harmed.



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We have limited working capital to pursue our business



On December 31, 2006, we had $2.6 million in cash and cash equivalents and a working capital of $11.5 million. During 2006, our operating activities resulted in the use of $2.8 million of cash. If we encounter unexpected expenses, we will need to raise additional working capital. We have no commitments for additional funding and so our ability to meet our long-term liquidity needs is uncertain. If we raise additional funds through the issuance of equity securities, our shareholders may experience significant dilution. Furthermore, additional financing may not be available when needed or, if available, financing may not be on terms favorable to us or our shareholders. If financing is not available when required or is not available on acceptable terms, we may be unable to develop or market our products or unable to take advantage of business opportunities, or we may be required to
significantly curtail our business operations.



We have incurred losses and we may not be profitable in the future



Since we commenced operations in February 1997, we have incurred net losses primarily from costs relating to the development and commercialization of our Duett sealing device and new products. At December 31, 2006, we had an accumulated deficit of $65.6 million. We expect to continue to significantly invest in our sales and marketing and research and development activities. Because of our plans to introduce new products and expand our commercialization, we may incur a net loss through at least the first quarter of 2007. Our business strategies may not be successful, and we may not become profitable in any future period or at all. If we do become profitable, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis.



We face intellectual property claims which could prevent us from manufacturing and selling our products or result in our incurring substantial costs and liabilities



The interventional medical device industry is characterized by numerous patent filings and frequent and substantial intellectual property litigation. Companies in the interventional medical device industry have employed intellectual property litigation in an attempt to gain a competitive advantage. We are the subject of two intellectual property lawsuits concerning our Vari-Lase products, both of which are expected to proceed to trial in 2007. In addition, while we do not believe that any of our new products infringes any existing patent, it is highly likely that we will become subject to intellectual property claims with respect to our new products in the future. Intellectual property litigation in recent years has proven to be very complex, and the outcome of such litigation is difficult to predict.



An adverse determination in any intellectual property litigation or interference proceedings could prohibit us from selling a product, subject us to significant liabilities to third parties or require us to seek licenses from third parties. The costs associated with these license arrangements may be substantial and could include ongoing royalties. Furthermore, the necessary licenses may not be available to us on satisfactory terms, if at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling a product.



Our defense of intellectual property claims filed in the future, regardless of the merits of the complaint, could divert the attention of our technical and management personnel away from the development and marketing of our products for significant periods of time. The costs incurred to future claims could be substantial and seriously harm us, even if our defense is ultimately successful.



Our future operating results are difficult to predict and may vary significantly from quarter to quarter, which may adversely affect the price of our common stock



The limited history of our sales and our history of losses make prediction of future operating results difficult. You should not rely on our past revenue growth as any indication of future growth rates or operating results. The price of our common stock will likely fall in the event that our operating results do not meet the expectations of analysts and investors. Comparisons of our quarterly operating results are an unreliable indication of our future performance because they are likely to vary significantly based on many factors, including:



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
        the level of sales of our products in the United States market;





        our ability to introduce new products and enhancements in a timely manner;





        the demand for and acceptance of our products;





        the success of our competition and the introduction of alternative products;





        our ability to command favorable pricing for our products;





        the growth of the market for our devices;





        the expansion and rate of success of our direct sales force in the United States and our independent distributors internationally;





        actions relating to ongoing FDA compliance;





        the effect of intellectual property disputes;





        the size and timing of orders from independent distributors or customers;





        the attraction and retention of key personnel, particularly in sales and marketing, regulatory, manufacturing and research and development;





        unanticipated delays or an inability to control costs;





        general economic conditions as well as those specific to our customers and markets; and





        seasonal fluctuations in revenue due to the elective nature of some procedures.




We may face product liability claims that could result in costly litigation and significant liabilities



The manufacture and sale of medical products entail significant risk of product liability claims. The medical device industry in general has been subject to significant medical malpractice litigation. Any product liability claims, with or without merit, could result in costly litigation, reduced sales, cause us to incur significant liabilities and divert our managements time, attention and resources. Because of our limited operating history and lack of experience with these claims, we cannot be sure that our product liability insurance coverage is adequate or that it will continue to be available to us on acceptable terms, if at all.



The market for interventional medical devices is highly competitive and will likely become more competitive, and our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements that may render our products obsolete



The existing market for interventional medical devices is intensely competitive. We expect competition to increase further as companies develop new products and/or modify their existing products to compete directly with ours. Each of our products encounters competition from at least several medical device companies, including Medtronic, Abbot Laboratories, St. Jude Medical and Datascope. Each of these companies has:




        better name recognition;





        broader product lines;





        greater sales, marketing and distribution capabilities;





        significantly greater financial resources;





        larger research and development staffs and facilities; and





        existing relationships with some of our potential customers.




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We may not be able to effectively compete with these companies. In addition, broad product lines may allow our competitors to negotiate exclusive, long-term supply contracts and offer comprehensive pricing for their products. Broader product lines may also provide our competitors with a significant advantage in marketing competing products to group purchasing organizations and other managed care organizations that are increasingly seeking to reduce costs through centralized purchasing. Greater financial resources and product development capabilities may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements that may render our products obsolete.



Our international sales are subject to a number of risks that could seriously harm our ability to successfully commercialize our products in any international market



Our international sales are subject to several risks, including:




        the ability of our independent distributors to sell our products;





        the impact of recessions in economies outside the United States;





        greater difficulty in collecting accounts receivable and longer collection periods;





        unexpected changes in regulatory requirements, tariffs or other trade barriers;





        weaker intellectual property rights protection in some countries;





        potentially adverse tax consequences; and





        political and economic instability.




The occurrence of any of these events could seriously harm our future international sales and our ability to successfully commercialize our products in any international market.



We have limited manufacturing experience and may encounter difficulties in our manufacturing operations which could seriously harm our business



We have limited experience in manufacturing our products. In particular, we have limited experience in lyophilization, which is a key manufacturing step for our D-Stat Dry hemostatic bandage. We believe our facilities are adequate for our projected production of our products for the foreseeable future, but future facility requirements will depend largely on future sales of our products in the United States. We may encounter unforeseen difficulties in expanding our production of our new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel, compliance with FDA regulations and requirements regarding good manufacturing practices, and the need for further regulatory approval of new manufacturing processes. Difficulties encountered by us in expanding and maintaining our manufacturing capabilities could
seriously harm our business.



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Our business and results of operations may be seriously harmed by changes in third-party reimbursement policies



We could be seriously harmed by changes in reimbursement policies of governmental or private healthcare payors, particularly to the extent any changes affect reimbursement for catheterization procedures in which our products are used. Failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from healthcare payors for procedures in which our products are used or adverse changes in governmental and private third-party payors policies toward reimbursement for such procedures would seriously harm our business.



In the United States, healthcare providers, including hospitals and clinics that purchase medical devices such as our products, generally rely on third-party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of catheterization procedures. Any changes in this reimbursement system could seriously harm our business.



In international markets, acceptance of our products is dependent in part upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country. Our failure to receive international reimbursement approvals could have a negative impact on market acceptance of our products in the markets in which these approvals are sought.



Our products and our manufacturing activities are subject to extensive governmental regulation that could prevent us from selling our products in the United States or introducing new and improved products



Our products and our manufacturing activities are subject to extensive regulation by a number of governmental agencies, including the FDA and comparable international agencies. We are required to:




        obtain the clearance of the FDA and international agencies before we can market and sell our products;





        satisfy these agencies content requirements for all of our labeling, sales and promotional materials; and





        undergo rigorous inspections by these agencies.




Compliance with the regulations of these agencies may delay or prevent us from introducing any new model of our existing products or other new products. Furthermore, we may be subject to sanctions, including temporary or permanent suspension of operations, product recalls and marketing restrictions if we fail to comply with the laws and regulations pertaining to our business.



We are also required to demonstrate compliance with the FDAs quality system regulations. The FDA enforces its quality system regulations through pre-approval and periodic post-approval inspections. These regulations relate to product testing, vendor qualification, design control and quality assurance, as well as the maintenance of records and documentation. If we are unable to conform to these regulations, the FDA may take actions which could seriously harm our business. In addition, government regulation may be established that could prevent, delay, modify or rescind regulatory clearance or approval of our products.



ITEM 1B. UNRESOLVED STAFF COMMENTS



None.



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ITEM 2. PROPERTIES



Our offices are located in two buildings totaling approximately 57,000 square feet of leased space in suburbs of Minneapolis, Minnesota. These facilities include approximately 37,000 square feet used for manufacturing activities and approximately 3,500 square feet used for research and laboratory activities, with the remainder used for general purpose office space. Our leases for these facilities expire in September 2008, with renewal options. We believe that we may require additional space for our expanding operations before the expiration of these leases. We believe that there is suitable space available in the local market (although not in our current facility) at reasonable rates that is available to us if we need expansion space prior to the end of our leases.



ITEM 3. LEGAL PROCEEDINGS



On December 11, 2003, we and one of our non-officer former employees were named as defendants in a lawsuit brought by Diomed Holdings, Inc. (Diomed) in the United States District Court for the District of Massachusetts. The complaint alleged that in marketing our Vari-Lase endovenous laser procedure kit we engaged in false advertising and infringed a registered trademark of Diomed. The complaint also alleged that the non-officer former employee, who previously worked for a company that conducted business with Diomed, improperly utilized trade secrets of Diomed in developing our Vari-Lase procedure kit. The complaint requested monetary damages and an injunction on the sale of our Vari-Lase procedure kit. On January 31, 2006, the Court granted our motion for summary judgment dismissing all counts of Diomeds complaint with the exception of one trade secret
misappropriation count and a portion of two other counts to the extent they were based on alleged trade secret misappropriation. Our counterclaim against Diomed was not dismissed. On June 23, 2006, we entered into an agreement with Diomed that settled the litigation and all issues surrounding Diomeds marked sheath patents. The terms of the settlement are confidential and did not have a material effect on the consolidated results of operations for the year ended December 31, 2006. The settlement did not affect the ongoing dispute between the parties regarding Diomeds United States Patent Number 6,398,777 discussed below.



On March 4, 2004, we were named as the defendant in an intellectual property lawsuit brought by Diomed in the United States District Court for the District of Massachusetts.  The complaint requested a judgment that our 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 us from selling our Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of our product, and other costs, disbursements and attorneys fees. On April 12, 2005, the judge entered a Memorandum and Order on Claims Construction from the Markman hearing phase of the litigation. In the Order, the judge held that in order to violate the Diomed patent, a competing method must deliberately put the tip of the laser fiber in physical contact with the wall of
the vein, must drain blood from the vein, must compress the vein and must maintain vein wall contact as the laser energy is delivered. We believe that our Vari-Lase products are not used in this method, and thus we do not believe the litigation has merit. On December 21, 2005, we filed our motion for summary judgment, in which we sought dismissal of all claims, and Diomed filed its motion for summary judgment, in which it sought a judgment of validity and infringement. On August 30, 2006, the Court issued its ruling which denied all partys motions for summary judgment concerning infringement and ruled that the patent is valid. The trial is scheduled to start on March 12, 2007. It is not possible to predict the timing or outcome of this litigation, including whether it will affect our ability to sell our Vari-Lase products, or to estimate the amount or range of potential loss.



On October 13, 2005, we were named as one of three defendants in an intellectual property lawsuit brought by VNUS® Medical Technologies, Inc. in the United States District Court for the Northern District of California. The complaint requested a judgment that our Vari-Lase procedure kit and Vari-Lase laser console infringes on four patents held by VNUS® Medical Technologies, Inc. and asked for relief in the form of an injunction that would prevent us from selling our Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of our product, and other costs, disbursements and attorneys fees. We believe that our Vari-Lase products do not violate these patents, and thus we do not believe the litigation has merit. This litigation is scheduled for trial on October 29, 2007. It is not possible to predict the timing or outcome of
this litigation, including whether it will affect our ability to sell our Vari-Lase products, or to estimate the amount or range of potential loss.



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From time to time we are involved in legal proceedings arising in the normal course of our business. As of the date of this report we are 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 our results of operations or financial condition.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



No matters were submitted to a vote of security holders during the quarter ended December 31, 2006.



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PART II



ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



Our common stock began trading on the NASDAQ Global Market under the symbol VASC on July 20, 2000. The following table sets forth, for the periods indicated, the range of high and low last sale prices for the common stock as reported by the NASDAQ Global Market.



High
        
        Low2006First Quarter
        
        7.950
        
        6.590Second Quarter
        
        9.350
        
        7.550Third Quarter
        
        8.240
        
        7.030Fourth Quarter
        
        8.850
        
        7.1002005First Quarter
        
        10.200
        
        8.030Second Quarter
        
        12.470
        
        9.070Third Quarter
        
        13.360
        
        9.270Fourth Quarter
        
        9.940
        
        6.750




Holders



As of December 31, 2006, we had 257 shareholders of record. Such number of record holders does not reflect shareholders who beneficially own common stock in nominee or street name.



Dividends



We have paid no cash dividends on our common stock, and do not intend to pay cash dividends on our common stock in the future.



The following graph shows a comparison of cumulative total returns for our common stock, the NASDAQ Stock Market Index (U.S.) and the NASDAQ Medical Industry Index (Medical Devices, Instruments and Supplies), assuming the investment of $100 in our common stock and each index on December 29, 2001 and the reinvestment of dividends, if any.



22

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ITEM 6. SELECTED FINANCIAL DATA



The following selected financial data as of December 31, 2006 and 2005 and for the three years ended December 31, 2006, 2005 and 2004 are derived from, and should be read together with, our consolidated financial statements included elsewhere in this Form 10-K. The following selected financial data as of December 31, 2004, 2003 and 2002 and for the fiscal years ended December 31, 2003 and 2002 are derived from consolidated financial statements not included herein. The information set forth below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this Form 10-K.



23

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Year Ended December 31,2006
        
        2005
        
        2004
        
        2003
        
        2002(in thousands, except per share amounts)Statements of Operations Data:Net sales
        
        $
        43,310
        
        $
        32,786
        
        $
        22,414
        
        $
        11,862
        
        $
        12,154Cost of sales
        
        
        14,231
        
        
        9,386
        
        
        6,757
        
        
        4,628
        
        
        5,039Gross profit
        
        
        29,079
        
        
        23,400
        
        
        15,657
        
        
        7,234
        
        
        7,115Operating expenses:Research and development
        
        
        4,578
        
        
        3,789
        
        
        3,401
        
        
        3,671
        
        
        3,227Clinical and regulatory
        
        
        2,493
        
        
        2,006
        
        
        1,906
        
        
        1,536
        
        
        1,348Sales and marketing
        
        
        17,097
        
        
        13,681
        
        
        11,360
        
        
        9,646
        
        
        11,964General and administrative
        
        
        3,716
        
        
        2,810
        
        
        2,138
        
        
        1,942
        
        
        2,167Thrombin qualification
        
        
        2,802
        
        
        1,620
        
        
        210
        
        
        
        
        
        Legal settlement
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        3,750Amortization of purchased technology
        
        
        72
        
        
        218
        
        
        218
        
        
        217
        
        
        145Total operating expenses
        
        
        30,758
        
        
        24,124
        
        
        19,233
        
        
        17,012
        
        
        22,601Operating loss
        
        
        (1,679
        )
        
        (724
        )
        
        (3,576
        )
        
        (9,778
        )
        
        (15,486
        )Interest income
        
        
        99
        
        
        163
        
        
        68
        
        
        150
        
        
        507Interest expense
        
        
        (206
        )
        
        
        
        
        
        
        
        
        
        
        Net loss
        
        $
        (1,786
        )
        $
        (561
        )
        $
        (3,508
        )
        $
        (9,628
        )
        $
        (14,979
        )Net loss per common share  Basic and diluted
        
        $
        (0.12
        )
        $
        (0.04
        )
        $
        (0.25
        )
        $
        (0.75
        )
        $
        (1.13
        )Weighted average number of common shares outstanding
        
        
        14,910
        
        
        14,515
        
        
        13,952
        
        
        12,859
        
        
        13,276As of December 31,2006
        
        2005
        
        2004
        
        2003
        
        2002(in thousands)Balance Sheet Data:Cash, cash equivalents and available-for-sale securities
        
        $
        2,557
        
        $
        4,282
        
        $
        7,184
        
        $
        5,885
        
        $
        16,750Working capital
        
        
        11,472
        
        
        10,887
        
        
        11,833
        
        
        9,223
        
        
        18,656Total assets
        
        
        20,967
        
        
        19,896
        
        
        16,822
        
        
        12,992
        
        
        22,280Long-term debt
        
        
        1,667
        
        
        
        
        
        
        
        
        
        
        
        Total shareholders equity
        
        
        14,467
        
        
        14,107
        
        
        13,690
        
        
        10,873
        
        
        20,369






24

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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and Notes thereto, and the other financial information included elsewhere in this Form 10-K Report. This Managements Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of our expectations regarding future trends affecting our business. These forward-looking statements and other forward-looking statements made elsewhere in this document are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Item 1A of Part I of this Form 10-K sets forth certain factors we believe could cause actual results to differ materially from those contemplated by the forward looking statements.



Overview



We are a medical device company focused on bringing solutions to interventional cardiologists and interventional radiologists. As a vertically-integrated medical device company, we generate ideas and create new interventional medical devices, and then deliver those products directly to the physician through our direct domestic sales force and international distribution network. We continue to develop new products and applications for our existing products.



Recent Events:




        On January 22, 2007, we received approval from the United States Food & Drug Administration (FDA) to launch the new 023 version of our Twin-Pass® dual access catheter. The original Twin-Pass catheter was launched in January 2006 as a two lumen catheter designed to be used in conjunction with steerable guidewires to access discrete regions of the coronary and peripheral arterial vasculature. The new 023 version features a larger 0.023 lumen that, in addition to the original clinical uses, allows the Twin-Pass 023 catheter to measure intra-arterial pressures and deliver specialty guidewires into the distal vasculature.



        On January 9, 2007, we entered into three separate agreements with King Pharmaceuticals, Inc. (King): a License Agreement, a Device Supply Agreement and a Thrombin-JMI Supply Agreement. We licensed exclusive rights to Thrombix, ThrombiGel and ThrombiGel Paste to King for $6 million. We will manufacture the licensed products under the Device Supply Agreement. The Device Supply Agreement requires King to pay us two separate $1 million milestone payments; one for the first commercial sale of ThrombiGel and/or Thrombix and one for the first commercial sale of ThrombiGel Paste. The Device Supply Agreement requires us to make a one-time payment of $2,500,000 to King if the FDA does not approve the surgical indication of ThrombiGel and a one-time payment of $2,500,000 to King if the FDA does not approve the surgical indication of
ThrombiGel Paste. We have also entered into a long term supply agreement with King for the supply of thrombin-JMI.



        On January 8, 2007, we received approval from the FDA for our InnerChange micro-introducer catheter. The InnerChange is a kit of custom designed components that allows a physician to gain access and perform a diagnostic angiogram using one micro-access needle stick. The InnerChange is available in both 4F and 5F versions with three different tip configurations for use in a variety of diagnostic catheterization procedures.



        On December 26, 2006, we received approval from the FDA for our PMA Supplement for the added indication for the use of the D-Stat® Flowable hemostat for the reduction in the incidence of clinically significant hematomas in the implantation of a pulse generator (pacemaker or ICD) in anticoagulated patients. The 269-pateint, randomized, prospective, multi-center clinical study showed a 48% reduction in the incidence of clinically significant hematomas compared to the standard of care.




25

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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 sales:



Year Ended December 31,2006
        
        2005
        
        2004Net sales
        
        100%
        
        100%
        
        100%Cost of sales
        
        33%
        
        29%
        
        30%Gross profit
        
        67%
        
        71%
        
        70%Operating expenses:Research and development
        
        11%
        
        11%
        
        15%Clinical and regulatory
        
        6%
        
        6%
        
        8%Sales and marketing
        
        39%
        
        42%
        
        51%General and administrative
        
        9%
        
        8%
        
        10%Thrombin qualification
        
        6%
        
        5%
        
        1%Amortization of purchased technology
        
        
        
        1%
        
        1%Total operating expenses
        
        71%
        
        73%
        
        86%Operating loss
        
        (4%)
        
        (2%)
        
        (16%)Interest income/expense, net
        
        
        
        
        
        Net loss
        
        (4%)
        
        (2%)
        
        (16%)




Our primary products are categorized into five product lines. The following table sets forth, for the periods indicated, net sales by product line along with the percent change from the previous year:



For Years Ended December 31,2006
        
        2005
        
        2004Net Sales
        
        Percent Change
        
        Net Sales
        
        Percent Change
        
        Net Sales
        
        Percent ChangeHemostat products
        
        $
        21,709,000
        
        9
        %
        $
        19,841,000
        
        22
        %
        $
        16,245,000
        
        44
        %Extraction catheters
        
        
        9,058,000
        
        42
        %
        
        6,357,000
        
        108
        %
        
        3,051,000
        
        3,034
        %Vein products
        
        
        7,049,000
        
        62
        %
        
        4,339,000
        
        81
        %
        
        2,392,000
        
        1,133
        %Specialty catheters
        
        
        3,126,000
        
        202
        %
        
        1,036,000
        
        679
        %
        
        133,000
        
        100
        %Access products
        
        
        1,604,000
        
        140
        %
        
        669,000
        
        148
        %
        
        270,000
        
        343
        %Other
        
        
        764,000
        
        40
        %
        
        544,000
        
        68
        %
        
        323,000
        
        33
        %Total Net Sales
        
        $
        43,310,000
        
        32
        %
        $
        32,786,000
        
        46
        %
        $
        22,414,000
        
        89
        %




Year ended December 31, 2006 compared to year ended December 31, 2005



Net sales increased to $43,310,000 for the year ended December 31, 2006 from $32,786,000 for the year ended December 31, 2005. The increase in net sales was a result of an increased market penetration rate in all our products categories as well as the introduction of new products. Approximately 88% of our net sales for the year ended December 31, 2006 were to customers in the United States and 12% of the net sales were to customers in international markets.



Gross profit as a percentage of net sales decreased to 67% for the year ended December 31, 2006 from 71% for the year ended December 31, 2005. Our selling mix continues to change as our lower margin products such as our Vari-Lase products and Pronto continue to outpace the D-Stat Dry products in growth. We expect gross margins to be in the range of 67% to 69% in 2007 as our selling mix continues to change and move toward our lower margin products such as the Vari-Lase and Pronto product lines. The newer V3 version of the Pronto has higher manufacturing costs than the original Pronto.



26

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Research and development expenses increased 21% to $4,578,000 for the year ended December 31, 2006 from $3,789,000 for the year ended December 31, 2005. The increase was the result of our continued emphasis on investment in research and development, including an increase to 18 full-time employees at December 31, 2006 versus 15 at December 31, 2005, and the addition of current year stock based compensation expense. We expect our normal research and development expenses to be approximately 9% to 11% of sales per quarter in 2007 as we continue to pursue additional new products at an expected rate of approximately two new products per year and we continue to move our longer term development projects forward.  Research and development expenses will decline as a percent of sales throughout 2007 as our sales increase.



Clinical and regulatory expenses increased 24% to $2,493,000 for the year ended December 31, 2006 from $2,006,000 for the year ended December 31, 2005. The increase was the result of increasing the number of full-time employees to 28 at December 31, 2006 versus 19 at December 31, 2005 and the current year addition of stock based compensation expense.  The additional employees have been added to manage the additional clinical study activity started in 2006 and continuing through out 2007. During 2006 our clinical studies consisted of the Pocket Protector study for a new indication of our D-Stat Flowable product and the D-Stat Dry study to obtain clinical data to support growing sales of the D-Stat Dry. Clinical and regulatory expenses fluctuate due to the timing of clinical and marketing studies. We expect clinical and regulatory expenses to be approximately 6% to 8% of sales per
quarter in 2007 as we continue to pursue additional new products at an expected rate of approximately two new products per year and we continue to move our longer term development projects forward.



Sales and marketing expenses increased 25% to $17,097,000 for the year ended December 31, 2006 from $13,681,000 for the year ended December 31, 2005. The primary reason for the increase in sales and marketing expenses is the direct result of our increase in our direct sales force to 82 employees at the end of 2006 compared to 74 as of December 31, 2005, with the majority of the 2005 head count increase occurring in the latter half of 2005. Our commissions also increased $850,000 or 55% in 2006 compared to 2005 as our head count increased as well as our sales force did a better job of making their quotas. The addition of stock based compensation expense also added $362,000 of expense in 2006. We expect to add approximately 10 field sales employees during 2007 to complete our geographic coverage of the United States. As a result, we expect our sales and marketing expenses to be between 37%
and 40% of sales per quarter in 2007. Sales and marketing expenses are expected to decline as a percent of sales throughout 2007 as our sales increase.



General and administrative expenses increased 32% to $3,716,000 for the year ended December 31, 2006 from $2,810,000 for the year ended December 31, 2005. The increase was primarily the result of higher legal fees relating to the Diomed and VNUS litigation (see Legal Proceedings in Item 3 of Part I of this Form 10-K) along with higher business insurance, the addition of stock based compensation expense in 2006, and increasing the number of full-time employees to 16 at December 31, 2006 versus 13 at December 31, 2005. We expect general and administrative expenses to be approximately 8% to 10% of sales per quarter in 2007.



Thrombin qualification project expenses were $2,802,000 for the year ended December 31, 2006 compared to $1,620,000 for the year ended December 31, 2005. 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 will be paying for certain development costs of Sigma to allow 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 starting in 2008 then (1) Sigma will be released from its agreement not to sell thrombin in or as a component of a hemostatic product for medical use, and (2) Sigma will have the right to terminate the agreement upon 30 days notice.



27

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The Sigma contract is part of our plan to fully qualify a second source of thrombin (in addition to the Thrombin JMI® Supply Agreement discussed in Agreements with King Pharmaceuticals above) and to bring the new thrombin through the regulatory process to be used in our hemostatic products. The payments associated with the Sigma agreement are part of our total estimated expenditures of $7.6 million to complete this project.



The costs and purchases incurred through December 31, 2006 and the total estimated costs and purchases for the thrombin project (including costs and purchases already incurred) are as follows:



Incurred (as ofDecember 31, 2006)
        
        Total EstimatedQualification expenses
        
        $
        4.6 million
        
        $
        5.3 millionCapital equipment purchases
        
        
        1.0 million
        
        
        1.0 millionThrombin inventory purchases(net of thrombin expensed)
        
        
        1.3 million
        
        
        1.3 million$
        6.9 million
        
        $
        7.6 million




We have expensed approximately $400,000 of the total $1.7 million purchased of the Sigma thrombin in our development work over the past two years leaving approximately $1.3 million of thrombin in our inventory. The $1.3 million in thrombin is expected to be used in our hemostat products once we gain regulatory approval.



As described in Agreements with King Pharmaceuticals above, in January 2007 we entered into a new 10 year thrombin supply agreement with King with a price fixed throughout the term, adjusted for a producer price index tied to pharmaceuticals. The thrombin price under the agreement is confidential information; however, the price reflects a 25% discount to the price we paid in the last year of our previous thrombin supply agreement with King. The new agreement does not terminate or affect our ability to complete the qualification of our own second thrombin source; however, with the near-term economic need to qualify a second source eliminated we will be able to evaluate and plan our continuing expenses and steps on this project. We expect to incur approximately $150,000 of qualification expenses in 2007.



Amortization of purchased technology was $72,000 for the year ended December 31, 2006 compared to $218,000 for the year ended December 31, 2005. The amortization resulted from our acquisition of the Acolysis assets from the secured creditors of Angiosonics, Inc. We allocated $870,000 from the acquisition to purchased technology and were amortizing the amount over four years, which was completed in April 2006.



Interest income decreased to $99,000 for the year ended December 31, 2006 from $163,000 for the year ended December 31, 2005 primarily as a result of lower cash balances maintained during the year.



Interest expense increased to $206,000 for the year ended December 31, 2006 from $-0- for the year ended December 31, 2005 as a result of the borrowings on our equipment line of credit.



Results of Operations



Year ended December 31, 2005 compared to year ended December 31, 2004



Net sales increased to $32,786,000 for the year ended December 31, 2005 from $22,414,000 for the year ended December 31, 2004. The increase in net sales was a result of an increased market penetration rate in all our product categories as well as the introduction of new products. Approximately 89% of our net sales for the year ended December 31, 2005 were to customers in the United States and 11% of the net sales were to customers in international markets.



28

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Gross profit as a percentage of net sales increased to 71% for the year ended December 31, 2005 from 70% for the year ended December 31, 2004. Our selling mix changed to our higher margin products such as our D-Stat Dry, which has gross margins greater than 80%.



Research and development expenses increased 11% to $3,789,000 for the year ended December 31, 2005 from $3,401,000 for the year ended December 31, 2004. The increase was the result of our increased investment in research and development as well as our increase in head count to 15 employees at December 31, 2005 versus 12 at December 31, 2004.



Clinical and regulatory expenses increased 5% to $2,006,000 for the year ended December 31, 2005 from $1,906,000 for the year ended December 31, 2004. The increase was the result of increased clinical study activity, increased FDA fees and increased number of employees compared to 2004. During 2005 our clinical studies consisted of the Pocket Protector study for a new indication of our D-Stat Flowable product and the D-Stat Dry study to obtain clinical data to support growing sales of the D-Stat Dry. Clinical and regulatory expenses fluctuate due to the timing of clinical and marketing studies.



Sales and marketing expenses increased 20% to $13,681,000 for the year ended December 31, 2005 from $11,360,000 for the year ended December 31, 2004. The increase in sales and marketing expenses is the direct result of our increase in our direct sales force to 72 employees at the end of 2005 compared to 57 as of December 31, 2004.



General and administrative expenses increased 31% to $2,810,000 for the year ended December 31, 2005 from $2,138,000 for the year ended December 31, 2004. The increase was primarily the result of higher legal fees relating to the Diomed litigation (see Legal Proceedings in Item 3 of Part I of this Form 10-K) along with higher business insurance and accounting fees in 2005 compared to 2004.



Thrombin qualification project expenses were $1,620,000 for the year ended December 31, 2005 compared to $210,000 for the year ended December 31, 2004.



Amortization of purchased technology was $218,000 for each of the years ended December 31, 2005 and 2004. The amortization resulted from our acquisition of the Acolysis assets from the secured creditors of Angiosonics, Inc. We allocated $870,000 from the acquisition to purchased technology and are amortizing the amount over four years.



Interest income increased to $163,000 for the year ended December 31, 2005 from $68,000 for the year ended December 31, 2004 primarily as a result of higher interest rates.



Income Taxes



We have not generated any fiscal year pre-tax income to date and therefore have not paid any federal income taxes since our inception in December 1996. No provision or benefit for 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 and if we generate taxable income. We have established a valuation allowance for the full value of our federal net operating loss, federal and state research and development credits and foreign tax losses.



As of December 31, 2006, we had approximately $58.9 million of federal net operating loss carryforwards available to offset future taxable income which begin to expire in the year 2013. As of December 31, 2006, we also had federal and state research and development tax credit carryforwards of approximately $2.7 million which begin to expire in the year 2013. As of December 31, 2006, we also had a foreign tax loss carryforward of approximately $2.7 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 2005 on our federal net operating loss carryforward, and concluded that, as of the date of this study, we would have no limitations on the net operating loss carryforward.



29

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Liquidity and Capital Resources



We have financed substantially all of our operations since inception through the issuance of equity securities and, to a lesser extent, sales of our products. Through December 31, 2006, we have sold capital stock generating aggregate net proceeds of approximately $79 million. At December 31, 2006, we had $2,557,000 in cash and cash equivalents on-hand compared to $4,282,000 at December 31, 2005. In January 2007 we received $6,000,000 upon the signing of the License Agreement with King Pharmaceuticals, Inc.



During the year ended December 31, 2006, we used $2,760,000 in cash as a result of operating activities, we incurred net capital expenditures in the amount of $1,704,000, and we generated $2,619,000 in financing activities.  On January 6, 2006, we drew down $2 million of the equipment line resulting in an increase of $1.7 million of cash, net of debt payments. The remaining $952,000 of financing activities was the result of the sale of common stock upon the exercise of outstanding stock options, exercise of stock warrants and issuances under employee stock plans. Our capital expenditures included software and equipment related to our new ERP system, leasehold improvements and manufacturing equipment. Our operating cash usage was primarily the result of an increase of accounts receivable as our sales grew 32% on a year-over-year basis in 2006 and a decrease in accounts payable since we paid
for the $1.7 million of Sigma thrombin in January 2006 which was in our accounts payable at the end of 2005.



We purchase our requirements for thrombin (a component in the Duett and D-Stat products) under a Purchase Agreement dated January 9, 2007 (see note 16 to the consolidated financial statements) with a subsidiary of King. The agreement provides for a fixed price, with adjustments based on a producer price index tied to pharmaceuticals. The previous agreement with King expired on May 29, 2005. In anticipation of the previous agreement expiring, we submitted purchase orders to King for approximately $3.5 million of thrombin to benefit from the pricing provisions of the agreement. As of December 31, 2006, we had purchase orders totaling $1 million outstanding with King.  As part of the supply agreement dated January 9, 2007, the outstanding purchase orders were cancelled and new purchase orders were placed at the lower price of the new agreement.



We currently have a $7 million
credit facility with Silicon Valley Bank. The $5 million revolving line of credit has a 12-month term, bears interest at the rate
of prime plus 0.5% and is secured by a first security interest on all of our assets. The $2 million equipment line of credit has a
36-month term, bears interest at the rate of prime plus 1.5% and is secured by a first security interest on all of our assets used
as collateral for the amounts borrowed on under the line. The credit facility includes two covenants: minimum tangible net worth
of $11,000,000 through September 30, 2007, $13,000,000 thereafter, and liquidity coverage of not less than 1.25 to 1.00. The
minimum tangible net worth covenant will increase by the sum of 50% of the Companys quarterly net profit beginning with the
quarter ending March 30, 2007 plus all consideration for equity securities received after December 1, 2006. We were in compliance
with these covenants at December 31, 2006. As of December 31, 2006, we had no outstanding balance on the $5 million revolving line
of credit and the availability on the revolving line of credit was $5.0 million. On January 6, 2006, we drew down $2 million of
the equipment line. As of December 31, 2006, we had a balance of $1,667,000 remaining on the equipment line.



30

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The following table summarizes our contractual cash commitments as of December 31, 2006:



Payments Due by PeriodContractual Obligations
        
        Total
        
        Less than 1year
        
        1-3 years
        
        3-5 years
        
        More than5 yearsFacility Operating Leases
        
        $
        712,000
        
        $
        407,000
        
        $
        305,000
        
        $
        
        
        $
        Equipment line of credit
        
        
        1,667,000
        
        
        800,000
        
        
        800,000
        
        
        67,000
        
        
        King Pharmaceuticals Thrombin Purchase
        
        
        1,003,000
        
        
        1,003,000
        
        
        
        
        
        
        
        
        Total Contractual Cash Obligations
        
        $
        3,382,000
        
        $
        2,210,000
        
        $
        1,105,000
        
        $
        67,000
        
        $
        




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 experience positive cash flow from our normal operating activities. We currently believe that our working capital of
$11,472,000 at December 31, 2006, our recent one-time receipt of $6 million under the terms of the King license agreement signed
in January 2007 and our anticipated cash from product sales will be sufficient to meet all of our operating and capital
requirements for at least the next twelve months. However, our actual liquidity and capital requirements will depend upon numerous
factors, the amount of revenues from sales of our existing and new products; the cost of maintaining, enforcing and defending
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.



Critical Accounting Policies



Managements Discussion and Analysis of Financial Condition and Results of Operations addresses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our consolidated 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 consolidated 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.



Our accounting policies are described in Note 2 to the consolidated financial statements. 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 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.



31

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Revenue Recognition



We recognize revenue in accordance with generally accepted accounting principles as outlined in the SECs Staff Accounting Bulletin No. 104 Revenue Recognition, 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. 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 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 December 31, 2006, this reserve was $45,000 compared to $30,000 at December 31, 2005. 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 December 31, 2006, this reserve was $65,000 compared to $110,000 at December 31, 2005. 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 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 December 31, 2006, this warranty provision was $46,000 compared to $50,000 at December 31, 2005. If the assumptions used in calculating the provision were to materially change, resulting in more defects than anticipated, an additional provision may be required.



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 year ended December 31, 2006, we recorded a $27.7 million valuation allowance related to our net deferred tax assets of $27.7 million. 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.



New Accounting Pronouncements



The Financial Accounting Standards Board (FASB) has issued Statement 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 became effective for us on January 1, 2006. We recorded $1,088,000 of Stock-Based Compensation expense for the year ended December 31, 2006. See the Stock-Based Compensation discussion in Note 2 of our consolidated financial statements for additional information.



32

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ITEM 7A. 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 one major bank and one investment firm in the United States. We have a formal written investment policy that restricts the placement of investments to 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 and Germany, we sell our products directly to hospitals and clinics in the local currency.



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 had $1,667,000 of indebtedness on our equipment line as of December 31, 2006. If we were to borrow additional amounts from our revolving credit line, we would be further exposed to changes in interest rates, see Note 5 to the consolidated financial statements. Advances under our revolving and equipment lines of credit bear interest at an annual rate indexed to prime. We will thus be exposed to interest rate risk with respect to these lines of credit to the extent that interest rates rise when there are amounts outstanding under these lines of credit. Based on our debt outstanding at December 31, 2006, a 1% increase in current market interest rates would have an impact of approximately $17,000 on an annual basis. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



The Consolidated Financial
Statements and Notes thereto required pursuant to this Item begin on page 40 of this Annual Report on Form 10-K.



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



None.



ITEM 9A. 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.



33

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Changes in Internal Controls.



During the fiscal quarter ended December 31, 2006, 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.



Managements Report on Internal Control Over Financial Reporting.



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.



Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control - Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework inInternal Control  Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2006.



Our managements assessment
of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Virchow,
Krause & Company, LLP, an independent registered public accounting firm, as stated in their report which is included herein on
page 43.



ITEM 9B. OTHER INFORMATION



In October 2004, we entered into an agreement with Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc. (SAFC), for the supply of thrombin (the Supply Agreement). Pursuant to the terms of the Supply Agreement, we agreed to pay for certain of SAFCs development costs to allow SAFC to produce thrombin. On December 15, 2006, we entered into an amendment (the Amendment) to the Supply Agreement with SAFC which (1) changed the effectiveness date of the Supply Agreement from January 1, 2007 to January 1, 2008, (2) revised the minimum final yield of units in the definition of lot, and (3) amended the purchase price per lot. The foregoing description of the Amendment is qualified in its entirety by reference to the complete Amendment, a copy of which is attached as Exhibit 10.12 to this Form 10-K and
incorporated herein by reference.



34

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PART III



ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE



Incorporated herein by reference
to the Sections under the headings Election of Directors, Committees of the Board of Directors and
Section 16(a) Beneficial Ownership Reporting Compliance contained in the Proxy Statement for our Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the year ended December 31,
2006.



See Item 1 of Part I hereof for information regarding our executive officers.



We have adopted a code of ethics that applies to all of our directors, officers (including our chief executive officer, chief financial officer, chief accounting officer, and any person performing similar functions) and employees. We have made our Code of Ethics available by filing it as Exhibit 14 with our 2003 Annual Report on Form 10-K.



ITEM 11. EXECUTIVE COMPENSATION



Incorporated herein by reference to the Sections under the headings Director Compensation, Employment Agreements and Executive Compensation and Other Information contained in the Proxy Statement for our Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the year ended December 31, 2006.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS



Incorporated herein by reference to the Section under the heading Security Ownership of Certain Beneficial Owners and Management contained in the Proxy Statement for our Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the year ended December 31, 2006.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE



Incorporated herein by reference to the Section under the heading Committees of the Board of Directors contained in the Proxy Statement for our Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the year ended December 31, 2006.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES



Incorporated herein by reference to the Section under the heading Additional Information about our Independent Auditor contained in the Proxy Statement for our Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the year ended December 31, 2006.



35

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PART IV



ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES



(a)  Documents filed as part of this Report.



(1)
        The following financial statements are filed herewith in Item 8 in Part II.




(i)
        Reports of Independent Registered Public Accounting Firm




(ii)
        Consolidated Balance Sheets




(iii)
        Consolidated Statements of Operations




(iv)
        Consolidated Statements of Changes in Shareholders Equity




(v)
        Consolidated Statements of Cash Flows




(vi)
        Notes to Consolidated Financial Statements




(2)
        Financial Statement Schedules




Schedule II  Valuation and Qualifying Accounts. Such schedule should be read in conjunction with the consolidated financial statements. All other supplemental schedules are omitted because of the absence of conditions under which they are required.



(3)
        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
        
        
        Bylaws of Vascular Solutions, Inc. (incorporated by reference to Exhibit 3.2 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).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)).4.2
        
        
        Form of warrant dated January 31 and February 14, 1997 issued to representatives of Miller, Johnson & Kuehn, Incorporated (incorporated by reference to Exhibit 4.2 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).4.3
        
        
        Form of warrant dated December 29, 1997 issued to representatives of Miller, Johnson & Kuehn, Incorporated (incorporated by reference to Exhibit 4.3 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).4.4
        
        
        Amended and Restated Investors Rights Agreement dated December 9, 1998, by and between Vascular Solutions, Inc. and the purchasers of Series A and Series B preferred stock (incorporated by reference to Exhibit 4.4 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).10.1
        
        
        Lease Agreement dated August 30, 2002 by and between First Industrial, L.P. as Landlord and Vascular Solutions, Inc. as Tenant (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 10-Q for the quarter ended September 30, 2002).10.2
        
        
        Sublease Agreement dated March 31, 2005 by and between Insignia Systems, Inc. and Vascular Solutions, Inc. (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 10-Q for the quarter ended March 31, 2005).






36

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ExhibitNumber
        
        Description10.3
        
        
        Consent Agreement dated March 31, 2005 by and between IRET  Plymouth, LLC as Landlord, Insignia Systems, Inc. as Tenant and Vascular Solutions, Inc. as Subtenant (incorporated by reference to Exhibit 10.2 of Vascular Solutions Form 10-Q for the quarter ended March 31, 2005).10.4
        
        
        Lease Agreement dated December 28, 2006 by and between IRET - Plymouth, LLC as Landlord and Vascular Solutions, Inc. as Tenant.10.5
        
        
        Mutual and General Release dated November 9, 1998 by and between Vascular Solutions, Inc., Dr. Gary Gershony and B. Braun Medical, Inc. (incorporated by reference to Exhibit 10.5 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).10.6
        
        
        Purchase and Sale Agreement dated September 17, 1998 by and between Vascular Solutions, Inc. and Davol Inc. (incorporated by reference to Exhibit 10.8 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).10.7
        *
        
        Form of Employment Agreement by and between Vascular Solutions, Inc. and each of its executive officers (incorporated by reference to Exhibit 10.5 of Vascular Solutions Form 10-Q for the quarter ended March 31, 2004).10.8
        
        
        Form of Distribution Agreement (incorporated by reference to Exhibit 10.12 of Vascular Solutions Registration Statement on Form S-1 (File No. 333-84089)).10.9
        *
        
        Vascular Solutions, Inc. Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibit 10.14 to Vascular Solutions Form 10-K for the year ended December 31, 2000).10.10
        *
        
        Stock Option and Stock Award Plan as Amended December 9, 2005 (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 8-K dated December 9, 2005).10.11
        **
        
        Supply Agreement dated October 18, 2004 by and between Vascular Solutions and Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc. (incorporated by reference to Exhibit 10.12 to Vascular Solutions Form 10-K for the year ended December 31, 2004).10.12
        **
        
        Amendment to Supply Agreement dated December 15, 2006 by and between Vascular Solutions and Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc.10.13
        **
        
        Private Label Purchase Agreement dated September 22, 2003 by and between Vascular Solutions and MedArt Corporation (incorporated by reference to Exhibit 10.18 of Vascular Solutions Form 10-Q for the quarter ended September 30, 2003).10.14
        
        
        Loan and Security Agreement dated December 31, 2003 by and between Vascular Solutions and Silicon Valley Bank (incorporated by reference to Exhibit 10.14 of Vascular Solutions Form 10-K for the year ended December 31, 2003).10.15
        
        
        Amendment to Loan Agreement dated December 9, 2004 by and between Vascular Solutions and Silicon Valley Bank (incorporated by reference to Exhibit 10.15 of Vascular Solutions Form 10-K for the year ended December 31, 2004).10.16
        
        
        Amendment to Loan Agreement dated December 29, 2005 by and between Vascular Solutions and Silicon Valley Bank (incorporated by reference to Exhibit 10.14 of Vascular Solutions Form 10-K for the year ended December 31, 2005).10.17
        
        
        Amendment to Loan Agreement dated December 28, 2006 by and between Vascular Solutions and Silicon Valley Bank.10.18
        *
        
        Form of Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 8-K dated September 22, 2004).10.19
        *
        
        Form of Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.2 of Vascular Solutions Form 8-K dated September 22, 2004).10.20
        *
        
        Form of Board of Directors Stock Option Agreement, as amended December 9, 2005 (incorporated by reference to Exhibit 10.2 of Vascular Solutions Form 8-K dated December 9, 2005).10.21
        *
        
        Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.3 of Vascular Solutions Form 8-K dated December 9, 2005).10.22
        
        
        License agreement dated January 9, 2007 by and between Vascular Solutions and King Pharmaceuticals, Inc.10.23
        **
        
        Device Supply agreement dated January 9, 2007 by and between Vascular Solutions and King Pharmaceuticals, Inc.






37

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ExhibitNumber
        
        Description10.24
        **
        
        Thrombin JMI® Supply Agreement dated January 9, 2007 by and between Vascular Solutions and King Pharmaceuticals, Inc.10.25
        *
        
        Vascular Solutions, Inc. Stock Option and Stock Award Plan, as amended January 25, 2006, effective April 18, 2006 (incorporated by reference to Exhibit 10.1 of Vascular Solutions Form 10-Q for the quarter ended March 31, 2006).14
        
        
        Code of Ethics (incorporated by reference to Exhibit 14 of Vascular Solutions Form 10-K for the year ended December 31, 2003).21
        
        
        List of Subsidiaries23.1
        
        
        Consent of Virchow, Krause & Company, LLP.24.1
        
        
        Power of Attorney (included on signature page).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.




________________________



* Management contract or compensatory plan or
arrangement previously filed with the Securities and Exchange Commission.

** Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, confidential portions of these exhibits have been deleted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.



38

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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 29th day of January 2007.



VASCULAR SOLUTIONS, INC.By:
        /s/Howard RootHoward RootChief Executive Officer and Director




KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Howard Root and James Hennen (with full power to act alone), as his true and lawful attorneys-in-fact and agents, with full powers of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to the Annual Report on Form 10-K of Vascular Solutions, Inc., for the year ended December 31, 2006 and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or their substitute or substitutes, lawfully do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on the 29th day of January 2007, by the following persons in the capacities indicated.



Signature
        
        Title/s/ Howard Root
        
        Chief Executive Officer and DirectorHoward Root
        
        (principal executive officer)/s/ James Hennen
        
        Vice President, Finance and Chief Financial Officer and SecretaryJames Hennen
        
        (principal financial officer)/s/ Timothy Slayton
        
        ControllerTimothy Slayton
        
        (principal accounting officer)/s/ Robert Paulson
        
        DirectorRobert Paulson/s/ Richard Nigon
        
        DirectorRichard Nigon/s/ Michael Kopp
        
        DirectorMichael Kopp/s/ Paul OConnell
        
        DirectorPaul OConnell/s/ John Erb
        
        DirectorJohn Erb/s/ Dr. Jorge Saucedo
        
        DirectorDr. Jorge Saucedo/s/ Dr. Gary Dorfman
        
        DirectorDr. Gary Dorfman






39

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Report of Independent Registered Public Accounting Firm





The Board of Directors and Shareholders

Vascular Solutions, Inc.



Under date of January 19, 2007, we reported on the consolidated balance sheets of Vascular Solutions, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders equity, and cash flows for each of the three years in the period ended December 31, 2006, as contained in the annual report on Form 10-K for the year ended December 31, 2006. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.



In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.



/s/ Virchow, Krause & Company, LLP




Minneapolis, Minnesota

January 19, 2007



40

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SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004



Description
        
        Balance at Beginning of Year
        
        Additions Charged toCosts and Expenses
        
        Less Deductions
        
        Balance atEnd of YearYEAR ENDED DECEMBER 31, 2006:Sales return allowance
        
        $
        30,000
        
        $
        107,000
        
        $
        92,000
        
        $
        45,000Allowance for doubtful accounts
        
        
        110,000
        
        
        (16,000
        )
        
        29,000
        
        
        65,000Total
        
        $
        140,000
        
        $
        91,000
        
        $
        121,000
        
        $
        110,000YEAR ENDED DECEMBER 31, 2005:Sales return allowance
        
        $
        20,000
        
        $
        56,000
        
        $
        46,000
        
        $
        30,000Allowance for doubtful accounts
        
        
        160,000
        
        
        (41,000
        )
        
        9,000
        
        
        110,000Total
        
        $
        180,000
        
        $
        15,000
        
        $
        55,000
        
        $
        140,000YEAR ENDED DECEMBER 31, 2004:Sales return allowance
        
        $
        20,000
        
        $
        20,000
        
        $
        20,000
        
        $
        20,000Allowance for doubtful accounts
        
        
        140,000
        
        
        34,000
        
        
        14,000
        
        
        160,000Total
        
        $
        160,000
        
        $
        54,000
        
        $
        34,000
        
        $
        180,000






41

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Report of Independent Registered Public Accounting Firm





The Board of Directors and Shareholders

Vascular Solutions, Inc.



We have audited the accompanying consolidated balance sheets of Vascular Solutions, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



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



As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123(R), Share Based Payment.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vascular Solutions, Inc. as of December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.



/s/ Virchow, Krause & Company, LLP




Minneapolis, Minnesota

January 19, 2007



42

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Report of Independent Registered Public Accounting Firm



The Board of Directors and Shareholders

Vascular Solutions, Inc.



We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting appearing under Item 9A, that Vascular Solutions, Inc. (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Vascular Solutions, Inc.s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provide a reasonable basis for our opinion.



A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.



In our opinion, managements assessment that Vascular Solutions, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Vascular Solutions, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Vascular Solutions, Inc. as of December 31, 2006 and 2005 and the related consolidated statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 2006, and our report dated January 19, 2007, expresses an unqualified opinion on those consolidated financial statements.



/s/ Virchow, Krause & Company, LLP




Minneapolis, Minnesota

January 19, 2007



43

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Vascular Solutions, Inc.



Consolidated Balance Sheets



December 312006
        
        2005AssetsCurrent assets:Cash and cash equivalents
        
        $
        2,557,000
        
        $
        4,282,000Accounts receivable, net of reserves of $110,000 and $140,000 at December 31, 2006 and 2005, respectively
        
        
        6,524,000
        
        
        4,854,000Inventories
        
        
        7,232,000
        
        
        6,962,000Prepaid expenses
        
        
        792,000
        
        
        578,000Total current assets
        
        
        17,105,000
        
        
        16,676,000Property and equipment, net
        
        
        3,669,000
        
        
        2,955,000Intangible assets, net
        
        
        193,000
        
        
        265,000Total assets
        
        $
        20,967,000
        
        $
        19,896,000Liabilities and shareholders equityCurrent liabilities:Accounts payable
        
        $
        1,261,000
        
        $
        2,898,000Accrued compensation
        
        
        2,270,000
        
        
        1,695,000Accrued expenses
        
        
        1,302,000
        
        
        1,196,000Current portion of long-term debt
        
        
        800,000
        
        
        Total current liabilities
        
        
        5,633,000
        
        
        5,789,000Long-term Debt, net of current portion
        
        
        867,000
        
        
        Commitments and contingenciesShareholders equity:Common stock, $0.01 par value:Authorized shares  40,000,000Issued and outstanding shares  15,141,181  2006;14,642,225  2005
        
        
        151,000
        
        
        147,000Additional paid-in capital
        
        
        79,841,000
        
        
        77,793,000Other
        
        
        52,000
        
        
        (42,000
        )Accumulated deficit
        
        
        (65,577,000
        )
        
        (63,791,000
        )Total shareholders equity
        
        
        14,467,000
        
        
        14,107,000Total liabilities and shareholders equity
        
        $
        20,967,000
        
        $
        19,896,000




See accompanying notes



44

---

Vascular Solutions, Inc.



Consolidated Statements of Operations



Year Ended December 312006
        
        2005
        
        2004Net sales
        
        $
        43,310,000
        
        $
        32,786,000
        
        $
        22,414,000Cost of goods sold (1)
        
        
        14,231,000
        
        
        9,386,000
        
        
        6,757,000Gross profit
        
        
        29,079,000
        
        
        23,400,000
        
        
        15,657,000Operating expenses:Research and development (1)
        
        
        4,578,000
        
        
        3,789,000
        
        
        3,401,000Clinical and regulatory (1)
        
        
        2,493,000
        
        
        2,006,000
        
        
        1,906,000Sales and marketing (1)
        
        
        17,097,000
        
        
        13,681,000
        
        
        11,360,000General and administrative (1)
        
        
        3,716,000
        
        
        2,810,000
        
        
        2,138,000Thrombin qualification
        
        
        2,802,000
        
        
        1,620,000
        
        
        210,000Amortization of purchased technology
        
        
        72,000
        
        
        218,000
        
        
        218,000Total operating expenses
        
        
        30,758,000
        
        
        24,124,000
        
        
        19,233,000Operating loss
        
        
        (1,679,000
        )
        
        (724,000
        )
        
        (3,576,000
        )Other income (expenses):Interest income
        
        
        99,000
        
        
        163,000
        
        
        68,000Interest expense
        
        
        (206,000
        )
        
        
        
        
        Net loss
        
        $
        (1,786,000
        )
        $
        (561,000
        )
        $
        (3,508,000
        )Basic and diluted net loss per common share
        
        $
        (0.12
        )
        $
        (0.04
        )
        $
        (0.25
        )Shares used in computing basic and dilutednet loss per common share
        
        
        14,910,135
        
        
        14,515,524
        
        
        13,952,278(1) Includes stock-based compensation charges of:Cost of goods sold
        
        $
        122,000
        
        $
        
        
        $
        Research and development
        
        
        174,000
        
        
        
        
        
        Clinical and regulatory
        
        
        89,000
        
        
        
        
        
        Sales and marketing
        
        
        362,000
        
        
        
        
        
        General and administrative
        
        
        341,000
        
        
        
        
        
        $
        1,088,000
        
        $
        
        
        $
        




See accompanying notes



45

---

Vascular Solutions, Inc.



Consolidated Statements of Changes in Shareholders Equity



Common Stock
        
        AdditionalPaid-In
        
        
        
        
        AccumulatedShares
        
        Amount
        
        Capital
        
        Other
        
        Deficit
        
        TotalBalance at December 31, 2003
        
        12,989,170
        
        $
        130,000
        
        $
        70,423,000
        
        $
        42,000
        
        $
        (59,722,000
        )
        $
        10,873,000Exercise of stock options
        
        227,300
        
        
        2,000
        
        
        341,000
        
        
        
        
        
        
        
        
        343,000Issuance of common stock under the Employee Stock Purchase Plan
        
        245,567
        
        
        3,000
        
        
        273,000
        
        
        
        
        
        
        
        
        276,000Sale of common stock in private placement at $6.75 per share in March 2004, net of offering costs
        
        888,900
        
        
        9,000
        
        
        5,584,000
        
        
        
        
        
        
        
        
        5,593,000Deferred compensation related to option grants
        
        
        
        
        
        
        
        54,000
        
        
        (54,000
        )
        
        
        
        
        Amortization of deferred compensation
        
        
        
        
        
        
        
        
        
        
        12,000
        
        
        
        
        
        12,000Comprehensive loss:Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        (3,508,000
        )
        
        (3,508,000
        )Translation adjustment
        
        
        
        
        
        
        
        
        
        
        101,000
        
        
        
        
        
        101,000Total comprehensive loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (3,407,000
        )Balance at December 31, 2004
        
        14,350,937
        
        
        144,000
        
        
        76,675,000
        
        
        101,000
        
        
        (63,230,000
        )
        
        13,690,000Exercise of stock options
        
        191,750
        
        
        2,000
        
        
        594,000
        
        
        
        
        
        
        
        
        596,000Issuance of common stock under the Employee Stock Purchase Plan
        
        99,538
        
        
        1,000
        
        
        511,000
        
        
        
        
        
        
        
        
        512,000Deferred compensation related to option grants
        
        
        
        
        
        
        
        13,000
        
        
        (13,000
        )
        
        
        
        
        Amortization of deferred compensation
        
        
        
        
        
        
        
        
        
        
        22,000
        
        
        
        
        
        22,000Comprehensive loss:Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        (561,000
        )
        
        (561,000
        )Translation adjustment
        
        
        
        
        
        
        
        
        
        
        (152,000
        )
        
        
        
        
        (152,000
        )Total comprehensive loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (713,000
        )Balance at December 31, 2005
        
        14,642,225
        
        
        147,000
        
        
        77,793,000
        
        
        (42,000
        )
        
        (63,791,000
        )
        
        14,107,000Exercise of stock options
        
        251,722
        
        
        2,000
        
        
        375,000
        
        
        
        
        
        
        
        
        377,000Issuance of common stock under the Employee Stock Purchase Plan
        
        88,484
        
        
        1,000
        
        
        574,000
        
        
        
        
        
        
        
        
        575,000Stock option compensation
        
        158,750
        
        
        1,000
        
        
        1,087,000
        
        
        
        
        
        
        
        
        1,088,000Deferred compensation related to option grants
        
        
        
        
        
        
        
        12,000
        
        
        (12,000
        )
        
        
        
        
        Amortization of deferred compensation
        
        
        
        
        
        
        
        
        
        
        31,000
        
        
        
        
        
        31,000Comprehensive loss:Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        (1,786,000
        )
        
        (1,786,000
        )Translation adjustment
        
        
        
        
        
        
        
        
        
        
        75,000
        
        
        
        
        
        75,000Total comprehensive loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (1,711,000
        )Balance at December 31, 2006
        
        15,141,181
        
        $
        151,000
        
        $
        79,841,000
        
        $
        52,000
        
        $
        (65,577,000
        )
        $
        14,467,000




See accompanying notes.



46

---

Vascular Solutions, Inc.



Consolidated Statements of Cash Flows



Year Ended December 312006
        
        2005
        
        2004Operating activitiesNet loss
        
        $
        (1,786,000
        )
        $
        (561,000
        )
        $
        (3,508,000
        )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation
        
        
        994,000
        
        
        596,000
        
        
        474,000Amortization
        
        
        72,000
        
        
        218,000
        
        
        218,000Deferred compensation expense
        
        
        31,000
        
        
        22,000
        
        
        12,000Stock-based compensation
        
        
        1,088,000
        
        
        
        
        
        Change in allowance for doubtful accounts
        
        
        (30,000
        )
        
        (40,000
        )
        
        20,000Changes in operating assets and liabilities:Accounts receivable
        
        
        (1,626,000
        )
        
        (1,304,000
        )
        
        (1,744,000
        )Inventories
        
        
        (234,000
        )
        
        (3,328,000
        )
        
        (473,000
        )Prepaid expenses
        
        
        (212,000
        )
        
        5,000
        
        
        (126,000
        )Accounts payable
        
        
        (1,638,000
        )
        
        2,043,000
        
        
        106,000Accrued compensation and expenses
        
        
        581,000
        
        
        620,000
        
        
        906,000Net cash used in operating activities
        
        
        (2,760,000
        )
        
        (1,729,000
        )
        
        (4,115,000
        )Investing activitiesPurchase of property and equipment, net
        
        
        (1,704,000
        )
        
        (2,200,000
        )
        
        (900,000
        )Proceeds from sales of securities
        
        
        
        
        
        
        
        
        3,020,000Net cash provided by (used in) investing activities
        
        
        (1,704,000
        )
        
        (2,200,000
        )
        
        2,120,000Financing activitiesNet proceeds from the exercise of stock options and stock warrants, net of expenses
        
        
        377,000
        
        
        596,000
        
        
        343,000Net proceeds from the sale of common stock, net of expenses
        
        
        575,000
        
        
        512,000
        
        
        5,869,000Proceeds from borrowings on long-term debt
        
        
        2,000,000
        
        
        
        
        
        Payments on long-term debt borrowings
        
        
        (333,000
        )
        
        
        
        
        Net cash provided by financing activities
        
        
        2,619,000
        
        
        1,108,000
        
        
        6,212,000Effect of exchange rate changes on cash and cash equivalents
        
        
        120,000
        
        
        (81,000
        )
        
        102,000Increase (decrease) in cash and cash equivalents
        
        
        (1,725,000
        )
        
        (2,902,000
        )
        
        4,319,000Cash and cash equivalents at beginning of year
        
        
        4,282,000
        
        
        7,184,000
        
        
        2,865,000Cash and cash equivalents at end of year
        
        $
        2,557,000
        
        $
        4,282,000
        
        $
        7,184,000Supplemental disclosure of cash flowCash paid for interest
        
        $
        192,000
        
        $
        
        
        $
        




See accompanying notes.



47

---

1. Description of Business



Vascular Solutions, Inc. (the Company) is a medical device company focused on bringing solutions to interventional cardiologists and interventional radiologists. The Companys main product lines consist of the following:




        Hemostatic (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 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 catheter and Skyway® support catheters, and



        Access products, principally consisting of micro-introducers and guidewires used to gain percutaneous access to the vasculature.




As a vertically-integrated medical device company, the Company generates ideas and creates new interventional medical devices, and then delivers the products directly to the physician through a direct domestic sales force and an international distribution network. The Company was incorporated in the state of Minnesota in December 1996 and began operations in February 1997.



2. Summary of Significant Accounting Policies



Basis of Consolidation



The consolidated financial statements include the accounts of Vascular Solutions, Inc. and its wholly owned subsidiary, Vascular Solutions GmbH, after elimination of intercompany accounts and transactions.



Segment Reporting



A business segment is a distinguishable component of an enterprise that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments. The Companys segments have similar economic characteristics and are similar in the nature of the products sold, type of customers, methods used to distribute the Companys products and regulatory environment. Management believes that the Company meets the criteria for aggregating its operating segments into a single reporting segment.



Foreign Currency Translation and Transactions



Vascular Solutions, GmbH accounts for its transactions in its functional currency the Euro. Foreign assets and liabilities are translated into U.S. dollars using the year-end exchange rates. Equity is translated at average historical exchange rates. Results of operations are translated using the average exchange rates throughout the year. Translation gains or losses are accumulated as a separate component of shareholders equity.



48

---

2. Summary of Significant Accounting Policies (Continued)



Comprehensive Loss



The components of comprehensive loss are net loss and the effects of foreign currency translation adjustments. The accumulated other comprehensive income (loss) for the foreign currency translation adjustment at December 31, 2006 and 2005 was $67,000 and $(8,000), respectively.



Fair Value of Financial Instruments



The carrying amount for cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximates fair value due to the immediate or short-term maturity of these financial instruments. The fair value of long-term debt approximate their carrying value because the terms are equivalent to borrowing rates currently available to the Company for debt with similar terms and maturities.



Use of Estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.



Cash and Cash Equivalents



The Company classifies all highly liquid investments with initial maturities of three months or less as cash equivalents. Cash equivalents consist of cash and money market funds and are stated at cost, which approximates market value. The Company deposits its cash in high quality financial institutions. The balances, at times, may exceed federally insured limits.



Credit risk and allowance for doubtful accounts



The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its 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 December 31, 2006 and 2005, the allowance for doubtful accounts was $65,000 and $110,000, respectively.



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 its balance sheet. At December 31, 2006 and 2005, the sales and return allowance was $45,000 and $30,000, respectively.



Accounts receivable are shown net of the combined total of the allowance for doubtful accounts and allowance for sales returns of $110,000 and $140,000 at December 31, 2006 and 2005, respectively.



49

---

2. Summary of Significant Accounting Policies (Continued)



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 at December 31:



2006
        
        2005Raw materials
        
        $
        4,340,000
        
        $
        4,965,000Work-in-process
        
        
        590,000
        
        
        834,000Finished goods
        
        
        2,302,000
        
        
        1,163,000$
        7,232,000
        
        $
        6,962,000




Property and Equipment



Property and equipment are stated at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets as follows:



Manufacturing equipment
        1 to 8 yearsOffice and computer equipment
        1 to 5 yearsFurniture and fixtures
        3 to 8 yearsLeasehold improvements
        Shorter of useful life orremaining term of the leaseResearch and development equipment
        3 to 7 years




Impairment of Long-Lived Assets



The Company will record impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amount. The amount of impairment loss recorded will be measured as the amount by which the carrying value of the assets exceeds the fair value of the assets. To date, the Company has determined that no impairment of long-lived assets exists.



Revenue Recognition



In the United States and Germany, 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, 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.



In all other 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.



50

---

2. Summary of Significant Accounting Policies (Continued)



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.



Shipping and handling costs



In accordance with the Emerging Issues Task Force (EITF) issue 00-10, Accounting for Shipping and Handling Fees and Costs, the Company includes shipping and handling revenues in net sales and shipping and handling costs in cost of goods sold.



Research and Development Costs



All research and development costs are charged to operations as incurred.



Warranty Costs



Certain of the Companys products are covered by warranties against defects in material and workmanship for periods of up to 24 months. The Company records a liability for warranty claims at the time of sale. The amount of the liability is based on the amount the Company is charged from its original equipment manufacturer to cover the warranty period. The original equipment manufacturer includes a year warranty with each product sold to the Company. The Company records 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.



Warranty provisions and claims for the years ended December 31, 2006 and 2005, were as follows:



2006
        
        2005Beginning balance
        
        $
        50,000
        
        $
        33,000Warranty provisions
        
        
        19,000
        
        
        21,000Warranty claims
        
        
        (23,000
        )
        
        (4,000
        )Ending balance
        
        $
        46,000
        
        $
        50,000




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. Refer to Notes 8, 9 and 10 for additional information related to these stock-based compensation plans.



Effective January 1, 2006, the Company adopted Statement 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.



51

---

2. Summary of Significant Accounting Policies (Continued)



Under the modified prospective approach, SFAS 123R
applies to new awards and to awards that were outstanding on January 1, 2006 that are subsequently modified, repurchased,
cancelled or vest. Under the modified prospective approach, compensation cost recognized in 2006 includes compensation cost for
all share-based payments granted prior to, but not yet vested on, January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123R, and compensation cost for all shared-based payments granted subsequent to January 1,
2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Prior periods were not restated
to reflect the impact of adopting the new standard.



As a result of adopting SFAS 123R on January 1, 2006, the net loss and net loss per share for the year ended December 31, 2006, were $1,088,000 and $0.07 lower, respectively, than if the Company had continued to account for stock-based compensation under APB Opinion No. 25.



The following table illustrates the effect on net loss and net loss per share had the Company accounted for stock-based compensation in accordance with SFAS 123R for the years ended December 31, 2005 and 2004:



Year Ended December 312005
        
        2004Net loss, as reported
        
        $
        (561,000
        )
        $
        (3,508,000
        )Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards
        
        
        (1,377,000
        )
        
        (1,231,000
        )Pro forma net loss
        
        $
        (1,938,000
        )
        $
        (4,739,000
        )Net loss per common share:Basic and diluted  as reported
        
        $
        (0.04
        )
        $
        (0.25
        )Basic and diluted  pro forma
        
        $
        (0.13
        )
        $
        (0.34
        )




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



2006
        
        2005
        
        2004Stock Options and Awards:Expected life (years)
        
        5.50
        
        5.50
        
        6.50Expected volatility
        
        41
        %
        58
        %
        94
        %Dividend Yield
        
        0
        %
        0
        %
        0
        %Risk-free interest rate
        
        4.62
        %
        4.34
        %
        3.85
        %Employee Stock Purchase Plan:Expected life (years)
        
        2.0
        
        2.0
        
        2.0Expected volatility
        
        36
        %
        58
        %
        94
        %Dividend Yield
        
        0
        %
        0
        %
        0
        %Risk-free interest rate
        
        4.75
        %
        4.34
        %
        3.85
        %




The weighted average fair value of stock options and awards granted with an exercise price equal to the deemed stock price on the date of grant during 2006, 2005 and 2004 was $5.42, $5.64 and $5.77, respectively.



52

---

2. Summary of Significant Accounting Policies (Continued)



The Company calculates expected volatility for stock options and awards using historical volatility as the Company believes the expected volatility will approximate 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 estimates the forfeiture rate for stock options using 10% for key employees and 15% for non-key employees.



The Company calculates expected volatility for
employee stock purchase plan shares using historical volatility over a two year period as the Company believes the expected
volatility will approximate historical volatility. A two year period is used to coincide with the maximum two year offering period
under the employee stock purchase plan.



The risk-free rates for the expected terms of the stock options and awards and the employee stock purchase plan is based on the U.S. Treasury yield curve in effect at the time of grant.



Income Taxes



Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and the tax bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance to the extent that realization of the related deferred tax asset is not assured.



Net Loss Per Common Share



In accordance with SFAS No. 128,Earnings Per Share, basic net loss per common share is computed by dividing net loss by the weighted average common shares outstanding during the periods presented. Diluted net loss per common share is computed by dividing net loss by the weighted average common and potential dilutive common shares outstanding computed in accordance with the treasury stock method. For all periods presented, diluted loss per share is the same as basic loss per common share because the effect of outstanding options and warrants is antidilutive.



Goodwill and Other Intangible Assets



In fiscal 2002, the Company adopted SFAS No. 142,Goodwill and Other Intangible Assets. Goodwill is tested for impairment annually in the fourth quarter or more frequently if changes in circumstances or the occurrence of events suggest impairment exists. The Company has concluded that no impairment of goodwill exists as of December 31, 2006.



Other intangible assets consist of purchased technology. Purchased technology was amortized using the straight-line method over its estimated useful life of four years. The Company reviewed intangible assets for impairment as changes in circumstances or the occurrence of events suggested the remaining value was not recoverable.



Reclassification



Certain 2005 and 2004 amounts have been reclassified to conform to the 2006 presentation.



53

---

3. Goodwill and Other Intangible Assets



As discussed in Note 2 above, the Company has adopted SFAS No. 141 and determined that the developed technology the Company acquired from Angiosonics, Inc. in April 2002 would be amortized over its useful life of four years. The goodwill acquired will not be amortized. In April 2006, the Company completed the amortization of the purchased technology.Amortization expense of purchased technology was $72,000, $218,000 and $218,000 for the years ended December 31, 2006, 2005 and 2004, respectively.



Balances of acquired intangible assets as of December 31, 2006 were as follows:



CarryingAmount
        
        AccumulatedAmortization
        
        NetAmortizing intangibles:Purchased technology
        
        $
        870,000
        
        $
        870,000
        
        $
        Non-amortizing intangibles:Goodwill
        
        
        193,000
        
        
        
        
        
        193,000$
        1,063,000
        
        $
        870,000
        
        $
        193,000




Balances of acquired intangible assets as of December 31, 2005 were as follows:



CarryingAmount
        
        AccumulatedAmortization
        
        NetAmortizing intangibles:Purchased technology
        
        $
        870,000
        
        $
        798,000
        
        $
        72,000Non-amortizing intangibles:Goodwill
        
        
        193,000
        
        
        
        
        
        193,000$
        1,063,000
        
        $
        798,000
        
        $
        265,000






4. Property and Equipment



Property and equipment consists of the following at December 31:



2006
        
        2005Property and equipment:Manufacturing equipment
        
        $
        3,782,000
        
        $
        3,083,000Office and computer equipment
        
        
        1,163,000
        
        
        1,153,000Furniture and fixtures
        
        
        313,000
        
        
        303,000Leasehold improvements
        
        
        554,000
        
        
        462,000Research and development equipment
        
        
        398,000
        
        
        367,000Construction-in-process
        
        
        692,000
        
        
        6,902,000
        
        
        5,368,000Less accumulated depreciation
        
        
        (3,233,000
        )
        
        (2,413,000
        )Net property and equipment
        
        $
        3,669,000
        
        $
        2,955,000






54

---

5. Lines of Credit



On December 28, 2006, the Company modified and extended the secured asset-based loan and security agreement dated December 31, 2003, and as amended December 29, 2005. The operating line of credit is a one-year, $5,000,000 facility with availability based primarily on eligible customer receivables and inventory. The interest rate is prime plus 0.5%. As of December 31, 2006, the Company had no outstanding loan balance against the facility. Based on the Companys eligible customer receivables, inventory and cash balances, $5,000,000 was available for borrowing as of December 31, 2006. The operating line of credit also requires a one time facility fee of $25,000.



The equipment line of credit is a three-year, $2,000,000 facility with an interest rate of prime plus 1.5%. On January 6, 2006, the Company executed a $2,000,000 advance on the equipment line of credit. The advance is secured by various equipment acquired by the Company during the year ended December 31, 2005. As of December 31, 2006, the Company had $1,667,000 outstanding loan balance against the facility. The weighted average interest rate for the year ended December 31, 2006 on the equipment line of credit was 9.5%.



The credit facility includes two covenants: minimum
tangible net worth of $11,000,000 through September 30, 2007, $13,000,000 thereafter, and liquidity coverage of not less than 1.25
to 1.00. The minimum tangible net worth covenant will increase by the sum of 50% of the Companys quarterly net profit
beginning with the quarter ending March 30, 2007 plus all consideration for equity securities received after December 1, 2006. The
Company was in compliance with these covenants at December 31, 2006.



Future minimum commitments under this equipment line of credit as of December 31, 2006 are as follows:



2007
        
        $
        800,0002008
        
        
        800,0002009
        
        
        67,000$
        1,667,000




6. Leases



The Company leases two buildings totaling approximately 57,000 square-feet under separate operating leases, which both expire in September 2008, with renewal options. Rent expense related to the operating lease was approximately $481,000, $402,000 and $343,000 for the years ended December 31, 2006, 2005, and 2004, respectively.



Future minimum lease commitments under this operating lease as of December 31, 2006 are as follows:



2007
        
        $
        407,0002008
        
        
        305,000$
        712,000




7. Income Taxes



At December 31, 2006, the Company had net operating loss carryforwards of approximately $58,915,000 for federal income tax purposes that are available to offset future taxable income and begin to expire in the year 2013. Included in the U.S. amount are approximately $2.3 million of deductions resulting from disqualifying dispositions of stock options. When these deductions from disqualifying dispositions are realized for financial statement purposes they will not result in a reduction in income tax expense, rather the benefit will be recorded as additional paid-in-capital. At December 31, 2006, the Company also had federal and Minnesota research and development tax credit carryforwards of approximately $2,709,000, which begin to expire in the year 2013. At December 31, 2006, the Company has foreign tax loss carryforwards of approximately $2,653,000 that do not expire. No benefit has been
recorded for any loss or credit carryforwards, and utilization in future years may be limited under Sections 382 and 383 of the Internal Revenue Code if significant ownership changes have occurred or from future tax legislation changes. The Company performed a section 382 study during the third quarter of 2005 on its federal net operating loss carryforward and the Company concluded that it will have no limitations on the net operating loss carryforward.



55

---

7. Income Taxes (Continued)



The components of the Companys deferred tax assets and liabilities as of December 31, 2006 and 2005 are as follows:



2006
        
        2005Deferred tax assets:Net operating loss carryforwards
        
        $
        24,011,000
        
        $
        24,257,000Tax credit carryforwards
        
        
        2,709,000
        
        
        2,086,000Depreciation and amortization
        
        
        199,000
        
        
        249,000Accrued compensation
        
        
        247,000
        
        
        210,000Stock based compensation
        
        
        419,000
        
        
        Inventory reserve
        
        
        47,000
        
        
        180,000Other
        
        
        80,000
        
        
        102,00027,712,000
        
        
        27,084,000Less valuation allowances
        
        
        (27,712,000
        )
        
        (27,084,000
        )Net deferred taxes
        
        $
        
        
        $
        




The Company records a valuation allowance to reduce the carrying value of the net deferred taxes to an amount that is more likely than not to be realized. The increase in the valuation allowance was $628,000, $667,000 and $2,196,000 for the years ending December 31, 2006, 2005 and 2004, respectively.



Reconciliation of the statutory federal income tax rate to the Companys effective tax rate is as follows:



2006
        
        2005
        
        2004Tax at statutory rate
        
        (34.0
        )%
        (34.0
        )%
        (34.0
        )%State income taxes, net of federal benefit
        
        (5.0
        )
        (5.0
        )
        (6.0
        )Meals and entertainment
        
        9.0
        
        19.0
        
        3.0Recognition of valuation allowance
        
        30.0
        
        20.0
        
        37.0Effective income tax rate
        
        
        %
        
        %
        
        %




8. Stock Options, Restricted Shares and Warrants



Stock Option 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 December 31, 2006, the Company had reserved 4,400,000 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. Prior to the initial public offering in July 2000, the Board of Directors determined the fair value of the Companys common shares underlying options by assessing
the business progress of the Company as well as the market conditions for medical device companies and other external factors. Vesting requirements of all awards under this plan are time based and vary by individual grant. 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.



56

---

8. Stock Options, Restricted Shares and Warrants (Continued)



On April 18, 2006, the Company granted stock options to its directors and non-employee medical advisors under the Stock Option Plan. The options issued to the Companys directors vest over a one-year period based on the continuation of service as a director of the Company. The options issued to the Companys medical advisors vest over a two-year period based on continued service in this capacity to the Company.



Option activity is summarized as follows:



|                                 |  | Shares
Available
for Grant
(exclusive of restrictedshares issued) |   | Plan OptionsOutstanding |   | ExercisePrice |      | Weighted Average ExercisePrice |        | Aggregate
IntrinsicValue |  
|-------------------------------- |  | ----------------------------------------------------------------- | - | ----------------------- | - | ------------- | ---- | ------------------------------ | ------ | ------------------------ | -
|                                 |  |                                                                   |   |                         |   |               |      |                                |        |                          |  
|Balance at December 31, 2003     |  | 1,044,000                                                         |   | 1,505,000               |   |               | 0.78 |                               | 12.00  |                          |  
|Shares reserved                  |  | 500,000                                                           |   |                        |   |               |      |                                |       |                          |  
|Granted                          |  | (357,000                                                          | ) | 357,000                 |   |               | 6.74 |                               | 10.89  |                          |  
|Exercised                        |  |                                                                  |   | (167,000                | ) |               | 0.78 |                               | 7.31   |                          |  
|Canceled                         |  | 50,000                                                            |   | (50,000                 | ) |               | 0.84 |                               | 7.48   |                          |  
|Balance at December 31, 2004     |  | 1,237,000                                                         |   | 1,645,000               |   |               | 0.78 |                               | 12.00  |                          |  
|Shares reserved                  |  | 500,000                                                           |   |                        |   |               |      |                                |       |                          |  
|Granted                          |  | (344,000                                                          | ) | 344,000                 |   |               | 8.90 |                               | 11.62  |                          |  
|Exercised                        |  |                                                                  |   | (181,000                | ) |               | 0.78 |                               | 10.89  |                          |  
|Canceled                         |  | 93,000                                                            |   | (93,000                 | ) |               | 0.81 |                               | 9.46   |                          |  
|Balance at December 31, 2005     |  | 1,486,000                                                         |   | 1,715,000               |   | $             | 0.78 |                               | $12.00 |                          | $
|Shares reserved                  |  | 500,000                                                           |   |                        |   |               |      |                                |       |                          |  
|Granted                          |  | (74,000                                                           | ) | 74,000                  |   |               |      |                                | 7.88   |                          |  
|Exercised                        |  |                                                                  |   | (198,000                | ) |               | 0.78 |                               | 7.48   |                          |  
|Forfeited                        |  | 53,000                                                            |   | (53,000                 | ) |               | 0.78 |                               | 9.46   |                          |  
|Expired                          |  | 26,000                                                            |   | (26,000                 | ) |               | 0.84 |                               | 9.46   |                          |  
|Balance at December 31, 2006     |  | 1,991,000                                                         |   | 1,512,000               |   | $             | 0.78 |                               | $12.00 |                          | $
|Exercisable at December 31, 2006 |  |                                                                   |   | 1,296,000               |   |               |      |                                |        |                          | $



The weighted average remaining contractual term of options exercisable at December 31, 2006, was 5.3 years. The total intrinsic value of options exercised during fiscal 2006, 2005 and 2004, was $1,163,000, $1,310,000 and $1,286,000.



57

---

8. Stock Options, Restricted Shares and Warrants (Continued)



The following table summarizes information about stock options outstanding at December 31, 2006:



Options Outstanding
        
        Options ExercisableRange ofExercise Prices
        
        Outstandingas ofDecember 31, 2006
        
        Weighted Average Remaining Contractual Life
        
        Weighted Average Exercise Price
        
        Exercisable
as of
December 31, 2006
        
        Weighted Average Exercise Price$
        0.78
        
        $
        0.81
        
        59,000
        
        6.1
        
        $
        0.79
        
        58,000
        
        $
        0.790.82
        
        
        0.84
        
        382,000
        
        6.1
        
        
        0.84
        
        369,000
        
        
        0.840.85
        
        
        2.07
        
        47,000
        
        1.6
        
        
        1.58
        
        47,000
        
        
        1.582.08
        
        
        2.51
        
        103,000
        
        4.8
        
        
        2.49
        
        103,000
        
        
        2.492.52
        
        
        7.48
        
        480,000
        
        4.6
        
        
        6.27
        
        433,000
        
        
        6.227.49
        
        
        10.00
        
        348,000
        
        6.4
        
        
        9.18
        
        213,000
        
        
        9.2110.01
        
        
        12.00
        
        93,000
        
        7.8
        
        
        11.06
        
        73,000
        
        
        11.031,512,000
        
        5.6
        
        $
        5.24
        
        1,296,000
        
        $
        4.74




As of December 31, 2006, there was $389,000of total unrecognized compensation costs related to the outstanding stock options, which is expected to be recognized over a weighted average period of 0.79 years.



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. During 2006 the Company granted restricted shares to employees under the Stock Option Plan. The restricted shares vest over a four-year period based on the continuation of employment.



Restricted share activity is summarized as follows:



SharesOutstanding
        
        Weighted Average Grant Date FairValueBalance at December 31, 2005
        
        
        
        
        Granted
        
        174,000
        
        
        5.42Vested
        
        
        
        
        Forfeited
        
        (15,000
        )
        
        5.41Expired
        
        
        
        
        Balance at December 31, 2006
        
        159,000
        
        $
        5.42




As of December 31, 2006, there was $498,000 of total unrecognized compensation costs related to the outstanding restricted shares, which is expected to be recognized over a weighted average period of 3.15 years. The Company used a discount factor of 30% to determine the fair value at the date of grant based on an analysis of the Companys private placement offering completed in March 2004 and other illiquidity factors. The Company estimates the forfeiture rate for restricted stock using 10% for key employees and 15% for non-key employees.



The net remaining shares available for grant under the stock option plan is 1,832,000 shares.



58

---

8. Stock Options, Restricted Shares and Warrants (Continued)



Deferred Compensation



In 2006, 2005, and 2004, the Company recorded $12,000, $13,000 and $54,000, respectively, of deferred compensation in connection with certain nonqualified stock options granted to medical advisory board members. The weighted average fair value of these options was $5.84. The deferred compensation recorded is amortized ratably over the period that the options vest and is adjusted for options which have been canceled. Vesting requirements for nonqualified stock options under this plan will vary by individual grant. Deferred compensation expense was $31,000, $22,000 and $12,000 for the years ended December 31, 2006, 2005, and 2004, respectively.



Warrants



As of December 31, 2006, the Company had the following warrants outstanding and exercisable:



Exercise Price
        
        Outstanding as ofDecember 31, 2005
        
        Expiration Date1.50
        
        21,000
        
        January 31, 20071.50
        
        3,000
        
        February 14, 20073.00
        
        68,000
        
        December 29, 2007$
        2.60
        
        92,000




9. Employee Stock Purchase Plan



The Company has an Employee Stock Purchase Plan (the Purchase Plan) under which 1,500,000 shares of common stock have been reserved for issuance. Eligible employees may contribute 1% to 10% of their compensation to purchase shares of the Companys common stock at a discount of 15% of the market value at certain plan-defined dates up to a maximum of 2,000 shares per purchasing period. The Purchase Plan terminates in May 2010. In fiscal 2006, 2005 and 2004, 98,500 shares, 99,500 shares, and 245,600 shares, respectively, were issued under the Purchase Plan. At December 31, 2006, 628,000 shares were available for issuance under the Purchase Plan.



As of December 31, 2006, there was $161,000 of total unrecognized compensation costs related to the employee stock purchase plan, which is expected to be recognized over a weighted average period of 0.55 years.



10. Employee Retirement Savings Plan



The Company has an employee 401(k) retirement savings plan (the Plan). The Plan provides eligible employees with an opportunity to make tax-deferred contributions into a long-term investment and savings program. All employees over the age of 21 are eligible to participate in the Plan beginning with the first quarterly open enrollment date following start of employment. Through December 31, 2001, the Plan allowed eligible employees to contribute up to 18% of their annual compensation. Effective January 1, 2002, the employee contribution limit was increased to 50% of their annual compensation, subject to a maximum limit determined by the Internal Revenue Service, with the Company contributing an amount equal to 25% of the first 5% contributed to the Plan. The Company recorded an expense of $120,000, $89,000 and $73,000 for contributions to the Plan for the years ended December 31, 2006, 2005, and 2004, respectively.



59

---

11. Concentrations of Credit and Other Risks



In the United States and Germany, the Company sells its products directly to hospitals and clinics. In all other 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 product could have a material adverse effect on the Companys financial condition and results of operations.



No customers were more than 5% of net sales for the years ended December 31, 2006, 2005 and 2004.



With respect to accounts receivable, the Company performs credit evaluations of its customers and does not require collateral. No customers were more than 5% of gross accounts receivable as of December 31, 2006 and 2005. There have been no material losses on customer receivables.



Sales by geographic destination as a percentage of total net sales were as follows for the years ended December 31:



2006
        
        2005
        
        2004Domestic
        
        88%
        
        89%
        
        89%Foreign
        
        12
        
        11
        
        11




12. Related Party Sales



In fiscal 2006, 2005 and 2004, the Company sold $518,000, $419,000 and $279,000 of product to a company in which a board member of the Company is a Vice President. As of December 31, 2006 and 2005, the Company had an accounts receivable balance due of $77,000 and $70,000 from this related party company.



13. 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 Duett and D-Stat products) under a Purchase Agreement dated January 9, 2007 (see footnote 16) with a subsidiary of King Pharmaceuticals, Inc. (King). The agreement provides for a fixed price, with adjustments based on a producer price index tied to pharmaceuticals. The previous agreement with King expired on May 29, 2005. In anticipation of the previous agreement expiring, the Company submitted purchase orders to King for approximately $3.5 million of thrombin to benefit from the pricing provisions of the agreement. As of December 31,
2006, the Company had purchased orders totaling $1 million outstanding out of the total submitted purchase orders of $3.5 million.  As part of the supply agreement dated January 9, 2007, the outstanding purchased orders were cancelled and the Company issued King new purchase orders for thrombin under the terms of the new agreement.



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 agreement, the Company will be paying for certain development costs of Sigma to allow
Sigma to produce thrombin. The payments are based on achievement of certain milestones over a two year period. The contract
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 agreement. During the term of the
contract, Sigma has agreed not to sell thrombin of the type developed for the Company under the contract in or as a component of a
hemostatic product for medical use. The Company does not have any minimum purchase requirements under the contract; however, if
the Company purchases less than three lots of thrombin in any year 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
contract on 30 days notice.



60

---

13. Dependence on Key Suppliers (Continued)



The Sigma contract is part of the Companys plan to fully qualify a second source of thrombin and to bring the new thrombin through the regulatory process to be used in the Companys hemostatic products. The cost associated with the Sigma agreement are part of the Companys total estimated expenditures of $7.6 million (including the payments to Sigma) to complete the thrombin qualification project.



The costs and purchases incurred through December 31, 2006 and the total estimated costs and purchases for the thrombin project (including costs and purchases already incurred) are as follows:



Incurred (as ofDecember 31, 2006)
        
        Total EstimatedQualification expenses
        
        $
        4.6 million
        
        $
        5.3 millionCapital equipment purchases
        
        
        1.0 million
        
        
        1.0 millionThrombin inventory purchases(net of thrombin expensed)
        
        
        1.3 million
        
        
        1.3 million$
        6.9 million
        
        $
        7.6 million




The costs and purchases incurred through December 31, 2005 and the total estimated costs and purchases for the thrombin project (including costs and purchases already incurred) were as follows:



Incurred (as ofDecember 31, 2005)
        
        Total EstimatedQualification expenses
        
        $
        1.8 million
        
        $
        4.3 millionCapital equipment purchases
        
        
        0.7 million
        
        
        0.8 millionThrombin inventory purchases
        
        
        1.7 million
        
        
        1.7 million$
        4.2 million
        
        $
        6.8 million




14. Commitments and Contingencies



All legal cost related to litigation are charged to operations as incurred, except settlements which are expensed when a claim is probable and estimatable.



Diomed Litigation



On December 11, 2003, the Company and a non-officer
employee of the Company were named as defendants in a lawsuit brought by Diomed in the United States District Court for the
District of Massachusetts. The complaint alleges that in marketing the Companys Vari-Lase endovenous laser procedure kit the
Company engaged in false advertising and infringed a registered trademark of Diomed. The complaint also alleges that the
non-officer employee, who previously worked for a company that conducted business with Diomed, improperly utilized trade secrets
of Diomed in developing the Companys Vari-Lase procedure kit. The complaint requests monetary damages and an injunction on
the sale of the Companys Vari-Lase procedure kit. The Company believes that the allegations included in the complaint are
wholly without merit. On January 31, 2006, the Court granted the Companys motion for summary judgment dismissing all counts
of Diomeds complaint with the exception of one trade secret misappropriation count and a portion of two other counts to the
extent they were based on alleged trade secret misappropriation. The Companys counterclaim against Diomed was not dismissed.
On June 23, 2006, the Company entered into an agreement with Diomed that settled the litigation and all issues surrounding
Diomeds marked sheath patents. The terms of the settlement are confidential and did not have a material effect on the
consolidated results of operations for the year ended December 31, 2006. The settlement did not affect the ongoing dispute between
the parties regarding Diomeds United States Patent Number 6,398,777 discussed below.



61

---

14. Commitments and Contingencies (Continued)



On March 4, 2004, the Company was named as the defendant in an intellectual property lawsuit brought by Diomed in the United States District Court for the District of Massachusetts.  The complaint requested a judgment that 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, Inc. and asked for relief in the form of an injunction that would prevent the Company from selling Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of the product, and other costs, disbursements and attorneys fees. On April 12, 2005, the judge entered a Memorandum and Order on Claims Construction from the Markman hearing phase of the litigation. In the Order, the judge held that in order to violate the Diomed patent, a competing method must deliberately put the tip of the laser fiber in physical contact with
the wall of the vein, must drain blood from the vein, must compress the vein and must maintain vein wall contact as the laser energy is delivered. The Company believes its Vari-Lase products are not used in this method, and thus does not believe the litigation has merit. On December 21, 2005, the Company filed a motion for summary judgment, in which the Company sought dismissal of all claims, and Diomed filed its motion for summary judgment, in which it sought a judgment of validity and infringement. On August 30, 2006, the Court issued its ruling which denied all partys motions for summary judgment concerning infringement and ruled that the patent is valid. The trial is scheduled to start on March 12, 2007. It is not possible to predict the timing or outcome of this litigation, including whether it will affect the Companys ability to sell its Vari-Lase products, or to estimate the amount or range of potential loss.



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. 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 infringes on four patents held by VNUS® Medical Technologies, Inc. and asked for relief in the form of an injunction that would prevent the Company from selling its Vari-Lase products, compensatory and treble damages caused by the manufacture and sale of our product, and other costs, disbursements and attorneys fees. The Company believes its Vari-Lase products do not violate these patents, and thus the Company does not believe the litigation has merit.



This litigation is scheduled for trial on October 29, 2007. It is not possible to predict the timing or outcome of this litigation, including whether it will affect the Companys ability to sell its Vari-Lase products, or to estimate the amount or range of potential loss.



MedArt Purchase Commitment



The Company signed a purchase agreement with MedArt Corporation on September 22, 2003. Under that agreement, the Company was obligated to purchase laser consoles with an aggregate purchase price of $1,197,000 for its Vari-Lase business during the first year of the agreement, which commenced in December 2003. The Company fulfilled its laser console purchase requirement of $1,197,000 during 2004.



62

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15. Quarterly Financial Data (Unaudited, in Thousands, Except per Share Data)





2006
        
        FourthQuarter
        
        ThirdQuarter
        
        SecondQuarter
        
        FirstQuarterNet sales
        
        $
        11,492
        
        $
        10,955
        
        $
        10,911
        
        $
        9,952Gross profit
        
        
        7,703
        
        
        7,361
        
        
        7,264
        
        
        6,751Operating income (loss)
        
        
        118
        
        
        (332
        )
        
        (627
        )
        
        (838
        )Net income (loss)
        
        
        90
        
        
        (368
        )
        
        (653
        )
        
        (855
        )Basic and diluted net income (loss) per share
        
        $
        0.01
        
        $
        (0.02
        )
        $
        (0.04
        )
        $
        (0.06
        )2005Net sales
        
        $
        8,859
        
        $
        8,574
        
        $
        8,079
        
        $
        7,274Gross profit
        
        
        6,169
        
        
        6,244
        
        
        5,771
        
        
        5,216Operating loss
        
        
        (450
        )
        
        16
        
        
        33
        
        
        (323
        )Net loss
        
        
        (407
        )
        
        60
        
        
        75
        
        
        (289
        )Basic and diluted net loss per share
        
        $
        (0.03
        )
        $
        0.00
        
        $
        0.00
        
        $
        (0.02
        )




16. Subsequent Event



On January 9, 2007, the Company entered into three separate agreements with King: a License Agreement, a Device Supply agreement and a Thrombin-JMI Supply Agreement. The Company licensed the exclusive rights of Thrombix, ThrombiGel and ThrombiGel Paste to King for $6 million. The Company will manufacture the licensed products under the Device Supply Agreement. The Device Supply Agreement requires King to pay the Company two separate $1 million milestone payments; one for the first commercial sale of ThrombiGel and/or Thrombix and one for the first commercial sale of ThrombiGel Paste. The Company will amortize the $6 million license fee on a straight-line basis over 10 years. The Company will also recognize the two $1 million milestone payments over the remaining 10-year license period once they are received.



The Device Supply Agreement requires the Company to make a one-time payment of $2,500,000 to King if the FDA does not approve the surgical indication of ThrombiGel and a one-time payment of $2,500,000 to King if the FDA does not approve the surgical indication of ThrombiGel Paste. The Company believes the probability of paying the one-time payments as defined under the Device Supply Agreement is remote, therefore the Company will not record a provision for the two one-time payments. The Company has also entered into a long-term supply agreement with King for the supply of thrombin-JMI.





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