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EXCEL - IDEA: XBRL DOCUMENT - VASCULAR SOLUTIONS INCFinancial_Report.xls

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014

OR

 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________

Commission File Number: 0-27605

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 North
Minneapolis, Minnesota 55369
(Address of principal executive offices, including zip code)

 (763) 656-4300
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former
fiscal year, if changed since last report)


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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer   o
Smaller Reporting Company o
                                                                                                                                        
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

The registrant had 17,176,422 shares of common stock, $.01 par value per share, outstanding as of October 17, 2014.



VASCULAR SOLUTIONS, INC.

TABLE OF CONTENTS
 
 
Page
2
 
Item 1.
2
 
2
 
3
 
4
 
5
 
6
     
Item 2.
13
 
Item 3.
20
 
Item 4.
21
 
21
    
 
Item 1. Legal Proceedings 21
 
Item 1A.
21
 
Item 2.
27
 
Item 3.
27
 
Item 4.
28
 
Item 5.
28
 
Item 6.
28

PART 1. FINANCIAL INFORMATION

Item 1.
Financial Statements
 
VASCULAR SOLUTIONS, INC.

Consolidated Balance Sheets
 
   
September 30, 2014
   
December 31, 2013
 
   
(unaudited)
   
(see note)
 
Assets
       
Current assets:
       
Cash and cash equivalents
 
$
41,649,000
   
$
30,785,000
 
Accounts receivable, net of reserves of $285,000 and $200,000 in 2014 and 2013, respectively
   
16,091,000
     
14,481,000
 
Inventories
   
15,732,000
     
14,002,000
 
Prepaid expenses and other
   
4,478,000
     
2,472,000
 
Current portion of deferred tax assets
   
6,000,000
     
6,000,000
 
Total current assets
   
83,950,000
     
67,740,000
 
                 
Property, plant and equipment, net
   
17,616,000
     
16,187,000
 
Goodwill
   
10,346,000
     
10,532,000
 
Intangible assets, net
   
10,614,000
     
11,943,000
 
Deferred tax assets, net of current portion
   
594,000
     
1,739,000
 
Total assets
 
$
123,120,000
   
$
108,141,000
 
                 
Liabilities and shareholders’ equity
               
Current liabilities:
               
Accounts payable
 
$
4,847,000
   
$
3,762,000
 
Accrued compensation
   
5,074,000
     
4,365,000
 
Accrued expenses
   
3,683,000
     
2,467,000
 
Accrued royalties
   
229,000
     
235,000
 
Current portion of deferred revenue
   
425,000
     
556,000
 
Total current liabilities
   
14,258,000
     
11,385,000
 
                 
Long-term deferred revenue, net of current portion
   
253,000
     
406,000
 
Long-term deferred tax liabilities
   
723,000
     
 
Total long-term liabilities
   
976,000
     
406,000
 
                 
Shareholders’ equity:
               
Common stock, $0.01 par value: Authorized shares – 40,000,000 Issued and outstanding shares – 17,176,172 – 2014; 16,964,953 – 2013
   
172,000
     
170,000
 
Additional paid-in capital
   
95,853,000
     
92,346,000
 
Accumulated other comprehensive earnings
   
(548,000
)
   
(1,000
)
Retained earnings
   
12,409,000
     
3,835,000
 
Total shareholders’ equity
   
107,886,000
     
96,350,000
 
Total liabilities and shareholders’ equity
 
$
123,120,000
   
$
108,141,000
 
 
See accompanying notes.
 
Note:  The balance sheet at December 31, 2013 has been derived from the audited financial statements at that date.
VASCULAR SOLUTIONS, INC.

Consolidated Statements of Earnings

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(unaudited)
   
(unaudited)
 
                 
Net revenue:
               
Product revenue
 
$
31,766,000
   
$
27,926,000
   
$
92,216,000
   
$
81,197,000
 
License, royalty and collaboration revenue
   
163,000
     
83,000
     
297,000
     
230,000
 
Total revenue
   
31,929,000
     
28,009,000
     
92,513,000
     
81,427,000
 
                                 
Product costs and operating expenses:
                               
Cost of goods sold
   
10,291,000
     
9,197,000
     
30,158,000
     
26,432,000
 
Collaboration expenses
   
93,000
     
32,000
     
125,000
     
41,000
 
Research and development
   
3,322,000
     
3,140,000
     
9,839,000
     
10,027,000
 
Clinical and regulatory
   
1,196,000
     
997,000
     
3,771,000
     
3,259,000
 
Sales and marketing
   
7,327,000
     
6,706,000
     
22,406,000
     
20,462,000
 
General and administrative
   
3,692,000
     
2,362,000
     
9,282,000
     
6,871,000
 
Litigation
   
     
812,000
     
     
812,000
 
Medical device excise taxes
   
385,000
     
339,000
     
1,083,000
     
995,000
 
Amortization of purchased technology and intangibles
   
410,000
     
404,000
     
1,234,000
     
1,162,000
 
Total product costs and operating expenses
   
26,716,000
     
23,989,000
     
77,898,000
     
70,061,000
 
                                 
Operating earnings
   
5,213,000
     
4,020,000
     
14,615,000
     
11,366,000
 
                                 
Other earnings (expenses):
                               
Interest expense
   
     
(3,000
)
   
     
(9,000
)
Foreign exchange gain (loss)
   
(9,000
)
   
7,000
     
(8,000
)
   
(2,000
)
                                 
Earnings before income taxes
   
5,204,000
     
4,024,000
     
14,607,000
     
11,355,000
 
                                 
Income tax expense
   
(2,634,000
)
   
(1,352,000
)
   
(6,033,000
)
   
(3,750,000
)
Net earnings
 
$
2,570,000
   
$
2,672,000
   
$
8,574,000
   
$
7,605,000
 
                                 
Net earnings per share – basic
 
$
0.15
   
$
0.16
   
$
0.51
   
$
0.47
 
Net earnings per share – diluted
 
$
0.15
   
$
0.16
   
$
0.49
   
$
0.45
 

See accompanying notes.
VASCULAR SOLUTIONS, INC.

Consolidated Statements of Comprehensive Earnings

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(unaudited)
   
(unaudited)
 
                 
Net earnings
 
$
2,570,000
   
$
2,672,000
   
$
8,574,000
   
$
7,605,000
 
Other comprehensive earnings (losses), net of $0 tax: Foreign currency translation adjustments
   
(346,000
)
   
192,000
     
(547,000
)
   
61,000
 
Comprehensive earnings
 
$
2,224,000
   
$
2,864,000
   
$
8,027,000
   
$
7,666,000
 

See accompanying notes.
VASCULAR SOLUTIONS, INC.

Consolidated Statements of Cash Flows
 
   
Nine Months Ended
 
   
September 30,
 
   
2014
   
2013
 
   
(unaudited)
 
Operating activities
       
Net earnings
 
$
8,574,000
   
$
7,605,000
 
Adjustments to reconcile net earnings to net cash provided by operating activities:
               
Depreciation
   
2,381,000
     
2,109,000
 
Amortization
   
1,234,000
     
1,162,000
 
Stock-based compensation
   
3,030,000
     
2,567,000
 
Deferred taxes, net
   
1,868,000
     
2,275,000
 
Excess tax benefit from stock-based compensation
   
     
(1,331,000
)
Change in fair value of contingent consideration
   
     
(79,000
)
Gain on disposal of equipment
   
(24,000
)
   
(22,000
)
Change in accounts receivable allowance
   
85,000
     
15,000
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(1,708,000
)
   
(691,000
)
Inventories
   
(1,738,000
)
   
(685,000
)
Prepaid expenses and other
   
(2,038,000
)
   
(176,000
)
Accounts payable
   
1,099,000
     
127,000
 
Accrued expenses and compensation
   
1,776,000
     
659,000
 
Amortization of deferred license fees and other deferred revenue
   
(285,000
)
   
101,000
 
Net cash provided by operating activities
   
14,254,000
     
13,636,000
 
                 
Investing activities
               
Purchase of property and equipment
   
(3,829,000
)
   
(3,486,000
)
Cash paid for acquisition of license
   
     
(500,000
)
Proceeds from the sale of equipment
   
28,000
     
22,000
 
Net cash used in investing activities
   
(3,801,000
)
   
(3,964,000
)
                 
Financing activities
               
Repurchase of common shares
   
(2,312,000
)
   
(1,211,000
)
Excess tax benefit from stock-based compensation
   
1,182,000
     
1,331,000
 
Proceeds from the exercise of stock options and sale of stock, net of expenses
   
1,609,000
     
2,759,000
 
Net cash provided by financing activities
   
479,000
     
2,879,000
 
Increase in cash and cash equivalents
   
10,932,000
     
12,551,000
 
Effect of exchange rate changes on cash and cash equivalents
   
(68,000
)
   
(3,000
)
Cash and cash equivalents at beginning of period
   
30,785,000
     
11,554,000
 
Cash and cash equivalents at end of period
 
$
41,649,000
   
$
24,102,000
 
                 
Supplemental disclosure of cash flow
               
Cash paid for interest
 
$
3,000
   
$
9,000
 
Cash paid for taxes
 
$
3,844,000
   
$
1,499,000
 
 
See accompanying notes.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements

(1)
Basis of Presentation

The accompanying unaudited consolidated financial statements of Vascular Solutions, Inc. (the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation have been included.  The consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission.  Interim results of operations are not necessarily indicative of the results to be expected for the full year or any other interim periods.

(2) Net Earnings per Share

In accordance with Accounting Standards Codification (ASC) 260, Earnings Per Share, basic net earnings per share for the three and nine months ended September 30, 2014 and 2013 is computed by dividing net earnings by the weighted average common shares outstanding during the periods presented.  Diluted net earnings per weighted average common share is computed by dividing net earnings by the weighted average common shares outstanding during the period, increased to include dilutive potential common shares issuable upon the exercise of stock options and restricted stock awards that were outstanding during the period.

Weighted average common shares outstanding for the three and nine months ended September 30, 2014 and 2013 were as follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(unaudited)
   
(unaudited)
 
Weighted average shares outstanding – basic
   
16,871,000
     
16,451,000
     
16,827,000
     
16,299,000
 
Weighted average shares outstanding – diluted
   
17,691,000
     
17,067,000
     
17,642,000
     
16,894,000
 

(3)
Revenue Recognition

In the United States, the Company sells its products and services directly to hospitals and clinics.  Revenue is recognized in accordance with generally accepted accounting principles as outlined in ASC 605-10-S99, 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) collectability is reasonably assured; and (iv) product delivery has occurred or services have been rendered.  The Company recognizes revenue as products are shipped and title passes to customers based on FOB shipping point terms.  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.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued

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

The Company’s revenues from license agreements and research collaborations are recognized when earned.  In accordance with ASC 605, for revenues which contain multiple deliverables, the Company separates the deliverables into separate accounting units if they meet the following criteria: (i) the delivered items have a stand-alone value to the customer; (ii) the fair value of any undelivered items can be reliably determined; and (iii) if the arrangement includes a general right of return, delivery of the undelivered items is probable and substantially controlled by the seller.  Deliverables that do not meet these criteria are combined with one or more other deliverables into one accounting unit.  Revenue from each accounting unit is recognized based on the applicable accounting literature, primarily ASC 605.

The Company currently has a license agreement with King Pharmaceuticals, Inc. (King), now a subsidiary of Pfizer, Inc., under which the Company licensed the exclusive rights of Thrombi-Pad®, Thrombi-Gel® and Thrombi-PasteTM products to King in exchange for a license fee.  The Company is amortizing the license fees on a straight-line basis over the projected 10 year economic life of the products.  The Company determines the economic life of the products under its license agreements by evaluating similar products the Company has launched or other similar products in the medical industry.  In addition, the Company had a five-year license agreement with Nicolai, GmbH in which the Company was amortizing the license fee on a straight-line basis over the five-year life of the agreement.  This agreement was fully amortized during 2013.

Starting in January 2012, the Company began to generate revenue from selling a reprocessing service for ClosureFAST® radiofrequency catheters.  In accordance with ASC 605-45, the Company recognizes this revenue gross, with the amount paid to the supplier of the reprocessing service reflected as cost of goods sold.

In addition, the Company has reviewed the provisions of ASC 808, Collaborative Arrangements, and the adoption of this ASC has had no impact on the amounts recorded under these agreements. In accordance with ASC 605-45-45, the Company includes shipping and handling revenues in net revenue, and shipping and handling costs in cost of goods sold.

In May 2014, the Financial Accounting Standards Board (FASB) issued guidance creating Accounting Standards Codification (“ASC”) Section 606, “Revenue from Contracts with Customers.”  The new section will replace Section 605, “Revenue Recognition” and creates modifications to various other revenue accounting standards for specialized transactions and industries.  The new section is intended to conform United States revenue accounting principles with concurrently issued International Financial Reporting Standards.  Prior to the guidance, revenue recognition differed between United States practice and those of much of the rest of the world.  The guidance also is intended to enhance disclosures related to disaggregated revenue information.  The updated guidance is effective for annual reporting periods beginning on or after December 15, 2016, and interim periods within those annual periods.  The Company will adopt the new provisions of this accounting standard at the beginning of fiscal year 2017, given that early adoption is not an option.  The Company will further study the implications of this statement in order to evaluate the expected impact on the consolidated financial statements.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued

(4)
Inventories

Inventories are stated at the lower of cost (weighted average first-in, first-out method) or market.  Appropriate consideration is given to deterioration, obsolescence and other factors in evaluating net realizable value.  Inventories are comprised of the following:
 
   
September 30,
2014
   
December 31,
2013
 
   
(unaudited)
     
         
Raw materials
 
$
7,533,000
   
$
6,386,000
 
Work-in-process
   
1,548,000
     
926,000
 
Finished goods
   
6,651,000
     
6,690,000
 
   
$
15,732,000
   
$
14,002,000
 
 
(5)
Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill and acquired intangible assets for the nine months ended September 30, 2014 are as follows:

   
 
Goodwill
   
Acquired
Intangibles
 
   
(unaudited)
 
 
Balance at December 31, 2013
 
$
10,532,000
   
$
11,943,000
 
Amortization
   
     
(1,234,000
)
Foreign currency translation adjustments
   
(186,000
)
   
(95,000
)
Balance at September 30, 2014
 
$
10,346,000
   
$
10,614,000
 

(6)
Credit Risk and Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments.  This allowance is regularly evaluated by the Company for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer’s ability to pay.  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 an individual credit evaluation and the specific circumstances of the customer.  At September 30, 2014 and December 31, 2013, the allowance for doubtful accounts was $220,000 and $150,000, 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 our balance sheet.  At September 30, 2014 and December 31, 2013, the sales and return allowance was $65,000 and $50,000, respectively.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued
 
Accounts receivable are shown net of the combined total of the allowance for doubtful accounts and allowance for sales returns of $285,000 and $200,000 at September 30, 2014 and December 31, 2013, respectively.
 
(7)
Concentrations of Credit and Other Risks

In the United States, the Company sells its products and services directly to hospitals and clinics.  In all international markets, the Company sells its products to distributors who, in turn, sell to hospitals and clinics.

With respect to accounts receivable, the Company performs credit evaluations of its customers and does not require collateral.  No single customer represented greater than 10% of gross accounts receivable as of either September 30, 2014 or December 31, 2013.  There have been no material losses on customer receivables.

Revenue by geographic destination as a percentage of total net revenue for the nine month periods ended September 30, 2014 and 2013 was 83% and 85% in the United States and 17% and 15% in international markets, respectively.  Revenues are attributable to countries based on location of the customer.  No single customer represented greater than 10% of the total net revenue for the three and nine months ended September 30, 2014 and 2013.

(8)
Dependence on Key Suppliers

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.

King Pharmaceuticals

The Company purchases its requirements for thrombin (a component in the Hemostat products) under a Thrombin-JMI Supply Agreement entered into with King on January 9, 2007.  Under the terms of the Thrombin-JMI Supply Agreement, King agrees to manufacture and supply thrombin to the Company on a non-exclusive basis.  The Thrombin-JMI Supply Agreement does not contain any minimum purchase requirements.  King agrees to supply the Company with such quantity of thrombin as the Company may order at a fixed price throughout the term of the Thrombin-JMI Supply Agreement as adjusted for inflation, variations in potency and other factors.  The Thrombin-JMI Supply Agreement has an initial term of 10 years, followed by successive automatic one-year extensions, subject to termination by the parties under certain circumstances, including: (i) termination by King without cause any time after the fifth anniversary of the date of the Thrombin-JMI Supply Agreement upon five years prior written notice to the Company, and (ii) termination by the Company without cause any time after the fifth anniversary of the date of the Thrombin-JMI Supply Agreement upon five years prior written notice to King provided that the Device Supply Agreement, which the Company also entered into with King on January 9, 2007, has expired on its terms or the parties have agreed to terminate it.

VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued

(9)
Commitments and Contingencies

Boston Scientific Corporation Litigation

On May 16, 2013, the Company filed a patent infringement complaint in the United States District Court for the District of Minnesota against Boston Scientific Corporation (Boston Scientific).  The complaint alleged that Boston Scientific infringed three of the Company’s patents concerning rapid exchange guide extension technology by manufacturing and selling its Guidezilla™ guide extension catheter.  On July 11, 2013, Boston Scientific filed its answer and counterclaim, alleging the Company’s patents are invalid, that the Guidezilla catheter does not infringe, and that the Company’s manufacture and sale of its GuideLiner catheter violates a U.S. patent owned by Boston Scientific that expired in June 2013.  On July 30, 2014, the Company agreed with Boston Scientific to settle the patent lawsuit and counterclaim.  As part of the settlement agreement, all litigation relating to guide extension was dismissed and the Company will receive an ongoing royalty from Boston Scientific in exchange for a license of the Company’s patents.  The terms of the settlement agreement are confidential.

Governmental Proceedings

On June 28, 2011, the Company received a subpoena from the U.S. Attorney’s Office for the Western District of Texas under the Health Insurance Portability & Accountability Act of 1996 (HIPAA) requesting the production of documents related to Vari-Lase products, and in particular the use of the Vari-Lase Short Kit for the treatment of perforator veins.  Subsequently, the Company learned that the U.S. Attorney’s Office commenced a criminal investigation of the same matter.  The Vari-Lase Short Kit was sold under a 510(k) clearance for the treatment of incompetence and reflux of superficial veins in the lower extremity from 2007 until it was voluntarily withdrawn from the market in July 2014 with total U.S. sales of approximately $534,000 (0.1% of the Company’s total U.S. sales for such period) and has not been the subject of any reported serious adverse clinical event.  On August 14, 2012, the United States District Court for the Western District of Texas unsealed a qui tam complaint that had been filed on November 19, 2010 by Desalle Bui, a former sales employee of the Company, which was the basis for the U.S. Attorney’s civil investigation, to which the federal government, after three extensions of time, elected to intervene.  The complaint contained allegations of off-label promotion of Vari-Lase products for the treatment of perforator veins, re-use of single-use Vari-Lase products and kickbacks to physicians, resulting in alleged damages to the government of approximately $20 million.  An amended complaint limited to allegations of off-label promotion of the Vari-Lase Short Kit resulting in an unspecified amount of damages and penalties was filed by the U.S. Attorney’s Office in December 2012.  On January 22, 2014, the Company agreed with the U.S. Attorney’s Office to settle the civil lawsuit, and the settlement agreement was executed on July 28, 2014.  Under the terms of the settlement agreement, the Company made a payment of $520,000, the Company made no admission of fault or liability, and the U.S. Attorney’s Office dismissed the civil lawsuit with prejudice and released all civil claims brought against the Company in the civil lawsuit.  Settlement of the civil lawsuit had no effect upon the criminal investigation, which is on-going.

From time to time, the Company is involved in additional legal proceedings arising in the normal course of business.  As of the date of this report, the Company is not a party to any legal proceeding not described in this section in which an adverse outcome would reasonably be expected to have a material adverse effect on the Company’s results of operations or financial condition.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued

King Agreements

On January 9, 2007, the Company entered into a License Agreement and a Device Supply Agreement with King.  Under the License Agreement, the Company licensed the exclusive rights to the Company’s products Thrombi-Pad, Thrombi-Gel and Thrombi-Paste to King in exchange for a one-time license fee.  Under the Device Supply Agreement, the Company agreed to manufacture the licensed products for sale to King in exchange for an initial payment.  The unamortized license fee was $457,000 and $610,000 at September 30, 2014 and December 31, 2013, respectively.  Amortization of the deferred revenue will be $51,000 per quarter for the remainder of the 10-year license period.  The amortization of license fee was $153,000 for both of the nine month periods ended September 30, 2014 and 2013.

(10)
Income Taxes

The Company is subject to income tax in numerous jurisdictions and at various rates and the use of estimates is required in determining the provision for income taxes.  For the nine month periods ended September 30, 2014 and 2013, the Company recorded a provision for taxes of $6,033,000 and $3,750,000 on earnings before tax of $14,607,000 and $11,355,000 resulting in an effective income tax rate of 41% and 33%, respectively.  The difference between the effective tax rate of 41% for the nine months ended September 30, 2014 and the U.S. federal statutory income tax rate of 34% was due mainly to a change in the valuation allowance against the Company’s deferred Minnesota tax assets discussed below.  The difference between the effective tax rate of 33% for the nine months ended September 30, 2013 and the U.S. federal statutory income tax rate of 34% was due mainly to the impact of recognizing $300,000 of research and development credits in the first quarter of 2013 that had been deferred from 2012 pending Congressional action which was completed in January 2013 and the recognition of $53,000 of refundable Ireland research and development credits in the second quarter of 2013.

The Company regularly assesses the likelihood that the deferred tax assets will be recovered from future taxable earnings.  The Company considers projected future taxable earnings and ongoing tax planning strategies, and then 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.  For the quarter ended September 30, 2014, based upon the Company’s assessment of all available evidence, including estimates of future profitability, the Company’s overall prospects of future business and the apportionment of the Company’s income to the State of Minnesota based on current apportionment methods, the Company determined that it is more likely than not that the Company will not be able to realize all remaining deferred tax assets relating to the Minnesota research and development credits and the Minnesota net operating loss carryforwards prior to their expirations.  As a result, the Company recorded additional income tax expense of $867,000 during the quarter ended September 30, 2014 as a discrete adjustment to the valuation allowance for its deferred tax assets, representing 16.7% and 5.9% of pretax income for the three and nine months ended September 30, 2014, respectively.  The Company continues to assess the potential realization of deferred tax assets on a quarterly basis.  If the Company’s actual results and updated projections vary significantly from the projections used as a basis for this determination, the Company may need to increase or decrease the valuation allowance against the gross deferred tax assets.  The Company will adjust earnings for the deferred tax in the period in which the determination is made.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued

The Company applies ASC 740, Income Taxes, which clarifies the accounting for uncertainty in tax positions recognized in the financial statements. These provisions create a single model to address uncertainty in tax positions and clarify the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.  ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The Company has recorded an unrecognized tax asset of $1,306,000 and $1,268,000 as of September 30, 2014 and December 31, 2013, respectively.  The impact of tax related interest and penalties is recorded as a component of income tax expense.  As of September 30, 2014, the Company has recorded $-0- for the payment of tax related interest and there were no tax penalties or interest recognized in the statements of earnings.

The Company is subject to income tax examinations in the U.S. Federal jurisdiction, as well as in the Republic of Ireland and various state jurisdictions.  At September 30, 2014, tax years 2011 through 2013 remain open to examination.

(11)
Business Combinations and Asset Acquisitions

Northeast Scientific

On September 17, 2013, the Company entered into an eight-year reprocessing services agreement with Northeast Scientific, Inc. (NES), a FDA-registered reprocessor of medical devices, whereby the Company paid NES a non-refundable amount of $500,000 for the exclusive right to offer NES’ reprocessing services in the United States for a commercial medical device.  NES is pursuing FDA approval for its reprocessing services for the device.  If FDA approval is obtained, the Company is required to pay NES a non-refundable amount of $400,000.  The agreement has an annual minimum unit termination clause, allowing NES to terminate the agreement if the Company does not meet certain annual minimums following FDA approval.

The Company accounted for the transaction as a non-business asset acquisition in the third quarter of 2013.  In accordance with ASC 805, the purchase price of $900,000 was assigned to an intangible asset and no goodwill was recognized.  The Company recorded a $400,000 accrual in the third quarter of 2013 for the payment to be made upon FDA approval, in addition to the $500,000 initial payment.  The Company will begin amortizing the intangible asset on a per unit basis over the remaining term of the agreement once the Company begins to send units to NES to be reprocessed following FDA approval.

(12)
Products and Services

The Company has three product categories as follows:

· Catheter products consist principally of catheters used in minimally invasive medical procedures for the diagnosis or treatment of vascular conditions, such as the GuideLiner® catheter used to access discrete regions of the coronary anatomy and the Pronto® extraction catheters used in treating acute myocardial infarction.  This category also includes products used in connection with gaining percutaneous access to the vasculature to perform minimally invasive procedures, such as micro-introducer kits.
· Hemostat products consist principally of blood clotting products, such as 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.  This category also includes our line of devices used in radial artery procedures, such as our Accumed wrist positioning splints and Vasc Band inflatable compression bands.
VASCULAR SOLUTIONS, INC.
Notes to Unaudited Consolidated Financial Statements – Continued
 
· Vein products and services consist principally of the Vari-Lase® endovenous laser, a laser console and procedure kit used for the treatment of varicose veins, and a reprocessing service for the ClosureFAST radiofrequency vein ablation catheter.
 
The following tables set forth, for the periods indicated, net revenue by product category along with the percent change from the previous period:

   
Three Months Ended September 30,
 
   
2014
   
2013
 
   
Net
Revenue
   
Percent
Change
   
Net
Revenue
   
Percent
Change
 
                 
Catheter products
 
$
21,116,000
     
18
%
 
$
17,965,000
     
17
%
Hemostat products
   
6,108,000
     
2
%
   
5,962,000
     
7
%
Vein products and services
   
4,542,000
     
14
%
   
3,999,000
     
11
%
Total product revenue
   
31,766,000
     
14
%
   
27,926,000
     
14
%
License
   
163,000
     
96
%
   
83,000
     
(5
%)
Total revenue
 
$
31,929,000
     
14
%
 
$
28,009,000
     
14
%
 
   
Nine Months Ended September 30,
 
   
2014
   
2013
 
   
Net
Revenue
   
Percent
Change
   
Net
Revenue
   
Percent
Change
 
                 
Catheter products
 
$
60,675,000
     
17
%
 
$
52,031,000
     
14
%
Hemostat products
   
18,305,000
     
3
%
   
17,768,000
     
3
%
Vein products and services
   
13,236,000
     
16
%
   
11,398,000
     
14
%
Total product revenue
   
92,216,000
     
14
%
   
81,197,000
     
12
%
License, royalty and collaboration
   
297,000
     
29
%
   
230,000
     
(12
%)
Total revenue
 
$
92,513,000
     
14
%
 
$
81,427,000
     
11
%
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Level Overview

 Vascular Solutions, Inc. (we, us or Vascular) is focused on bringing clinically advanced solutions to interventional cardiologists, interventional radiologists, electrophysiologists, and vein practices worldwide.   As a vertically-integrated medical device company, we generate ideas, create new minimally invasive medical devices, and then deliver these products and related services to physicians through our direct domestic sales force and our international distribution network.  We continue to develop new products and new applications for our existing products.
 
During the past few years, the number of catheterization procedures performed worldwide has been declining gradually due to a number of factors – among them, the effects of weak economies on overall health care utilization rates, efforts by third-party payers to lower costs associated with medical procedures, investigations by government agencies into potential over-utilization of procedures, the implementation by hospitals of policies designed to reduce the incidence of unnecessary procedures in the wake of these outside investigations, and new diagnostic imaging and functional assessment modalities that more effectively screen patients to determine the need for treatment. Although worldwide demographic factors, including the growing incidence of obesity, diabetes, and cardiovascular disease, seem to favor long-term growth in the number of interventional procedures, we believe these recent pressures on utilization rates are likely to result in relatively flat catheterization volumes for the foreseeable future. We intend to remain competitive in this market through the continued introduction of new products and services. We expect to originate these new products and services primarily through our internal research and development and clinical efforts, but we may supplement them with targeted acquisitions or other external collaborations. Additionally, our growth has been, and will continue to be, impacted by our expansion and penetration into new geographic markets, the expansion and penetration of our direct sales organization in existing geographic markets, and our continuing focus on increasing the efficiency of our existing direct sales organization.
             Our product portfolio includes a broad spectrum of over 80 products consisting of over 600 stock keeping units (SKUs) covering a wide array of blood clotting devices, extraction catheters, access catheters, guide catheters, micro-introducer kits, guidewires, snare and retrieval devices, reprocessing service for radiofrequency catheters, and endovenous laser and procedure kits for the treatment of varicose veins.  Our management, including our chief executive officer who is our chief operating decision maker, report and manage our operations in three main categories based on similarities in the products or services sold.  We have corporate infrastructure and direct sales capabilities in the United States and have established distribution relationships in most major international markets.  In order to drive sales growth, we have invested not only in the expansion of our global distribution system, but also new product development and clinical trials to obtain regulatory approvals.  A significant portion of our net revenue historically has been, and we expect to continue to be, attributable to new and enhanced products and services.   We expect to continue to further validate the clinical and competitive benefits of our technology platforms to drive utilization of our current products and the development of new and enhanced products and services.

The interventional medical device industry is characterized by intense competition, rapidly evolving technology, and a high degree of government regulation.  To grow our business, we have focused on continually developing and commercializing new products.  Looking ahead, we expect our business may be impacted by the following trends and opportunities:
 
· The future regulatory approval of newly-developed products.  Any new product that we develop must be approved by the Food and Drug Administration (FDA) in the United States and by similar regulatory bodies in other countries before they can be sold.  The requirements for obtaining product approval have undergone change, and the FDA frequently implements changes to the product approval process.  We monitor the changing regulatory landscape and modify our regulatory submissions as necessary to obtain product approvals.
 
· Successfully integrating acquired products and services into our existing operations.  The acquisition of products and services complementary to our existing product portfolio and customer call points provides an additional business opportunity, but is dependent on the successful integration of the acquired products into our existing business structure.
 
· Managing intellectual property.  The interventional medical device industry is characterized by numerous patent filings and litigation claims made to protect new and evolving product ideas.  To maximize the profitability of new product ideas, we seek patent protection for those product design and method concepts which we believe have the potential to provide substantial product revenue.  Managing intellectual property assets and claims is a significant challenge for our business.
Results of Operations

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Net revenue:
               
Product revenue
   
100
%
   
100
%
   
100
%
   
100
%
License and collaboration revenue
   
-
     
-
     
-
     
-
 
Total revenue
   
100
%
   
100
%
   
100
%
   
100
%
                                 
Product costs and operating expenses:
                               
Cost of goods sold
   
32
%
   
33
%
   
33
%
   
33
%
Collaboration expenses
   
-
     
-
     
-
     
-
 
Research and development
   
11
%
   
11
%
   
11
%
   
12
%
Clinical and regulatory
   
4
%
   
4
%
   
4
%
   
4
%
Sales and marketing
   
23
%
   
24
%
   
24
%
   
25
%
General and administrative
   
12
%
   
8
%
   
10
%
   
8
%
Litigation
   
-
     
3
%
   
-
     
1
%
Medical device excise taxes
   
1
%
   
1
%
   
1
%
   
1
%
Amortization of purchased technology and intangibles
   
1
%
   
2
%
   
1
%
   
2
%
Total product costs and operating expenses
   
84
%
   
86
%
   
84
%
   
86
%
Operating earnings
   
16
%
   
14
%
   
16
%
   
14
%
Other earnings and expenses, net
   
-
     
-
     
-
     
-
 
Earnings before income taxes
   
16
%
   
14
%
   
16
%
   
14
%
Income taxes
   
(8
%)
   
(5
%)
   
(7
%)
   
(5
%)
Net earnings
   
8
%
   
9
%
   
9
%
   
9
%

Three and nine months ended September 30, 2014, compared to three and nine months ended September 30, 2013

Net revenue increased 14% to $31,929,000 for the quarter ended September 30, 2014 from $28,009,000 for the quarter ended September 30, 2013.  This increase in revenue is comprised of the following components:

   
% Change
 
Volume of existing product and service revenue
   
18
%
New product or service introductions, which consist of any product or service that had no revenue in the comparable period in 2013
   
-
%
Product and service pricing
   
(4
%)
     
14
%

Approximately 84% and 85% of our net revenue was earned in the United States and 16% and 15% of our net revenue was earned in international markets for the three month periods ended September 30, 2014 and September 30, 2013, respectively.
Net revenue increased 14% to $92,513,000 for the nine months ended September 30, 2014 from $81,427,000 for the nine months ended September 30, 2013.  This increase in revenue is comprised of the following components:

   
% Change
 
Volume of existing product and service revenue
   
17
%
New product or service introductions, which consist of any product or service that had no revenue in the comparable period in 2013
   
-
%
Product and service pricing
   
(3
%)
     
14
%

Approximately 83% and 85% of our net revenue was earned in the United States and 17% and 15% of our net revenue was earned in international markets for the nine month periods ended September 30, 2014 and September 30, 2013, respectively.

We recognized $163,000 and $83,000 of license, royalty and collaboration revenue during the three month periods ended September 30, 2014 and 2013, respectively, and $297,000 and $230,000 of license, royalty and collaboration revenue during the nine month periods ended September 30, 2014 and 2013, respectively, due to our license and device supply agreements with King, our royalty agreement with a third party, and our distribution agreement with Nicolai which expired on March 31, 2013.  Collaboration expense of $93,000 and $32,000 was recognized during the three months ended September 30, 2014 and 2013, respectively, and collaboration expense of $125,000 and $41,000 was recognized during the nine months ended September 30, 2014 and 2013, respectively, as a result of an agreement we entered into in April 2013 to develop a new hemostatic device for a third party.  License, royalty and collaboration revenue is expected to be approximately $135,000 in the fourth quarter of 2014.

Gross margin increased to 67.8% for the quarter ended September 30, 2014, compared to 67.2% for the quarter ended September 30, 2013.  The increase in gross margin was due to the increase in sales of our higher margin GuideLiner catheters as a percentage of our total product sales.  We expect gross margins to be between 66.5% and 67.5% in the fourth quarter of 2014, subject to variations in our selling mix between United States and international markets and between our lower margin products such as the Vari-Lase products and our higher margin products such as the D-Stat Dry and GuideLiner products.  Gross margin remained relatively flat at 67.4% for the nine month period ended September 30, 2014, compared to 67.5% for the nine month period ended September 30, 2013.

Research and development expense for the third quarter of 2014 totaled $3,322,000, or 11% of revenue, compared to $3,140,000, or 11% of revenue, for the third quarter of 2013.  Research and development expense for the nine month period ended September 30, 2014 totaled $9,839,000 or 11% of revenue, compared to $10,027,000, or 12% of revenue, for the nine month period ended September 30, 2013.  Research and development expenses have increased compared to the three months ended September 30, 2013 due to additional research and development employees being hired during the third quarter of 2014.  We expect our research and development expenses to be approximately 11% to 12% of revenue in the fourth quarter of 2014.

Clinical and regulatory expense for the third quarter of 2014 totaled $1,196,000, or 4% of revenue, compared to $997,000, or 4% of revenue, for the third quarter of 2013.  Clinical and regulatory expense for the nine month period ended September 30, 2014 totaled $3,771,000 or 4% of revenue, compared to $3,259,000, or 4% of revenue, for the nine month period ended September 30, 2013.  Clinical and regulatory expenses have increased on a dollar basis for the three and nine month periods ended September 30, 2014, compared to the three and nine month periods ended September 30, 2013, due to additional expenses relating to preparations for planned future clinical studies.  We expect clinical and regulatory expenses to continue to be approximately 4% of revenue in the fourth quarter of 2014.
Sales and marketing expense for the third quarter of 2014 totaled $7,327,000, or 23% of revenue, compared to $6,706,000, or 24% of revenue, for the third quarter of 2013.  Sales and marketing expense for the nine month period ended September 30, 2014 totaled $22,406,000 or 24% of revenue, compared to $20,462,000, or 25% of revenue, for the nine month period ended September 30, 2013.  The decrease in sales and marketing expenses as a percentage of revenue for the three and nine month periods ended September 30, 2014, compared to the three and nine month periods ended September 30, 2013, was due to our increased sales while maintaining a relatively constant number of field sales employees.  We expect to maintain the same relative size of our direct U.S. sales force for the remainder of 2014.  As result, we expect our sales and marketing expenses as a percentage of revenue to be approximately 22% to 23% in the fourth quarter of 2014.

General and administrative expense for the third quarter of 2014 totaled $3,692,000, or 12% of revenue, compared to $2,362,000, or 8% of revenue, for the third quarter of 2013.  General and administrative expense for the nine month period ended September 30, 2014 totaled $9,282,000 or 10% of revenue, compared to $6,871,000, or 8% of revenue, for the nine month period ended September 30, 2013.  General and administrative expenses increased for the three and nine month periods ended September 30, 2014 compared to the three and nine month periods ended September 30, 2013 as a result of a $1,300,000 and $2,200,000 increase in legal expenses, respectively, primarily related to the patent infringement lawsuit filed against Boston Scientific which was settled in July 2014 and the qui tam litigation and related U.S. Attorney criminal investigation (see Note 9 to the Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q).  While legal expenses are difficult to forecast, we expect legal expenses to remain at this elevated level in the fourth quarter of 2014 due to the on-going U.S. Attorney criminal investigation.  As a result, we expect general and administrative expense to be approximately 12% to 14% of revenue in the fourth quarter of 2014.

Litigation expense for the three and nine months ended September 30, 2014 and September 30, 2013 was $-0- and $812,000, respectively.  On October 11, 2013, an agreement was reached with Terumo Corporation to settle its patent and trademark infringement litigation, whereby we made a one-time payment to Terumo Corporation in the amount of $812,000 during the fourth quarter of 2013.  The settlement amount was recognized as litigation expense in the quarter ended September 30, 2013.

Medical device excise taxes for the third quarter of 2014 totaled $385,000, or 1.2% of revenue, compared to $339,000, or 1.2% of revenue, for the third quarter of 2013.  Medical device excise taxes for the nine month period ended September 30, 2014 totaled $1,083,000, or 1.2% of revenue, compared to $995,000, or 1.2% of revenue, for the nine month period ended September 30, 2013.  The statutory rate of the medical device excise tax is 2.3% of revenues on initial sales of finished medical products sold in the United States.  The tax does not apply to service revenues or international sales.  The Company’s effective rate for this tax is less than the statutory rate due to international sales, service revenues and sales of purchased finished goods (where the seller is responsible for paying the tax).  We expect our medical device excise taxes to be approximately 1.2% in the fourth quarter of 2014.

Amortization of purchased technology and other intangibles was $410,000 and $404,000 for the three months ended September 30, 2014 and 2013, respectively.   Amortization of purchased technology and other intangibles was $1,234,000 and $1,162,000 for the nine months ended September 30, 2014 and 2013, respectively.   The amortization resulted from our product and license acquisitions.  As part of these asset purchases and licensing agreements, we allocated $16,000,000 to purchased technology and other intangibles that are being amortized over a period of 9 to 11 years.  For a complete discussion of the most recent acquisition, see Note 11 to the Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q.  We expect amortization expense to be approximately $410,000 in the fourth quarter of 2014.
Income tax expense was $2,634,000 and $6,033,000 for the three and nine months ended September 30, 2014, respectively, on earnings before tax of $5,204,000 and $14,607,000, respectively, resulting in an effective income tax rate of 51% and 41% for the three and nine months ended September 30, 2014, respectively.  The difference between the effective tax rates of 51% and 41% and the statutory rate of 34%, relates primarily to a change in the valuation allowance against the Company’s deferred Minnesota tax assets (see Note 10 to the Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q for a complete discussion).  We expect our effective income tax rate will be approximately 36% in the fourth quarter of 2014.

Liquidity and Capital Resources

Our cash and cash equivalents totaled $41,649,000 at September 30, 2014 compared to $30,785,000 at December 31, 2013, an increase of $10,864,000.  The majority of our cash is maintained in our operating accounts.  A portion of our cash equivalents are invested in a money market fund invested in high quality, short-term money market instruments denominated in U.S. dollars such as debt instruments guaranteed by the governments of the United States, Western Europe, Australia, Japan and Canada, high quality corporate issuers and bank obligations.  The money market fund’s assets are rated in the highest short-term category by nationally recognized rating agencies, such as Moody’s or Standard & Poor’s.

Cash provided by operations.  We generated $14,254,000 of cash from operations for the nine months ended September 30, 2014, primarily resulting from our net earnings of $8,574,000, non-cash depreciation and amortization expense of $3,615,000 and non-cash stock-based compensation of $3,030,000.  Cash from operations was reduced by a $2,038,000 increase in prepaid expenses, a $1,738,000 increase in inventory, and a $1,708,000 increase in our accounts receivable for the nine months ended September 30, 2014.  These cash reductions were partially off-set by a combined $2,875,000 increase in accounts payable and accruals.  The increase in prepaid expenses and inventory was consistent with our expectations. The increase in net accounts receivable of 11% for the nine month period ended September 30, 2014 is consistent with our 14% increase in net revenue over the same period.  Day’s sales outstanding both at September 30, 2014 and December 31, 2013 were 48 days.

Cash used for investing activities.  We used $3,801,000 of cash in investing activities for the nine months ended September 30, 2014, primarily consisting of the $3,829,000 of capital expenditures relating to the purchase of manufacturing and computer equipment, as well as the purchase of additional research and development equipment.

On February 18, 2014, we entered into a purchase agreement with IRET – Plymouth, LLC (“IRET”) to acquire a manufacturing and office building of approximately 79,300 square feet located at 6464 Sycamore Court North, Maple Grove, Minnesota, for a total purchase price of $7,200,000 (the “Purchase Agreement”).  Subject to the satisfaction of certain terms and closing conditions customary for a real estate transaction of this type, the closing is expected to take place on December 1, 2014.  Under the terms of the Purchase Agreement, in February 2014, we deposited $400,000 into escrow to be held as earnest money until the closing of the transaction.  We currently lease the building and intend to continue to do so until the transaction closes.  The building houses our principal manufacturing, research and development and regulatory operations.  We intend to expand the manufacturing capacity of the building and move our research and development and regulatory operations into an adjoining office building that we currently own in 2015.

Cash provided by financing activities.  We generated $479,000 of cash in financing activities for the nine months ended September 30, 2014.  This amount was primarily due to the recognition of $1,182,000 of excess tax benefits from stock based compensation, the receipt of $904,000 upon the exercise of outstanding stock options and sale of stock and the receipts of $705,000 in exchange for the sale of common stock pursuant to our Employee Stock Purchase Plan.  These amounts were reduced by the $2,312,000 of cash used to repurchase 100,565 shares of our common stock that vested under outstanding restricted stock awards to satisfy income tax withholding obligations.
We currently anticipate that we will experience positive cash flow from our normal operating activities for the foreseeable future.  We currently believe that our working capital of $69.7 million at September 30, 2014 will be sufficient to meet all of our operating and capital requirements for the foreseeable future.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of September 30, 2014.

Contractual Obligations

The following table summarizes our contractual cash commitments as of September 30, 2014:

   
Payments Due by Period
 
 
Contractual Obligations
 
 
Total
   
Less than
1 year
   
 
1 - 3 years
   
 
3 - 5 years
   
More than
5 years
 
Purchase of building
 
$
6,800,000
   
$
6,800,000
   
$
-
   
$
-
   
$
-
 
Facility operating leases
   
909,000
     
909,000
     
-
     
-
     
-
 
Product license rights
   
400,000
     
400,000
     
-
     
-
     
-
 
Total
 
$
8,109,000
   
$
8,109,000
   
$
-
   
$
-
   
$
-
 

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

Critical Accounting Policies

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

The material accounting policies that we believe are most critical to an investor’s understanding of our financial results and condition and which require complex management judgment are discussed in our Annual Report on Form 10-K for the year ended December 31, 2013 under the caption “Critical Accounting Policies.”
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995

The Private Securities Litigation Reform Act of 1995 (the Act) provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their business, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement.  We desire to take advantage of the safe harbor provisions with respect to any forward-looking statements we may make in this filing, other filings with the Securities and Exchange Commission and any public oral statements or written releases. The words or phrases “will likely,” “is expected,” “will continue,” “is anticipated,” “believe,” “estimate,” “projected,” “forecast,” or similar expressions are intended to identify forward-looking statements within the meaning of the Act.  Forward-looking statements such as these are based on management’s current expectations as of the date of this report but involve risks, uncertainties and other factors which may cause actual results to differ materially from those contemplated by such forward-looking statements.   We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  In accordance with the Act, we identify the following important general factors which, if altered from the current status, could cause our actual results to differ from those described in any forward-looking statements: risks associated with patent infringement lawsuits and government criminal investigations, adoption of our new products, limited profitability, exposure to possible product liability claims, the development of new products by others, dependence on third party distributors in international markets, doing business in international markets, the availability of third party reimbursement, actions by the FDA related to our products, the loss of key vendors, and those factors set forth under the heading “Risk Factors” in Item 1A of Part II of this Quarterly Annual Report on Form 10-Q.  This list is not exhaustive, and we may supplement this list in any future filing with the Securities and Exchange Commission or in connection with the making of any specific forward-looking statement.  We undertake no obligation to, and do not intend to, revise or update publicly any forward-looking statement for any reason.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

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

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

In the United States, we sell our products and services directly to hospitals and clinics.  In international markets, we sell our products to independent distributors who, in turn, sell to hospitals.  Sales to independent distributors are denominated in United States dollars, with the exception of sales to Germany, where sales are denominated in Euros.  Sales to distributors out of our subsidiary in Ireland are denominated in Euros.

We distribute certain products on behalf of certain U.S. and international manufacturers.  We pay for all distributed products in United States dollars.

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.  A change of 0.1 in the Euro exchange rate would result in an increase or decrease of approximately $46,000 in the amount of United States dollars we receive in payment on the accounts receivable denominated in Euros with our subsidiary in Ireland and our German distributor, Nicolai GmbH.  Under our current policies, we do not use foreign currency derivative instruments to manage exposure to fluctuations in the Euro exchange rate.

We are exposed to declines in the interest rates paid on deposited funds.  A 0.1% decline in the current market interest rates paid on deposits would result in interest earnings being reduced by approximately $42,000 on an annual basis.
Item 4.
Controls and Procedures

Evaluation of disclosure controls and procedures.
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
 
Changes in internal control over financial reporting.
 
During the fiscal quarter ended September 30, 2014, 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.
 
PART II.  OTHER INFORMATION

Item 1.
Legal Proceedings

The description of litigation and government proceedings included in Note 9 to the Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q is incorporated into this Item 1 of Part II by reference.

From time to time, we are involved in additional legal proceedings arising in the normal course of 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 1A.
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 or services.

We have launched over 80 new products or services since 2003.  Our success will depend on the continued launch of new products and services and the medical community’s acceptance of our new products and services.  We cannot predict how quickly, if at all, the medical community will accept our new products and services, or, if accepted, the continuation or extent of their use.  Our potential customers must:
 
 
·
believe that our products or services offer benefits compared to the methodologies and/or devices that they are currently using;
 
 
·
use our products or services and obtain acceptable clinical outcomes;
 
 
·
believe that our products or services 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 are often selling a new technology, we have limited ability to predict the level of growth or timing of sales of these products or services.  If we encounter difficulties in growing our sales of our new medical devices or services, our business will be seriously harmed.

We may face intellectual property litigation, which could prevent us from manufacturing and selling our products or services or result in us incurring substantial costs and liabilities.

The interventional medical device industry is characterized by numerous patent filings.  As a result, participants in the industry frequently experience substantial intellectual property litigation.

Some companies in the interventional medical device industry have employed intellectual property litigation in an attempt to gain a competitive advantage.  In addition, non-practicing patent assertion entities have accumulated patent rights related to the medical device industry and are asserting them against operating companies in an attempt to collect settlements or licensing fees.  Intellectual property litigation has proven to be very complex, and the outcome of such litigation is difficult to predict.  While we do not believe that any of our products or services infringe any existing patent or other intellectual property right, we have been involved in substantial intellectual property litigation and expect to continue to become subject to intellectual property claims with respect to our new or existing products or services.

On February 14, 2013, Terumo Corporation and Terumo Medical Corporation (Terumo) filed a complaint for patent and trademark infringement against us and Lepu Medical Technology (Beijing) Co. in the United States District Court for the District of New Jersey.  The complaint alleged that a prior version of the Vasc Band radial compression device manufactured by Lepu Medical Technology infringed a Terumo patent.  On October 11, 2013, we reached an agreement with Terumo to settle the litigation.  Under the settlement, we made a one-time payment to Terumo in the amount of $812,500 and Terumo agreed that the current design of our Vasc Band product does not infringe any claim of any issued Terumo patent and agreed that it will not sue the Company on any future issued patent concerning the current design of the Vasc Band product.

On May 16, 2013, we filed a patent and copyright infringement complaint in the U.S. District Court for the District of Minnesota against Boston Scientific Corporation alleging that it is infringing three of our United States patents by manufacturing and selling its Guidezilla guide extension catheter.  Boston Scientific filed a counterclaim alleging that our GuideLiner catheter infringes a Boston Scientific patent that expired in June 2013.  On July 30, 2014, we agreed with Boston Scientific to settle the patent lawsuit.  As part of the settlement agreement, all litigation relating to guide extension was dismissed.  The terms of the settlement agreement are confidential.

An adverse determination in any intellectual property litigation or interference proceedings against us could prohibit us from selling a product or service, subject us to significant immediate payments to third parties and require us to seek licenses from third parties.  The costs associated with these license arrangements may be substantial and could include substantial up-front payments and 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 or service.

Our involvement in any future intellectual property claims, regardless of the merits of any asserted claim against us, could divert the attention of our technical and management personnel away from the development and marketing of our products and services for significant periods of time.  Furthermore, the penalties involved with an adverse outcome may be severe, and the costs incurred related to defending such claims could have a material adverse effect on our results of operations or financial condition, even if we ultimately prevail in them.
The medical device industry is the subject of numerous governmental investigations into marketing and other business practices, and we currently are the subject of a pending government criminal investigation.  The criminal investigation could result in the commencement of litigation, indictment of the company and its officers, substantial litigation costs, fines, penalties and administrative remedies, including the potential disqualification from participation in government health care programs including Medicare and Medicaid, which would prevent us from continuing to carry on our existing business.  Any adverse determination in the current government criminal investigation or any future civil or criminal litigation could have a material adverse effect on our ability to continue to operate our business as currently conducted and negatively impact our financial results and stock price.

The products and business activities of medical device companies are subject to rigorous regulation by the FDA and other federal, state and international governmental authorities under statutes and regulations governing health care fraud.  The U.S. Attorney’s Offices have increased their scrutiny over the medical device industry in recent years.  The U.S. Congress, Department of Justice, Office of Inspector General of the Department of Health and Human Services, and Department of Defense have all issued subpoenas and other requests for information to conduct investigations of, and commenced civil and criminal litigation against, medical device manufacturers, primarily related to financial arrangements with health care providers, regulatory compliance and product promotional practices.

During 2012, the U.S. Attorney’s Office for the Western District of Texas intervened in a qui tam civil lawsuit initiated against us involving allegations of off-label promotion of our Vari-Lase Short Kit endovenous laser product (see Note 9 to the Unaudited Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q).  Subsequently, we learned that the U.S. Attorney’s Office commenced a criminal investigation of the same matter.  On January 22, 2014, we agreed with the U.S. Attorney’s Office to settle the civil lawsuit, and the settlement agreement was executed on July 28, 2014.  Under the terms of the settlement agreement, the Company made a payment of $520,000, the Company made no admission of fault or liability, and the U.S. Attorney’s Office dismissed the civil lawsuit with prejudice and released all civil claims brought against the Company in the civil lawsuit.

Settlement of the civil lawsuit had no effect upon the criminal investigation, which is on-going. We cannot predict when the criminal investigation will be resolved, the outcome of the investigation, its impact on us, or whether other federal or state legal or regulatory authorities will initiate additional related or unrelated investigations or lawsuits against us.  We expect to continue to incur substantial expenses in defending ourselves in the criminal investigation.  The outcome of a criminal investigation could include substantial fines, penalties and administrative remedies such as a deferred prosecution agreement or corporate integrity agreement, or the indictment of the company or its officers.  If we were to be convicted of a crime related to the delivery of an item or service under Title XVIII of the Social Security Act, or a felony related to health care fraud, the company would become automatically excluded by the Department of Health and Human Services (“HHS”) from participation in government health care programs, including Medicare and Medicaid.  If we were to be convicted of a misdemeanor related to health care fraud, the company could be excluded by HHS from participation in government health care programs, including Medicare and Medicaid.  Exclusion from government health care programs would substantially adversely affect our ability to continue to conduct our business.  The cost of our defense of any indictment that might issue as a result of the investigation would be material and could divert the attention of management from the day-to-day operations of our business.  The consequences of the current investigation, as well as consequences of any future governmental investigation or lawsuit of any related or unrelated matter, could have a material adverse effect on our business, results of operations and stock price.
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 ongoing introduction of new products and services that affect our overall product mix make the 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 operating results between quarters are an unreliable indication of our future performance because they are likely to vary significantly based on many factors, including:

 
·
the level of sales of our products and services in our markets;
 
 
·
our ability to introduce new products or services and enhancements in a timely manner;
 
 
·
the demand for, and acceptance of, our products and services;
 
 
·
the success of our competition and the introduction of alternative products or services;
 
 
·
our ability to command favorable pricing for our products and services;
 
 
·
the growth of the market for our products and services;
 
 
·
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 effects of intellectual property disputes;
 
 
·
the effects of government investigations and litigation;
 
 
·
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 entails significant risk of product liability claims.  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.  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 and services 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 or services obsolete.

The existing market for interventional medical devices and services is intensely competitive.  We expect competition to increase further as companies develop new products and services or modify their existing products and services to compete directly with ours.  Each of our products and services encounters competition from several medical device companies, including Medtronic Inc., Boston Scientific Corporation and Covidien plc.  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.

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 or services.  Broader product lines may also provide our competitors with a significant advantage in marketing competing products or services 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 or services obsolete.

We rely on continued development and improvement of our products and service, which if not successful, may have an adverse effect on our financial condition and results of operations.

We are continually engaged in developing new products and services and improving our existing products and services.  New or improved products and services represent a significant component of our sales growth.  We dedicate significant financial and managerial resources to product and services development and improvement.  We may not achieve our development objectives within our schedule and budget, or at all, due to technical or operational challenges.  Failure to achieve our development objectives on schedule may increase our development expenses and adversely impact our revenues.  If we do achieve our development objectives, we may not be able to obtain regulatory approval for new or improved products or services, and we may not be successful in marketing and selling such products or services.  Failure to obtain regulatory approval or successfully market and sell new or improved products and services could adversely impact our revenues and results of operations.

Constraints or interruption in production from any of our key suppliers may have a material adverse effect on our business, financial condition and results of operations.

In the interest of operational efficiency and due to quality considerations, we obtain some of the components for the products that we manufacture from a sole source.  If the availability of components from a sole source of supply is constrained or interrupted, there is no assurance that we could find an alternative source of supply quickly and cost effectively, if at all.  In addition, due to the stringent regulations and requirements of the FDA and equivalent regulatory entities regarding the manufacture of our products, we may not be able to quickly establish additional or replacement sources for some components or materials.  Unavailability of components could have a material adverse effect on our ability to manufacture and sell products and our results of operations.
We also distribute finished products that are available only from their manufacturer.  In addition, the reprocessing services that we offer are performed by a single provider.  Operational, quality or regulatory issues of the manufacturers of the products we distribute, or the provider of our reprocessing services, could constrain or interrupt the availability of those products or services.  Any constrain or interruption in supply of finished products that we distribute, or the reprocessing services that we offer, could have a material adverse effect on our ability to sell products and services to customers, our financial condition and our results of operations.

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

Our international sales are subject to several risks, including:
 
 
·
the ability of our independent distributors to sell our products and services;
 
 
·
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 and services in any international market.

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 or services are used.  Failure by physicians, hospitals and other users of our products or services to obtain sufficient reimbursement from healthcare payors for procedures in which our products or services 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 or services such as our products and services, 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 and services 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 and services in the markets in which these approvals are sought.
Our products and services and our manufacturing activities are subject to extensive governmental regulation that could prevent us from selling our products or services in the United States or introducing new and improved products or services.

Our products and services 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 and services;
 
 
·
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 or services.  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 or services.

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

Purchase of Equity Securities by the Issuer and Affiliated Purchasers:

 
Period
 
Total Number
of Shares
Purchased (1)
   
Average
Price Paid
per Share
   
Total Number of
Shares Purchased
as Part of a Publicly
Announced Plans or
Programs
   
Maximum Number of
Shares that May Yet be
Purchased Under the
Plans or Programs
 
July 1 – 31, 2014
   
81
   
$
25.07
     
-
     
-
 
August 1 – 31, 2014
   
-
     
-
     
-
     
-
 
September 1 – 30, 2014
   
840
   
$
23.38
     
-
     
-
 

(1)  At the request of our employees and pursuant to the terms of their Restricted Stock Awards, we purchased 81 shares of common stock in July and 840 shares of common stock in September, all at the fair market value of the common stock on the day of vest, to satisfy income tax withholding obligations for those employees.

Item 3.
Defaults Upon Senior Securities

None.
Item 4.
Mine Safety Disclosures

Not applicable.

Item 5.
Other Information

 None.

Item 6.
Exhibits

Exhibit
Number
 
 
Description
3.1
 
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 March 31, 2000).
3.2
 
Amended and Restated Bylaws of Vascular Solutions, Inc. (incorporated by reference to Exhibit 3.1 of Vascular Solutions’ Form 8-K dated October 19, 2007).
4.1
 
Specimen of Common Stock certificate (incorporated by reference to Exhibit 4.1 of Vascular Solutions’ Registration Statement on Form S-1 (File No. 333-84089)).
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase


SIGNATURES

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

  VASCULAR SOLUTIONS, INC.
      
Date:  October 21, 2014
By:
/s/ Howard Root
   
Howard Root
   
Chief Executive Officer and Director
   
(principal executive officer)
     
 
By:
/s/ James Hennen
   
James Hennen
   
Senior Vice President of Finance and
   
Chief Financial Officer
   
(principal financial officer)
     
 
By:
/s/ Timothy Slayton
   
Timothy Slayton
   
Controller
   
(principal accounting officer)
 
 
Page 29