Overview

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

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

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

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

• Specialty catheters, consisting of a variety of catheters for clinical niches including the Langston® dual lumen catheters, Twin-Pass® dual access catheters, Skyway® support catheters, and GopherTM support catheter and

• Access products, principally consisting of micro-introducers, the MICRO EliteTM snare, the Guardian® hemostasis valve, and guidewires used in connection with percutaneous access to the vasculature.

In 2000 we received FDA clearance for our first product, the Duett™ sealing device, which is used to seal the puncture site following catheterization procedures. In 2001, due to competitive developments in the sealing device market, we made the strategic decision to develop additional products and de-emphasize the promotion of our Duett sealing device. We have grown from net revenue of $6.2 million in 2000 solely from the Duett device to net revenue of $52.6 million in 2007, with 97% of our 2007 net revenue coming from products other than the Duett device. This increase in revenue represents a compound annual growth rate of 36% and was driven by our commitment to the research and development of multiple new devices to diagnose and treat existing and new vascular conditions.

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

Results of Operations

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


                                                      Three Months Ended          Six Months Ended
                                                           June 30,                   June 30,

                                                     2008           2007          2008         2007


Revenue:                                                  98 %           99 %         97 %         99 %
Product revenue
License and collaboration revenue                          2 %            1 %          3 %          1 %

Total revenue                                            100 %          100 %        100 %        100 %

Product costs and operating expenses:
Cost of goods sold                                        35 %           33 %         34 %         33 %
Collaboration expenses                                     1 %            -            1 %          -
Research and development                                  10 %           10 %         10 %         11 %
Clinical and regulatory                                    5 %            6 %          6 %          6 %
Sales and marketing                                       34 %           37 %         36 %         38 %
General and administrative                                 8 %            9 %          9 %          8 %
Litigation                                                10 %            -            5 %         22 %
Thrombin qualification                                     -              -            -            1 %

Total product costs and operating expenses               103 %           95 %        101 %        119 %

Operating income (loss)                                   (3 %)           5 %         (1 %)       (19 %)
Other income and expenses, net                             -              -            -            -

Income (loss) before income taxes                         (3 %)           5 %         (1 %)       (19 %)
Income taxes                                               -              -            -            -

Net income (loss)                                         (3 %)           5 %         (1 %)       (19 %)

Three and six months ended June 30, 2008, compared to three and six months ended June 30, 2007

Net revenue increased 15% to $15,238,000 for the quarter ended June 30, 2008 from $13,228,000 for the quarter ended June 30, 2007. The increase in net revenue was a result of double digit percentage revenue increases in four of our five product categories. Approximately 88% of our net revenue for the second quarter ended June 30, 2008 was from sales to customers in the United States and 12% of the net revenue was from sales to customers in international markets. Net revenue increased 16% to $29,353,000 for the six months ended June 30, 2008 from $25,382,000 for the six months ended June 30, 2007. Approximately 87% of our net revenue for the six months ended June 30, 2008 was from sales to customers in the United States and 13% of the net revenue was from sales to customers in international markets.

Gross margin across all product lines declined to 64% for the quarter ended June 30, 2008 from 66% for the quarter ended June 30, 2007. We expect gross margins to be in the range of 64% to 66% for the remainder of 2008, subject to changes in our selling mix between our lower margin products such as the Vari-Lase and products sold to King and our higher margin products such as the D-Stat Dry. Gross margin across all product lines declined to 65% for the six months ended June 30, 2008 from 67% for the six months ended June 30, 2007.

Research and development expenses increased 15% to $1,553,000 for the quarter ended June 30, 2008 from $1,346,000 for the quarter ended June 30, 2007. Research and development expenses increased 6% to $3,019,000 for the six months ended June 30, 2008 from $2,839,000 for the six months ended June 30, 2007. The increase was the result of our continued emphasis on investment in new products, including an increase to 21 full-time employees in Research and Development at June 30, 2008 from 20 at June 30, 2007. We expect our research and development expenses to be approximately 9% to 10% of revenue per quarter for the second half of 2008 as we continue to pursue additional new products at an expected rate of between two and four new products per year and as we continue to move our longer-term development projects forward.

Clinical and regulatory expenses increased 1% to $759,000 for the quarter ended June 30, 2008 from $751,000 for the quarter ended June 30, 2007. Clinical and regulatory expenses increased 7% to $1,610,000 for the six months ended June 30, 2008 from $1,511,000 for the six months ended June 30, 2007. The increase was the result of increased activity in two clinical studies we have in process. Clinical and regulatory expenses fluctuate due to the timing of clinical and marketing studies. We expect clinical and regulatory expenses to be approximately 5% to 6% of revenue per quarter for the second half of 2008.

Sales and marketing expenses increased 7% to $5,174,000 for the quarter ended June 30, 2008 from $4,851,000 for the quarter ended June 30, 2007. Sales and marketing expenses increased 8% to $10,387,000 for the six months ended June 30, 2008 from $9,613,000 for the six months ended June 30, 2007. The primary reason for the increase in sales and marketing expenses was the increase in commissions paid to our direct sales force as a result of achieving certain revenue milestones. We do not expect to materially increase the number of field sales employee in 2008. As a result, we expect our sales and marketing expenses to be between 30% and 33% of revenue per quarter for the second half of 2008. Sales and marketing expenses are expected to decline as a percent of revenue as our revenue increases.

General and administrative expenses decreased 1% to $1,192,000 for the quarter ended June 30, 2008 from $1,198,000 for the quarter ended June 30, 2007. General and administrative expenses increased 27% to $2,734,000 for the six months ended June 30, 2008 from $2,146,000 for the six months ended June 30, 2007. The decrease in the second quarter of 2008 was the result of lower legal fees as substantially all outstanding litigation matters have been resolved. The increase for the six months ended June 30, 2008 was principally due to an increase in legal fees relating to litigation with Marine Polymer and VNUS as discussed in Note 11 to the financial statements. We expect general and administrative expenses to be approximately 7% to 8% of revenue per quarter for the second half of 2008.

Litigation expenses were $1,457,000 for the quarter ended June 30, 2008, and $1,484,000 for the six months ended June 30, 2008. During the quarter ended June 30, 2008 we recorded a litigation gain of $1,659,000 and we recorded litigation expense of $3,116,000 following the settlement agreements reached with Diomed and VNUS. For a complete discussion see Note 11 to the financial statements.

Thrombin qualification expenses were $-0- for the quarter ended June 30, 2008 compared to $18,000 for the quarter ended June 30, 2007. Thrombin qualification expenses were $-0- for the six months ended June 30, 2008 compared to $129,000 for the six months ended June 30, 2007. On October 18, 2004, we entered into a supply agreement with Sigma-Aldrich Fine Chemicals, an operating division of Sigma-Aldrich, Inc. (Sigma) for the supply of thrombin to us. Pursuant to the terms of the agreement, we agreed to pay certain development costs of Sigma necessary for Sigma to produce thrombin. The initial contract term ends after ten years and is automatically extended for up to five additional successive one-year terms unless one party delivers notice of termination at least one year prior to the scheduled termination of the agreement. During the term of the agreement, Sigma has agreed not to sell thrombin of the type developed for us under the agreement in or as a component of a hemostatic product for medical use. We do not have any minimum purchase requirements under the agreement; however, if we purchase less than three lots of thrombin in any year commencing in 2008 then (i) Sigma will be released from its agreement not to sell thrombin in or as a component of a hemostatic product for medical use, and (ii) Sigma will have the right to terminate the agreement upon 30 days' notice.

The Sigma contract was part of our plan to qualify a second source of thrombin (in addition to the Thrombin-JMI® Supply Agreement discussed in above Note 10 to the Unaudited Consolidated Financial Statements in Item 1 of Part 1 of this Form 10-Q) and to bring the new thrombin through the regulatory process to be used in our hemostatic products. We have purchased $1.7 million of thrombin from Sigma, of which we have expensed approximately $400,000 in our development work. We received regulatory approval in February 2008 allowing us to use the Sigma thrombin in our hemostat products sold in international markets. In the second quarter of 2008 we began using Sigma thrombin in the manufacture of our international hemostat products and have consumed $100,000 to date, resulting in approximately $1.2 million in inventory at June 30, 2008. We expect to consume the remaining supply of Sigma thrombin in the manufacture of our hemostat products sold in international markets prior to its expiration.

Interest expense decreased to $18,000 for the quarter ended June 30, 2008 from $41,000 for the quarter ended June 30, 2007. Interest expense decreased to $42,000 for the six months ended June 30, 2007 from $85,000 for the six months ended June 30, 2007. This decline is a direct result of a lower equipment line of credit balance due to the monthly payments being made, as well as lower interest rates.

Interest income decreased to $48,000 for the quarter ended June 30, 2008 from $107,000 for the quarter ended June 30, 2007. Interest income decreased to $140,000 for the six months ended June 30, 2008 from $198,000 for the six months ended June 30, 2007. This decrease in interest income is primarily a result of the lower cash balance being maintained following the payments made in settlement of the Diomed litigation and VNUS litigation.

Income Taxes

Income tax expense was $53,000 for the quarter ended June 30, 2008, and $140,000 for the six months ended June 30, 2008, primarily the result of federal and state alternative minimum tax (AMT). With the exception of the year ended December 31, 2007, we have not generated any significant pre-tax income. No provision or benefit for future federal and state income taxes has been recorded for net operating losses incurred in any period since our inception because the benefits may not be realized until we generate sustainable taxable income. We have established a valuation allowance in the amount of the full value of our federal net operating loss, federal and state research and development credits and foreign tax losses. The adoption of FIN 48has not impacted our operating results since we have historically established a valuation allowance for the full value of our deferred assets. However, we established a FIN 48 reserve of $512,000 for the six months ended June 30, 2008.

As of June 30, 2008, we had approximately $49.2 million of federal net operating loss carryforwards available to offset future taxable income which begin to expire in the year 2013. As of June 30, 2008, we also had federal and state research and development tax credit carryforwards of approximately $3.7 million which begin to expire in the year 2013. As of June 30, 2008, we also had a foreign tax loss carryforward of approximately $3.1 million, which does not expire. Under the United States Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances, including significant changes in ownership interests. Future use of our existing net operating loss carryforwards may be restricted due to changes in ownership or from future tax legislation. We performed a section 382 "change in ownership" study during the third quarter of 2005 on our federal net operating loss carryforward, and concluded that, as of the date of the study, we would have no limitations on the net operating loss carryforward.

Liquidity and Capital Resources

We have financed substantially all of our operations since inception through the issuance of equity securities and sales of our products. Through June 30, 2008, we have sold capital stock generating aggregate net proceeds of approximately $80.4 million. At June 30, 2008, we had $5,405,000 in cash and cash equivalents on-hand, compared to $10,759,000 in cash and cash equivalents at December 31, 2007.

During the six months ended June 30, 2008, we used $4,748,000 in cash for operating activities, we generated $4,961,000 in cash from investing activities, and we used $104,000 in cash for financing activities. The financing activities consisted of the repurchase of our shares for income tax withholding purposes upon vesting of outstanding restricted share awards and payments made on our equipment line of credit, off-set by the sale of common stock upon the exercise of outstanding stock options. The majority of the cash generated by investing activities was the result of transferring $5,473,000 from restricted cash to cash, which was used to make the settlement payment to Diomed. Capital expenditures of $512,000 were incurred, relating primarily to the purchase of additional manufacturing equipment and additional research and development equipment. Our cash usage through operating activities was primarily the result of settlement payments made to Diomed and VNUS, and for additional purchases of inventory.

We have a combined $12 million credit facility with Silicon Valley Bank consisting of a $10 million revolving line of credit with a 24-month term that bears interest at the rate equal to the greater of prime plus 0.5% or 7.25% and is secured by a first security interest on all of our assets; and a $2 million equipment line of credit with a 36-month term that 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 under the equipment line of credit. The credit facility includes three covenants: a minimum of $10 million in tangible net worth, a minimum of $3 million of unrestricted cash in deposit accounts with Silicon Valley

Bank and an adjusted net income for each financial reporting period. The adjusted net income covenant requires an adjusted net income greater than $100,000 for each subsequent rolling three month period ending June 30, 2008, and an adjusted net income greater than $500,000 for each subsequent rolling three month period thereafter. The amount required as a minimum tangible net worth will increase by an amount equal to the sum of 50% of the Company's quarterly net profit and all consideration received by us upon the issuance of equity securities. The minimum required tangible net worth was $10.6 million at June 30, 2008. We were in compliance with all of the covenants on June 30, 2008. As of June 30, 2008, we had no outstanding balance on the $10 million revolving line of credit and an availability of $10 million. As of June 30, 2008, we had a balance of $467,000 on the equipment line of credit, which was paid in full on July 9, 2008. Following the pay-off of the equipment line of credit, we no longer have the ability to borrow any additional funds under the $2 million credit facility.

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

                                                   Payments Due by Period
Contractual                               Less than                                      More than
Obligations                  Total         1 year       1 - 3 years     3 - 5 years       5 years

Facility operating
leases                    $ 5,749,000    $   694,000    $  1,534,000    $  1,628,000    $ 1,893,000
Equipment line of
credit*                       467,000        467,000               -               -              -

Total contractual cash
obligations               $ 6,216,000    $ 1,161,000    $  1,534,000    $  1,628,000    $ 1,893,000

* This obligation excludes interest.

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

We currently anticipate that we will continue to experience positive cash flow from our operating activities through the remainder of 2008. We currently believe that our working capital of $15.4 million at June 30, 2008 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 unpredictable factors, including the amount of revenues from sales of our existing and new products; the cost of maintaining, enforcing and defending our patents and other intellectual property rights; competing technological and market developments; developments related to regulatory and third party reimbursement matters; and other factors.

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

Critical Accounting Policies

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

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

Inventory

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

Revenue Recognition

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

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

We analyze the rate of historical returns when evaluating the adequacy of the allowance for sales returns, which is included with the allowance for doubtful accounts on our balance sheet. At June 30, 2008, this reserve was $35,000 compared to $40,000 at December 31, 2007. If the historical data we use to calculate these estimates does not properly reflect future returns, revenue could be overstated.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer's ability to pay. At June 30, 2008, this reserve was $95,000 compared to $90,000 at December 31, 2007. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Warranty Costs

We provide a warranty for certain products against defects in material and workmanship for periods of up to 24 months. We record a liability for warranty claims at the time of sale. The amount of the liability is based on the amount we are charged by our original equipment manufacturer to cover the warranty period. The original equipment manufacturer includes a one-year warranty with each product sold to us. We record a liability for the uncovered warranty period offered to a customer, provided the warranty period offered exceeds the initial one-year warranty period covered by the original equipment manufacturer. At June 30, 2008, this warranty provision was $33,000 compared to $34,000 at December 31, 2007. If the assumptions used in calculating the provision were to materially change, resulting in more defects than anticipated, an additional provision may be required.

Income Taxes

The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient taxable income in the United States and, to a lesser extent, Germany, based on estimates and assumptions. We record a valuation allowance to reduce the carrying value of our net deferred tax asset to the amount that is more likely than not to be realized. For the quarter ended June 30, 2008, we recorded a $29.0 million valuation allowance and a $512,000 reserve related to our net deferred tax assets of $29.5 million as a result of FASB Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109. In the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase net income in the period such determination is made. On a quarterly basis, we evaluate the realizability of our deferred tax assets and assess the requirement for a valuation allowance.

Stock-Based Compensation

We account for stock-based compensation in accordance with SFAS No. 123(R), . . .