LEMAITRE VASCULAR INC - Quarter Report: 2013 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2013

Or

For the transition period from                      to                      .

Commission File Number 001-33092

LEMAITRE VASCULAR, INC.

(Exact name of registrant as specified in its charter)

(781) 221-2266

(Registrant’s telephone number, including area code)

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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  ¨

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 Rule12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes  ¨    No  x

The registrant had 15,416,169 shares of common stock, $.01 par value per share, outstanding as of October 31, 2013.

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LEMAITRE VASCULAR

FORM 10-Q

TABLE OF CONTENTS

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Part I. Financial Information

LeMaitre Vascular, Inc.

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

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LeMaitre Vascular, Inc.

Consolidated Statements of Operations

(unaudited)

See accompanying notes to consolidated financial statements.

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LeMaitre Vascular, Inc.

Consolidated Statements of Comprehensive Income

(unaudited)

See accompanying notes to consolidated financial statements.

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LeMaitre Vascular, Inc.

Consolidated Statements of Cash Flows

(unaudited)

See accompanying notes to consolidated financial statements.

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LeMaitre Vascular, Inc.

Notes to Consolidated Financial Statements

September 30, 2013

(unaudited)

Description of Business

Unless the context requires otherwise, references to LeMaitre Vascular, we, our, and us refer to LeMaitre Vascular, Inc. and our subsidiaries. We develop, manufacture, and market medical devices and implants used primarily in the field of vascular surgery. We operate in a single segment in which our principal product lines are balloon catheters, biologic vascular patches, carotid shunts, laparoscopic cholecystectomy devices, radiopaque tape, remote endarterectomy devices, valvulotomes, vascular grafts, vascular patches, vein removal systems, and vessel closure systems. Our offices are located in Burlington, Massachusetts; Mississauga, Canada; Sulzbach, Germany; Milan, Italy; Madrid, Spain; and Tokyo, Japan.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of normal, recurring adjustments considered necessary for a fair presentation of the results of these interim periods have been included. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. Our estimates and assumptions, including those related to bad debts, inventories, intangible assets, sales returns and discounts, share-based compensation, and income taxes are updated as appropriate. The results for the nine months ended September 30, 2013 are not necessarily indicative of results to be expected for the entire year. The information contained in these interim financial statements should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2012, including the notes thereto, included in our Form 10-K filed with the Securities and Exchange Commission (SEC).

Consolidation

Our consolidated financial statements include the accounts of LeMaitre Vascular and the accounts of our wholly-owned subsidiaries, LeMaitre Vascular GmbH, LeMaitre Vascular GK, Vascutech Acquisition LLC, LeMaitre Acquisition LLC, LeMaitre Vascular SAS, LeMaitre Vascular S.r.l., LeMaitre Vascular Spain SL, LeMaitre Vascular Switzerland GmbH, and LeMaitre Vascular ULC. All significant intercompany accounts and transactions have been eliminated in consolidation.

Correction of an Error

During the second quarter of 2013, we identified an error in our historic inventory valuation that resulted in an understatement of the periodic carrying amount of our inventory. We corrected this error in the second quarter of 2013. As a result of the error, inventory was understated as of December 31, 2011 and 2012 by $0.2 million and $0.4 million, respectively, and cost of sales was overstated by $0.2 million in each of those years. Our financial statements for the nine months ended September 30, 2013 reflect the correction of this error, which resulted in an understatement of cost of sales of $0.4 million and an overstatement of net income of $0.3 million in the nine months ended September 30, 2013. We evaluated the materiality of the error from a qualitative and quantitative perspective and concluded the error was not material to our consolidated financial statements for the years ended December 31, 2011 and 2012, as well as the expected results for the year ending December 31, 2013.

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Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (FASB) issued new guidance which requires disclosure of changes in accumulated other comprehensive income balances by component and significant reclassification adjustments from accumulated other comprehensive income in a single note or on the face of the financial statements. This guidance became effective January 1, 2013. The adoption of this standard, which is related to disclosure only, did not have an impact on our results of operations or financial position.

As part of the process of preparing our consolidated financial statements we are required to determine our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from recognition of items for income tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from taxable income during the carryback period or in the future; and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must reflect this increase as an expense within the tax provision in the statement of operations. We do not provide for income taxes on undistributed earnings of foreign subsidiaries, as our current intention is to permanently reinvest these earnings.

We recognize, measure, present and disclose in our financial statements uncertain tax positions that we have taken or expect to take on a tax return. We operate in multiple taxing jurisdictions, both within the United States and outside of the United States, and may be subject to audits from various tax authorities regarding transfer pricing, the deductibility of certain expenses, intercompany transactions, and other matters. Within specific countries, we may be subject to audit by various tax authorities operating within the country and may be subject to different statutes of limitation expiration dates. Management’s judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, liabilities for uncertain tax positions, and any valuation allowance recorded against our net deferred tax assets. We will continue to monitor the realizability of our deferred tax assets and adjust the valuation allowance accordingly.

Our policy is to classify interest and penalties related to unrecognized tax benefits as income tax expense. This policy has been consistently applied in all periods.

Our 2013 income tax expense varies from the statutory rate mainly due to discrete items related to a research and development tax credit earned in 2012, but enacted into law in January 2013 and the recognition of uncertain tax positions as a result of the lapse in the statute of limitations, lower statutory rates from our foreign entities and certain permanent items. Our 2012 income tax expense varied from the statutory rate amounts mainly due to the inclusion of certain foreign entities with losses, from lower statutory rates at our foreign German entity, offset by certain permanent and discrete items.

We have reviewed the tax positions taken, or to be taken, in our tax returns for all tax years currently open to examination by a taxing authority. As of September 30, 2013, the gross amount of unrecognized tax benefits exclusive of interest and penalties was $130,000. We remain subject to examination until the statute of limitations expires for each respective tax jurisdiction. The statute of limitations will be open with respect to these tax positions until 2017. A reconciliation of beginning and ending amount of our unrecognized tax benefits is as follows:

As of September 30, 2013, a summary of the tax years that remain subject to examination in our most significant tax jurisdictions is as follows:

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Inventories consist of the following:

We held inventory on consignment of $0.6 million and $0.7 million as of September 30, 2013 and December 31, 2012, respectively.

XenoSure Manufacturing and Distribution Rights

In October 2012, we entered into an Asset Purchase Agreement (the Neovasc Agreement) with Neovasc, Inc. and its subsidiary, Neovasc Medical Inc. (collectively Neovasc) to acquire the manufacturing and distribution rights of the XenoSure biologic vascular patch. Previously, we were the exclusive distributor of the XenoSure biologic vascular patch through January 26, 2016 and held an option to purchase the manufacturing and distribution rights. Assets acquired in October 2012 include intellectual property, manufacturing know-how, and a five year non-compete agreement. Other provisions of the Neovasc Agreement include transitional assistance from Neovasc and mutual indemnification for losses arising out of or relating to certain breaches of, and misrepresentations under, the Neovasc Agreement. Additionally, we have entered into a supply agreement with Neovasc while we transition manufacturing to our Burlington facility.

The purchase price for this acquisition was $4.6 million. We paid Neovasc $4.3 million at the closing of the acquisition. The remaining $0.3 million was paid in October 2013. We accounted for the acquisition as a business combination. We recorded $2.8 million of intangible assets and $1.8 million of goodwill. The weighted-average amortization period for the acquired intangible assets is 12.0 years. The goodwill of $1.8 million will be deductible for tax purposes over 15 years.

Clinical Instruments International, Inc.

In July 2013, we entered into an Asset Purchase Agreement with Clinical Instruments International, Inc. (Clinical Instruments) to acquire substantially all the assets of Clinical Instruments for $1.1 million. We paid $0.9 million at the closing and the remaining $0.2 million is payable in October 2014. We accounted for the acquisition as a business combination. Assets acquired include inventory and intellectual property.

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The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of the acquisition:

The goodwill of $0.6 million will be deductible for tax purposes over 15 years.

Of the $0.3 million of acquired intangible assets, the following table reflects the allocation of the acquired intangible assets and related estimated useful lives:

InaVein LLC

In August 2013, we entered into an Asset Purchase Agreement with InaVein LLC (InaVein) to acquire substantially all the assets of InaVein for $2.5 million and acquisition-related contingent consideration totaling $1.4 million in 2014 and 2015 dependent on the performance of the acquired business and the timing of regulatory approval in China. We paid $2.1 million at the closing and the remaining $0.4 million is payable in August 2014. We accounted for the acquisition as a business combination. Assets acquired include receivables, inventory, equipment, and intellectual property. Liabilities assumed include payables and service contracts.

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The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of the acquisition:

The goodwill of $0.7 million will be deductible for tax purposes over 15 years.

Of the $1.1 million of acquired intangible assets, the following table reflects the allocation of the acquired intangible assets and related estimated useful lives:

Schaublin Medica SA Distribution Agreement

In October 2012, we entered into a definitive agreement with Schaublin Medica SA (Schaublin) to terminate its distribution of our products in Switzerland and to acquire certain assets and rights from Schaublin effective as of January 1, 2013 for $0.2 million. The purchase price is due in three equal installments with payments made in October 2012 and January 2013 and the final payment due in January 2014. In 2012, we recorded $0.1 million of intangible assets and recognized $0.1 million of transition services as selling expense. We allocated the payment to the tangible and intangible assets acquired based on the estimated fair value of each of these elements to the transaction. The weighted-average amortization period for the acquired intangible assets is 7.0 years.

TryTech Distribution Agreement

In December 2012, we entered into a definitive agreement with TryTech Corporation (TryTech) to terminate its distribution of our products in a certain Japanese territory and to acquire certain assets and rights from TryTech effective as of April 1, 2013 for $0.1 million. The purchase price is due in three equal installments with payments made in December 2012 and March 2013 and the final payment due in March 2014. We recorded $0.1 million of intangible assets. We allocated the payment to the tangible and intangible assets acquired based on the estimated fair value of each of these elements to the transaction. The weighted-average amortization period for the acquired intangible assets is 3.0 years.

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Medistim Norge AS Distribution Agreement

In October 2013, we entered into a definitive agreement with Medistim Norge AS (Medistim) to terminate its distribution of our products in Norway and to acquire certain assets and rights from Medistim effective as of January 1, 2014 for $0.2 million. The purchase price is due in three installments with the first payment made in October 2013 and the remaining two payments due in December 2013 and December 2014. We will account for this transaction during the three months ending December 31, 2013.

Tag Medical Pty Ltd Distribution Agreement

In October 2013, we entered into a definitive agreement with Tag Medical Pty Ltd (Tag) to terminate its distribution of our products in Australia and to acquire certain assets and rights from Tag effective as of January 1, 2014 for $0.2 million. The purchase price is due in three installments with the first payment made in November 2013 and the remaining two payments due in December 2013 and December 2014. We will account for this transaction during the three months ending December 31, 2013.

OptiLock Implantable Port

On June 1, 2010, we sold our OptiLock Implantable Port product line to Minvasive Ltd. (Minvasive). In exchange for consideration of approximately $0.2 million, Minvasive received our existing inventory, tangible and intangible assets, and a customer list associated with the product line. Payment terms included $30,000 due at signing, with the remaining balance to be paid in the form of a royalty on future sales. In May 2012, Minvasive provided notice that it was filing for insolvency protection under German law. As a result, we wrote-off the remaining balance of approximately $52,000 as a loss on divestitures during the three months ended June 30, 2012.

TAArget and UniFit Stent Grafts

On June 30, 2011, we sold our TAArget and UniFit stent graft product lines to Duke Vascular, Inc. (Duke). In exchange for consideration of approximately $0.1 million in cash and a $0.5 million promissory note, Duke received most of our existing inventory, tangible and intangible assets, and a customer list associated with the product lines. We received the initial cash payment on June 30, 2011. The $0.5 million promissory note bore interest at 7% and was payable on June 30, 2012. We recorded the estimated fair value of the promissory note as $0.2 million receivable in other long term assets. As a result of this transaction we recorded a net charge of approximately $0.4 million in cost of sales during the year ended December 31, 2011. In 2012, we received $0.5 million which was applied to the outstanding promissory note balance of $0.2 million, interest income, and as a gain on divestiture of $0.3 million.

Our acquisitions have historically been made at prices above the fair value of the acquired identifiable assets, resulting in goodwill, due to expectations of synergies that will be realized by combining businesses. These synergies include the use of our existing sales channel to expand sales of the acquired businesses’ products, consolidation of manufacturing facilities, and the leveraging our existing administrative infrastructure. The net assets acquired have been recorded based on estimates of fair value and, for acquisitions completed within the past year, are subject to adjustment upon finalization of the valuation process.

The fair market valuations associated with these transactions fall within Level 3 of the fair value hierarchy, due to the use of significant unobservable inputs to determine fair value. The fair value measurements were calculated using unobservable inputs, primarily using the income approach, specifically the discounted cash flow method. The amount and timing of future cash flows within our analysis was based on our due diligence models, most recent operational budgets, long range strategic plans and other estimates.

Goodwill consists of the following:

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The components of our identifiable intangible assets were as follows:

These intangible assets are being amortized over their useful lives ranging from 1 to 15 years. The weighted-average amortization period for these intangibles as of September 30, 2013 is 7.7 years. Amortization expense is included in general and administrative expense and is as follows:

Estimated amortization expense for the remainder of 2013 and each of the five succeeding fiscal years is as follows:

Accrued expenses consist of the following:

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Purchase Commitments

As of September 30, 2013, as part of our normal course of business, we have purchase commitments to purchase $3.6 million of inventory through 2015.

The FASB establishes standards for reporting information regarding operating segments in financial statements. Operating segments are identified as components of an enterprise about which separate, discrete financial information is available for evaluation by the chief operating decision-maker in making decisions on how to allocate resources and assess performance. We view our operations and manage our business as one operating segment. No discrete operating information is prepared by us except for product sales by product line and by legal entity for local reporting purposes.

Most of our revenues were generated in the United States, Germany, Japan, Canada and other European countries, and substantially all of our assets are located in the United States. Net sales to unaffiliated customers by country were as follows:

Our 2006 Stock Option and Incentive Plan allows for granting of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock units, unrestricted stock awards, and deferred stock awards to our officers, employees, directors, and consultants.

The components of share-based compensation expense were as follows:

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We have computed the fair values of employee stock options for option grants issued during the nine months ended September 30, 2013 and 2012 using the Black-Scholes option model with the following assumptions:

The weighted-average fair value per share of restricted stock unit grants issued for the nine months ended September 30, 2013 was $6.67. The weighted-average fair value per share of restricted stock unit grants issued for the nine months ended September 30, 2012 was $6.23.

We issued approximately 255,000 and 119,000 shares of common stock following the exercise or vesting of underlying stock options or restricted stock units in the nine months ended September 30, 2013 and 2012, respectively.

The computation of basic and diluted net income per share was as follows:

Authorized Shares

On June 14, 2012, our stockholders approved an amendment (Charter Amendment) to our Second Amended and Restated Certificate of Incorporation to reduce the number of authorized shares of common stock from 100,000,000 to 37,000,000 shares and of undesignated preferred stock from 5,000,000 to 3,000,000 shares. The Charter Amendment was previously approved by our Board of Directors on April 12, 2012, subject to approval by our stockholders. The Charter Amendment was filed with the Secretary of State of the State of Delaware on June 14, 2012.

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Stock Repurchase Plan

In July 2009, our Board of Directors authorized a repurchase of our common stock from time to time on the open market or in privately negotiated transactions. In November 2011, our Board of Directors increased this authorization to $10.0 million and extended the program through December 31, 2013. The timing and number of any shares repurchased will be determined based on our evaluation of market conditions and other factors. Repurchases may also be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under insider trading laws. The repurchase program may be suspended or discontinued at any time and will conclude no later than December 31, 2013, unless otherwise extended by our Board of Directors. The repurchase program is being funded using our available cash and cash equivalents. We have the authority to purchase $3.5 million of shares of our common stock remaining under the repurchase program as of September 30, 2013. The following is a summary of the stock repurchase activity for the nine months ended:

Dividends

In February 2011, our Board of Directors approved a policy for the payment of quarterly cash dividends on our common stock. Future declarations of quarterly dividends and the establishment of future record and payment dates are subject to approval by our Board of Directors on a quarterly basis. The dividend activity for the periods presented is as follows:

On October 23, 2013, our Board of Directors approved a quarterly cash dividend on our common stock of $0.03 per share payable on December 4, 2013 to stockholders of record at the close of business on November 20, 2013, which will total approximately $0.5 million.

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The fair value accounting guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

As of September 30, 2013, we had cash equivalents in a money market fund that was valued using Level 1 inputs (quoted market prices for identical assets) at a fair value of $8.3 million.

We had no Level 2 assets being measured at fair value on a recurring basis as of September 30, 2013.

We determine the fair value of acquisition-related contingent consideration based on assessment of the probability that we would be required to make such future payment. The following table provides a rollforward of the fair value, as determined by Level 3 inputs:

Our accumulated other comprehensive loss consisted of foreign currency translation for the nine months ended September 30, 2013 and 2012, respectively.

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This Quarterly Report on Form 10-Q contains forward-looking statements (within the meaning of the federal securities law) that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this report regarding our strategy, future operations, future financial position, future net sales, projected costs, projected expenses, prospects and plans and objectives of management are forward-looking statements. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that the expectations underlying any of our forward-looking statements are reasonable, these expectations may prove to be incorrect, and all of these statements are subject to risks and uncertainties. Should one or more of these risks and uncertainties materialize, or should underlying assumptions, projections, or expectations prove incorrect, our actual results, performance, or financial condition may vary materially and adversely from those anticipated, estimated, or expected. These risk and uncertainties include, but are not limited to: the risk that the Company may not realize the anticipated benefits of its strategic activities; the risk that assumptions about the market for the Company’s products and the productivity of the Company’s direct sales force and distributors may not be correct; risks related to the integration of acquisition targets; risks related to product demand and market acceptance of the Company’s products; the risk that the XenoSure product is not as accretive and does not achieve the gross margins currently anticipated by the Company; the risk that the Company experiences increased expense, production delays or quality difficulties in the transition of the XenoSure manufacturing operations; risks related to attracting, training and retaining sales representatives and other employees in new markets such as Australia and Norway; and the risk that the Company is not successful in transitioning to a direct-selling model in new territories.

Forward-looking statements reflect management’s analysis as of the date of this quarterly report. Further information on potential risk factors that could affect our business and financial results is detailed in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission, including under the section headed “Risk Factors” in our most recent Annual Report on Form 10-K. Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in this report and our other SEC filings, including our audited consolidated financial statements and the related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC on March 27, 2013. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.

Unless the context requires otherwise, references to “LeMaitre Vascular,” “we,” “our,” and “us” in this Quarterly Report on Form 10-Q refer to LeMaitre Vascular, Inc. and its subsidiaries.

LeMaitre, AlboGraft, AlboSure, LifeSpan, Trivex, UnBalloon, and XenoSure are registered trademarks of LeMaitre Vascular, and MultiTASC is an unregistered trademark of LeMaitre Vascular. This Quarterly Report on Form 10-Q also includes the registered and unregistered trademarks of other persons, which are the property of their respective owners.

Overview

We are a medical device company that develops, manufactures, and markets medical devices and implants for the treatment of peripheral vascular disease. Our principal product offerings are sold throughout the world, primarily in the United States, the European Union and, to a lesser extent, Japan and Canada. We estimate that the annual worldwide market for all peripheral vascular devices approximates $3 to $4 billion, within which our core product lines address roughly $800 million. We have grown our business by using a three-pronged strategy: focusing on the vascular surgeon customer, competing in niche markets, and expanding our sales platform by increasing our worldwide direct sales force and acquiring and developing complementary vascular devices. We have used acquisitions as a primary means of further accessing the larger peripheral vascular device market, and we expect to continue to pursue this strategy in the future. Additionally, we have increased our efforts to expand our vascular device offerings through new product development efforts. We currently manufacture most of our product lines in our Burlington, Massachusetts, headquarters.

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Our products are used by vascular surgeons who treat peripheral vascular disease through both open surgical methods and endovascular techniques. In contrast to interventional cardiologists and interventional radiologists, neither of whom are certified to perform open surgical procedures, vascular surgeons can perform both open surgical and minimally invasive endovascular procedures, and are therefore uniquely positioned to provide a wider range of treatment options to patients.

Our principal product lines include the following: balloon catheters, biologic vascular patches, carotid shunts, laparoscopic cholecystectomy devices, radiopaque marking tape, remote endarterectomy devices, valvulotomes, vascular grafts, vascular patches, vein removal systems, and vessel closure systems.

Historically we have experienced comparatively greater success in niche product markets characterized by low or limited competition and higher product technology differentiation, for example the market for valvulotome devices. In the valvulotome market, we believe that we have been able to increase selling prices without compromising market share. There can be no assurance that we will not meet resistance to increased selling prices in the future. In contrast, we have experienced comparatively lesser success in more competitive product markets where there is less product technology differentiation, such as prosthetic polyester and ePTFE grafts, where we face stronger competition from larger companies with greater resources. While there can be no assurance that we will be successful in more competitive and less differentiated markets, we believe that these challenging market dynamics can be mitigated by our strong relationships with our vascular surgeon customers. For example, in the biologic patch market, we have been able to increase our market share significantly, mainly through the conversion of competitor accounts to our vascular biologic patch.

Our business opportunities include the following:

We sell our products primarily through a direct sales force. As of September 30, 2013 our sales force was comprised of 87 sales representatives in North America, Europe, and Japan. We also sell our products in other countries through distributors. Our worldwide headquarters is located in Burlington, Massachusetts. Our international operations are headquartered in Sulzbach, Germany. We also have sales offices located in Tokyo, Japan; Mississauga, Canada; Madrid, Spain; and Milan, Italy. For the nine months ended September 30, 2013 approximately 93% of our net sales were generated in markets in which we employ direct sales representatives.

Because we believe that direct-to-hospital sales engender closer customer relationships, and allow for higher selling prices and gross margins, we periodically enter into transactions with our distributors to transition their sales of our medical devices to our direct sales organization:

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We anticipate that the expansion of our direct sales organization in Canada and Switzerland will result in increased sales and marketing expenses during 2013. We anticipate that going direct in Norway and Australia will result in increased administrative, selling, and marketing expenses in 2014.

Our strategy for growing our business includes the acquisition of complementary product lines and companies and occasionally the discontinuance or divestiture of products or activities that are no longer complementary:

In addition to relying upon acquisitions to grow our business, we also rely on our product development efforts to bring differentiated technology and next-generation products to market. These efforts have led to the following recent product developments:

In addition to our sales growth strategies, we have also executed several operational initiatives designed to consolidate and streamline manufacturing within our Burlington, MA facilities. We expect that these plant consolidations will result in improved control over our production capacity as well as reduced costs over the long-term. Our most recent manufacturing transitions included:

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Our execution of these strategies may affect the comparability of our financial results from period to period and may cause substantial fluctuations from period to period, as we incur related restructuring and other non-recurring charges, as well as longer term impacts to revenues and operating expenditures. For example, in 2011 we exited the stent graft business and realized gains of approximately $0.7 million in 2011 and $0.2 million in 2012.

Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the Euro, affect our financial results. For the nine months ended September 30, 2013, approximately 34% of our sales were from outside the Americas. We expect foreign currencies will continue to represent a similarly significant percentage of our sales in the future. Selling, marketing, and administrative costs related to these sales are largely denominated in the same respective currency, thereby partially mitigating our transaction risk exposure. However, most of our foreign sales are denominated in local currency, and if there is an increase in the rate at which a foreign currency is exchanged for U.S. dollars, it will require more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. In such cases we will report less sales in U.S. dollars than we did before the rate increase went into effect.

Adjustments to Previously Issued Unaudited Preliminary Results of Operations

We recorded an additional provision for income taxes of $60,000 for the three months ending September 30, 2013 due to higher income taxes than expected on certain stock option exercises since the reporting of our preliminary results on October 29, 2013, which reduced net income by $60,000 in the period.

Results of Operations

Comparison of the three and nine months ended September 30, 2013 to the three and nine months ended September 30, 2012.

The following tables set forth, for the periods indicated, our results of operations, net sales by geography, and the change between the specified periods expressed as a percentage increase or decrease:

Net sales. Net sales increased 12% to $15.3 million for the three months ended September 30, 2013, compared to $13.6 million for the three months ended September 30, 2012. Sales increases for the three months ended September 30, 2013 were primarily driven by increased sales in biologic vascular patches of $0.7 million, catheters of $0.3 million, shunts of $0.3 million, valvulotomes of $0.2 million, and Dacron grafts of $0.2 million, and were partially offset by decreased sales of radiopaque tape of $0.2 million. The Clinical and InaVein acquisitions contributed $0.3 million of sales during the three months ended September 30, 2013.

Net sales increased 11% to $46.6 million for the nine months ended September 30, 2013, compared to $41.9 million for the nine months ended September 30, 2012. Sales increases for the nine months ended September 30, 2013 were primarily driven by increased sales in biologic vascular patches of $1.9 million, valvulotomes of $0.9 million, catheters of $0.8 million, Dacron grafts of $0.5 million, and vessel closure systems of $0.5 million, and were partially offset by decreased sales of radiopaque tape and non-occlusive modeling catheters. The primary drivers in the increased sales were higher average selling prices across all product lines, increases in unit sales, and the recovery of Dacron graft sales previously prohibited in certain European countries.

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Direct-to-hospital net sales were 93% for the nine months ended September 30, 2013, down from 95% for the nine months ended September 30, 2012.

Net sales by geography. Net sales in the Americas increased by $0.9 million for the three months ended September 30, 2013. The increase was primarily driven by increased sales of biologic vascular patches, vessel closure systems, and newly acquired products, as well as higher average selling prices across nearly all product lines, and was partially offset by decreased sales of radiopaque tape. International net sales increased $0.8 million for the three months ended September 30, 2013. The increase was primarily driven by increased sales of biologic vascular patches, catheters, valvulotomes, and Dacron grafts.

Net sales in the Americas increased by $2.3 million for the nine months ended September 30, 2013. The increase was primarily driven by increased sales of biologic vascular patches, valvulotomes, vessel closure systems, and catheters, as well as higher average selling prices across nearly all product lines, and was partially offset by decreased sales of radiopaque tape of $0.4 million. International net sales increased $2.4 million for the nine months ended September 30, 2013. The increase was primarily driven by increased sales of biologic vascular patches, catheters, Dacron grafts, and valvulotomes.

Gross Profit. Gross profit increased 7% to $10.7 million for the three months ended September 30, 2013, while gross margin decreased 3.4% to 70% in the same period. The gross margin decrease was largely driven by, unfavorable geographic and product mix, start-up costs associated with our biologic vascular patch manufacturing as well as transition costs associated with our newly acquired Clinical manufacturing facility. These decreases were partially offset by non-recurring inventory write-offs associated with our Dacron graft manufacturing in 2012 and higher average selling prices across all product lines. The gross profit increase was a result of higher sales.

Gross profit increased 9% to $33.2 million for the nine months ended September 30, 2013, while gross margin decreased 1.5% to 71.1% in the same period. The gross margin decrease was largely driven by unfavorable geographic mix, increased sales of our lower margin biologic vascular patches, and start-up costs associated with our biologic vascular patch. These decreases were partially offset by non-recurring inventory write-offs associated with our Dacron graft manufacturing in 2012, higher average selling prices across all product lines, improved manufacturing efficiencies and the correction of an inventory valuation error recorded in the second quarter of 2013. The gross profit increase was a result of higher sales.

In October 2012, we entered into a definitive agreement with Neovasc, Inc. to acquire the manufacturing and distribution rights of the XenoSure biologic vascular patch, which we expect will continue to negatively affect gross margin through the second quarter of 2014 as we transition production to our Burlington facility. We expect to realize efficiencies which may improve gross margins on our XenoSure biologic vascular patch beginning in the second half of 2014.

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Sales and marketing. For the three months ended September 30, 2013, sales and marketing expense increased 6% to $5.2 million. Selling expense increased $0.4 million while marketing expense decreased by $0.1 million. Selling expense increases were driven by increased compensation and other personnel related costs of $0.3 million, primarily due to additional sales personnel in Switzerland and Canada. Marketing expense decreases were largely driven by a reduction of direct marketing and advertising expenses. As a percentage of net sales, sales and marketing expense was 34% in the three months ended September 30, 2013.

For the nine months ended September 30, 2013, sales and marketing expense increased by 6% to $16.2 million. Selling expense increased $1.3 million while marketing expense decreased by $0.3 million. Selling expense increases were driven by increased compensation and other personnel related costs of $1.0 million, partially due to additional sales personnel in Switzerland and Canada, and increased sales meetings and related costs of $0.2 million. Marketing expense decreases were largely driven by a $0.3 million reduction in advertising costs which was offset by an increase in compensation expenses of $0.1 million. As a percentage of net sales, sales and marketing expense was 35% in the nine months ended September 30, 2013.

General and administrative. For the three months ended September 30, 2013, general and administrative expense increased 13% to $3.3 million. The increase was largely the result of expenses associated with our newly formed subsidiary in Canada, increased compensation costs of $0.2 million, increased professional services costs of $0.2 million, and increased intangible amortization of $0.1 million, which was partially offset by decreased employee termination and bad debt costs. As a percentage of net sales, general and administrative expense was 21% in the three months ended September 30, 2013.

For the nine months ended September 30, 2013, general and administrative expense increased 12% to $9.2 million. The increase was largely the result of expenses associated with our newly formed subsidiary in Canada, increased compensation costs of $0.5 million, increased professional services costs of $0.5 million, and increased intangibles amortization of $0.2 million, which was partially offset by decreased employee termination and bad debt costs. As a percentage of net sales, general and administrative expense was 20% in the nine months ended September 30, 2013.

Research and development. For the three months ended September 30, 2013, research and development expense increased 3% to $1.3 million. Product development expense decreased $0.1 million primarily due to decreased product testing costs. Clinical and regulatory expense increased $0.1 million primarily due to increased testing costs. As a percentage of net sales, research and development expense was 8% for the three months ended September 30, 2013.

For the nine months ended September 30, 2013, research and development expense increased 9% to $3.8 million. Product development expense increased $0.1 million primarily due to increased compensation expense.

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Clinical and regulatory expense increased $0.2 million mainly due to increased compensation and outside services. As a percentage of net sales, research and development expense was 8% for the nine months ended September 30, 2013.

Medical device excise tax. Commencing in 2013, we were subject to a medical device excise tax of 2.3% of sales within the United States. The medical device excise tax was $0.2 million and $0.5 million for the three months and nine months ended September 30, 2013, respectively. We estimate this tax will negatively affect income from operations by approximately $0.7 million in 2013.

Gain / loss on divestitures. We recorded a $0.1 million gain on divestiture relating to our TAArget and UniFit stent graft product lines as a result of payments received from Duke Vascular during the three months ended September 30, 2012. We recorded a $0.1 million write-off on a note receivable associated with our 2010 Optilock divesture as the acquirer provided notice that it was filing for insolvency protection under German law in the second quarter of 2012.

Foreign exchange gains / losses. Foreign exchange losses for the nine months ended September 30, 2013 were $0.1 million. For the nine months ended September 30, 2012, foreign exchange losses were $0.2 million, primarily the result of a cumulative translation adjustment recorded at our Biomateriali subsidiary upon the liquidation and dissolution of that legal entity.

Income tax expense. We recorded a provision for taxes of $0.1 million on pre-tax income of $0.8 million for the three months ended September 30, 2013, compared to $0.4 million on pre-tax income of $1.1 million for the three months ended September 30, 2012. We recorded a provision for taxes of $0.8 million on pre-tax income of $3.2 million for the nine months ended September 30, 2013, compared to $1.3 million on a pre-tax income of $3.1 million for the nine months ended September 30, 2012. Our 2013 provision was based on the estimated annual effective tax rate of 35.2%, comprised of estimated federal and state income taxes of approximately $1.6 million, as well as foreign income taxes of $0.3 million. Our income tax expense for the current period varies from the statutory rate amounts mainly due to discrete items related to a $0.2 million research and development tax credit earned in 2012, but enacted into law in January 2013 and the recognition of $0.2 million of uncertain tax positions as a result of the lapse in the statute of limitations, lower statutory rates from our foreign entities and certain permanent items. Our September 30, 2012 provision for taxes was based on the estimated annual effective tax rate of 39.4% and was comprised of estimated federal and state income taxes of approximately $1.0 million, as well as a foreign income tax benefit of $0.1 million. Our 2012 income tax expense varied from the statutory rate amounts mainly due to the inclusion of certain foreign entities with losses, from lower statutory rates at our foreign German entity, offset by certain permanent and discrete items. We monitor the mix of profitability by tax jurisdiction and adjust our annual expected rate on a quarterly basis as needed. While it is often difficult to predict the final outcome or timing of the resolution for any particular tax matter, we believe that our tax reserves reflect the probable outcome of known contingencies.

We have assessed the need for a valuation allowance against our deferred tax assets and concluded that as of September 30, 2013, we will continue to carry a valuation allowance against $3.1 million of deferred tax assets, principally foreign net operating loss carry-forwards, which based on the available evidence, we believe it is more likely than not that such assets will not be realized.

For the remainder of 2013, we expect that our effective tax rate will be comparable to the statutory tax rates less the benefits related to research and development tax credits from both 2012 and 2013 as a result of legislation enacted in January 2013, reductions in uncertain tax positions due to the lapse of the statute of limitations and the benefit from the exercise of certain stock options.

Liquidity and Capital Resources

At September 30, 2013, our cash and cash equivalents were $13.6 million as compared to $16.4 million at December 31, 2012. Our cash and cash equivalents are highly liquid investments with maturities of 90 days or less at the date of purchase and consist of money market funds, and are stated at cost, which approximates fair value. We did not hold any marketable securities nor any mortgage asset-backed or auction-rate securities in our investment portfolio as of September 30, 2013. All of our cash held outside of the United States is available for corporate use.

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Operating and Capital Expenditure Requirements

We require cash to pay our operating expenses, make capital expenditures, and pay our long-term liabilities. Since our inception, we have funded our operations through public offering and private placements of equity securities, short-term borrowings, and funds generated from our operations.

We recognized operating income of $3.3 million for the nine months ended September 30, 2013. For the year ended December 31, 2012, we recognized operating income of $4.2 million. We expect to fund any increased costs and expenditures from our existing cash and cash equivalents, though our future capital requirements depend on numerous factors. These factors include, but are not limited to, the following:

Our cash balances may decrease as we continue to use cash to fund our operations, make acquisitions, make purchases under our share repurchase program, make payments under our quarterly dividend program, and make deferred payments related to prior acquisitions. We believe that our cash and cash equivalents and the interest we earn on these balances will be sufficient to meet our anticipated cash requirements for at least the next twelve months. If these sources of cash are insufficient to satisfy our liquidity requirements beyond the next twelve months, we may seek to sell additional equity or debt securities or borrow funds from, or establish a revolving credit facility with, a financial institution. The sale of additional equity and debt securities may result in dilution to our stockholders. If we raise additional funds through the issuance of debt securities, such securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations and possibly our ability to pay dividends. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all.

Stock Repurchase Plan

In July 2009, our Board of Directors authorized a repurchase of our common stock from time to time on the open market or in privately negotiated transactions. In November 2011, our Board of Directors increased this authorization to $10.0 million and extended the program through December 31, 2013. The timing and number of any shares repurchased will be determined based on our evaluation of market conditions and other factors. Repurchases may also be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under insider trading laws. The repurchase program may be suspended or discontinued at any time and will conclude no later than December 31, 2013, unless otherwise extended by our Board of Directors. The repurchase program is being funded using our available cash and cash equivalents. We have the authority to purchase $3.5 million of shares of our common stock remaining under the repurchase program as of September 30, 2013. The following is a summary of the stock repurchase activity for the nine months ended:

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Dividends

In February 2011, our Board of Directors approved a policy for the payment of quarterly cash dividends on our common stock. Future declarations of quarterly dividends and the establishment of future record and payment dates are subject to approval by our Board of Directors on a quarterly basis. The dividend activity for the periods presented is as follows:

On October 23, 2013, our Board of Directors approved a quarterly cash dividend on our common stock of $0.03 per share payable on December 4, 2013 to stockholders of record at the close of business on November 20, 2013, which will total approximately $0.5 million.

Cash Flows

Net cash provided by operating activities. Net cash provided by operating activities was $4.0 million for the nine months ended September 30, 2013, and consisted of $2.5 million net income, adjusted for non-cash items of $3.4 million (including depreciation and amortization of $2.0 million, stock-based compensation of $1.0 million, and provision for inventory write-offs of $0.4 million) and was offset by changes in working capital of $1.9 million. The net cash used by changes in working capital was principally the result of an increase in inventory.

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Net cash provided by operating activities was $4.3 million for the nine months ended September 30, 2012, and consisted of $1.9 million net income, adjusted for non-cash items of $3.9 million (including depreciation and amortization of $1.6 million, provision for inventory write-offs of $0.9 million, stock-based compensation of $0.9 million, and the effects of foreign currency translations of $0.3 million) and was offset by changes in working capital of $1.5 million. The net cash used by changes in working capital was principally the result of an increase in inventory of $3.1 million and in accounts payable and other liabilities of $1.6 million.

Net cash used in investing activities. Net cash used in investing activities was $5.9 million for the nine months ended September 30, 2013. This was primarily driven by acquisition related payments to InaVein and Clinical Instruments of $3.2 million and the purchase of property and equipment of $2.4 million of which $0.9 million related to facility build-out and manufacturing equipment associated with our biologic vascular patch.

Net cash used in investing activities was $0.7 million for the nine months ended September 30, 2012. This was primarily driven by the purchase of property and equipment and was partially offset by a $0.3 million collection of a note receivable related to our 2011 stent graft divestiture.

Net cash used in financing activities. Net cash used in financing activities was $1.0 million for the nine months ended September 30, 2013, driven primarily by payment of common stock dividends of $1.4 million and $0.3 million of treasury stock to cover minimum withholding taxes of restricted stock unit vestings which were partially offset by proceeds from stock option exercises of $0.7 million.

Net cash used in financing activities was $3.1 million for the nine months ended September 30, 2012, driven primarily by the purchase of $2.0 million of our shares of common stock under our stock repurchase plan and the payment of common stock dividends of $1.1 million.

Contractual obligations. Our principal contractual obligations consist of operating leases and inventory purchase commitments. The following table summarizes our commitments to settle contractual obligations as of September 30, 2013: