Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar and share amounts referenced in this Item 7 are in thousands, except per share amounts.)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying Consolidated Financial Statements and notes thereto contained in Item 8, “Financial Statements and Supplementary Data,” to provide an understanding of our results of operations, financial condition and cash flows. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under Item 1A “Risk Factors,” the cautionary statement regarding forward-looking statements at the beginning of Part I and elsewhere in this Form 10-K.
Year Ended December 31, 2021 compared to December 31, 2020
For a comparison of our results of operations for the years ended December 31, 2021 and December 31, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022.
Overview
We are a leading innovator in treatments for atrial fibrillation (Afib), left atrial appendage (LAA) management and post-operative pain management. Our ablation and left atrial appendage management (LAAM) products are used by physicians during both open-heart and minimally invasive procedures. In open-heart procedures, physicians are typically performing heart surgery for other conditions, and our products are used in conjunction with (or “concomitant” to) such a procedure. Minimally invasive procedures are performed on a standalone basis, and often include multi-disciplinary or “hybrid” approaches, combining surgical procedures using AtriCure ablation and AtriCure LAAM products with catheter ablation procedures performed by an electrophysiologist. Our pain management device is used by physicians to freeze nerves during cardiothoracic or thoracic surgical procedures. We anticipate that substantially all of our revenue for the foreseeable future will relate to products we currently sell or are in the process of developing.
We sell our products to medical centers through our direct sales force in the United States and in certain international markets, such as Germany, France, the United Kingdom, Australia and the Benelux region. We also sell our products to distributors who in turn sell our products to medical centers in Japan, China and other international markets. Our business is primarily transacted in U.S. Dollars; direct sales transactions outside the United States are transacted in Euros, British Pounds or Australian Dollars.
During 2022, we continued to experience variability in demand for our products as non-emergent procedures were deferred in order to preserve resources for COVID-19 patients and caregivers, and hospital staffing was impacted by the pandemic and related factors. Beginning in the second quarter, many regions began to stabilize with overall improvements in procedure volume. We expect some variability to continue as we operate in many geographic regions with diverse restrictions that are impacted as new variants of the virus emerge and hospital staffing constraints continue to impact allocation of resources. Despite the challenging environment resulting from the pandemic, we reported annual revenues of $330,379 for the year ended December 31, 2022, an increase of 20.4% when compared to our prior year as a result of growing adoption across key product lines. We continue to build on our strategic initiatives of product innovation, investing in clinical science and providing superior training and education.
PRODUCT INNOVATION. In April 2022, we launched our EnCompass ® clamp, following the July 2021 510(k) clearance for ablation of cardiac tissue during cardiac surgery. The EnCompass clamp marks innovation in our core open ablation market, and is expected to drive deeper penetration of cardiac surgery procedures. During September 2022, we received final labeling approval for the next generation EPi-Sense ST device and began a limited launch evaluation in the fourth quarter.
CLINICAL SCIENCE. We continue to invest in studies to expand labeling claims, support indications for the treatment of Afib and other arrhythmias and stroke, and gather clinical data regarding our products.
HEAL-IST. In February 2022, FDA approved the protocol for the Hybrid Epicardial and Endocardial Sinus Node Sparing Ablation Therapy for Inappropriate Sinus Tachycardia (IST) clinical trial (HEAL-IST). The HEAL-IST clinical trial is designed to study the safety and efficacy of a hybrid sinus node sparing ablation procedure using the Isolator Synergy Surgical Ablation System for the treatment of symptomatic, drug refractory or drug intolerant IST. The trial is a
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prospective, multicenter, single arm trial that evaluates safety 30 days post-procedure and evaluates primary effectiveness of freedom from IST (as specified) at 12 months post-procedure. The trial provides for enrollment of up to 142 patients at up to 40 sites in the United States, United Kingdom and European Union. The first patient enrollment in the trial occurred in June 2022; site initiation and enrollment is ongoing.
LeAAPS. In April 2022, FDA approved the protocol for the Left Atrial Appendage Exclusion for Prophylactic Stroke Reduction (LeAAPS) IDE clinical trial. The trial is designed to evaluate the effectiveness of prophylactic LAA exclusion using the AtriClip LAA Exclusion System for the prevention of ischemic stroke or systemic arterial embolism in cardiac surgery patients without pre-operative AF diagnosis who are at risk for these events. This prospective, multicenter, randomized trial evaluates safety at 30 days post-procedure to demonstrate no increased risk with LAA exclusion during cardiac surgery, and efficacy over a minimum follow-up of five years post procedure. The trial provides for enrollment of up to 6,500 subjects at up to 250 sites worldwide. In January 2023, we announced first patient enrollment in the trial; site initiation and enrollment is ongoing.
TRAINING. Our professional education and marketing teams conduct virtual, in-person and mobile training for physicians and healthcare professionals, as well as our sales teams. Our training methods ensure invaluable access to continuing education and awareness of our products and related procedures. The 2021 FDA approval of the EPi-Sense System has enabled us to educate and train physicians on the benefits of Hybrid AF therapy in treating long-standing persistent Afib patients. Our Advanced Hybrid Ablation Training Courses are co-sponsored by the Heart Rhythm Society (HRS).
Results of Operations
Year Ended December 31, 2022 compared to December 31, 2021
The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts and as percentages of total revenue:
Year Ended December 31,
2022 2021
% of % of
Amount Revenue Amount Revenue
Revenue $ 330,379 100.0 % 274,329 100.0 %
Cost of revenue 84,439 25.6 68,469 25.0
Gross profit 245,940 74.4 205,860 75.0
Operating expense (benefit):
Research and development expenses 57,337 17.4 48,506 17.7
Selling, general and administrative expenses 231,272 70.0 204,649 74.6
Change in fair value of contingent consideration — — (184,800) (67.4)
Intangible asset impairment — — 82,300 30.0
Total operating expenses 288,609 87.4 150,655 54.9
(Loss) income from operations (42,669) (12.9) 55,205 20.1
Other expense, net (3,529) (1.1) (4,818) (1.8)
(Loss) income before income tax expense (46,198) (14.0) 50,387 18.4
Income tax expense 268 0.1 188 0.1
Net (loss) income $ (46,466) (14.1) % $ 50,199 18.3 %
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Revenue. The following table sets forth, for the periods indicated, our revenue by product type and geography expressed as dollar amounts and the corresponding change in such revenues between periods, in both dollars and percentages:
Year Ended December 31, Change
2022 2021 Amount %
Open ablation $ 86,119 $ 72,396 $ 13,723 19.0 %
Minimally invasive ablation 38,553 39,380 (827) (2.1) %
Pain management 39,974 22,787 17,187 75.4 %
Appendage management 112,555 94,568 17,987 19.0 %
Total United States $ 277,201 $ 229,131 $ 48,070 21.0 %
Total International 53,178 45,198 7,980 17.7 %
Total Revenue $ 330,379 $ 274,329 $ 56,050 20.4 %
Worldwide revenue increased 20.4% (21.8% on a constant currency basis). Throughout the United States market, cardiac surgery volumes recovered and product adoption continued. Our Isolator Synergy System continued to generate the majority of our ablation-related revenue. Key drivers of growth included the AtriClip ® Flex-V ® device within the appendage management franchise, the cryoSPHERE ® probe for pain management, and the 2022 launch of the EnCompass clamp in open ablation. Minimally invasive ablation sales decreased as declines in legacy product sales outpaced growth in Hybrid AF therapy procedures using the EPi-Sense system. International revenue increased 17.7% (25.7% on a constant currency basis) throughout our major European and Asia markets. Similar to the Unites States, International revenue growth was driven by appendage management, open ablation and pain management products, while minimally invasive ablation sales declined due to reduction in revenues from legacy products exceeding the growth in Hybrid AF therapy procedures using the EPi-Sense system.
Revenue reported on a constant currency basis is a non-GAAP measure and is calculated by applying previous period foreign currency (Euro) exchange rates, which are determined by the average daily Euro to Dollar exchange rate, to each of the comparable periods. Revenue is analyzed on a constant currency basis to better measure the comparability of results between periods. Because changes in foreign currency exchange rates have a non-operating impact on revenue, we believe that evaluating growth in revenue on a constant currency basis provides an additional and meaningful assessment of revenue to both management and investors.
Cost of revenue and gross margin. Cost of revenue increased $15,970 primarily reflecting revenue growth. The gross margin decrease of approximately 60 basis points was driven by inflationary and supply chain pressures and a shift in product mix to lower margin products, partially offsetting the benefit from higher volume.
Research and development expenses. Research and development expenses increased $8,831, or 18.2%. We expanded our product development, regulatory and clinical teams throughout 2022, resulting in additional $4,551 personnel costs including variable compensation, travel and share-based compensation. Product development project spend increased $1,053 as we continue to evolve our product pipeline. Clinical activities, regulatory submissions and consulting expenses, including compliance with EU MDR, drove $1,944 incremental costs, while amortization expense increased $820 following the April 2021 PMA of the CONVERGE IDE clinical trial. See Note 4 of the Consolidated Financial Statements for further discussion.
Selling, general and administrative expenses. Selling, general and administrative expenses increased $26,623, or 13.0%. Higher headcount and rising travel expenses contributed $18,575 increase in personnel costs. Our commitment to physician training and return to in-person meetings, trade shows and marketing activities drove a $5,007 increase in expenses as compared to the prior year. Other administrative and operating expenses increased $3,114, largely for legal activity and information technology costs.
Change in fair value of contingent consideration. The credit to operating expenses during the year ended December 31, 2021 reflects a change in the forecasted timing and probability of achievement of the regulatory and reimbursement milestones related to the aMAZE clinical trial. See Note 2 of the Consolidated Financial Statements for further discussion.
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Impairment of intangible assets. During the year ended December 31, 2021, the Company recorded an impairment charge for the IPR&D asset associated with the aMAZE PMA. See Note 4 of the Consolidated Financial Statements for further discussion.
Other income and expense. Other income and expense consists primarily of net interest expense and foreign currency transaction gains and losses. Net interest expense was $2,992 for 2022 and $4,452 for 2021. The decrease in net interest expense was driven by higher interest income from funds received for interest on past due trade receivables.
Liquidity and Capital Resources
As of December 31, 2022, we had cash, cash equivalents and investments of $172,622 and borrowing capacity of approximately $28,750. All cash equivalents and investments and most of our operating cash are held in United States financial institutions. A minor portion of our cash is held in foreign banks to support our international operations. We had net working capital of $156,822 and an accumulated deficit of $326,619 as of December 31, 2022.
Uses of liquidity and capital resources. Our executive officers and Board of Directors review our funding sources and future capital requirements in connection with our annual operating plan and periodic updates to the plan. Our future capital requirements depend on a number of factors, including, without limitation: market acceptance of our current and future products; costs to develop and support our products, including clinical evidence needs; future expenses to expand and support our sales, training and marketing efforts; operating and filing costs relating to changes in regulatory policies or laws; costs for clinical trials and to secure regulatory approval for new products; legal defense costs; costs to prosecute, defend and enforce our intellectual property rights; and possible acquisitions and joint ventures, including potential business integration costs. Our principal cash requirements include costs of operations, capital expenditures, debt service costs and other contractual obligations.
Credit facility. Our Loan and Security Agreement with Silicon Valley Bank (SVB), as amended, (Loan Agreement), provides for a $60,000 term loan, with an option to make available an additional $30,000 in term loan borrowings, and a $30,000 revolving line of credit. The Loan Agreement has a five year term and expires November 2026. The term loan accrues interest at the Prime Rate plus 1.25% and is subject to an additional 3.00% fee on the term loan principal amount at maturity. Principal payments are to be made ratably commencing 24 months after the inception of the loan through the loan's maturity date. At the option of the Company, the commencement of term loan principal payments may be extended an additional twelve months. As of December 31, 2022, our outstanding debt was $60,000, of which $3,333 is classified as current and $56,667 is classified as noncurrent. We had unused borrowing capacity of approximately $28,750 under our revolving credit facility. For additional information on the terms and conditions, as well as applicable interest and fee payments, see Note 8 - Indebtedness.
Our corporate headquarters lease agreement requires a $1,250 letter of credit which renews annually and remains outstanding as of December 31, 2022.
Capital Expenditures. We incur capital expenditures on an ongoing basis to continue investment in our growth and our ability to better serve our customers. Throughout 2021 and 2022, we expanded our manufacturing operations as we completed the renovation of an additional facility of our Mason, Ohio campus.
Other Contractual Obligations. Our future obligations include both current and long-term obligations. In December 2022, the Company entered into a clinical trial management agreement for the LeAAPS clinical trial. The terms of the agreement require we make milestone payments upon achievement of various enrollment and project milestones over the estimated ten year term, yet the agreement may be terminated early for any reason. Furthermore, we will incur additional variable costs, including pass through costs from clinical trial sites. We expect to disburse between $6,000 and $9,000 of fixed and variable costs based on estimated achievement of milestone payments, site initiation and trial enrollment within the next twelve months. We have operating and finance leases primarily for our corporate offices, manufacturing and warehouse facilities, as well as computer equipment. Our finance leases consist primarily of principal and interest payments related to our Mason, Ohio headquarters. As of December 31, 2022, we have current finance lease obligations of $992 and long-term obligations of $9,147. Our operating leases for office and warehouse space includes current obligations of $1,147 and long-term obligations of $3,095. For additional information, see Note 9 - Leases. We additionally maintain a license agreement with terms that require royalty payments of 5% of specified product sales. See Note 10 - Commitments and Contingencies for information about the terms. We have contractual obligations for contingent consideration payments related to the SentreHEART acquisition. Subject to the terms and conditions of the SentreHEART merger agreement, such contingent consideration would be paid in AtriCure common stock and cash, up to a specified maximum number of shares. The SentreHEART milestones expire on December 31, 2023 and December 31, 2026. As of December 31, 2022, we believe the likelihood of payment is remote, and the estimated fair value of the contingent consideration is $0. See Note 2 – Fair Value.
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Sources of liquidity. We believe that our current cash, cash equivalents and investments, along with the cash we expect to generate or use for operations or access via our term loan and revolving line of credit, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. However, we have on file with the SEC a shelf registration statement which allows us to sell any combination of debt securities, common stock, preferred stock, warrants, depository shares and units in one or more offerings should we choose to do so in the future. We expect to maintain the effectiveness of the shelf registration statement for the foreseeable future.
If our sources of cash are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or obtain a revised or additional credit facility. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities would have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Finally, our term loan agreement and revolving line of credit require compliance with certain financial and other covenants. If we are unable to maintain these financing arrangements, we may be required to reduce the scope of our planned research and development, clinical activities and selling, training, education and marketing efforts.
Historical Cash Flow Activity. The following table summarizes our consolidated cash flow activities:
Years Ended December 31,
2022 2021 Change
Net cash used in operating activities $ (22,141) $ (13,780) $ 8,361
Net cash provided by investing activities 44,006 23,504 20,502
Net cash used in financing activities (7,059) (7,642) (583)
Cash flows used in operating activities. Net cash used in operating activities increased $8,361 in 2022 as compared to 2021, largely reflecting the improvement in operating results after non-cash charges of $5,673 offset by an increase in cash needs for working capital and other assets and liabilities of $14,034. Working capital fluctuations are primarily due to the $11,237 reduction in accrued liabilities from higher annual variable compensation payments in 2022 due to improved operating performance in 2021 versus 2020, as well as an increase of $3,031 from our investment in inventories.
Cash flows provided by investing activities. Net cash provided by investing activities increased by $20,502 in 2022 compared to 2021, reflecting higher net sales and maturities of available-for-sale securities of $27,630, offset by an increase of $7,128 for the purchase of property and equipment primarily for the expansion of our manufacturing facilities.
Cash flows used in financing activities. Net cash from financing activities decreased by $583 in 2022 compared to 2021, driven by $1,171 reduced debt fee payments, offset by an $505 increase in net cash used in equity compensation plan activity. Lower stock performance contributed to less proceeds from stock option exercise activity and fewer shares repurchased for payment of taxes for stock awards offset with slight increases in employee stock purchase plan activity.
Inflation
Inflationary pressures may have an adverse impact on our results of operations or financial condition in the foreseeable future. Inflation has impacted our operating costs throughout 2022. Continued increases in our cost of revenue may effect our ability to maintain our gross margin if the selling prices of our products do not increase commensurately, while continued increases in our operating expenses may adversely effect our operating results and the ability to make discretionary investments. We will continue to monitor the impact of inflation on our cost of revenue and operating expenses.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses, and disclosures of contingent assets and liabilities at the date of the financial statements. On a periodic basis, we evaluate our estimates, using authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. We have described our significant accounting policies in Note 1 – Description of Business and Summary of Significant Accounting Policies to our Consolidated Financial Statements included in this Form 10-K.
We believe the following critical accounting policies involve a significant level of estimation uncertainty and judgments that are reasonably likely to have a material impact on our Consolidated Financial Statements. We base our
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judgments and estimates on historical experience, current conditions and other reasonable factors. Actual results could differ from those estimates under different assumptions or conditions.
Revenue Recognition— Revenue is generated from the sale of medical devices. We recognize revenue in an amount that reflects the consideration we expect to be entitled to in exchange for those devices when control of promised devices is transferred to customers. We account for revenue in accordance with FASB ASC 606, “Revenue from Contracts with Customers”. Significant judgments and estimates involved in the Company’s recognition of revenue include the estimation of a provision for returns. We estimate the provision for sales returns and allowances using the expected value method based on historical experience and other factors that we believe could impact our expected returns, including defective or damaged products and invoice adjustments. In the normal course of business, we generally do not accept product returns unless a product is defective as manufactured, and we do not provide customers with the right to a refund.
Inventories —Our inventories are stated at the lower of cost or net realizable value based on the first-in, first-out cost method (FIFO) and consist of raw materials, work in process and finished goods. Our industry is characterized by rapid product development and frequent new product introductions. Uncertain timing of product approvals, variability in product launch strategies and variation in product use all impact inventory reserves for excess, obsolete and expired products. An increase to inventory reserves results in a corresponding increase in cost of revenue. Inventories are written off against the reserve when they are physically disposed.
Share-Based Employee Compensation— We estimate the fair value of performance share awards with a performance condition initially based on the closing stock price on the date of grant assuming the performance goal will be achieved. Such performance share awards have specified performance targets based on the compound annual growth rate (CAGR) of our revenue over a three-year performance period. With respect to these performance share awards, the number of shares that vest and are issued to the recipient is based upon revenue performance over the performance period. We may adjust the expense over the performance period based on changes to estimates of performance target achievement. If such goals are not met or service is not rendered for the requisite service period, no compensation cost is recognized, and any recognized compensation cost from prior periods will be reversed.
Income Taxes— Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities from changes in tax rates is recognized in the period that includes the enactment date.
Our estimate of the valuation allowance for deferred tax assets requires significant estimates and judgments about our future operating results. Deferred income tax assets are reduced by valuation allowances if, based on the consideration of all available evidence, it is more-likely-than-not that a deferred tax asset will not be realized. Significant weight is given to evidence that can be objectively verified. We evaluate deferred income tax assets on an annual basis to determine if valuation allowances are required by considering all available evidence. Deferred income tax assets are realized by having sufficient future taxable income to allow the related tax benefits to reduce taxes otherwise payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future taxable income, future reversals of existing taxable temporary differences, taxable income in prior carryforward years and tax planning strategies that are both prudent and feasible. In evaluating the need for a valuation allowance, the existence of cumulative losses in recent years is significant objectively verifiable negative evidence that must be overcome by objectively-verifiable positive evidence to avoid the need for a valuation allowance. Our valuation allowance offsets substantially all net deferred income tax assets as it is more-likely-than-not that the benefit of such deferred income tax assets will not be recognized in future periods.
Recent Accounting Pronouncements
See Note 1 – Description of Business and Summary of Significant Accounting Policies to the Consolidated Financial Statements in Item 8 of Part II for more information regarding recent accounting pronouncements.