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.)
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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 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. 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, 2022 compared to December 31, 2021
For a comparison of our results of operations for the years ended December 31, 2022 and December 31, 2021, 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, 2022, filed with the SEC on February 22, 2023.
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, the physician is 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 LAAM products with catheter ablation procedures performed by electrophysiologists. Our pain management devices are 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, Germany, France, the United Kingdom, the Benelux region, Australia and Canada. We also sell our products to distributors who in turn sell our products to medical centers in other markets. Our business is primarily transacted in U.S. Dollars; direct international sales transactions are transacted in Euros, British Pounds, Australian Dollars or Canadian Dollars.
In 2023, we realized significant global revenue growth and continued our strategic initiatives of product innovation, clinical science and expanding physician awareness and adoption through superior training and education. Our worldwide revenues for the year ended December 31, 2023 of $399,245 was an increase of 20.8% over the prior year driven by growing adoption across key product lines. Historically there have been limited competitors in our key markets, but we have begun to see more entrants that may cause variability in 2024 results. Highlights of the strategic and operational advancements in 2023 include:
PRODUCT INNOVATION. We received final labeling approval for the next generation EPi-Sense ST device and began a limited launch evaluation in the fourth quarter of 2022, followed by full product launch in the second quarter of 2023. In October 2023, we received clearance for our next generation cryoSPHERE probe for pain management and expect to launch in the first quarter of 2024. Additionally, we completed several 510k submissions to FDA for new products in development. We also continue to make significant progress on European Medical Device Regulation (EU MDR) clearance submissions for our products. As of the second quarter of 2023, all of our products have been submitted to our notified body under EU MDR. These activities are in addition to several research and development programs currently underway.
CLINICAL SCIENCE. We continue to invest in studies to expand labeling claims, support various indications for our products and gather clinical data regarding our products.
LeAAPS. The Left Atrial Appendage Exclusion for Prophylactic Stroke Reduction (LeAAPS) IDE clinical 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, the first patient was enrolled in the trial, and we ended 2023 with nearly 1,400 patients enrolled. Site initiation and enrollment is ongoing.
ICE-AFIB. Trial enrollment was completed in the second quarter of 2023 for the ICE-AFIB clinical trial, which is designed to study the safety and efficacy of our cryoICE ® system for persistent and long-standing persistent Afib treatment during concomitant on-pump cardiac surgery. The trial provided for enrollment of up to 150 patients at up to 20 sites in the United States. Patient follow-up for twelve months post ablation required by the study protocol remains ongoing.
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CEASE-AF. During the second quarter of 2023, results from our CEASE-AF trial were presented at the European Heart Rhythm Association meeting. CEASE-AF is a prospective, multi-center randomized control trial for persistent and long-standing persistent Afib treatment that demonstrated superior freedom from atrial arrhythmias for staged hybrid ablation compared to endocardial catheter ablation.
DEEP AF. During the fourth quarter of 2023, 12-month follow-up results of enrolled patients from our DEEP AF IDE trial were presented at the American Heart Association meeting. The DEEP AF IDE pivotal trial evaluated the safety and efficacy of the AtriCure Bipolar System when used in a staged approach where a minimally invasive surgical ablation procedure is first performed. The patient undergoes the endocardial catheter procedure approximately 91-120 days later. The results from this single arm study for persistent and long-standing persistent Afib treatment demonstrated superior freedom from atrial arrhythmias for staged hybrid ablation compared to a pre-specified performance goal.
TRAINING. Our professional education and marketing teams conduct virtual and in-person training programs for physicians and healthcare professionals. These training methods ensure invaluable access to continuing education and awareness of our products and related procedures. During 2023, we launched new training courses for Advanced Practice Providers, pain management in pectus procedures, as well as a best practice course for developing arrhythmia programs, with a primary focus on Hybrid therapies. These trainings allow for collaborative, hands-on engagement with our physician partners and other healthcare professionals. Additionally, our professional education courses continue to benefit from use of inanimate models or synthetic cadavers, known as CADets. These reusable CADets provide a sustainable alternative to the use of animals or cadavers, in addition to reducing spend on training programs.
SOCIETY GUIDELINES. In 2023, the American College of Cardiology (ACC), American Heart Association (AHA), American College of Clinical Pharmacy (ACCP), and HRS released Guidelines for Diagnosis and Management of Atrial Fibrillation, and they upgraded Left Atrial Appendage Management to the highest recommendation of Class 1 and now include Hybrid AF™ Therapy as a Class 2 recommendation. These societal guidelines are reflective of the scientific evidence suggesting that surgical and hybrid ablation is safe and effective for patients who have Afib.
Results of Operations
Year Ended December 31, 2023 compared to December 31, 2022
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,
2023 2022
% of % of
Amount Revenue Amount Revenue
Revenue $ 399,245 100.0 % 330,379 100.0 %
Cost of revenue 98,875 24.8 84,439 25.6
Gross profit 300,370 75.2 245,940 74.4
Operating expense (benefit):
Research and development expenses 73,915 18.5 57,337 17.4
Selling, general and administrative expenses 253,138 63.4 231,272 70.0
Total operating expenses 327,053 81.9 288,609 87.4
Loss from operations (26,683) (6.7) (42,669) (12.9)
Other expense, net (3,164) (0.8) (3,529) (1.1)
Loss before income tax expense (29,847) (7.5) (46,198) (14.0)
Income tax expense 591 0.1 268 0.1
Net loss $ (30,438) (7.6) % $ (46,466) (14.1) %
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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
2023 2022 Amount %
Open ablation $ 105,287 $ 86,119 $ 19,168 22.3 %
Minimally invasive ablation 44,577 38,553 6,024 15.6 %
Pain management 49,199 39,974 9,225 23.1 %
Appendage management 134,481 112,555 21,926 19.5 %
Total United States $ 333,544 $ 277,201 $ 56,343 20.3 %
Total International 65,701 53,178 12,523 23.5 %
Total Revenue $ 399,245 $ 330,379 $ 68,866 20.8 %
Worldwide revenue increased 20.8% (20.6% on a constant currency basis). In the United States, we experienced growth in all key product lines as a result of deepening market penetration and expanding physician adoption. Key products contributing to the increase in revenue in the United States were:
• the ENCOMPASS ® clamp in open ablation,
• Hybrid AF™ Therapy procedures using the EPi-Sense System in minimally invasive ablation,
• the cryoSPHERE ® probe for post-operative pain management and
• the AtriClip ® Flex⋅V ® for appendage management.
International revenue increased 23.5% (22.1% on a constant currency basis), across all franchises and major geographic regions.
Revenue reported on a constant currency basis is a non-GAAP measure calculated by applying previous period foreign currency exchange rates, which are determined by the average daily 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 $14,436 primarily reflecting higher sales volumes. The gross margin increase of 80 basis points was driven by favorable production efficiencies, partially offset by less favorable geographic and product mix.
Research and development expenses. Research and development expenses increased $16,578, or 28.9%. Expansion of product development, regulatory and clinical teams resulted in $7,413 of additional personnel costs, including variable compensation and share-based compensation. Clinical trial expenses increased $6,667 due to strong enrollment activity in the LeAAPS clinical trial throughout the year. Additionally, our expanding product pipeline and domestic and international regulatory submissions drove a $2,389 increase in spending.
Selling, general and administrative expenses. Selling, general and administrative expenses increased $21,866, or 9.5%. Personnel costs increased $26,971 as a result of growth in headcount, variable compensation and share-based compensation. Trade shows and marketing activities increased $1,538 and other administrative and operating expenses increased $2,274 as compared to the prior year. This increase was offset by a $4,019 decrease in training costs as a result of growing efficiencies and enhancements to our global training programs and a net gain of $4,412 from non-recurring legal settlements during the first half of 2023. Legal settlement activity included a $7,500 gain from proceeds on a legal matter settled during the first quarter of 2023, partially offset by a $3,088 charge for settlement of an intellectual property matter during the second quarter of 2023. See Note 10 – Commitments and Contingencies for further information.
Other income and expense. Other income and expense consists primarily of net interest expense and net foreign currency transaction losses. Net interest expense was $3,133 for 2023 and $2,992 for 2022.
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Liquidity and Capital Resources
As of December 31, 2023, we had cash, cash equivalents and investments of $137,285 and borrowing capacity of approximately $28,750 under the SVB Credit Facility. As a result of the new asset-based credit agreement with JPMorgan Chase Bank, N.A. entered into on January 5, 2024, unused borrowing availability increased to approximately $61,885 (see Note 8 – Indebtedness for related discussion). 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 $191,677 and an accumulated deficit of $357,057 as of December 31, 2023.
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 principal cash requirements include costs of operations, capital expenditures, debt service costs and other contractual obligations. Our future capital requirements depend on a number of factors, including, without limitation: market acceptance of our current and future products; investments in working capital; costs to develop and support our products, including professional training; costs to expand and support our sales 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; costs to prosecute, defend and enforce our intellectual property rights; maintenance and enhancements to our information systems and security; and possible acquisitions and joint ventures, including potential business integration costs. We continue to evaluate additional measures to maintain financial flexibility, and we will continue to closely monitor macroeconomic conditions including, but not limited to, inflationary pressures, rising interest rates, and fluctuations in currency exchange rates that may impact our liquidity and access to capital resources.
Credit facility. As of December 31, 2023, we had a Loan and Security Agreement with Silicon Valley Bank (SVB), (SVB Loan Agreement). The SVB 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. We had unused borrowing capacity of approximately $28,750 under our revolving credit facility.
As of January 5, 2024, we entered into an asset-based credit agreement with JPMorgan Chase Bank, N.A. as Administrative Agent, JPMorgan Chase Bank, N.A. and Silicon Valley Bank, a division of First-Citizen Bank and Trust Company, as Joint Lead Arrangers and Joint Bookrunners (Credit Agreement) that provides for a $125,000 asset-based revolving credit facility (ABL Facility), with an option to increase the revolving commitment by an additional $40,000. A portion of the ABL facility, limited to $5,000, is available for the issuance of letters of credit. The Credit Agreement has a three-year term and expires January 5, 2027. Amounts available to be drawn from time to time under the ABL Facility are determined by calculating the applicable borrowing base, which is based upon applicable percentages of the values of eligible accounts receivable, eligible inventory, eligible liquid assets, less reserves as determined by the Administrative Agent, all as specified in the Credit Agreement. The borrowings bear interest at a rate per annum equal to, at the Company's election: (i) an alternate base rate (ABR) plus an applicable margin or (ii) an adjusted term secured overnight financing rate (SOFR) plus an applicable margin. At the time of closing, the Company borrowed $61,865 and had unused borrowing availability of approximately $61,885. The proceeds of the ABL Facility were used to terminate the Company’s indebtedness under the SVB Loan Agreement. As a result of the new Credit Agreement, the $60,000 borrowings outstanding under the SVB Loan Agreement as of December 31, 2023 are classified as noncurrent in the Consolidated Balance Sheet.
Our corporate headquarters lease agreement requires a $1,250 letter of credit which renews annually and remains outstanding as of December 31, 2023.
For additional information on the terms and conditions, as well as applicable interest and fee payments, see Note 8 – Indebtedness.
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 through 2023, we continued expansion and renovation of our manufacturing and engineering facilities in our Mason, Ohio campus.
Other Contractual Obligations. Our future obligations include both current and long-term obligations. In 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 incur additional variable costs, including pass through costs from clinical trial sites. We expect to disburse between $14,000 and $17,000 of fixed and
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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 and automobiles. Our finance leases consist primarily of principal and interest payments related to our Mason, Ohio headquarters building. As of December 31, 2023, we have current finance lease obligations of $1,086 and long-term obligations of $8,061. Our operating leases for office and warehouse space includes current obligations of $1,447 and long-term obligations of $3,307. For additional information, see Note 9 – Leases.
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. As of December 31, 2023, we believe the likelihood of payment is remote, and the estimated fair value of the contingent consideration is $0. See Note 2 – Fair Value.
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 Credit Agreement, 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 Credit Agreement requires 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,
2023 2022 Change
Net cash provided by (used in) operating activities
$ 4,484 $ (22,141) $ 26,625
Net cash provided by investing activities 21,817 44,006 (22,189)
Net cash used in financing activities
(32) (7,059) 7,027
Cash flows provided by (used in) operating activities. Net cash provided by operating activities increased $26,625 in 2023 as compared to 2022, largely reflecting the improvement in operating results of $16,028 driven by higher sales, improvements to gross and operating margin and a net gain from legal settlements. Cash used for working capital remained relatively flat year over year, with increased investment in inventories largely offset by increased accruals for annual variable compensation payments due to improved operating performance.
Cash flows provided by investing activities. Net cash provided by investing activities decreased by $22,189 in 2023 compared to 2022, reflecting the $30,000 acquisition of intellectual property, partially offset by a $4,883 decrease in purchases of property and equipment following our 2022 manufacturing facilities expansion and $2,928 increase in net maturities of available-for-sale securities.
Cash flows used in financing activities. Net cash from financing activities increased by $7,027 in 2023 compared to 2022, reflecting savings of $5,644 due to fewer shares repurchased at a lower value for payment of taxes on stock awards and an increase of $1,536 of proceeds from the employee stock purchase plan and stock option exercise 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 2023 and 2022. Continued increases in our cost of revenue may affect 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 affect our operating results and the
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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 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 are not obligated to 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 sales 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
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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.