The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto contained in Item 1 of Part I of this Form 10-Q and our audited financial statements and notes thereto as of and for the year ended December 31, 2008 included in our Form 10-K filed with the Securities and Exchange Commission to provide an understanding of our results of operations, financial condition and cash flows.

Forward-Looking Statements

This Form 10-Q, including the sections titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors," contains forward-looking statements regarding our future performance. All forward-looking information is inherently uncertain and actual results may differ materially from assumptions, estimates or expectations reflected or contained in the forward-looking statements as a result of various factors, including those set forth under "Risk Factors" and elsewhere in this quarterly report on Form 10-Q, and in our annual report on Form 10-K for the year ended December 31, 2008. Forward-looking statements convey our current expectations or forecasts of future events. All statements contained in this Form 10-Q other than statements of historical fact are forward-looking statements. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. The words "may," "continue," "estimate," "intend," "plan," "will," "believe," "project," "expect," "anticipate" and similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. With respect to the forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements speak only as of the date of this Form 10-Q. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise.

Overview

We are a medical device company and a leader in developing, manufacturing and selling innovative cardiac surgical ablation systems designed to create precise lesions, or scars, in cardiac, or heart, tissue. Our primary product line, which accounts for a majority of our revenues, is our AtriCure Isolator ® bipolar ablation system, or Isolator system. Our Isolator system consists primarily of a compact power generator known as an ablation and sensing unit, or ASU, a switchbox unit, or ASB, which allows physicians to toggle between multiple products and multiple configurations of our Isolator Synergy™ clamps. We sell two configurations of our clamps, one designed for ablation during open-heart, or open, procedures and one designed for ablation during sole-therapy minimally invasive procedures. We also sell a multifunctional pen which is often used by physicians in combination with our Isolator system to ablate cardiac tissue and for temporary pacing, sensing, stimulating and recording during the evaluation of cardiac arrhythmias. During 2008, we introduced our Coolrail linear ablation device which has been adopted by physicians to create an extended lesion set during minimally invasive procedures. Additionally, we sell various configurations of enabling devices, such as our Lumitip dissection tool. In August 2007, we acquired a cardiac cryoablation product line, which uses extreme cold to ablate tissue. Prior to our acquisition of the product line, we sold the product line as a distributor. In March 2009, we introduced a disposable cryoablation device, Cryo1™, which we believe will be adopted by physicians for cardiac ablation during open-heart procedures.

We commenced a full commercial release of our primary product line, the Isolator system, for use during open heart procedures in 2003, and have brought new products to market over time. During 2005, we commercialized the Isolator system for use during minimally invasive sole-therapy procedures. Our revenues have grown from $9.8 million in 2003 to $55.3 million in 2008. In August 2005 we raised net proceeds of $43.2 million through an initial public offering. Since then, we have invested heavily in expanding our product development organization and activities and building our sales and marketing organizations and activities. Our operating expenses have increased from $10.5 million in 2003 to $53.0 million in 2008.

In the United States, we primarily sell our products through our direct sales force. AtriCure Europe B.V., our wholly-owned European subsidiary incorporated and based in the Netherlands, sells our products throughout Europe, primarily through distributors,

with the exception of Germany, Switzerland and Austria, where we sell directly. Additionally, we sell our products to other international distributors, primarily in Asia, South America and Canada. Our business is primarily transacted in U.S. dollars, with the exception of transactions with our European subsidiary, which are primarily transacted in Euros. Our sales outside of the United States represented 16.7% and 12.3% of our revenues for three months ended March 31, 2009 and 2008, respectively.

Our costs and expenses consist of cost of revenues, research and development expenses and selling, general and administrative expenses. Cost of revenues consist principally of the cost of purchasing materials and manufacturing our products. Research and development expenses consist principally of expenses incurred with respect to internal and external research and development activities and the conduct of clinical activities and trials. Selling, general and administrative expenses consist principally of costs associated with our sales, marketing and administrative functions and unrestricted educational grants to medical institutions.

Results of Operations

Three months ended March 31, 2009 compared to March 31, 2008

The following table sets forth, for the periods indicated, our results of
operations expressed as dollar amounts and as percentages of total revenues:



                                                             Three Months Ended March 31,
                                                             2009                     2008
                                                                   % of                     % of
                                                      Amount      Revenue      Amount      Revenue
                                                                (dollars in thousands)
Revenues                                             $ 13,674       100.0 %   $ 13,530       100.0 %
Cost of revenues                                        2,945        21.5 %      3,231        23.9 %

Gross profit                                           10,729        78.5 %     10,299        76.1 %
Operating expenses:
Research and development expenses                       2,917        21.3 %      2,433        18.0 %
Selling, general and administrative expenses            8,932        65.3 %     11,762        86.9 %
Goodwill impairment                                     6,812        49.8 %          -         0.0 %

Total operating expenses                               18,661       136.5 %     14,195       104.9 %

Loss from operations                                   (7,932 )     -58.0 %     (3,896 )     -28.8 %
Other income (expense):
Interest expense                                          (61 )      -0.5 %        (39 )      -0.3 %
Interest income                                            20         0.2 %        161         1.2 %
Other                                                     (24 )      -0.2 %        169         1.2 %

Other (expense) income                                    (65 )      -0.5 %        291         2.2 %

Loss before income tax expense                         (7,996 )     -58.5 %     (3,605 )     -26.7 %
Income tax benefit                                        (31 )      -0.2 %          -         0.0 %

Net loss                                             $ (7,965 )     -58.2 %   $ (3,605 )     -26.7 %

Revenues. Total revenues increased 1.1%, from $13.5 million for the three months ended March 31, 2008 to $13.7 million for the three months ended March 31, 2009. The increase in revenues was due primarily to an increase in unit sales in international markets partially offset by a negative impact from currency exchange rate fluctuation of 1.3% and a reduction in unit sales in the United States.

Cost of revenues. Cost of revenues decreased $0.3 million, from $3.2 million for the three months ended March 31, 2008 to $2.9 million for the three months ended March 31, 2009. The decrease was primarily due to a reduction in sales of our ORLab, which carries a higher cost of revenue than our disposable products and a reduction in product cost, partially offset by an increase in the number of units sold in our international markets. As a percentage of revenues, cost of revenues decreased from 23.9% for the three months ended March 31, 2008 to 21.5% for the three months ended March 31, 2009. The decrease in cost of revenues as a percentage of revenues was primarily due to a reduction in revenues from ORLab sales and a reduction in product cost, partially offset by an increased mix of international revenues, which generally have a lower average selling price.

Research and development expenses. Research and development expenses increased $0.5 million, from $2.4 million for the three months ended March 31, 2008 to $2.9 million for the three months ended March 31, 2009. As a percentage of revenues, research and development expenses increased from 18.0% for the three months ended March 31, 2008 to 21.3% for the three months ended March 31, 2009. The increase was primarily attributable to an increase in share-based compensation, an increase in product development project costs, and an increase in expenditures for our ABLATE and EXCLUDE clinical trials.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased $2.9 million, from $11.8 million for the three months ended March 31, 2008 to $8.9 million for the three months ended March 31, 2009. The decrease was primarily due to lower headcount-related expenses, a result of our reduction in force which occurred in the fourth quarter of 2008, partially offset by an increase in share-based compensation. As a percentage of total revenues, selling, general and administrative expenses decreased from 86.9% for the three months ended March 31, 2008 to 65.3% for the three months ended March 31, 2009.

Goodwill impairment. As a result of a reduction in our market capitalization during the first quarter of 2009, we believed an indication of impairment existed and we performed an interim Step 1 analysis of our goodwill as of March 31, 2009. The Step 1 process concluded that the carrying value of our goodwill exceeded the estimated fair value. We were unable to complete Step 2 prior to the issuance of our financial statements for the three month period ended March 31, 2009, however a full impairment loss was determined as probable and reasonably estimated based upon the completion of Step 1 and correspondingly, we recognized a full impairment loss of $6.8 million as of March 31, 2009. We will complete Step 2 during the three month period ending June 30, 2009.

Net interest income. Net interest expense was $40,485 for the three months ended March 31, 2009, compared to net interest income of $121,741 for the three months ended March 31, 2008, due primarily to a decrease in average net cash, cash equivalents and investments outstanding, and a reduced average effective interest rate and amortization of financing fees related to our credit facility which began in July 2008.

Other (expense) income. Other (expense) income consists of foreign currency transaction (loss) gain, grant income and non-employee option (expense) income related to the fair market value change for fully vested options outstanding for consultants, which are accounted for as free standing derivatives. Foreign currency transaction loss was $48,387 for the three months ended March 31, 2009 compared to foreign currency transaction gain of $33,074 for the same period in 2008. Non-employee option income was $24,829 for the three months ended March 31, 2009, compared to $61,878 for the three months ended March 31, 2008. Grant income was $74,187 for the three months ended March 31, 2008, and no income was recorded during the three months ended March 31, 2009.

Liquidity and Capital Resources

As of March 31, 2009, we had cash and cash equivalents of $8.6 million and short-term and long-term debt of $0.1 million, resulting in a net cash position of $8.5 million. We had working capital of $17.9 million and an accumulated deficit of $85.4 million.

Cash flows used in operating activities. Net cash used in operating activities was $2.4 million for the three months ended March 31, 2009 and $3.8 million for the three months ended March 31, 2008. Net cash used in operating activities for the three months ended March 31, 2009 was primarily attributable to the net loss of $8.0 million, an increase in accounts receivable of $1.1 million and a decrease in accounts payable and accrued liabilities of $2.4 million. The increase in accounts receivable was primarily due to an increase in revenues. The decrease in accounts payable and accrued liabilities was primarily due to the payment of inventory purchases made during 2008 and the payment of severance related expenses incurred as a result of the reduction in force that occurred during the fourth quarter of 2008. These uses of cash were partially offset by non-cash charges related to share-based compensation of $1.1 million and a goodwill impairment charge of $6.8 million. Net cash used in operating activities was $3.8 million for the three months ended March 31, 2008. Net cash used in operating activities for the three months ended March 31, 2008 was primarily attributable to a net loss of $3.6 million and increases in accounts receivable and inventory of $1.3 million and $1.0 million, respectively. The increase in accounts receivable was primarily due to an increase in and the timing of revenues. The increase in inventories was primarily related to anticipated growth and new product introductions. The increases were partially offset by a net increase in accounts payable and accrued liabilities of $0.8 million, due primarily to an increase in accounts payable associated with the purchase of inventories and an increase in operating expenses.

Cash flows provided by investing activities. Net cash provided by investing activities was $5.6 million for the three months ended March 31, 2009 and $4.3 million for the three months ended March 31, 2008. In the first three months of 2009, net cash provided by investing activities included $6.0 million related to the release of the restriction on our cash and cash equivalents, due to the re-payment of the borrowings under the National City credit facility. The three month period ended March 31, 2008 included maturities of investments of $5.1 million, For each of these periods, net cash provided by investing activities reflected purchases of property and equipment of $0.4 million and $0.8 million, respectively.

Cash flows used in financing activities. Net cash used in financing activities was $6.1 million for the three months ended March 31, 2009. For the three months ended March 31, 2009, cash flows used in financing activities included payments made on our debt and capital lease obligations of $6.0 million, including a $6.0 million repayment in full of our National City credit facility. For the three months ended March 31, 2008, cash flows used in financing activities reflected a $0.4 million repayment of a note associated with our acquisition of a product line and payments made on our debt and capital lease obligations of $0.1 million. These uses were partially offset by proceeds from the exercise of stock options of $0.1 million.

Credit facility. On July 1, 2008 we entered into a two-year credit facility with National City Bank. As of March 31, 2009, we repaid in full the outstanding balance under the credit facility and the facility was terminated effective May 1, 2009. As of December 31, 2008, $6.0 million was outstanding under the credit facility and $6.0 million was held as restricted cash and cash equivalents and reported as long-term liabilities and assets, respectively.

On May 1, 2009, we entered into a Loan and Security Agreement (the "Agreement") with Silicon Valley Bank (the "Bank") that provides a term loan and a revolving credit facility under which we can borrow a maximum of $10.0 million. We have borrowed the maximum amount of $6.5 million under the term loan. We can borrow up to $10.0 million under the revolving loan facility with the availability subject to a borrowing base formula. We may borrow, repay and reborrow funds under the revolving loan facility until the maturity date on which all outstanding amounts under the revolving loan facility must be repaid. The Agreement also includes up to a $1.0 million sublimit for stand-by letters of credit. No amounts have been borrowed under the revolving loan facility.

In connection with the term loan, the Bank received a warrant to purchase 371,732 shares of our common stock at $1.224 per share, exercisable for a term of 10 years.

Interest on the term loan accrues at a rate of 10.0% per year, and interest on the revolving loan will accrue at a fluctuating rate equal to the Bank's announced prime rate of interest, subject to a floor of 4.0%, plus between 1.0% and 2.0%, depending on our Adjusted Quick Ratio (as defined in the Agreement). Principal on the term loan will be amortized over 36 months of equal principal payments, plus applicable interest.

The Agreement matures on April 30, 2012 and is secured by all of our assets, including intellectual property, and a pledge of sixty-five percent of our stock in our subsidiary, AtriCure Europe B.V.

The Agreement contains customary covenants for credit facilities of this size and type that include, among others, covenants that limit our ability to dispose of assets, enter into mergers or acquisitions, incur indebtedness, incur liens, pay dividends or make distributions on our capital stock, make investments or loans, and enter into certain affiliate transactions, in each case subject to customary exceptions for a credit facility of this size and type. The Agreement also contains financial covenants including minimum EBITDA and a limitation on capital expenditures. Additional covenants, including a minimum Adjusted Quick Ratio and minimum fixed charge coverage ratio, apply when we have outstanding borrowings under the revolving loan facility or when we achieve specific covenant milestones.

The Agreement contains customary events of default for credit facilities of this size and type that include, among others, non-payment defaults, covenant defaults, a default in the event a material adverse change occurs, defaults in the event our assets are attached or we are enjoined from doing business, bankruptcy and insolvency defaults, cross-defaults to certain other material indebtedness, material judgment defaults and inaccuracy of representations and warranties. The occurrence of an event of default could result in an increase to the applicable interest rate by 3.0%, an acceleration of all obligations under the Agreement, an obligation of us to repay all obligations in full, and a right by the Bank to exercise all remedies available to it under the Agreement and related agreements including the Guaranty and Security Agreement.

Unsecured promissory note. Under the terms and conditions of the Bill of Sale and Assignment Agreement with CooperSurgical, Inc. ("Cooper") we entered into an unsecured promissory note agreement for $0.4 million, which bore interest at 5.0%. The note was repaid in full in January 2008 and was recorded as payment on debt in our Condensed Consolidated Statement of Cash Flows.

Uses of liquidity and capital resources. Our future capital requirements depend on a number of factors, including possible acquisitions and joint ventures, the rate of market acceptance of our current and future products, the resources we devote to developing and supporting our products, future expenses to expand and support our sales and marketing efforts, costs associated with the Department of Justice investigation, costs relating to changes in regulatory policies or laws that affect our operations and costs of filing, prosecuting, defending and enforcing our intellectual property rights. Global economic turmoil may adversely impact our revenue, access to the capital markets or future demand for our products.

We believe that our current cash and cash equivalents, combined with proceeds from our May 1, 2009 term loan with Silicon Valley Bank and cash we expect to generate from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. If these sources of cash are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. 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 could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Further, our credit facility with Silicon Valley Bank limits our ability to secure additional debt.

Contractual Obligations and Commitments

Off-Balance-Sheet Arrangements

As of March 31, 2009, we had operating lease agreements not recorded on the condensed consolidated balance sheet. Operating leases are utilized in the normal course of business.

Inflation

Inflation has not had a significant impact on our historical operations and we do not expect it to have a significant impact on our results of operations or financial condition in the foreseeable future.

Seasonality

During the first quarter, we have historically experienced an increase in our operating expenses and operating loss due to higher selling, general and administrative expenses related primarily to our participation in and attendance at large industry events. During the third quarter, we typically experience a decline in revenues that we attribute primarily to the elective nature of the procedures in

which our products are used, which we believe arises from fewer people choosing to undergo elective procedures during the summer months.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities at the date of the financial statements. On a periodic basis, we evaluate our estimates, including those related to sales returns and allowances, accounts receivable, inventories and share-based compensation. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates under different assumptions or conditions. Our Annual Report on Form 10-K for the fiscal year ending December 31, 2008 includes additional information about the Company, our operations, our financial position, our critical accounting policies and accounting estimates and should be read in conjunction with this Quarterly Report.

Recent Accounting Pronouncements

Please see Note 2 in the Notes to the Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements.