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 ("SEC") 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 this product line, we sold the product line as a distributor. In March 2009, we introduced a disposable cryoablation device, Cryo1™, which is being adopted by physicians for cardiac ablation during open procedures. During September 2009, we received CE Mark approval for our AtriClip™ Gillinov-Cosgrove Left Atrial Appendage Exclusion System, or the AtriClip System. The AtriClip™ System is designed to safely and effectively exclude the left atrial appendage and is being launched in Europe through a phased approach during our fourth quarter of 2009 and is planned to be released in the United States during the first half of 2010.

In the United States, we primarily sell our products through our direct sales force. AtriCure Europe, B.V., our wholly-owned European subsidiary, which is incorporated and based in the Netherlands, sells our products throughout Europe, primarily through distributors, with the exception of Germany and Switzerland, where we sell our products through our direct sales force. 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 19.5% and 16.0% of our revenues for three month periods ended September 30, 2009 and 2008, respectively, and 18.2% and 14.6% of our revenues for the nine month periods ended September 30, 2009 and 2008, respectively.

Our costs and expenses consist of cost of revenues, research and development expenses, selling, general and administrative expenses and non-recurring expense related to the impairment of our goodwill and a settlement reserve during the nine month period ended September 30, 2009. 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.

Results of Operations

Three months ended September 30, 2009 compared to September 30, 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 September 30,
                                                           2009                             2008
                                                                   % of                             % of
                                                  Amount         Revenues          Amount         Revenues
                                                                  (dollars in thousands)
Revenues                                         $ 13,281           100.0 %       $ 14,802           100.0 %
Cost of revenues                                    3,278            24.7 %          3,396            22.9 %

Gross profit                                       10,003            75.3 %         11,406            77.1 %
Operating expenses:
Research and development expenses                   2,581            19.4 %          3,009            20.3 %
Selling, general and administrative expenses        8,088            60.9 %         10,215            69.0 %
Settlement reserve                                  3,767            28.4 %             -               -

Total operating expenses                           14,435           108.7 %         13,224            89.3 %

Loss from operations                               (4,432 )         (33.4 )%        (1,818 )         (12.3 )%
Other income (expense):
Interest expense                                     (241 )          (1.8 )%          (174 )          (1.2 )%
Interest income                                         8             0.1 %             80             0.5 %
Other                                                 (35 )          (0.3 )%           142             1.0 %

Other (expense) income                               (268 )          (2.0 )%            48             0.3 %
Loss before income tax benefit                     (4,700 )         (35.4 )%        (1,770 )         (12.0 )%
Income tax benefit                                      3              -                -               -

Net loss                                         $ (4,697 )         (35.4 )%      $ (1,770 )         (12.0 )%

Revenues. Total revenues decreased 10.3%, from $14.8 million for the three months ended September 30, 2008 to $13.3 million for the three months ended September 30, 2009. The decrease was primarily driven by a reduction in revenues from domestic sales, which decreased 14.0% or $1.7 million, resulting primarily from a reduction in revenues from the sale of minimally invasive products.

Cost of revenues. Cost of revenues decreased $0.1 million, from $3.4 million for the three months ended September 30, 2008 to $3.3 million for the three months ended September 30, 2009. As a percentage of revenues, cost of revenues increased from 22.9% for the three months ended September 30, 2008 to 24.7% for the three months ended September 30, 2009. The change in cost of revenues was primarily due to a reduction in revenues, partially offset by an increased mix of international sales. The decrease in cost of revenues as a percentage of revenues was also impacted by an increased mix of sales from international customers and an increased mix of revenues from international customers for the sale of capital equipment. Our capital equipment products carry a higher cost of revenues than our disposable products.

Research and development expenses. Research and development expenses decreased $0.4 million, from $3.0 million for the three months ended September 30, 2008 to $2.6 million for the three months ended September 30, 2009. As a percentage of revenues, research and development expenses decreased from 20.3% for the three months ended September 30, 2008 to 19.4% for the three months ended September 30, 2009. The decrease was primarily attributable to a decrease in expenditures for product development project costs of $0.6 million, partially offset by an increase in consulting expenses in support of clinical trial activities of $0.3 million.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased $2.1 million or 20.8%, from $10.2 million for the three months ended September 30, 2008 to $8.1 million for the three months ended September 30, 2009. The decrease was primarily due to lower headcount-related expenses and travel of approximately $1.6 million, which was the result of our reduction in sales force that occurred in the fourth quarter of 2008, and a $0.6 million decrease in sales and marketing expenses, as a result of reduced spending in support of tradeshows, training and educational grants. As a percentage of total revenues, selling, general and administrative expenses decreased from 69.0% for the three months ended September 30, 2008 to 60.9% for the three months ended September 30, 2009.

Settlement reserve. For the three months ended September 30, 2009, in conjunction with the DOJ investigation and qui tam complaint, we have recorded an estimated settlement reserve of $3.8 million, which represents the net present value of the tentative settlement amount. See Note 7, "Commitments and Contingencies" for further details.

Net interest expense. Net interest expense increased $0.1 million to $0.2 million for the three months ended September 30, 2009, due primarily to an increase in our effective interest rate.

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. For the three months ended September 30, 2009, other expense included $39,610 of certain non-employee option expense due to an increase in the value of the options and $4,482 related to foreign currency transaction gains associated with partial settlement of intercompany balances. Other income for the three months ended September 30, 2008 included income of $48,624 associated with a reduction in value of certain non-employee stock options, $19,261 related to foreign currency transaction gains associated with partial settlement of intercompany balances and $74,187 million in grant income related to our grant agreement with the Cleveland Clinic Foundation.

Nine months ended September 30, 2009 compared to September 30, 2008

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

                                                        Nine Months Ended September 30,
                                                     2009                              2008
                                                              % of                             % of
                                            Amount          Revenues          Amount         Revenues
                                                             (dollars in thousands)
Revenues                                   $  40,733           100.0 %       $ 43,191           100.0 %
Cost of revenues                               9,330            22.9 %         10,122            23.4 %

Gross profit                                  31,403            77.1 %         33,069            76.6 %
Operating expenses:
Research and development expenses              8,636            21.2 %          8,035            18.6 %
Selling, general and administrative
expenses                                      25,585            62.8 %         32,574            75.4 %
Goodwill impairment                            6,812            16.7 %             -               -
Settlement reserve                             3,767             9.3 %             -               -

Total operating expenses                      44,800           110.0 %         40,609            94.0 %

Loss from operations                         (13,398 )         (32.9 )%        (7,540 )         (17.5 )%
Other income (expense):
Interest expense                                (581 )          (1.4 )%          (256 )          (0.6 )%
Interest income                                   44             0.1 %            314             0.7 %
Other                                           (216 )          (0.5 )%           514             1.2 %

Other (expense) income                          (753 )          (1.8 )%           572             1.3 %
Loss before income tax benefit               (14,151 )         (34.7 )%        (6,968 )         (16.1 )%
Income tax benefit                                46             0.1 %             -               -

Net loss                                   $ (14,105 )         (34.6 )%      $ (6,968 )         (16.1 )%

Revenues. Total revenues decreased 5.7% from $43.2 million for the nine months ended September 30, 2008 to $40.7 million for the nine months ended September 30, 2009. Revenues from domestic sales decreased $3.6 million or 9.7% and revenues from international sales increased $1.1 million or 18.1%. The decrease in domestic revenues was due primarily to a decrease in revenues from the sale of minimally invasive products. Neutralizing the impact of foreign currency exchange rate fluctuations, total revenues decreased 4.7% as compared to the reported 5.7%, and international revenues grew 24.9% as compared to the reported 18.1%.

Cost of revenues. Cost of revenues decreased $0.8 million, from $10.1 million for the nine months ended September 30, 2008 to $9.3 million for the nine months ended September 30, 2009. The decrease in cost of revenues was primarily due to a reduction in total revenues and a reduction in revenues from the sale of capital equipment, which carry a higher cost of revenues than our disposable products. As a percentage of revenues, cost of revenues decreased from 23.4% for the nine months ended September 30, 2008 to 22.9% for the nine months ended September 30, 2009. The decrease in cost of revenues was primarily due to a reduction in sales of capital equipment, partially offset by an increased mix of revenues from international customers.

Research and development expenses. Research and development expenses increased $0.6 million, from $8.0 million for the nine months ended September 30, 2008 to $8.6 million for the nine months ended September 30, 2009. As a percentage of revenues, research and development expenses increased from 18.6% for the nine months ended September 30, 2008 to 21.2% for the nine months ended September 30, 2009. The increase was primarily attributable to a $0.6 million increase in consulting expenses to support clinical trial activities, an increase in clinical trial expense of $0.4 million and an increase in share-based compensation of $0.4 million, partially offset by a decrease in product development project costs of $0.4 million.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased $7.0 million, from $32.6 million for the nine months ended September 30, 2008 to $25.6 million for the nine months ended September 30, 2009. The decrease was primarily due to lower headcount-related and travel expenses of $5.4 million, primarily the result of a reduction in our sales force which occurred during the fourth quarter of 2008 and a $0.8 million decrease in marketing expenses due primarily to reduced spending in support of tradeshow activities. These reductions in expenses were partially offset by an increase in legal expense of $0.5 million, related primarily to our DOJ investigation, and an increase in share-based compensation expense of $0.4 million. As a percentage of total revenues, selling, general and administrative expenses decreased from 75.4% for the nine months ended September 30, 2008 to 62.8% for the nine months ended September 30, 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 analysis of our goodwill as of March 31, 2009. The analysis concluded that the carrying value of our goodwill exceeded the estimated fair value, and as such, we recognized a full impairment loss of $6.8 million as of March 31, 2009.

Settlement reserve. For the nine months ended September 30, 2009, in conjunction with the DOJ investigation and qui tam complaint, we have recorded an estimated settlement reserve of $3.8 million, which represents the net present value of the proposed settlement amount. See Note 7, "Commitments and Contingencies" for further details.

Net interest income (expense). Net interest income (expense) decreased $0.6 million from income of $0.1 million for the nine months ended September 30, 2008 to expense of ($0.5) million for the nine months ended September 30, 2009. The decrease was primarily due to the write-off of deferred financing costs of $0.1 million in connection with the termination of our credit facility with National City Bank, increased interest expense associated with borrowings under the term loan component of our new credit facility of $0.3 million (driven by a higher effective interest rate and an increase in average borrowings outstanding) and $0.1 million related to the amortization of the discount on long-term debt for the warrant issued in conjunction with our new credit facility.

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. For the nine months ended September 30, 2009, other expense of $0.2 million included $0.1 million related to foreign currency transaction losses associated with partial settlements of intercompany balances and $0.1 million of certain non-employee option expense due to an increase in the value of the options. Other income of $0.5 million for the nine months ended September 30, 2008 included income of $0.2 million associated with a reduction in value of certain non-employee stock options, $0.1 million related to foreign currency transaction gains associated with the partial settlement of intercompany balances, and $0.2 million in grant income related to our grant agreement with the Cleveland Clinic Foundation.

Liquidity and Capital Resources

As of September 30, 2009, we had cash, cash equivalents, short-term investments and long-term investments of $16.4 million and short-term and long-term debt of $5.6 million, resulting in a net cash position of $10.8 million. We had working capital of $19.8 million and an accumulated deficit of $91.6 million.

Cash flows provided by (used in) operating activities. Net cash provided by operating activities was $0.3 million for the nine months ended September 30, 2009 and net cash used in operating activities was $4.9 million for the nine months ended September 30, 2008. Net cash provided by operating activities for the nine months ended September 30, 2009 was primarily attributable to a goodwill impairment charge of $6.8 million, the recording of a settlement reserve related to the DOJ investigation of $3.8 million, non-cash charges related to share-based compensation of $2.7 million and depreciation and amortization of $1.8 million. These positive non-cash reconciling items were partially offset by a net loss of $14.1 million and a decrease in accounts payable and accrued liabilities of $1.7 million, driven primarily by a reduction in our overall expense structure. Net cash used in operating activities for the nine months ended September 30, 2008 was primarily attributable to the net loss of $7.0 million, an increase in accounts receivable and inventory of $1.6 million and $0.2 million, respectively, and a net increase in accounts payable and accrued liabilities of approximately $0.1 million. Net cash used by operations was partially offset by adjustments for depreciation and amortization of $2.2 million and non-cash charges related to share-based compensation of $1.8 million. 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.

Cash flows provided by investing activities. Net cash used in investing activities was $0.8 million for the nine months ended September 30, 2009 and $1.0 million for the nine months ended September 30, 2008. Net cash used in investing activities for the nine months ended September 30, 2009 was due to purchases of available-for-sale securities of $5.8 million and purchases of property and equipment of $1.0 million, partially offset by the change in restricted cash and cash equivalents of $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. Net

cash used in investing activities for the nine months ended September 30, 2008 reflected purchases of property and equipment of $1.6 million, offset by the net purchases and maturities of investments of $7.0 million, and the repayment of a $0.4 million note associated with our acquisition of a product line and an increase in cash to restricted cash of $6.0 million.

Cash flows (used in) provided by financing activities. Net cash (used in) provided by financing activities for the nine months ended September 30, 2009 and 2008 was ($0.5) million and $5.3, respectively. For the nine months ended September 30, 2009, cash flows used in financing activities was attributable to payments made on our debt and capital lease obligations of $6.9 million, including a $6.0 million repayment in full of our National City credit facility, and $0.2 million in payment of debt fees, partially offset by proceeds from borrowings of long-term debt under our new credit facility of $6.5 million, and $0.1 million in proceeds from the issuance of common stock under our employee stock purchase plan. For the nine months ended September 30, 2008, cash provided by financing activities included borrowings against our credit facility in the amount of $6.0 million, as well as proceeds from exercises of stock options of $0.2 million, partially offset by payments made on our debt and capital lease obligations and fees of $0.9 million.

Credit facility. 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. The Agreement also includes up to a $1.0 million sublimit for stand-by letters of credit. The Agreement matures on April 30, 2012 and is secured by all of our assets, including intellectual property.

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. In addition, in connection with the term loan under the Agreement, 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. On October 6, 2009 the Warrant was exercised via a net share settlement and 276,143 shares were issued.

On November 4, 2009 and effective September 30, 2009, we entered into a Consent, Waiver and First Loan Modification Agreement ("Amendment") with Silicon Valley Bank, which amended, among other things, the financial covenants in the Agreement.

As of September 30, 2009, we had no borrowings under our revolving credit facility and borrowing availability of $0.5 million. Also as of September 30, 2009, we had borrowings of $5.6 million under the term loan, which includes approximately $2.2 million classified as current. We are required to make monthly principal payments on the term loan of $0.2 million plus interest. The warrant associated with our term loan was recorded as discount on long-term debt at its intrinsic value and is being amortized over the term of the loan and is reflected as a reduction of long-term debt. Amortization expense totaled $64,685 and $109,341 for the three and nine month periods ended September 30, 2009, respectively. The effective interest rate on borrowings under the term loan, including amortization of the warrant and debt issuance costs, is 15.2%. As of September 30, 2009, the Company had an outstanding letter of credit of $250,000 issued to its corporate credit card program provider which expires on July 31, 2010.

On July 1, 2008 we entered into a two-year credit facility with National City Bank. This credit facility was terminated effective May 1, 2009 and the outstanding balance was repaid in full. 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.

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 . . .