AtriCure (ATRC) is a great growth business with a profit problem, or better said, it suffers from continued losses. While growth is very strong, continued funding requirements have caused severe dilution for investors in the past, resulting in very modest growth on a per share basis.
While the company has promised to reduce losses in 2017 and deliver on positive adjusted EBITDA in 2018, it is unlikely that actual GAAP profits are within reach next year, implying further dilution for investors to come. While I am attracted to relative cheap sales multiples and strong growth, AtriCure manages to disappoint investors over and over again by causing dilution. With no profit trigger within sight in the coming twelve months, I would remain very cautious for now.
Who Is AtriCure, And What Is Its Journey?
AtriCure has been founded in 2000 as a developer of innovative surgical devices which create precision lesions in cardiac and soft tissues. The company has developed the Isolator which is a bipolar ablation clamp, a key alternative to create lesions which block the electrical impulses which cause atrial fibrillation.
This Isolator system was commercialized in 2003 and was available in a version used in open-body surgery and one for minimal invasive procedures. While the Isolator was FDA approved for some procedures, it took many more years before it was approved to prevent atrial fibrillation. While surgeons used the Isolator to treat AF before offical approval (so called off-label usage), it withheld AtriCure from marketing the product for that application.
AF is a very prevalent disease, estimated to affect 5 million people in the developed world, of which half in the US. The irregular heartbeat caused by AF increases the risk of a stroke, making the Isolator a very cost-effective system to improve the outcome for patients.
Strong Growth Following The IPO
AtriCure went public in August of 2005 by selling 4.6 million shares at $12 apiece. Net of cash, AtriCure was valued at just $100 million at the time while sales rose by 24% to $38 million that year. The relatively low sales multiple, given the industry valuations and strong growth could be explained by the fact that losses were relatively steep at $15 million a year.
While shares gained ground in 2007 and 2008, it was the crisis which nearly bankrupted the company, with shares falling to levels as low as $1 in 2009. The crisis resulted in sales stagnating around $55 million in 2009, which was a problem as losses continued and financing opportunities were not readily available given the state of the financial markets at the time.
Over time, the company has diversified its revenue base, and it no longer relies solely on the Isolator. AtriCure designed a cryoablation system as well, being a reusable device which uses extreme cold to ablate cardiac tissue. The AtriClip system was launched in 2009. AtriClip is designed to exclude the left atrial appendage, thereby eliminating the blood flow between the appendage and atrium.
These product introductions allowed for continued growth as the company made it through the crisis, with cost saving efforts dramatically reducing reported losses. This was recognized by the market: shares of the company rose back to $20 by the end of 2013 as topline sales growth accelerated to 25% per year.
Continued growth allowed the company to surpass the $100 million sales mark in 2014, yet continued losses and bolt-on deal resulted in continued dilution. At this point, AtriCure operated with 26 million shares, roughly 2.5 times as many shares compared to the time of the IPO.
Further dilution was incurred in 2015 as the company bought nContact in order to boost its minimal invasive business. This $91 million deal was largely paid for by the issuance of shares, while the near term contribution was limited with just $8.2 million in sales. Unless growth really picks up, the +10 times sales multiple looks very steep, yet investors bought into the growth thesis as shares set a high of $25 in 2015.
2016 Is A Struggle, Cash Outflows Continue
Alongside the release of the 2015 results, AtriCure guided for 25% revenue growth, implying sales will come in at $162 million in 2016. Adjusted EBITDA was expected to be minus $14-$15 million.
For your reference, the 2015 operating loss of $26 million was accompanied by a negative adjusted EBITDA result of $11.5 million, suggesting that operating losses might come in at $30 million in 2016.
Shares fell to just $15 in April as the first quarter revenue growth came in at ¨just¨ 20.3%, instead of the promised 25% for the year, the company maintained the full year guidance. Growth accelerated to 21.8% in Q2, yet it became apparent that the 25% growth target would not be met. The guidance was cut to 20-22% growth, implying full year sales will come in at $156-$158 million. The only good thing is that adjusted EBITDA losses were expected to improve to minus $12-14 million.
The preliminary fourth quarter results, released in early 2017, reveal that trends have decelerated. Fourth quarter revenue growth is now seen at just 15%, implying that full year sales are seen at just $155 million by now. This new triggered a new sell-off in the shares, trading at $16 at the moment.
Difficult Start To 2017, Better Days Forecasted
While the outlook for the fourth quarter is disappointing, the company was happy to provide an outlook for this year. Sales are seen 13-15% higher, which suggests revenues of $177 million.
The good news is that adjusted EBITDA losses are expected to improve towards minus $4-6 million. While this looks encouraging, actual operating losses are likely seen around $25 million, indicating that the company continues to bleed money.
Continued dilution has already increased the outstanding share base towards 31.7 million shares at the end of the third quarter. This means that the company now trades at $500 million, for a relatively appealing 2.8 times sales multiple. This looks appealing with peers trading at 4-5 times multiples, yet the financial outlook for AtriCure remains troubling.
While the company still holds $20 million net in cash, AtriCure is expected to burn this cash in the coming year, undoubtedly resulting in further dilution. While the company continues to point to the fact that adjusted EBITDA is expected to turn positive in 2018, that still does not translate into actual profits.
AtriCure is potentially a very lucrative business which is on track to post sales of $177 million this year. Sales have increased by a factor of 5 times in the time period of little over a decade, the dream of any growth investor. The issue is that the number of outstanding shares has increased by a factor of 3 over this period of time, indicating that growth per share comes in at an average of just 5% per year.
This growth is not that inspiring, certainly as the company is not (yet) profitable. The good thing is that relative valuations are cheap at 2.8 times sales. Its major peer Medtronic trades at 4 times sales which can be explained by the fact that the company is very profitable, yet growth comes in at just 4% per year at the moment.
As AtriCure could easily warrant a 5 times sales multiple if it were to become profitable, decent upside might be within reach if this can be achieved, and consequently dilution stopped. The issue is that GAAP earnings are not expected in either 2017 and 2018, as dilution will continue to cause an overhang in the meantime, with progress in terms of margins being very slow. Perhaps management would be best advised to prioritize revenue growth per share rather than actual growth, as much more margin work is required as well.
Based on these conditions I see few triggers in 2017, which makes me to conclude that I should closely watch the developments going forwards from the sidelines.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.