We are organized into five business units based on product markets: arthroscopy, spinal and neurosurgery, ear nose and throat surgery, cosmetic surgery and cardiology. Our reportable segments are arthroscopy, cosmetic surgery and other which includes spinal and neurosurgery, ear nose and throat surgery and cardiology. Total revenues for the three month period ended July 1, 2000 for the arthroscopy, cosmetic surgery and the other business segments were $14.9 million, $1.4 million and $2.1 million, respectively. Total revenues for the three month period ended July 3, 1999 for the arthroscopy, cosmetic surgery and other business segments were $10.4 million, $1.5 million, and $0.3 million, respectively. Total revenues for the six month period ended July 1, 2000 for the arthroscopy, cosmetic surgery and the other business segments were $28.0 million, $6.0 million and $2.1 million, respectively. Total revenues for the six month period ended July 3, 1999 for the arthroscopy, cosmetic surgery, and other business segments were $19.2 million, $2.1 and $0.6 million, respectively.

Income (loss) from operations for the three month period ended July 1, 2000, for the arthroscopy, cosmetic surgery and other business segments was $4.4 million, $0.7 million and $0.2 million, respectively. Income (loss) from operations for the three month period ended July 3, 1999, for the arthroscopy, cosmetic surgery and other business segments was $3.0 million, $0.8 million and ($0.2) million, respectively. Income (loss) from operations for the six month period ended July 1, 2000, for the arthroscopy, cosmetic surgery and other business segments was $8.2 million, $3.8 million and ($1.0) million, respectively. Income (loss) from operations for the six month period ended July 3, 1999, for the arthroscopy, cosmetic surgery and other business segments was $4.6 million, $1.2 million and ($0.3) million, respectively. Our reportable segments do not include certain corporate expenses which amounted to $1.9 million and $4.1 million, respectively, for the three- and six-month periods ending July 1, 2000 and $2.3 million and $4.1 million, respectively, for the three- and six-month period ended July 3, 1999, respectively.

On March 24, 2000 the Board of Directors approved a two-for-one stock split of our common stock, which was approved by our stockholders on June 5, 2000. Basic and diluted net income per share amounts have been adjusted to reflect the effect of the stock split in the financial statements for the periods presented.

Coblation technology is applicable across many soft-tissue surgical markets. Our systems are used to perform many types of arthroscopic surgery. Our strategy includes applying our patented Coblation technology to a broad range of other soft-tissue markets, including spinal surgery, neurosurgery, cosmetic surgery, ear nose and throat (ENT) surgery, and various cardiology applications.

In April 1998, we announced that we had entered the cosmetic surgery market to commercialize Coblation technology in this field. In early 1999, we entered into a license and distribution agreement with Collagen Aesthetics, Inc., which has been purchased by Inamed Corporation. Under this agreement, Inamed Corporation acquired exclusive, worldwide, marketing rights for our cosmetic surgery line of products for the dermatology and cosmetic surgery markets.

In early 1998, we formed a business unit, AngioCare™, for the purpose of further developing and for commercializing our technology in specific applications in the field of cardiology. As part of those efforts, in February 1998, we entered into a license agreement with Boston Scientific Corporation, under which Boston Scientific Corporation will help develop, obtain regulatory approval for and market products based on Coblation technology for myocardial revascularization procedures.

In September 1999, we announced that we had entered the spinal surgery market. We are marketing and selling the spinal surgery products through a network of independent distributors supported by regional managers worldwide.

In February 2000, we announced that we had entered into the neurosurgery market. In July 2000, we signed an agreement with Integra NeuroSciences, a division of Integra LifeSciences Holding Corporation, for Integra to become the exclusive sales and distribution partner in certain countries for our products for the neurosurgical market.

We have received 510(k) clearance to market our Arthroscopic System for use in arthroscopic surgery of the knee, shoulder, ankle, elbow, wrist and hip, and our Arthroscopic System is CE marked for use in arthroscopic surgery. Our Cosmetic Surgery System is CE marked, and we have received 510(k) clearance for use in general dermatology procedures and for skin resurfacing for the purpose of wrinkle reduction in the United States. Our ENT Surgery System is CE marked, and we have received 510(k) clearances for use of our ENT Surgery System in general head, neck, oral and sinus surgery, including the treatment of snoring, turbinates and tonsillectomy surgery procedures in the United States. Our Spinal Surgery System is CE marked and we have received 510(k) clearance in the United States to market this system for spinal surgery. Our neurosurgery products are CE marked. We have received 510(k) clearance to market Coblation technology for general surgery.

In December 1995, we introduced our Arthroscopic System commercially in the United States and have derived a significant portion of our sales from this system. Our strategy includes placing controller units, at substantial discounts, to generate future disposable revenue. Our strategy also includes applying our patented Coblation technology to a range of other soft-tissue surgical markets including the products we have introduced in the fields of spinal surgery, neurosurgery in Europe, cosmetic surgery and ear, nose and throat surgery. We have received 510(k) clearance for use of our technology in several additional fields. We cannot be sure that any of our clinical studies in other fields will lead to 510(k) applications or that the applications will be cleared by the FDA on a timely basis, if at all. In addition, we cannot be sure that the products, if cleared for marketing, will ever achieve commercial acceptance.

Product sales for the three month period ended July 1, 2000 were $17.2 million, an increase of $7.1 million, or 70%, from $10.1 million for the prior year period. Product sales for the six month period ended July 1, 2000 were $32.8 million, an increase of $13.7 million or 71% from $19.2 million from the prior year period. The increase in product sales for both the three- and six-month periods resulted primarily from an increase in the number of unit sales of both controllers and disposable devices. The higher unit volume of sales resulted primarily from increased demand for newly introduced models of disposable devices for arthroscopy, sales of disposable and controller devices for new product lines, and increasing international sales. We attribute increasing disposable device sales both domestically and internationally to our strategic plan to build market share through continued promotional programs of controller placements, and by continuing to introduce new products designed to address surgical procedures that have traditionally been difficult to perform.

International product sales for the three- and six-month periods ended July 1, 2000 were 15% and 13%, respectively, of total product sales, compared to 16% and 11%, respectively, of product sales, for the same periods of the prior year. We believe the increase in absolute dollars year over year for product sales is attributable to our increasing marketing presence overseas and regulatory approval to market our arthroscopic products in Japan.

Based upon the estimated number of arthroscopic procedures performed each year, we believe that knee procedures represent the largest segment of the arthroscopic market, while shoulder procedures, in units, represent the fastest growing segment. To achieve increasing disposable device sales in arthroscopy over time, we believe we must continue to penetrate the market in knee procedures, expand physicians' education with respect to Coblation technology and continue to work on new product development efforts specifically for knee applications. We believe that, in our four years of product shipments, we have penetrated 35% to 40% of the hospitals that perform arthroscopic procedures in the United States. We believe that approximately 50% of our arthroscopy disposable device sales are being generated by the sale of disposable devices for use in shoulder procedures.

License fees and royalty income was $1.2 million and $3.3 million, respectively, for the three- and six-month periods ended July 1, 2000, as compared to $2.1 million and $2.8 million, respectively, for the three- and six-month periods ended July 3, 1999. The differences in license fees and royalty revenue in the current three- and six-month periods are primarily due to the timing of licensing payments and milestones received from our business partners and a litigation settlement payment in June 1999 resulting from a patent infringement suit initiated by us.

We cannot assure you that we will be able to continue to recognize future license fees, or that products will be developed, cleared for marketing and achieve sufficient commercial acceptance, so that we may continue to receive licensing and royalty revenues from our business partners.

Cost of product sales for the three months ended July 1, 2000 was $6.6 million or 38% of product sales, as compared with $4.3 million or 43% of product sales for the three months ended July 3, 1999. For the six months ended July 1, 2000, cost of product sales was $13.0 million or 39% of product sales, as compared with $8.2 million or 43% of product sales for the six months ended July 3,1999. The absolute dollar increase in cost of product sales for the three- and six-month periods ended July 1, 2000, compared to the same periods of the prior year, is attributable to increasing unit sales of both controllers and disposable devices. The decrease in cost of product sales as a percentage of product sales for the three and six-month periods ended July 1, 2000 as compared to the prior year periods is attributable to increased manufacturing efficiency for established product lines and increased production volume.

We cannot be sure that gross margins will remain at current levels or show improvement in the future due to the distribution channels used, product mix, and fluctuation in manufacturing production levels as new products are introduced. We believe our gross margin will depend upon the mix of disposable device sales versus controller sales and/or placements and the various distribution channels utilized to sell our products in all commercialized fields. There can be no assurance that we will be successful in maintaining the mix of disposable devices to controllers or in increasing demand for our disposable devices. In addition, inefficiencies in manufacturing new products and the distribution channels utilized to sell those products may adversely impact gross margin.

We anticipate that sales and marketing spending will continue to increase in absolute dollars due to the expansion of our distribution capabilities to address the spinal surgery market, higher dealer commissions from increased sales, the additional cost of penetrating international markets, higher promotional, demonstration and sample expenses, additional investments in the sales, marketing and support staff necessary to market our current products and commercialize future products.

The provision for income taxes was $227,000 and $456,000 for the three- and six-month periods ended July 1, 2000, respectively, compared with $54,000 and $65,000 for the three- and six-month periods ended July 3, 1999, respectively. Because we use net operating loss carryforwards generated in prior years, our tax rate is below the statutory rate. We have federal net operating loss carryforwards which expire in the years 2001 through 2018, and state net operating loss carryforwards which expire in the years 2001 through 2003. We are subject to certain alternative minimum tax requirements in the current year for which an estimate is made based on the anticipated effective tax rate at the end of the fiscal year.

Net income was $4.3 million and $8.6 million, respectively, for the three- and six-month periods ended July 1, 2000, compared to $1.3 million and $1.5 million for the three- and six-month periods ended July 3, 1999. Net income for the current periods reflects an increase in product sales, license fees and gross margin, partially offset by increased spending in operating expenses. Although we have experienced substantial revenue growth since inception and have been profitable on a quarterly basis since the quarter ended April 3, 1999, due to our short operating history and numerous other factors, we cannot be sure that we can sustain revenue growth or profitability.

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard 133, (SFAS No. 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments, embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. We must adopt this standard no later than fiscal year 2001. To date, we have not engaged in hedging activities.

In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 requires that license and other upfront fees from research collaborators be recognized over the term of the agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process. SAB 101, as amended, is effective for our fourth quarter of 2000. Accordingly, we will report a change in accounting principle for the fiscal quarter ending December 30, 2000. We are currently evaluating the application of SAB 101 and believe that certain revenue previously recognized may be deferred to future periods. The cumulative effect of this change in accounting principle, may result in an increase of our accumulated deficit.

We became a public company in February 1996. Included here are risk factors as updated from our Annual Report on Form 10-K, filed March 31, 2000 for the year ended January 1, 2000. The following factors represent current challenges to us that create risk and uncertainty. Failure to adequately overcome any of the following challenges, either singularly or in combination, could have a material adverse effect on our results of operations, business, or financial position.

We commercially introduced our Arthroscopic System in December 1995. Since our Arthroscopic System accounts for the majority of our product sales, we are highly dependent on its sales. Our spinal surgery, neurosurgery, cosmetic surgery, and ENT surgery products have only recently become available, and to date, we have sold only a small number of units. We cannot assure you that we will be able to continue to manufacture arthroscopy products in commercial quantities at acceptable costs, or that we will be able to continue to market such products successfully.

To achieve increasing disposable device sales over time, we believe we must continue to penetrate the market in knee procedures, expand physicians' education with respect to Coblation technology and continue working on new product development efforts specifically for knee applications. Furthermore, in order to maintain and increase current market penetration we must be aggressive in increasing our installed base of controllers to generate increased disposable device revenue. To date, we have placed our arthroscopic controllers at substantial discounts in order to stimulate demand for our disposable devices.

We believe that surgeons will not use our products unless they determine, based on experience, clinical data and other factors, that these systems are an attractive alternative to conventional means of tissue ablation. There are only a few independently published clinical reports and limited long-term clinical follow-up to support the marketing efforts for our Arthroscopic System. We believe that continued recommendations and endorsements by influential arthroscopic surgeons are essential for market acceptance of our Arthroscopic System. If our Coblation technology does not continue to receive endorsement by influential surgeons or our long-term data does not support our current claims of efficacy, our business, financial condition, results of operations and future growth prospects could be materially adversely affected.

We have developed several new applications for our Coblation technology in spinal and neurosurgery, cosmetic surgery and ENT surgery. Additionally we have established a program to explore the application of our Coblation technology in various areas within cardiology. Our products for these non-arthroscopic indications are in various stages of commercialization and development, and we may be required to undertake time-consuming and costly commercialization, development and additional regulatory approval activities. We are awaiting 510(k) clearance in the United States to market our Spinal Surgery System specifically for use in neurosurgery. If we do not receive this or future clearances we will be unable to market this and future products for specific indications and our business, financial condition, results of operations and future growth prospects could be materially adversely affected. We cannot assure you that product development will ever be successfully completed, that regulatory clearances or approvals, if applied for, will be granted by the FDA or foreign regulatory authorities on a timely basis, if at all, or that the products will ever achieve commercial acceptance.

We may have to make a significant investment in additional preclinical and clinical testing, regulatory, physician training and sales and marketing activities to further develop and commercialize the spinal surgery, neurosurgery, cosmetic surgery, ENT surgery and cardiology product lines. Although we believe that these products offer certain advantages, we cannot assure you that these advantages will be realized, or if realized, that these products will result in any meaningful benefits to physicians or patients.

Development and commercialization of our current and future non-arthroscopic products are subject to the risks of failure inherent in the development of new medical devices. These risks include the following: that such products will not be easy to use, will require extensive training or will not be cost-effective; that we will experience delays in testing or marketing; that such testing or marketing will result in unplanned expenditures or in expenditures above those anticipated by us; that our products will not be proven safe or effective; that third parties will develop and market superior or equivalent products; that such products will fail to receive necessary regulatory clearances or approvals; that such products will be difficult or uneconomical to manufacture on commercial scale; and that proprietary rights of third parties will preclude us and our collaborative partners from marketing such products.

In addition, the success of our non-arthroscopic products will depend on their adoption as alternatives to conventional means of tissue ablation. Clinical experience and follow-up data for our non-arthroscopic indications are limited, and we have sold only a small number of units to date. We believe that recommendations and endorsements by influential physicians are essential for market acceptance of our products.

We currently have limited experience in marketing and selling our products. To the extent that we have established or will enter into distribution arrangements for the sale of our products, we are and will be dependent upon the efforts of third parties. We are marketing and selling our arthroscopic surgery, spinal surgery, neurosurgery and ENT surgery product lines in the United States and internationally through a network of independent distributors supported by regional sales managers and a small direct sales force. These distributors sell arthroscopy, spinal surgery, neurosurgery and ENT surgery devices for a number of other manufacturers. We cannot assure you that these distributors will commit the necessary resources to effectively market and sell our arthroscopic surgery, spinal surgery, neurosurgery or ENT surgery product lines, or that they will be successful in selling our products.

We have recently established a marketing presence in various countries and we cannot assure you that these newly established operations will be successful. In order to successfully market our products internationally, we will need to address many issues with which we have little or no experience, including the securing of necessary regulatory approvals in international markets and the potential reuse of our disposable devices by our customers. Even if we are able to successfully deal with these issues, we cannot assure you that we will be able to establish successful distribution capabilities internationally or receive favorable pricing for our products. In addition, we may face currency exchange risks as part of our international expansion. To the extent our marketing and sales efforts are unsuccessful, our business, financial condition, results of operations and future growth prospects may be materially adversely affected.

To be successful, we must manufacture our products in commercial quantities in compliance with regulatory requirements at acceptable costs. Our manufacturing operations consist of an in-house assembly operation for the manufacture of disposable devices and controllers. We currently produce 44 models of disposable devices incorporating different functionalities, including suction and fluid management. As we increase the number of product designs for our disposable devices, the complexity of our manufacturing processes will increase. We manufacture three different controller models. Although the manufacturing processes for the controllers designed to date are substantially the same, we cannot be certain that we will be able to continue to manufacture these controllers without additional expense and capabilities. We could also encounter difficulties in manufacturing our current or future products which could reduce yields, result in supply disruptions and adversely affect our gross margins. If we have delays in manufacturing, we will not have adequate finished inventory to meet our needs. If our quality assurance programs do not continue to meet the demands of the complexity and capacity of the products we manufacture, we may experience product returns.

In addition, we use a single subcontractor to sterilize the disposable devices. Although this subcontractor has sterilization facilities in several locations, we cannot assure you that we would be able identify and qualify an alternate sterilizer. Our inability to secure an alternative sterilizer, if required, would limit our ability to manufacture disposable devices and could have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

In arthroscopy, we compete against companies such as Johnson & Johnson, Smith & Nephew, Inc., Conmed Corporation, Stryker Corporation and Oratec Interventions, Inc. that market products to remove or shrink tissue. Specifically, Johnson & Johnson and Stryker Corporation are currently marketing bipolar electrosurgical systems for tissue ablation. We are also aware of additional competitors that may commercialize products using technology similar to ours. In spinal surgery, we compete against companies that market products to remove tissue and treat spinal disorders. In ENT surgery, we compete against companies that offer manual instruments, such as Smith & Nephew, Inc., Stryker Corp., Conmed Corporation, and Xomed Surgical Products, Inc., which was recently acquired by Medtronic, Inc. In addition, we compete with companies that develop and market lasers for various ENT surgery applications, including ESC Medical Systems Ltd. Smaller companies, including Somnus Medical Technologies Inc., Elmed Inc. and Ellman International, Inc., also sell medical devices for the treatment of various ENT disorders including snoring and obstructive sleep apnea. In cosmetic surgery, we compete against companies such as Coherent Medical Group and ESC Medical Systems Ltd. that market lasers for use in this field. In addition, other large companies manufacture and sell medical devices that use radio frequency energy for certain applications in dermatology and cosmetic surgery. In cardiology, we may compete with companies that use lasers to treat cardiovascular disease. Other approaches to alleviating cardiovascular disease, including drugs or other surgical approaches, may also be competitive.

Many of our competitors have significantly greater financial, manufacturing, marketing, distribution and technical resources than we do. Some of these companies offer broad product lines that they may offer as a single package and frequently offer significant discounts as a competitive tactic. For example, in order to compete successfully, we anticipate that we may have to continue to offer substantial discounts on our controllers in order to increase demand for our disposable devices, and this competition could have a material adverse effect on our business, financial condition, results of operations and future growth prospects. Furthermore, some of our competitors utilize purchasing contracts that link discounts on the purchase of one product to purchases of other products in their broad product lines. Many of the hospitals in the United States have purchasing contracts with our competitors. Accordingly, customers may be dissuaded from purchasing our products rather than the products of these competitors to the extent the purchase would cause them to lose discounts on products.

Failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from health care payors for procedures in which our products are used or adverse changes in governmental and private third-party payors' policies toward reimbursement for such procedures would have a material adverse effect on our business, financial condition, results of operations and future growth prospects. Reimbursement for arthroscopic, spinal surgery and ENT surgery procedures performed using devices that have received FDA approval has generally been available in the United States. Typically, elective cosmetic surgery procedures are not reimbursed.

We are unable to predict what changes will be made in the reimbursement methods used by third-party health care payors. In addition, some health care providers are moving toward a managed care system in which providers contract to provide comprehensive health care for a fixed cost per person. Managed care providers are attempting to control the cost of health care by authorizing fewer elective surgical procedures. We anticipate that in a prospective payment system, such as the diagnosis related group system utilized by Medicare, and in many managed care systems used by private health care payors, the cost of our products will be incorporated into the overall cost of the procedure and that there will be no separate, additional reimbursement for our products. We anticipate that hospital administrators and physicians will justify the use of our products by the apparent cost savings and clinical benefits that we believe will be derived from the use of our products. However, we cannot assure you that this will be the case.

If we obtain the necessary international regulatory approvals, market acceptance of our products in international markets would be dependent, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country and include both government-sponsored health care and private insurance. We intend to seek international reimbursement approvals, although we cannot assure you that any such approvals will be obtained in a timely manner, if at all.

Our participation in collaborative and licensing arrangements with third parties subjects us to a number of risks. Collaborative partners typically have significant discretion in electing whether to pursue any of the planned activities. We cannot control the amount and timing of resources our collaborative partners may devote to our products, and we cannot assure you that our partners will perform their obligations as expected. Business combinations or significant changes in a corporate partner's business strategy may adversely affect that partner's ability to meet its obligations under the arrangements. If a collaborative partner were to terminate or breach its agreement with us, or otherwise fail to complete its obligations in a timely manner, our business, financial condition, results of operations and future growth prospects would be materially adversely affected. To the extent that we are not able to establish further collaborative arrangements or that any or all of our existing collaborative arrangements are terminated, we would be required to seek new collaborative arrangements or to undertake commercialization at our own expense, which could significantly increase our capital requirements, place additional strain on our human resource requirements and limit the number of products which we would be able to develop and commercialize. In addition, we cannot assure you that our existing and future collaborative partners will not pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors.

We cannot assure you that disputes will not arise in the future with respect to the ownership of rights to any technology or products developed with any collaborative partner. Lengthy negotiations with potential new collaborative partners or disagreements between established collaborative partners and us could lead to delays in or termination of the research, development or commercialization of certain products or result in litigation or arbitration that would be time consuming and expensive. Failure by any collaborative partner to commercialize successfully any product to which it has obtained rights from us, or the decision by a collaborative partner to pursue alternative technologies or commercialize or develop alternative products, either on its own or in collaboration with others, could have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

We cannot assure you that the patents we have obtained, or any patents we may obtain as a result of our pending U.S. or international patent applications, will provide any competitive advantages for our products. We also cannot assure you that those patents will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of which have substantial resources and have made substantial investments in competing technologies, have not already applied for or obtained, or will not seek to apply for and obtain, patents that will prevent, limit or interfere with our ability to make, use and sell our products either in the United States or in international markets. Patent applications are maintained in secrecy for a period after filing. We may not be aware of all of the patents and patent applications potentially adverse to our interests.

A number of medical device and other companies and universities and research institutions have filed patent applications or have issued patents relating to monopolar and/or bipolar electrosurgical methods and apparatus. We have received, and we may receive in the future, notifications of potential conflicts of existing patents, pending patent applications and challenges to the validity of existing patents. In addition, we have become aware of, and may become aware of in the future, patent applications and issued patents that relate to our products and/or the surgical applications and issued patents and, in some cases, have obtained internal and/or external opinions of counsel regarding the relevance of certain issued patents to our products. We do not believe that our products currently infringe any valid and enforceable claims of the issued patents that we have reviewed. However, if third-party patents or patent applications contain claims infringed by our technology and such claims are ultimately determined to be valid, we may not be able to obtain licenses to those patents at a reasonable cost, if at all, or be able to develop or obtain alternative technology. Our inability to do either would have a material adverse effect on our business, financial condition, results of operations and prospects. We cannot assure you that we will not have to defend ourselves in court against allegations of infringement of third-party patents, or that such defense would be successful.

In addition to patents, we rely on trade secrets and proprietary know-how which we seek to protect, in part, through confidentiality and proprietary information agreements. We require our key employees and consultants to execute confidentiality agreements upon the commencement of an employment or consulting relationship with us. These agreements generally provide that all confidential information, developed or made known to the individual during the course of the individual's relationship with us, is to be kept confidential and not disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. We cannot assure you that employees will not breach such agreements, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known to or be independently developed by competitors.

Defending and prosecuting intellectual property suits, USPTO interference proceedings and related legal and administrative proceedings are costly and time-consuming. Further litigation may be necessary to enforce our patents, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings will be costly and will result in significant diversion of effort by technical and management personnel. An adverse determination in any of the litigation or interference proceedings to which we may become a party could subject us to significant liabilities to third parties, require us to license disputed rights from third parties or require us to cease using such technology, which would have a material adverse effect on our business, financial condition, results of operations and future growth prospects. Patent and intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, and could include ongoing royalties. We cannot assure you that we can obtain the necessary licenses on satisfactory terms, if at all.

Within the last 12 months, our common stock closing price has ranged between $20.68 and $61.75 per share. The market price of our common stock could continue to fluctuate substantially due to a variety of factors, including: quarterly fluctuations in results of our operations; our ability to successfully commercialize our products; announcements regarding results of regulatory approval filings, clinical studies or other testing; technological innovations or new commercial products by us or our competitors; developments concerning government regulations, proprietary rights or public concern as to the safety of our technology; the execution of new collaborative agreements and material changes in our relationships with our business partners; market reaction to acquisitions and trends in sales, marketing, and research and development; changes in earnings estimates by analysts; sales of common stock by existing stockholders or other speculative activity in our stock and economic and political conditions.

The market price for our common stock may also be affected by our ability to meet analysts' expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against the company. If similar litigation were instituted against us, it could result in substantial costs and a diversion of our management's attention and resources, which could have an adverse effect on our business, results of operations and financial condition.

On February 18, 2000, we filed a complaint for declaratory relief in the Superior Court of California, County of Santa Clara against a former independent contractor who alleges that he is owed options under our stock option plan. The defendant has filed a counterclaim in the United States District Court, Northern District of California asserting breach of contract and ownership rights in certain of ArthroCare's patents, among other claims. We believe these claims are groundless and plan to vigorously defend against them.

United States

Our products are considered medical devices and are subject to extensive regulation in the United States. We must obtain premarket clearance or approval by the FDA for each of our products and indications before they can be commercialized. FDA regulations are wide ranging and govern, among other things: product design and development; product testing; product labeling; product storage; premarket clearance or approval; advertising and promotion; and product sales and distribution.

Noncompliance with applicable regulatory requirements can result in enforcement action, which may include: warning letters; fines, injunctions and civil penalties against us; recall or seizure of our products; operating restrictions, partial suspension or total shutdown of our production; refusing our requests for premarket clearance or approval of new products; withdrawing product approvals already granted; and criminal prosecution.

Unless an exemption applies, generally, before we can introduce a new medical device into the United States market, we must obtain FDA clearance of a 510(k) premarket notification or approval of a premarket approval application, or PMA application. If we can establish that our device is "substantially equivalent" to a "predicate device," i.e., a legally marketed Class I or Class II device or a preamendment Class III device (i.e., one that was in commercial distribution before May 28, 1976) for which the FDA has not called for PMAs, we may seek clearance from the FDA to market the device by submitting a 510(k) premarket notification. The 510(k) premarket notification will need to be supported by appropriate data, including, in some cases, clinical data, establishing the claim of substantial equivalence to the satisfaction of the FDA.

We have received 510(k) clearance to market our Arthroscopic System for surgery of the knee, shoulder, elbow, wrist, hip and ankle joints. We have received 510(k) clearance in the United States to market our Spinal Surgery System. In addition, we have received 510(k) clearance to market our Cosmetic Surgery System in general dermatology procedures and for skin resurfacing for the purpose of wrinkle reduction. We have received 510(k) clearance to market the ENT Surgery System in general head and neck surgical procedures as well as snoring, minimally-invasive sinus surgery and tonsil treatments. We cannot assure you that we will be able to obtain necessary clearances or approvals to market any other products, or existing products for new intended uses, on a timely basis, if at all. Delays in receipt or failure to receive clearances or approvals, the loss of previously received clearances or approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in the intended use of the device, requires a new 510(k) clearance. The FDA requires each manufacturer to make this determination in the first instance, but the FDA can review any such decision. If the FDA disagrees with a manufacturer's decision not to seek a new 510(k) clearance, the agency may retroactively require the manufacturer to submit a premarket notification requesting 510(k) clearance. The FDA also can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance is obtained. We have modified some of our marketed devices, but have determined that, in our view, new 510(k) clearances are not required. No assurance can be given that the FDA would agree with any of our decisions not to seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for any modification, the FDA also may require us to cease marketing and/or recall the modified device until we obtain a new 510(k) clearance.

If we cannot establish that a proposed device is substantially equivalent to a legally marketed device, we must seek premarket approval through submission of a PMA application. A PMA application must be supported by extensive data, including, in many instances, preclinical and clinical trial data, as well as extensive literature to prove the safety and effectiveness of the device. If necessary, we will file a PMA application for approval to sell our potential products. The PMA process can be expensive, uncertain and lengthy. We cannot assure you that we will be able to obtain PMA approvals on a timely basis, if at all, and delays in receipt or failure to receive approvals, could have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

We are also required to demonstrate and maintain compliance with the Quality System Regulation, or QSR. The QSR incorporates the requirements of Good Manufacturing Practice and relates to product design, testing, and manufacturing quality assurance, as well as the maintenance of records and documentation. The FDA enforces the QSR through inspections. We cannot assure you that we or our key component suppliers are or will continue to be in compliance, will not encounter any manufacturing difficulties, or that we or any of our subcontractors or key component suppliers will be able to maintain compliance with regulatory requirements. Failure to do so will have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

We may not promote or advertise our products for uses not within the scope of our clearances or approvals or make unsupported safety and effectiveness claims. These determinations can be subjective. We cannot assure you that the FDA would agree that all of our promotional claims are permissible or that the FDA will not require us to revise our promotional claims or take enforcement action against us based upon our labeling and promotional materials.

International

International sales of our products are subject to strict regulatory requirements. The regulatory review process varies from country to country. We are continually applying for regulatory approval in a variety of countries. We have obtained regulatory clearance to market our Arthroscopic System in Europe, Japan, Australia, Taiwan, Korea, Canada, South America, the Middle East, Israel and Mexico, to market our cosmetic surgery products in Europe, Canada, Australia, the Middle East and South America and to market our ENT surgery products in Europe, Canada, Australia, China, Israel, the Middle East, South America and Taiwan, our spinal surgery products in and currently we are applying for additional international regulatory approvals in other international markets. We cannot assure you that we will obtain such clearances and approvals on a timely basis, or at all.

For European distribution, we have received ISO 9001/EN46001 certification and the EC Certificate pursuant to the European Union Medical Device Directive 93/42/EEC, allowing us to CE mark our products after assembling appropriate documentation. ISO 9001/EN46001 certification standards for quality operations have been developed to ensure that companies know the standards of quality on a worldwide basis. Failure to maintain the CE Mark will preclude us from selling our products in Europe. We cannot assure you that we will be successful in maintaining certification requirements.

The development, manufacture and sale of medical products involves significant risk of product liability claims. Our current product liability insurance coverage limits are $10.0 million per occurrence and $10.0 million in the aggregate. We cannot assure you that such coverage limits are adequate to protect us from any liabilities we might incur in connection with the development, manufacture and sale of our products. In addition, we may be required to increase our product liability coverage as potential products are successfully commercialized. Product liability insurance is expensive and may not be available to us in the future on acceptable terms, if at all. We have not received any product liability claims to date. However, a successful product liability claim or series of claims brought against us in excess of our insurance coverage could have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

We have an investment portfolio of fixed income securities that are classified as "available-for-sale securities." These securities, like all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. We attempt to limit this exposure by investing primarily in short-term securities.

On February 18, 2000, we filed a complaint for declaratory relief in the Superior Court of California, County of Santa Clara against a former independent contractor who alleges that he is owed options under our stock option plan. The defendant has filed a counterclaim in the United States District Court, Northern District of California asserting breach of contract and ownership rights in certain of ArthroCare's patents, among other claims. We believe these claims are groundless and plan to vigorously defend against them.

None

The annual meeting of stockholders was held on June 5, 2000. Matters voted on at that meeting were (I) the election of six directors, (II) Approval of an amendment to the Company's Certificate of Incorporation to increase the authorized number of shares of Common Stock by 55,000,000 shares to a total of 75,000,000 shares of Common Stock authorized for issuance. (III) Approval of an amendment to the Company's Certificate of Incorporation to effect a two-for-one stock split of the Company's outstanding Common Stock, (IV) Approval of an amendment to the Company's 1993 Stock Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 400,000 shares (without giving effect to the approval of Proposal No. 3 above), (V) Approve an amendment to the 1995 Director Option Plan to (i) Approve an increase in the number of shares of Common Stock reserved for issuance thereunder by 145,000 shares (without giving effect to the approval of Proposal No. 3 above), (ii) increase the number of options for shares of Common Stock automatically granted to non-employee directors upon election and re-election to 25,000 and 7,500, respectively (without giving effect to the approval of Proposal No. 3 above). and (iii) provide for accelerated vesting of directors' options upon a change of control of the Company, (VI) The ratification of the appointment of PricewaterhouseCoopers LLP as the our independent accountants for the 2000 fiscal year. Tabulation for each proposal and individual directors were as follows:

PROPOSAL I. ELECTION OF DIRECTORS

Nominee	Votes	Votes Withheld
Michael A. Baker	7,231,680	15,658
Annette J. Campbell-White	7,234,580	12,758
Raymond Larkin Jr.	7,234,420	12,918
John S. Lewis	7,234,880	12,458
Robert R. Momsen	7,234,730	12,494
Hira V. Thapliyal Ph.D.	7,234,730	12,608

PROPOSAL II. AMENDMENT TO THE COMPANY'S CERTIFICATE OF INCORPORATION TO INCREASE THE AUTHORIZED NUMBER OF SHARES OF COMMON STOCK BY 55,000,000 SHARES TO A TOTAL OF 75,000,000 SHARES OF COMMON STOCK AUTHORIZED FOR ISSUANCE.

FOR:

6,422,376

AGAINST:

823,032

ABSTAIN:

1,930

PROPOSAL III. AMENDMENT TO THE COMPANY'S CERTIFICATE OF INCORPORATION TO EFFECT A TWO-FOR-ONE STOCK SPLIT OF THE COMPANY'S OUTSTANDING COMMON STOCK.

FOR:

7,244,956

AGAINST:

1,022

ABSTAIN:

1,360

PROPOSAL IV. AMENDMENT TO COMPANY'S 1993 STOCK PLAN TO INCREASE THE NUMBER OF SHARES OF COMMON STOCK RESERVED FOR ISSUANCE THERUNDER BY 400,000 SHARES (WITHOUT GIVING EFFECT TO THE APPROVAL OF THE STOCK SPLIT).

FOR:

3,970,451

AGAINST:

1,385,232

ABSTAIN:

1,891,655

PROPOSAL V. AMENDMENT TO COMPANY'S 1995 DIRECTOR OPTION PLAN TO (i) INCREASE THE NUMBER OF SHARES OF COMMON STOCK RESERVED FOR ISSUANCE THERUNDER BY 145,000 SHARES (WITHOUT GIVING EFFECT TO THE APPROVAL OF THE STOCK SPLIT), (ii) INCREASE THE NUMBER OF OPTIONS FOR SHARES OF COMMON STOCK AUTOMATICALLY GRANTED TO NON-EMPLOYEE DIRECTORS UPON ELECTION AND RE-ELECTION TO 25,000 AND 7,500 RESPECTIVELY (WITHOUT GIVING EFFECT TO THE APPROVAL OF THE STOCK SPLIT), AND (iii) PROVIDE FOR ACCELERATED VESTING OF DIRECTORS' OPTIONS UPON A CHANGE OF CONTROL OF THE COMPANY.

FOR:

4,718,117

AGAINST:

637,495

ABSTAIN:

1,891,726

PROPOSAL VI. RATIFICATION OF APPOINTMENT OF PRICEWATERHOUSECOOPERS LLP.

FOR:

7,242,904

AGAINST:

1,923

ABSTAIN:

2,511

Item 5. Other Information

None

a) Exhibits

2. Reports on Form 8-K

ARTHROCARE CORPORATION


SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ARTHROCARE CORPORATION a Delaware corporation

	(Registrant)

Date: August 15, 2000

	By:	/s/ Michael A. Baker

	Michael A. Baker
	President, Chief Executive Officer and Director
	(Principal Executive Officer)

Date: August 15, 2000

	By:	/s/ Christine Hänni

	Christine Hänni
	Vice President of Finance, Chief Financial Officer and Assistant Secretary
	(Principal Financial Officer and Accounting Officer)

EXHIBIT INDEX

Exhibit Number	Exhibit Description
10.36++	License Agreement between ArthroCare Corporation and Stryker Corporation, dated June 28, 2000.
27.1	Financial Data Schedule.

++ confidential treatment requested.