10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

Commission File Number: 0-27422

ARTHROCARE CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware	94-3180312
(State or other jurisdiction of Incorporation or organization)	(I.R.S. employer Identification number)

680 Vaqueros Avenue, Sunnyvale, California 94085

(Address of principal executive offices and zip code)

(408) 736-0224

(Registrant’s telephone number, including area code)

Securities registered pursuant to 12 (b) of the Act:	None
Securities registered pursuant to section 12 (g) of the Act:	Common Stock, $0.001 Par Value; Preferred Share Purchase Rights

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  x  No  ¨

As of June 28, 2002, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $146,000,000 (based upon the closing sales price of such stock as reported by The Nasdaq Stock Market on such date). Shares of Common Stock held by each officer, director, and holder of 5% or more of the outstanding Common Stock on that date have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 14, 2003, the number of outstanding shares of the Registrant’s Common Stock was 21,219,789.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by items 10, 11, 12, and 13 of Part III of Form 10-K is incorporated by reference from the Registrant’s proxy statement for the 2003 Annual Stockholders Meeting which will be filed with the Securities and Exchange Commission within 120 days after the close of the Registrant’s fiscal year ended December 31, 2002.

PART I

ITEM 1.    BUSINESS

This Report on Form 10-K contains certain forward-looking statements regarding future events with respect to ArthroCare Corporation (“ArthroCare,” “we,” “us,” “our,” and “company” refer to ArthroCare Corporation, a Delaware corporation unless the context otherwise requires). Actual events or results could differ materially due to a number of factors, including those described herein and in the documents incorporated herein by reference, and those factors described under “Additional Factors that Might Affect Future Results.”

Overview

We are a medical device company that develops, manufactures and markets products based on our patented Coblation^® technology. Our products allow surgeons to operate with a high level of precision and accuracy, limiting damage to surrounding tissue thereby potentially reducing pain and speeding recovery for the patient. Our products operate at lower temperatures than traditional electrosurgical or laser surgery tools and enable surgeons to ablate, shrink, sculpt, cut, aspirate and suction soft tissue, and to seal small bleeding vessels. Ablation is the disintegration or removal of tissue. Our soft-tissue surgery systems consist of a controller unit and an assortment of sterile, single-use disposable devices that are specialized for specific types of surgery. We believe our Coblation technology can replace the multiple surgical tools traditionally used in soft-tissue surgery procedures with one multi-purpose surgical system.

Coblation technology is applicable across many soft-tissue surgical markets. Our systems are used to perform many types of surgical procedures. Our strategy includes applying our patented Coblation technology to a broad range of soft-tissue surgical markets, including arthroscopy, spinal surgery, neurosurgery, cosmetic surgery, ear, nose and throat (ENT) surgery, gynecology, urology, general surgery and various cardiology applications. In addition to our Arthroscopy business unit, first put in place to introduce Coblation-based surgical instruments for use in the shoulder and knee arthroscopic procedures, we have formed the following business units for commercialization of our technology in non-orthopedic markets: ArthroCare Spine^™ to commercialize our technology in the spinal and neurosurgery markets; ENT commercialize our ENT surgery products for use in head and neck surgical procedures; Visage^® products to commercialize our cosmetic surgery products for use in various cosmetic surgery procedures; and newly formed ArthroCare Coblation Technologies to commercialize our Coblation-based products through OEM partnerships in gynecology, urology, laparoscopic and open surgical procedures for use in general surgery, and AngioCare for developing cardiology applications.

We have received 510(k) clearance from the United States Food and Drug Administration, or FDA, to market our Arthroscopic Surgery 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. The CE Mark is a requirement to sell our products in most of Western Europe. Our Cosmetic Surgery System has been cleared by the FDA and is CE marked for general dermatologic procedures and skin resurfacing in connection with wrinkle reduction procedures. Our ENT Surgery System is CE marked, and we have applied for the CE mark and received 510(k) clearances from the FDA for use of our ENT Surgery System in general head, neck, oral and sinus surgery procedures, including tonsillectomy and adenoidectomy, turbinate reduction to relieve nasal obstruction and soft palate stiffening to treat snoring. Our Spinal Surgery System is CE marked, and we have received 510(k) clearances in the United States to market this system for spinal surgery and neurosurgery. We have also applied the CE mark and received 510(k) clearance from the FDA to market products based on Coblation technology for use in general surgery, gynecology, urology, plastic and reconstructive surgery, and orthopedic surgery.

We commercially introduced our Arthroscopic Surgery System in December 1995, and have derived a significant portion of our sales from this system. Through December 31, 2002, we had shipped more than 16,300 controller units and more than 2,000,000 disposable devices for a variety of indications. We are marketing and selling our arthroscopic, ENT, cosmetic surgery and spinal surgery products in the United States through a

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network of direct sales representatives and independent distributors supported by regional managers. We have more than 70 distributors representing more than 400 field sales representatives in the United States. We have also established distribution capability in Europe, Australia, New Zealand, China, Korea, Japan, Taiwan, Canada, Mexico, the Caribbean, North Africa, the Middle East, and Central America. We have entered into a strategic relationship with the GyneCare division of Ethicon, Inc. to commercialize Coblation-based products for laparoscopic and open surgical procedures for gynecological applications. We have also entered into a strategic relationship with ACMI, under which ACMI will market and sell our products for urologic indications, including transurethral resection of the prostate (TURP).

The following is a list of our Coblation-based disposable devices as of December 31, 2002:

Product Families	Date of Introduction	Current # of models
Ablative Probes
90 degree	August 1995	3
TurboDome™	July 1996	3
TurboBevel™	December 1996	3
Small Joint	December 1997	3
Eliminator™	June 1998	1
Saber™	June 1998	2
LoPro™	April 1998	1
Microblator™	December 1999	1
Coblade™	May 2000	1
ACD50	April 2001	1
TOPAZ™	June 2002	2
Straight Saber	December 2002	1
Razor 2.5	September 2002	1
Suction Wands
CoVac™	June 1998	3
TurboVac™ / RazorVac / DiamondVac™	December 1998	3
MultiVac™	February 2000	3
Titan™	September 2000	1
Tristar™	September 2000	1
Shrinkage Wands
CAPSX™	April 1998	2
CAPSure™ also CAPSure 30	June 1999	1
MicroCAP	August 2000	1
Spinal and Neuro Surgery
ACCESS™ SpineWand™	September 1999	1
Aggressor™	June 2000	1
DisCoblator™	September 1999	2
Perc-DLE™	March 2001	1
SpineVac™	June 2000	1
VersiTor™	May 2000	1
Perc DC	November 2002	1
Cosmetic Surgery
Soft Touch™ Wand	June 1998	2
MicroElectro Dissector	December 1998	1
MicroTouch™ Wand	December 1999	1
Plasma Scalpel	September 1999	1

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Product Families	Date of Introduction	Current # of models
ENT Surgery
Hummingbird™	March 1999	1
Plasma Scalpel™	November 1998	3
Plasma Hook	April 2001	1
Evac 70™	January, 2001	2
Reflex Ultra 45 & 55	January 2002	1
General Surgery
Plasma Scalpel GS	September 1999	1
TurboVac GS	November 1999	2
Versitor/Aggressor	May 2000	2
Plasma Hook/Blade	March 2001	3
Plasma Dissector	December 2001	2

For information regarding the status of our regulatory approvals for our products, see the information under the heading “Government Regulation.”

ArthroCare was incorporated in California in 1993 and reincorporated in Delaware in 1995. We maintain an Internet website at www.arthrocare.com. On our website we make available, free of charge, the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act of 1934. You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our reports, proxy statements, and other documents filed electronically with the SEC are available at the website maintained by the SEC at http://www.sec.gov.

ArthroCare Strategy

Our objective is to leverage our patented Coblation technology to design, develop, manufacture and sell innovative, clinically superior surgical devices for the surgical treatment of soft-tissue conditions throughout the body. The key elements of our strategy include:

• Expand our product offering to address large and rapidly growing markets.    We are continuously expanding our portfolio of products and enhancing our existing products to serve the needs of physicians. For example, we have increased our penetration of arthroscopy procedures in the knee through the addition of disposable devices with suction capability.

• Replace current technology with Coblation technology.    Coblation technology offers a variety of options for physicians performing soft-tissue surgery. Currently, our systems are being used to perform many types of arthroscopic, cosmetic, ENT, spinal, neurosurgery and general surgery procedures which were traditionally performed by mechanical, electrosurgical or laser surgery tools. In fact, soft tissue anywhere in the body potentially can be treated with and benefit from our technology.

• Focus on disposable device sales.    We have utilized an aggressive promotional product placement program in order for our controllers to reside in hospitals throughout the world. Once a controller is placed within an institution it may be utilized by a variety of physicians who focus on different medical specialties. The same controller may be used to perform arthroscopic, ENT, spinal, cosmetic, neurosurgery or general surgery.

• Layer growth opportunities.    We have established an extensive distributor network, supported by our regional managers, in selected markets. We have been executing a global distribution strategy in which

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we have been expanding our direct sales presence in arthroscopy, spinal surgery and ENT markets. We have signed agreements with several marketing partners to assist with regulatory requirements and to market and distribute our products internationally. In addition, in October and November 2002 we acquired two of our European Distributors, Atlantech Medical Devices Ltd in the UK and Atlantech GmbH in Germany, providing us with an immediate direct sales force in two key European Markets.

• Establish strategic partnerships to commercialize our Coblation technology.    Our gynecology and urology products are being commercialized through strategic partnerships with GyneCare and ACMI, respectively.

Coblation Technology

Our products are based on our patented soft-tissue surgical controlled ablation technology, which we call Coblation technology. Coblation technology involves an innovative use of, and the capability of performing at, temperatures lower than traditional electrosurgical tools.

Traditional electrosurgical tools use heat to burn away targeted tissue, which often results in thermal damage to tissue surrounding the surgical area. Additionally, the lack of tactile feedback with these devices makes it difficult for surgeons to control the depth of tissue penetration. Coblation technology employs a highly targeted, non-thermal process that minimizes the risk of thermal burn to surrounding tissue while increasing the surgeon’s control and precision.

Coblation technology uses an electrically conductive fluid in the gap between the electrode and tissue. When electrical current is applied to this fluid, it creates a charged layer of particles, or plasma field. As this plasma field comes into contact with the targeted tissue, the molecular bonds within the cells of the targeted tissue are broken. This process causes the cells to disintegrate cell layer by cell layer, so that tissue is volumetrically removed. Because this effect is confined to the surface layer of the targeted tissue, minimal damage occurs to surrounding tissue, potentially resulting in reduced pain and faster recovery for the patient. An additional advantage is that Coblation can be performed in a continuous mode, resulting in efficient tissue ablation thereby reducing the overall procedure time as compared to conventional methods. In addition to achieving more precise tissue ablation or shrinkage and less damage to surrounding tissue, surgical devices based on Coblation technology can seal bleeding vessels near the surgical site.

We believe Coblation technology is applicable to soft-tissue surgery throughout the body, and we have expanded its use into several non-arthroscopic indications. In addition, we are exploring possibilities for the use of Coblation technology in other markets, such as laparoscopic general surgery and cardiac surgery

We commercially introduced our soft-tissue surgery system in December 1995 through what we call today our Arthroscopy business unit. Since our arthroscopic soft-tissue surgery system accounts for a significant portion of our product sales, we are highly dependent on its sales. Our ArthroCare Spine, ArthroCare ENT and Coblation Technologies business units to date, have sold a relatively smaller number of units compared to the unit sales in our Arthroscopy business unit. We cannot assure you that we will be able to continue to manufacture our 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 controller units at substantial discounts in order to stimulate demand for our disposable devices.

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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 surgical systems. We believe that continued recommendations and endorsements by influential surgeons are essential for market acceptance of our surgical systems. If our Coblation technology does not continue to receive endorsement by influential surgeons or long-term data does not support the effectiveness of our surgical systems, our business, financial condition, results of operations and future growth prospects will be materially adversely affected.

The Arthroscopy Market

In 2002, approximately 4.2 million arthroscopic procedures were performed worldwide. Due to patient demand for less invasive procedures, we believe the number of arthroscopic procedures is growing. In addition, a greater emphasis on physical fitness and an aging population are increasing the incidence of joint and soft tissue injuries. Joints are susceptible to injuries from blows, falls or twisting, as well as from natural degeneration and stiffening associated with aging.

Historically, joint injuries have been treated using open surgery involving large incisions, a hospital stay and a prolonged recovery period. In contrast, arthroscopic surgery, which was introduced in the early 1980’s, is performed through several small incisions called portals and can be performed on an outpatient basis. We believe that arthroscopic surgery has gained wide market acceptance because it offers shorter hospital stays and reduced recovery time, resulting in reduced costs and improved medical outcomes. Arthroscopic surgery performed on elite athletes often results in rapid returns to action. Publicity concerning these athletes increases the demand for less invasive surgical options by the general public.

To perform arthroscopic surgery, a surgeon uses a tool to view the site and other tools to perform the surgery. The tool used to view the site, called and arthroscope, is a small fiber-optic viewing instrument made up of a small lens, a light source and a video camera. During the arthroscopic procedure, an irrigant such as saline is flushed through the joint to permit clear visualization through the arthroscope and to create the space within the joint for the surgical procedure. The surgeon inserts the arthroscope into the joint through a portal measuring approximately six millimeters, or ¼ of an inch, in length. Other portals are used for the insertion of surgical instruments to perform the surgery and to facilitate the flow of irrigants. With small incision sites and direct access to most areas of the joint, a surgeon can diagnose and correct an array of joint problems such as cartilage and meniscus tears, ligament tears and removal of loose and degenerative tissue.

The advantages of arthroscopic surgery over open surgery are often significant. Due to the smaller incisions and reduced surgical trauma, the patient might experience several benefits including reduced pain, treatment on an outpatient basis, reduced hospitalization times, smaller scars, immediate joint mobility and less muscle atrophy, less surrounding tissue damage, lower rate of complications, and generally quicker rehabilitation. In addition, treatment on an outpatient basis and reduced operating time can significantly lower hospital costs.

Knee

The knee is the most commonly injured joint. In 2002, we estimate that knee injuries accounted for approximately 2.6 million arthroscopic procedures worldwide. Damage to a meniscus, a disc of fibrous tissue that helps cushion the knee joint, is the most common form of knee injury. A meniscus can be torn by a twist of the leg when the knee is flexed, displaced either inward toward the center of the shin bone or outward beyond the surface of the thighbone, or worn down by normal aging. The knee is also susceptible to partial or complete tears of the ligaments and degeneration of the cartilage on the underside of the kneecap. In addition, the cartilage covering the bony surfaces of the knee can become rough or tear loose from the bone as a result of age or injury, causing pain and interfering with smooth joint movement.

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Shoulder

The shoulder joint, because of its range of motion, is susceptible to a number of injuries. In 2002, approximately 1.1 million arthroscopic procedures in the shoulder were performed in the world. We believe that shoulder arthroscopy is the fastest-growing portion of the arthroscopy market. With repetitive motion and lifting of the arm, such as that which occurs during a tennis serve, a bone formation of the upper arm may pinch one of the shoulder muscles and cause persistent pain, known as rotator cuff injury. Strengthening exercises and physiotherapy can treat this condition; however, many rotator cuff injuries require surgical intervention. We believe that a significant percentage of the population is born with a susceptibility to rotator cuff injuries.

Elbow, Ankle, Wrist and Hip

The elbow, ankle, wrist and hip joints are also susceptible to certain stress-related injuries and deterioration due to aging. In 2002, approximately 550,000 arthroscopic procedures were performed in the elbow, ankle, wrist or hip in the world. We believe that the current number of surgical procedures in the elbow, ankle, wrist and hip is relatively small due to the limitations of conventional arthroscopic surgical equipment.

Non-Traumatic Soft Tissue Injuries

It is estimated that nearly 15 million Americans suffer from injuries called tendonopathies, or tendonosis, which is a chronic pain associated with degeneration of tendons commonly used in everyday activity. Runners’ knee, tennis and golfers’ elbow, jumpers’ knee, and heel spurs are but a few of the conditions limiting the lifestyles of normal daily activities without pain. Currently, the few options for these chronic conditions include rest, rehabilitation, bracing, and steroid injections. Surgical options have until now been equally limited to surgical release procedures, grafts, and surgical debridement, each with a significant recovery period.

Conventional Arthroscopic Treatment Methodologies: The Problem

Most arthroscopic procedures require the surgeon to probe, cut, sculpt and shape tissue and seal bleeding vessels to achieve satisfactory results. Surgeons frequently use a combination of instruments when performing an arthroscopic procedure because each instrument is designed to perform a specific function. Use of an assortment of tools requires the surgeon to insert and remove each of the tools from the portals several times during the same procedure.

Surgical procedures can employ one or more of four groups of surgical instruments: (1) power or motorized instruments, such as cartilage and bone shavers; (2) mechanical instruments, such as basket punches, graspers and scissors; (3) electrosurgical systems; or (4) laser systems.

Power instruments are generally used to smooth tissue and cartilage defects on the surface of the bones of the joint. The damaged tissue is removed form the joint using suction thorough a tube surrounding the shaft of the tool, which can become obstructed by bits of tissue and bone. Power shavers have rotating cutters inside a tube and are available in a number of tip angles or sizes for the precise shaving of tissue. Mechanical instruments must be resharpened at regular intervals and sterilized after each procedure.

Conventional electrosurgical systems are used to seal blood vessels, which is necessary to minimize bleeding and maximize the arthroscopic surgeon’s visibility of the procedure through the arthroscope. Conventional electrosurgical systems contain two electrodes: the electrode tip held by the surgeon and a dispersive pad that rests under the patient’s body. The metal electrode tip of the instrument, which resembles a pencil point, is placed on or near the bleeding vessel to be sealed. A generator connected to the electrode delivers high-frequency voltage that arcs between the electrode and the target tissue, sealing blood vessels in its vicinity. After arcing, the current travels through the remaining tissue of the patient’s body, through the skin to the dispersive electrode pad, before being directed back to the generator.

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Laser systems are used to remove tissue while sealing bleeding vessels. Because laser systems are not tactile tools, the surgeon cannot feel how much tissue is being ablated. The surgeon must be extensively trained to precisely position the laser to control the depth of tissue penetration to minimize unintended tissue damage. In addition, the temperature of the laser instrument is high and, as a result, can cause damage to surrounding tissue and vascular areas. We believe that laser tools have not received wide acceptance because of high capital cost and significant ongoing maintenance and operating expenses, as well as the concern about damage that may be caused by the significant heat generated by these devices.

The ArthroCare Arthroscopic System: A Solution

Our Arthroscopic System is a radio frequency surgical device intended to perform tissue ablation, resection as well as sealing bleeding vessels. Our Arthroscopic System is comprised of an assortment of disposable bipolar multi-electrode and single electrode devices, a connecting cable, foot pedal or handswitch and a radio frequency controller. We sell our Arthroscopic System for use in all six major joints: knee, shoulder, elbow, ankle, wrist and hip. Many types of tissue, including cartilage and ligaments, can be ablated using our Arthroscopic System.

Our controller delivers radio frequency energy to the disposable device. Surgeons can use the disposable device for ablation, resection, and coagulation of soft tissue and to seal bleeding vessels. The surgeon can control the mode of operation and power setting with the foot pedal or keys on the front panel of the controller. The incorporation of ablation, suction and fluid management into a single disposable device potentially reduces operating time and expense.

A surgeon using the Arthroscopic System does not need to remove and insert a variety of instruments to perform different tasks as is required when using conventional arthroscopic instruments. Our disposable devices are approved for sale in tip sizes ranging from 1.5 mm to 4.5 mm, and in tip angles ranging from zero to 90 degrees. We currently sell 32 models for arthroscopy in various tip sizes, angles and shapes, enabling the surgeon to ablate different volumes of tissue and to reach treatment sites not readily accessible by existing mechanical instruments and motorized cutting tools. In addition, some of our disposable devices provide suction capability.

We commercially introduced the Arthroscopic System in December 1995. The list price of the controller, including the cable, is approximately $7,500. The disposable devices have list prices ranging from approximately $151 to $270, and typically one disposable device is used per procedure. We are marketing and selling our Arthroscopic System worldwide through a network of direct sales representatives and independent orthopedic distributors supported by regional managers. We have continually increased our manufacturing capabilities while maintaining yields.

The Spinal Surgery Market

We believe spinal surgery had an estimated market size in 2002 of more than $1.8 billion, or 1.6 million procedures worldwide and is the most rapidly growing segment of the orthopedic surgery market, increasing in excess of 20% annually. Chronic back pain afflicts approximately five million people in the U.S. and is the number one cause of healthcare expenditures. Chronic back pain is estimated to cost the nation more than $50 billion per year in direct and indirect medical expenses. Approximately one-half of those afflicted suffer from disabling pain. Chronic back pain is the most common reason for disability for persons under age 50 and is the second leading cause of workers’ absenteeism. The major causes of persistent, often disabling, back pain are disruption of a portion of the disc, chronic inflammation of the disc, also known as herniation, or relative instability of the vertebral bodies surrounding a given disc, such as the instability that often occurs due to a degenerative disease. Intervertebral discs mainly function to cushion and tether the vertebrae, providing flexibility and stability to the patient’s spine. As discs degenerate, they lose their water content and height, bringing the adjoining vertebrae closer together. This results in a weakening of the shock absorption properties of the disc and a narrowing of the nerve openings in the sides of the spine which may pinch these nerves. This disc degeneration can eventually cause back and leg pain.

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Often, inflammation from disc herniation can be treated successfully by non-surgical means, such as rest, therapeutic exercise, or through the use of anti-inflammatory medications. In some cases, the disc tissue is irreparably damaged, thereby necessitating a discectomy, the removal of a portion of the disc or the entire disc to eliminate the source of inflammation and pressure. In more severe cases, the adjacent vertebral bodies must be stabilized following excision of the disc material to avoid recurrence of the disabling back pain. One approach to stabilizing the vertebrae, termed spinal fusion, is to insert an interbody graft or implant into the space vacated by the degenerative disc. In this procedure, a small amount of bone may be grafted from other portions of the body, such as the hip, and packed into the implants. This allows the bone to grow through and around the implant, fusing the vertebral bodies and alleviating the pain.

Another surgical treatment for degenerative disc disease, termed laminectomy, involves cutting away the lamina, the bony plate that connects the bony ridges of the spine, known as pedicles. This allows the nerve tissue to shift position to release pressure.

Until recently, spinal discectomy, laminectomy and fusion procedures resulted in major operations and traumatic dissection of muscle and bone removal or bone fusion. The open surgical procedures are invasive and typically require a team of surgeons due to the length and complexity of the procedure. Recovery time is also lengthy. To overcome the disadvantages of traditional traumatic spinal surgery, minimally invasive spinal surgery was developed. In minimally invasive spinal procedures, the spinal canal is not penetrated and therefore bleeding with ensuing scarring is minimized or completely avoided. In addition, the risk of instability from ligament and bone removal is generally lower in minimally invasive procedures than with open discectomy. Further, less trauma during surgery often results in rapid rehabilitation and fast recovery.

Conventional Treatment Methodologies for Treatment of Spine Diseases and Disorders: The Problem

Techniques for the treatment of spinal diseases and disorders include laser and mechanical techniques. These procedures can be “open” or minimally invasive depending on the complexity, and generally require the surgeon to form a passage or operating corridor from the skin of the patient to the spinal disc(s) for passage of surgical instruments and implants. Typically, the formation of this operating corridor requires the removal of soft tissue, muscle or other types of tissue. This tissue is usually removed with mechanical or powered instruments, such as graspers, cutters and drills. Multiple mechanical and powered instruments must be used and are time-intensive. In addition, these instruments sever blood vessels within this tissue, often causing profuse bleeding that obstructs the surgeon’s view of the target site.

Once the operating corridor is established, the nerve root is retracted and a portion of the disc is removed with mechanical or powered instruments. These instruments are typically slow and tedious, and can require up to 40 minutes to remove a single disc. In addition, these instruments, particularly powered instruments, are not extremely precise, and it is often difficult during the procedure to differentiate between the target disc tissue and other structures within the spine, such as bone, cartilage, ligaments, nerves and surrounding tissue. Thus, the surgeon must be extremely careful to minimize damage to the cartilage and bone within the spine, and to avoid damaging nerves.

Both lasers and monopolar radio frequency devices have been used in spinal surgery. We believe both have significant drawbacks. Lasers are expensive and tedious to use. Another disadvantage of lasers is the difficulty in judging the depth of tissue ablation. Because healthy tissue, bones, ligaments and nerves often lie within close proximity of the spinal disc, it is essential to maintain a minimum depth of tissue penetration. Monopolar radio frequency devices increase the risk of unwanted electrical stimulation to portions of the patient’s body by utilizing electric current that disperses into the patient’s body.

The Arthrocare Spinal Surgery System: A Solution

In September 1999, we announced our expansion into the spinal surgery market. Our Spinal Surgery System is CE marked. We have received 510(k) clearance for use of the system in spinal and neurosurgery procedures in

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the United States. Our spinal surgery products, based on our Coblation technology, include multi-functional disposable devices optimized for spinal surgery. The disposable products are compatible with the controller that is used for arthroscopic, ENT and general surgery procedures.

Our controller is used to deliver radio frequency energy to the disposable devices. The disposable devices are intended for single use and utilize multiple or single electrodes to ablate tissue and seal bleeding vessels. In some cases, our disposable devices may also include one or more tubes for the delivery of electrically conductive fluid to the target site and/or for suction capability. The incorporation of ablation, suction and fluid management into a single disposable device potentially reduces operating time and expense. Although we have had limited clinical experience with these products in spinal surgery procedures, we believe physician and patient benefits experienced in arthroscopic surgery, such as more rapid recovery time, reduced thermal injury to tissue and reduced post-operative pain when compared to existing techniques, could also apply to spinal surgery procedures.

Our disposable devices consist of the ACCESS SpineWand, VersiTor, Aggressor, SpineVac, Perc-D, Perc-DL and the DisCoblator. The ACCESS SpineWand is a bipolar electrosurgical device designed for controlled ablation of soft tissue. We believe that the ACCESS SpineWand is an effective tool for creating precise incisions through connective tissue to provide access to the disc in spinal procedures.

The DisCoblator is a bipolar electrosurgical device designed for aggressive removal of large tissue volumes. The DisCoblator includes fluid delivery and suction capabilities and incorporates an active screen electrode design to inhibit clogging. We have marketed the DisCoblator to volumetrically remove a portion or all of the disc during the procedures. The DisCoblator is capable of removing a disc in less time than mechanical instruments, such as graspers or cutters.

During fiscal year 2001, we introduced the Perc-DLE Convenience Pack for volumetric tissue removal in the nucleus of the disc. Nucleoplasty^®, a minimally invasive percutaneous discectomy procedure utilizing our Coblation technology, to treat symptomatic patients with contained herniated discs through the process of ablation and coagulation of soft tissue, combines both approaches for partial removal of the nucleus of a disc. Coblation ablates tissue via a low-temperature, molecular dissociation process to create small channels within the disc. On withdrawal, the channels are thermally treated producing a zone of thermal-coagulation further shrinking and stiffening the disc. Late in 2002 we introduced the Perc-DC, a surgical wand very similar to the Perc-D, but designed so it can be used to perform a Nucleoplasty procedure in the cervical portion of the spine.

The Neurosurgery Market

Approximately 250,000 surgical procedures are performed in the brain each year, and more than 110,000 metastatic brain tumors are diagnosed annually in the United States. According to the American Cancer Society, brain tumors are the second fastest growing cause of cancer death among people over age 65 and are one of the most common types of cancer found in children. In addition, brain trauma affects another 1.5 million people each year in the United States.

Conventional Treatment Methodologies for Treatment of Neurological Diseases: The Problem

Neuro surgery, radiation, and chemotherapy are the three most common treatments used individually or in combination, for brain tumors. While surgery is the preferred method of treatment, it is not always practical given difficult or impossible access to the tumor. Coblation therapy can allow minimally invasive access to the tumor and allow the physician to quickly remove solid tissue with minimal thermal injury.

The Arthrocare Neurosurgery System: A Solution

In February 2000, we announced that we were expanding our marketing efforts for our Spinal Surgery System to specifically address selected applications in neurosurgery. Our Spinal Surgery System is CE marked in

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Europe, and we have received 510(k) clearance for the use of this system in neurosurgery procedures in the United States. Our spinal surgery and neurosurgery products, based on our Coblation technology, include multi-functional disposable devices optimized for spinal and neurosurgery. The disposable products are compatible with the controller that is used for arthroscopic, ENT and general surgery procedures.

Our controller is used to deliver radio frequency energy to the disposable devices. The disposable devices are intended for single use and utilize multiple or single electrodes to ablate tissue and seal bleeding vessels. In some cases, our disposable devices may also include one or more tubes for the delivery of electrically conductive fluid to the target site and/or for suction capability. The incorporation of ablation, suction and fluid management into a single disposable device potentially reduces operating time and expense. Although we have had limited clinical experience with these products in neurosurgery procedures, we believe physician and patient benefits experienced in arthroscopic surgery, such as more rapid recovery time, reduced thermal injury to tissue when compared to existing techniques, could also apply to neurosurgery procedures.

The Ear, Nose and Throat (ENT) Market

We believe that in 2002, approximately 6 million ENT procedures were performed worldwide. The most common procedures are placement of ear tubes and the removal of tonsils and adenoids. We estimate that there are approximately 2 million tonsillectomies performed worldwide each year. Other commonly performed ENT procedures include endoscopic sinus surgery, septoplasty, turbinate reduction and procedures to remove or stiffen tissue to treat obstructive sleep apnea and snoring. These procedures are performed by highly specialized ear, nose and throat surgeons typically in an outpatient or ambulatory surgery center. For decades, monopolar electrosurgical instruments (e.g. bovie) have been the standard for removal of soft tissue and cauterization in ENT procedures. As in other surgical procedures, the high levels of heat associated with bovies often results in significant post-operative pain and extended recovery periods.

The Arthrocare ENT Surgery System

Our ENT Surgery System uses the same technology as the Arthroscopic System, which removes soft tissue through a more precise and significantly cooler process than that of traditional electrosurgery devices. Our controller is used to deliver radio frequency energy to the disposable devices. The disposable devices are intended for single use and utilize multiple or single electrodes. We have three categories of wands to address the ENT Market. Suction wands simultaneously ablate and remove tissue in applications such as tonsillectomy, providing enhanced visibility. Channeling wands combine controlled ablation and effective coagulative lesion formation in applications such as turbinate reduction to relieve nasal obstruction and stiffening of the soft palate for the treatment of snoring. Excision wands provide precise dissection of soft tissue with minimal damage to surrounding tissue. Coblation devices have been used in over 50,000 tonsillectomy and/or adenoidectomy procedures to date. Published clinical data and anecdotal surgeon feedback indicate that Coblation-assisted tonsillectomy provides a better overall post-operative experience for patients including less pain, a faster return to normal diet and activity and less need for prescription medications. Coblation devices have also been used in over 100,000 turbinate reduction and snoring procedures with the primary benefits versus competitive methods being faster lesion formation and fewer and less severe post-operative morbidity.

Our ENT Surgery System is CE marked, and we have received 510(k) clearances in the United States for use of the system in general head, neck and oral surgical procedures, including sinus surgery, the treatment of snoring, reduction of nasal turbinates, adenoidectomy and tonsillectomy. We have been marketing the ENT products through a network of direct sales representatives and independent distributors supported by sales managers since February 1999.

The Cosmetic Surgery Market

The cosmetic surgery market primarily consists of three segments: invasive surgical procedures that remove or alter body structures such as rhytidectomy (face lift), rhinoplasty (nose restructuring), blepheroplasty (eye lift)

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and liposuction; resurfacing procedures that reduce wrinkles and even out skin tone such as laser resurfacing and chemical peels and non- or less invasive cosmetic procedures such as botulinum toxin, collagen injections, and microdermabrasion. Of the total procedures, approximately 2 million were invasive surgical procedures, approximately 2 million were resurfacing procedures and 5 million were non- or less-invasive cosmetic procedures.

Conventional Treatment Techniques for Resurfacing: The Problem

Conventional treatments for skin resurfacing include chemical peels, dermabrasion and laser resurfacing. In chemical peels, an acid-based solution is used to improve the texture of the skin and reduce wrinkles by removing its damaged outer layers. Light chemical peels can improve texture but do not address wrinkles. Deeper chemical peels can reduce wrinkles but often produce uneven results and hypopigmentation (loss of color). In dermabrasion a mechanical device is used to remove the damaged outer layers of the skin. While dermabrasion has fallen out of favor in the majority of practices, laser resurfacing remains the most popular resurfacing procedure for the treatment of wrinkles. In particular, the carbon dioxide, or CO₂, laser is considered the gold standard for efficacy in the treatment of wrinkles. However, the excessive heat diffusion into surrounding healthy skin cells during the procedure results in an unacceptably long recovery period and a significant level of side effects such as hypopigmentation and scarring.

The Visage Coblation Cosmetic Surgery System: A Solution

Our Cosmetic Surgery System utilizes the same technology as the Arthroscopic System and removes skin cells through a more precise and significantly cooler process than traditional electrosurgery systems or dermatologic lasers. Our cosmetic Surgery System is a bipolar radio frequency, electrosurgical device used in skin resurfacing and other dermatologic and cosmetic procedures. Our Cosmetic Surgery System incorporates a bipolar disposable device, a connecting resterilizable headpiece with cable and a radio frequency controller which differs from the controllers used in arthroscopy, ENT surgery and spinal surgery. The controller delivers radio frequency energy to multi-electrode or single electrode disposable devices. Our Cosmetic Surgery System has been cleared by the FDA for skin resurfacing for treatment of wrinkles as well as for general dermatologic procedures. We believe our Cosmetic Surgery System, when used for skin resurfacing, results in more rapid recovery than seen with CO₂ laser systems.

The General Surgery, Cardiology, Urology and Gynecology Markets

We have established a new division, Coblation Technologies, to develop and manufacture products as an OEM supplier of Coblation based surgical instruments to companies in general surgery, cardiology, urology and gynecology, markets. In gynecology, we have entered into a strategic relationship with the GyneCare, division of Ethicon, Inc., to commercialize coblation based products for laparoscopic and open surgical procedures. In urology, we have entered into a strategic relationship with ACMI under which ACMI will market and sell our products for urologic indications, including transurethral resection of the prostate (TURP).

Benefits of Our Coblation Technology

Our patented Coblation technology, delivered in the form of multi-electrode and single electrode, bipolar disposable devices, offers a number of benefits that we believe may provide advantages over competing surgical methods and devices. The principal benefits include:

• Ease of use.    Our Coblation-based soft-tissue surgery systems perform many of the functions of mechanical tools, power tools and electrosurgery instruments, allowing the surgeon to use a single instrument. The lightweight device is simple to use and complements the surgeon’s existing tactile skills without the need for extensive training.

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• Precision.    In contrast to conventional tools, our Coblation-based soft-tissue surgery systems permit surgeons to perform more precise tissue ablation and sculpting. We believe this may result in more rapid patient rehabilitation.

• Benefits to patients.    Coblation technology operates at cooler temperatures than traditional electrosurgical tools. This can lead to significant benefits for patients treated with Coblation-based disposable devices due to the minimal amount of thermal injury to surrounding tissue. As a result, we believe that patients are likely to experience less trauma and pain following surgery and may recover more quickly.

• Ablation and sealing of bleeding vessels.    Our Coblation-based soft-tissue surgery systems allow for the efficient sealing of small bleeding vessels without changing tools.

• Cost reduction.    Our Coblation soft-tissue surgery systems eliminate the need to introduce multiple instruments to remove and sculpt tissue and seal bleeding vessels. We believe this may reduce operating time and thereby produce cost savings for health care providers.

Dependence upon Collaborative Arrangements

GyneCare.    We have entered into a strategic relationship with the GyneCare division of Ethicon, Inc. to commercialize Coblation-based products for laparoscopic and open surgical procedures for gynecological applications.

ACMI.    We have also entered into a strategic relationship with ACMI, under which ACMI will market and sell our products for urologic indications, including transurethral resection of the prostate (TURP).

Research and Development

We have focused our research and development efforts in three areas. First, in response to physician feedback, we are continually working on enhancements to designs of our products to provide greater versatility in existing features and functions. Second, we continue to design new disposable devices that incorporate added functionalities. Third, we are exploring new applications of our Coblation technology in other soft-tissue surgical markets. We have undertaken preliminary studies and development for the use of our technology in several fields. Research and development expenses were $8.8 million in 2002, $8.0 million in 2001 and $7.1 million in 2000. Finally, we continue to explore and develop the plasma physics underlying Coblation technology. To this end we are engaged with a number of doctors, scientists and research institutions to further understand the technology and develop additional applications and other technical improvements.

Manufacturing

Our disposable devices and controllers are currently manufactured in a portion of our 52,000 square foot facility in Sunnyvale, California. This facility was acquired through a 5-year lease agreement in September 2001 and became fully operational for our clean room manufacturing operations in January 2002. ArthroCare has also purchased a 23,000 square foot facility in a tax-free industrial park in Costa Rica for the purpose of manufacturing and packaging additional disposable devices. This new facility will displace production which had been outsourced to sources in Mexico and will enable continued unit sales growth for the company. The Costa Rican operation is fully functional and was producing approximately 65% of the company’s production requirements by year end. We believe that our Sunnyvale and Costa Rican operations will provide adequate capacity for our manufacturing needs through 2005.

Our products are manufactured from several components, most of which are supplied to us from third parties. Most of the components that we use in the manufacture of our products are available from more than one qualified supplier. For some components, however, there are relatively few alternative sources of supply and the

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establishment of additional or replacement suppliers may not be accomplished quickly. With respect to a few components, we rely upon single source suppliers. For example, two single source suppliers provide us with components used in substantially all of our disposable devices. We also use a single subcontractor to sterilize our disposable devices, but do not believe a major disruption is likely because the supplier has multiple sterilization facilities throughout the United States as well as internationally. See “Additional Factors that Might Affect Future Results—We Have Limited Manufacturing Experience” for additional information regarding the potential disruption in supply of our products and risks to our operations resulting from our reliance upon single source suppliers.

We manufacture several different controller models for which the manufacturing process is substantially the same.

We currently manufacture over 65 different versions of disposable devices. Due to the various attributes of our disposable devices, which include, among other functions, fluid management and suction, the manufacturing process is varied. In order to improve yields and product cost, we operate under a continuous improvement process.

We have established quality assurance systems in conformance with the FDA’s Quality System Regulation, or QSR. Our facility in Sunnyvale has received ISO 9001/EN 46001 certification and is in conformance with the Medical Device Directive, or MDD, for the sale of products in Europe.

The company has an agreement with a logistics company in Sweden that provides for the warehousing, shipping and trackability of its products sold to customers throughout Europe, Asia, the Middle East and South America and is currently embarked on a major operational effort to partner with a third party logistics provider to optimize the cost and effectiveness of the company’s global logistics and inventory management functions.

Marketing and Sales

We have shipped more than 16,300 controller units and over 2,000,000 disposable devices, through December 31, 2002 for a variety of indications. We use a combination of distributors supported by regional sales mangers, a direct sales force and corporate partners to sell our products both domestically and internationally. Domestically, we have more than 70 distributors representing more than 400 field sales representatives in the United States. In Europe we accelerated our strategy to move to a direct sales organization, by acquiring Atlantech Medical Devices, our distributor in the United Kingdom, in October 2002, and Atlantech GmbH, ArthroCare’s German distributor, in November 2002. This has provided us with an immediate direct sales force in two key European markets. Upon the completion of these transactions ArthroCare had 51 employees in Europe, 35 of these involved in sales and marketing.

In the rest of the world, we have established distribution capability in certain countries by means of exclusive and non-exclusive distribution agreements with corporations, including Kobayashi Pharmaceutical for the distribution of our arthroscopy, spinal surgery and ENT surgery products in Japan. We have also established distribution capability through relationships with distributors in arthroscopy products in Europe, South Africa, South and Central America and Russia. For information regarding product sales in certain market segments and geographic areas, see Note 14, “Segment Information,” in the Notes to Consolidated Financial Statements in this Form 10-K.

GyneCare, a division of Ethicon, Inc. is our worldwide distributor for gynecology and ACMI is our worldwide distributor for urology.

We believe the use of our products is generally intuitive to surgeons and does not require extensive training. We frequently conduct training seminars and demonstrations at regional training centers and trade shows. Our partners also conduct training activities in their areas of responsibility.

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At hospitals and surgical centers where several procedures can be performed simultaneously, the procurement of multiple controllers is required. We have offered our controllers at substantial discounts in the past and may be required to continue to offer such discounts to generate demand for our disposable devices. In addition, motorized and mechanical instruments, lasers and electro surgery systems currently used by hospitals, surgical centers and private physicians have become widely accepted. If physicians do not determine that our soft-tissue surgery systems are an attractive alternative to conventional means, our business would be materially adversely affected.

Patents and Proprietary Rights

Our ability to compete effectively depends in part on developing and maintaining the proprietary aspects of our Coblation technology. We own over 70 issued U.S. Patents and over 20 issued international patents. In addition, we have over 100 U.S. and international pending patent applications. We believe that our issued patents are directed at the core technology used in our soft-tissue surgery systems, included both multi-electrode and single electrode configurations of our disposable devices, as well as the use of Coblation technology in specific surgical procedures. The issued patents are directed at, among other things, the following:

• Systems and methods for applying radio frequency energy to tissue in the presence of electrically conductive fluid such as isotonic saline;

• Disposable devices having an electrode array and a system designed to supply current independently to individual electrodes; and

• Systems and methods for employing radio frequency energy in urology, gynecology, ENT, spine surgery, cosmetic surgery, skin resurfacing, neurosurgery and cardiac procedures.

The pending patent applications include coverage for the fundamental tissue ablation and cutting technology as well as methods and apparatus for specific procedures.

We cannot assure you that the patents we have obtained, or any patents that we may obtain as a result of our U.S. or international patent applications, will provide any competitive advantages for our products or that they will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of whom have substantial resources and have made substantial investments in competing technologies, 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.

A number of 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. 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 application and issued patents and, in some cases, have obtained internal and/ or external opinions of our 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 cannot assure you that we would be able to obtain licenses to those patents at a reasonable cost, if at all, or be able to develop or obtain alternative technology. The inability to do either would have a material adverse effect on our business, financial condition, results of operations and future growth prospects. We cannot assure you that we will not have to defend ourselves in court against allegations of infringement.

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 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

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individual by us 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 the 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.

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. We cannot assure you that we will not become subject to patent infringement claims or litigation or interference proceedings declared by the United States Patent and Trademark office, or USPTO, to determine the priority of inventions. In July 2000, we filed a lawsuit against Smith & Nephew alleging infringement of several of our patents. This lawsuit is pending and a jury trial is scheduled to commence in April 2003. The defense and prosecution of this lawsuit and intellectual property suits generally, USPTO interference proceedings and related legal and administrative proceedings are both costly and time-consuming. We believe that this lawsuit was necessary, and if others violate our proprietary rights, further litigation may be necessary to enforce our patents, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings will be costly and cause significant diversion of effort by our technical and management personnel. An adverse determination, other litigation or interference proceedings to which we may become a party could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease using such technology. Furthermore, we cannot be sure that we could obtain necessary licenses on satisfactory licenses on satisfactory terms, if at all. Adverse determinations in judicial or administrative proceedings or failure to obtain necessary licenses could prevent us from manufacturing and selling our products, which would have a material adverse effect on our business, financial condition, results of operations, and future growth prospects.

Competition

We believe that the principal competitive factors in soft-tissue surgery markets include:

• Acceptance by leading physicians;

• Improved patient outcomes;

• Superior product quality;

• The publication of peer-reviewed clinical studies;

• Product innovation;

• Sales and marketing capability; and

• Strong intellectual property.

Arthroscopy

In arthroscopic procedure, we compete directly with the providers of tissue removal systems, including conventional electrosurgical systems, manual instruments, power shavers and laser systems. Smith & Nephew Endoscopy (which owns Acufex Microsurgical, Inc. and Dyonics, Inc. and has recently acquired Oratec Interventions, Inc.), Conmed Corporation (including its Linvatec unit), and Stryker Corporation each have large shares of the market for manual instruments, power shavers and arthroscopes.

Johnson & Johnson, including Mitek, a division of its Ethicon, Inc. unit, markets a bipolar electrosurgical system developed by Gyrus Medical Ltd., a company based in the United Kingdom which competes with us. Stryker Corporation and Smith & Nephew have recently introduced a bipolar electrosurgical system. The bipolar

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electrosurgical systems marketed by Mitek, Stryker and Smith & Nephew competes directly with our tissue ablation and shrinkage technology in Arthroscopy. In addition, the Linvatec unit of Conmed Corporation is marketing a monopolar electrosurgical tool for tissue ablation in arthroscopy. The Endoscopy Division of Smith & Nephew, by virtue of its acquisition of Oratec Interventions, now manufactures and sells a monopolar tissue ablation, shrinkage system that competes directly with our arthroscopic products, and have recently introduced a bipolar tissue ablation and coagulation system that also competes directly with our coblation arthroscopy products.

We believe that our Arthroscopic System, comprising the controller unit and disposable devices, presents a competitive pricing structure compared to alternative tools being used in arthroscopic procedures. While our disposable devices perform many functions in one tool, most competitive disposable devices only perform a single function. In such cases, multiple disposable or reusable devices would be required. Laser systems have a significantly higher capital cost than our controller and require significant ongoing maintenance and operating expenses. We are also aware of additional competitors that may commercialize products using technology similar to ours.

Spinal and Neurosurgery

We believe that Coblation technology will compete effectively against conventional tissue removal technology used in spinal and neurosurgery procedures, such as mechanical instruments, monopolar electrosurgical instruments, ultrasonic and powered instruments. Mechanical instruments for tissue removal in the spine are manufactured and sold by a large number of small, diverse, specialty companies, and the substantial bulk of monopolar electrosurgical instruments are manufactured by Valleylab and Linvatec (unit of Conmed). We may indirectly compete with large companies in the spine fusion and discectomy markets such as DePuy Acromed, Medtronic Sofamor Danek, Stryker, Centerpulse and Synthes. In addition, we are aware of several small companies offering alternative treatments for back pain that may indirectly compete with our products. For example, Oratec Interventions, now part of the Smith & Nephew Endoscopy Division, manufactures and sells a catheter that uses resistive heating to reduce chronic low back pain caused by degenerative disc disease. Radionics, a division of Tyco, manufactures and sells a catheter that uses resistive heating to reduce chronic low back pain caused by degenerative disc disease. Stryker recently purchased Pain Concepts, formerly a privately held company that produces the Dekompressor, which used an auger to mechanically pull tissue out of the disc for percutaneous discectomy. In neurosurgery, we directly compete with a variety of tissue removal systems designed for removing brain and cranial-based tumors, such as the CUSA^™, an ultrasonic tissue aspiration system manufactured by Valleylab.

Ear, Nose and Throat Surgery (ENT)

There are large companies, such as Smith & Nephew, Inc., and Medtronic, Incorporated (which owns Xomed Surgical Products, Inc.), which have shares of the ENT market for manual and powered instruments for ENT, head and neck surgical procedures. In addition, we face competition from laser companies, such as ESC Medical Systems Ltd., which develops and markets lasers for various ENT surgery applications. We expect that competition from these and other well-established competitors will increase as will competition from smaller medical device companies, such as Somnus Medical Technologies, Inc (owned by Gyrus Medical Ltd.). Somnus Medical Technologies, Inc. manufactures and sells medical devices that utilize radio frequency energy for the treatment of upper airway disorders, such as turbinate reduction, snoring and obstructive sleep apnea.

The cosmetic surgery industry includes a number of large and well established companies that provide devices for rejuvenating skin, hair removal, scar removal, the treatment of vascular and pigmented lesions and other applications, including companies that manufacture and sell dermabrasion equipment or chemical peels, and companies that manufacture and sell lasers. In skin resurfacing, we directly compete with much larger companies that manufacture lasers for medical use, such as Lumenis, Inc., a company that resulted from the acquisition of Coherent Medical Group by ESC medical Group. The combined company develops and markets

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lasers for a broad range of cosmetic applications, including the non-invasive treatment of varicose veins and other benign vascular lesions, hair removal, skin rejuvenation and others. In addition, other large companies manufacture and sell medical devices that use radio frequency energy for certain applications in dermatology and cosmetic surgery.

We cannot assure you that we can effectively convince surgeons and physicians to adopt our Coblation technology in the face of competition. In addition, we cannot be sure that these or other companies will not succeed in developing technologies and products that are more effective than ours or that would render our technology or products obsolete or uncompetitive. Many of these competitors have significantly greater financial, manufacturing, marketing, distribution and technical resources than us. We have received 510(k) clearances to market tissue ablation products to treat disorders in other surgical fields that we may enter. These fields are intensely competitive and we cannot assure you that these potential products would be successfully marketed.

Coblation Technologies

We believe that Coblation technologies will compete effectively against a variety of technologies used in gynecology, urology, laparoscopic, and cardiology procedures. There are several large companies, such as Ethicon ENDO, a division of Johnson and Johnson; Valleylab, a division of US Surgical; Gyrus and Olympus Medical Systems Group, which have shares of the gynecology market for mechanical, ultrasonic, monopolar and bipolar instruments. In the field of urology, we face competition from companies that market monopolar, bipolar, mechanical, ultrasonic, and laser devices for a variety of urological procedures, including transurethral prostatectomy (TURP) and transurethral incisions in the prostate (TUIP). These companies include Karl Storz, Olympus Medical Systems Group, C.R. Bard, Gyrus, Medtronic, Urologix, and Laserscope. We expect that competition from these and other well-established competitors will increase as will competition from smaller medical device companies in both the field of gynecology and urology. Cardiology is dominated by several large companies, including Edwards Lifescience, Medtronic, Guidant, Johnson and Johnson, and St. Jude Medical. These companies, including several smaller companies, offer mechanical, powered, laser, and electrosurgical systems.

We cannot assure you that we, or our corporate partners, can effectively convince surgeons and physicians to adopt Coblation technology in the face of competition. In addition, we cannot be sure that these or other companies will not succeed in developing technologies and products that are more effective than ours or that would render our technology or products obsolete or uncompetitive. Many of these competitors have significantly greater financial, manufacturing, marketing, distribution and technical resources than us or our corporate partners. The gynecology, urology and cardiology fields are intensely competitive and we cannot assure you that Coblation-based potential products would be successfully marketed by us or our corporate partners.

Third-Party Reimbursement

In the United States, health care providers, such as hospitals and physicians, that purchase medical devices, such as our products, generally rely on third-party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of the procedure in which the medical device is being used. Reimbursement for arthroscopic, ENT surgery, spinal and neuro surgery, gynecology, urology and general surgery and cardiac surgery procedures performed using devices that have received FDA clearance has generally been available in the United States. Generally, cosmetic procedures are not reimbursed. 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.

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Government Regulation

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 must 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 clearance to market our Spinal Surgery System in the United States for spinal and neuro surgery as well as the treatment of symptomatic patients with contained herniated discs. In addition, we have received 510(k) clearance to market our Cosmetic Surgery System in general dermatology and for skin resurfacing for the treatment of wrinkles. We have received 510(k) clearance to market our ENT Surgery System in general head, neck and sinus surgical procedures, as well as treatment of snoring, turbinate reduction, submucosal palatal and tissue shrinkage procedures and tonsillectomies. We have received 510(k) clearance to market our Coblation-based products for a variety of laporscopic and open general surgery and gynecology procedures. We have received 510(k) clearance to market our Coblation-based urology products for endoscopic urological procedures, including transurethral prostatectomy (TURP) and transurethral incisions in the prostate (TUIP). Our gynecology and urology products are CE marked and are available for sale in the European Union (EU). We cannot assure you that we will be able to obtain necessary clearances or approvals to

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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, technology, materials, packaging, and certain manufacturing process may require 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 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. For example, the company recently received and responded to a notification from the FDA that certain claims made in promotional materials were not clearly supported by 510(k) clearances. The company intends to resolve this matter expeditiously and to maintain compliance with FDA requirements.

International

International sales of our products are subject to strict regulatory requirements. The regulatory review process varies from country to country. We have obtained regulatory clearance to market our Arthroscopic System in Europe, Japan, Australia, Taiwan, Korea, Canada, China, Israel, Middle East, South America and Mexico; to market our cosmetic surgery products in Europe, Australia, Canada, Middle East, Taiwan, Korea, Australia, South America and Israel; to market our ENT surgery products in Europe, Australia, Canada, China, Israel, Japan, Middle East, Korea Taiwan, Australia, and South America; to market our spinal surgery products in Europe, Canada, Japan, South America, Australia, Korea, Mexico, Middle East, Taiwan; to market our general surgery products in Europe, Canada, Middle East, Korea, South America, and Taiwan; and to market neurosurgery and urology products in Europe, but we have not obtained any other international regulatory

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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. During the years ended December 31, 2002, December 31, 2001 and December 31, 2000, approximately 18%, 18% and 14%, respectively, of our sales were derived internationally.

Product Liability Risk and Insurance Coverage

The development, manufacture and sale of medical products entail significant risk of product liability claims. Our current product liability insurance coverage limits are $10,000,000 per occurrence and $10,000,000 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 require increased product liability coverage as products are successfully commercialized in additional applications. Product liability insurance is expensive and in the future may not be available to us on acceptable terms, if at all. 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 prospects.

Employees

As of December 31, 2002, we had 498 employees of which 253 people were engaged in manufacturing activities, 32 people were engaged in research and development activities, 133 people were engaged in sales and marketing activities, 32 people were engaged in regulatory affairs and quality assurance and 48 people were engaged in administrative and finance. In Europe, ArthroCare has 52 employees in sales, marketing, customer service and administration responsible for our International business. No employees are covered by collective bargaining agreements, and we believe we maintain good relations with our employees.

We are dependent upon a number of key management and technical personnel. The loss of the services of one or more key employees or consultants could have a material adverse effect on us. Our success also depends on our ability to attract and retain additional highly qualified management and technical personnel. We face intense competition for qualified personnel, any of whom often receive competing employment offers. We cannot assure you that we will continue to be able to attract and retain such personnel. Furthermore, our scientific advisory board members are all otherwise employed on a full-time basis. As a result, the scientific advisory board members are not available to devote their full time or attention to our affairs.

Facilities

We lease an approximately 52,000 square foot facility in Sunnyvale California for administrative offices, research and development, general and administrative purposes, manufacturing, warehousing, and distribution. Our lease for the building will expire in September 2006.

We also lease, on a month to month basis, approximately 24,000 square feet in a neighboring building in Sunnyvale, California for the same purposes as above. The leases on approximately 32,000 square feet in two other neighboring buildings expired in February 2002.

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We are leasing an approximately 4,100 square foot building in Stockholm, Sweden and an approximately 750 square foot building in France for administrative, sales and marketing purposes. We own an approximately 23,000 square foot building in Costa Rica for manufacturing and distribution. Atlantech leases an approximately 3,500 square foot building in the U.K. and an approximately 1,400 square foot building in Germany.

We believe that the currently owned and leased facilities will be sufficient for operational purposes through 2005.

Additional Factors That Might Affect Future Results

We Are Dependent Upon Our Arthroscopic System

We commercially introduced our Arthroscopic System in December 1995. Since our Arthroscopic System accounted for 77% of our product sales in 2002 we are highly dependent on its sales. During the past three years we began to market our spinal surgery, neurosurgery, ENT surgery, cosmetic surgery, and general surgery products. While sales of these products collectively are growing, to date, they represent a small percentage of the total units we sold in 2002. 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 priced 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 surgeons or 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.

Commercial Success of Our Non-Arthroscopic Products Is Uncertain

We have developed several applications for our Coblation technology in spinal and neurosurgery, ENT surgery, cosmetic surgery, gynecology, urology, and general surgery. Additionally we have established a program to explore the application of our Coblation technology in various areas within cardiac surgery through our Coblation Technologies Business Unit. 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. If we do not receive future clearances we may be unable to market these and other 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 o 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 our spinal surgery, neurosurgery, gynecology, urology, cosmetic surgery, ENT surgery, general surgery and cardiac surgery product offerings. 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.

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Development and commercialization of our current and future non-arthroscopic products are subject to the risks of failure inherent in the development for new medical devices. These risks include the following:

• Such products may not be easy to use, will require extensive training or may not be cost-effective;

• New products may experience delays in testing or marketing;

• There may be unplanned expenditures or in expenditures above those anticipated by us;

• Such products will not be proven safe or effective;

• Third parties may develop and market superior or equivalent products;

• Such products may not receive necessary regulatory clearances or approvals; and

• Proprietary rights of third parties may 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 endorsement of influential physicians are essential for market acceptance of our products.

For information regarding the status of our regulatory approvals for our products, see the information under the heading “Government Regulation.”

We Have Limited Marketing and Sales Experience

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 through a network of independent distributors supported by regional sales managers and a direct sales force. These distributors sell arthroscopy, spinal surgery, neurosurgery, and ENT surgery and Cosmetic surgery 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, coblation technology surgery, spinal surgery, neurosurgery, ENT and Cosmetic 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, 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.

We Have Limited Manufacturing Experience

To be successful, we must manufacture our products in commercial quantities in compliance with regulatory requirements at acceptable costs. At the present time, we have limited manufacturing experience. Our

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manufacturing operations consist of an in-house assembly operation for the manufacture of disposable devices and controllers. We currently produce more than 65 models of disposable devices utilizing 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 several 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 of 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.

We Are Dependent on Key Suppliers

We depend on two sole source suppliers for many of our product components, including two components that we include in substantially all of our disposable devices. If the supply of materials from a sole source supplier were interrupted, replacement or alternative sources might not be readily obtainable due to the regulatory requirements applicable to our manufacturing operations. In addition, a new or supplemental filing with applicable regulatory authorities may require clearance prior to our marketing a product containing new material. This clearance process may take a substantial period of time and we cannot assure you that we would be able to obtain the necessary regulatory approval for the new material to be used in our products on a timely basis, if at all. This could create supply disruptions that would materially adversely affect our business, financial condition, results of operations and future growth prospects.

In addition, we currently single source our product sterilization requirements. While there are alternate sources available, we would be required to qualify and validate a new supplier(s) which could lead to a disruption in the company’s operation and ability to supply products for a period of time.

We Face Intense Competition

The markets for our current and potential products are intensely competitive. These markets include arthroscopy, spinal surgery, neurosurgery, ENT surgery, cosmetic surgery, gynecology, urology, general surgery and cardiology. We cannot assure you that other companies will not succeed in developing technologies and products that are more effective than ours or that would render our technology or products obsolete or uncompetitive in these markets.

In arthroscopy, we compete against companies, such as Johnson & Johnson, Smith & Nephew, Inc., Conmed Corporation, Stryker Corp., and Arthrex, which market products to remove or shrink tissue. Specifically, Johnson & Johnson, Smith & Nephew and Stryker are currently marketing worldwide bipolar electrosurgical systems for tissue ablation and shrinkage. We are also aware of additional competitors that may commercialize products using technology similar to ours. In spinal surgery, we compete against companies which market products to remove tissue and treat spinal disorders. We compete against Stryker, which recently purchased Pain Concepts and their Dekompressor device which uses a mechanical auger to perform percutaneous discectomy. In addition, the Oratec division of Smith & Nephew, and the Radionics division of Tyco, are currently marketing percutaneous thermal heating products for treating certain types of disc pain, and Stryker is marketing a new product for percutaneous removal of tissue in the disc to treat certain types of back and leg pain. Our Coblation-assisted microdiscectomy (CAM) procedure competes indirectly with large spine companies and their mechanical instruments, such as DePuy Acromed, Medtronic Sofamor Danek, Centerpulse Spine Tech, Stryker Spine and Synthes. 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 acquired by Medtronic, Inc. In addition, we compete with companies that develop and market lasers for various ENT surgery applications, including Lumenis. In addition, we compete with companies that develop and market

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lasers for various ENT surgery applications, including Lumenis. Smaller companies, including Somnus Medical Technologies Inc. (purchased by Gyrus Group, a company based in Cardiff, Wales 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 Lumenis, which markets 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 Coblation Technologies, we face competition from companies that sell general surgery and gynecology devices, including Ethicon ENDO, a division of Johnson and Johnson, Valleylab, a division of US Surgical, Gyrus, Olympus Medical Systems Group, and several smaller companies that sell mechanical, ultrasonic, monopolar and bipolar instruments; in urology, we face competition from companies that market monopolar, bipolar, mechanical, ultrasonic, and laser devices for a variety of urological procedures, including Karl Storz, Olympus Medical Systems Group, C.R. Bard, Gyrus, Medtronic, Urologix, and Laserscope; in cardiology, we face competition from several large companies, including Edwards Lifescience, Medtronic, Guidant, Johnson and Johnson, and St. Jude Medical, as well as many smaller companies.

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, place controllers at customers sites at no cost or in return for a minimum purchase commitment of our surgical wands in order to increase demand for our disposable devices, and that 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.

We Face Uncertainty Over Reimbursement

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 environmental 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, neurosurgery, ENT surgery, gynecology, urology, cardiology and general surgery procedures performed using devices that have received FDA clearance has generally been available in the United States. Typically, 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.

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.

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Our Business Depends on Attracting and Retaining Collaborators and Licensors

In order to successfully develop and commercialize certain products, we may enter into collaborative or licensing arrangements with medical device companies and other entities to fund and complete our research and development activities, pre-clinical and clinical testing, manufacturing, regulatory approval activities and to achieve successful commercialization of future products. In addition, we have entered into distribution agreements with GyneCare and ACMI to market and sell our gynecology and urology products, respectively. See the information under the heading “Collaborative Arrangements” for a discussion of these arrangements.

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 product, 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 in a timely manner, our business, financial condition, results of operations and 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 of 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.

Our Operating Results Will Fluctuate

We achieved profitability in 1999 and, as of December 31, 2002, we had retained earnings of $0.8 million. Results of operations may fluctuate significantly from quarter to quarter due to many factors, including the following:

• The introduction of new product lines;

• Increased penetration in existing applications;

• Product returns;

• Achievement of research and development milestones;

• The amount and timing of receipt and recognition of license fees;

• Manufacturing or supply disruptions;

• Timing of expenditures;

• Absence of a backlog of orders;

• Receipt of necessary regulatory approvals;

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• The level of market acceptance for our products;

• Timing of the receipt of orders and product shipments; and

• Promotional programs for our products.

We cannot assure you that future quarterly fluctuations will not adversely affect our business, financial condition, results of operations of future growth prospects. Our revenues and profitability will be critically dependent on whether or not we can successfully continue to market our Coblation-based technology product lines. We cannot assure you that we will maintain or increase our revenues or level of profitability.

We May Be Unable to Effectively Protect Our Intellectual Property

Our ability to compete effectively depends in part on developing and maintaining the proprietary aspects of our Coblation technology. We believe that our issued patents are directed at the core technology used in our soft-tissue surgery systems, including both multi-electrode and single electrode configurations of our disposable devices, as well as the use of Coblation technology in specific surgical procedures.

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, 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.

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We May Become Subject to Patent Litigation

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. We cannot assure you that we will not become subject to patent infringement claims or litigation or interference proceedings declared by the United States Patent and Trademark office, the USPTO, to determine the priority of inventions. In February 1998, we filed a lawsuit against Ethicon, Inc., Mitek Surgical Products, a division of Ethicon, Inc., and GyneCare, Inc. alleging, among other things, infringement of several of our patents. The parties subsequently settled this lawsuit. Under the terms of the settlement, Ethicon, Inc. has licensed a portion of our U.S. patents for current products in the arthroscopy and gynecology markets. The settlement agreement also established a procedure for resolution of certain potential intellectual property disputes in these two markets without litigation. Under this procedure, the licenses granted in the Ethicon settlement have been extended to Australia, Canada and Japan. In June 2000, we filed a lawsuit against Stryker, alleging infringement of several of our patents. The lawsuit has been settled. In July 2000, we filed a lawsuit against Smith & Nephew alleging infringement of several of our patents. This lawsuit is pending and a jury trial is scheduled to commence in April 2003.

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 right 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.

The Market Price of Our Stock May Be Highly Volatile

During the fiscal year ended December 31, 2002 our common stock has traded between a range of $9.16 and $18.70 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 filing, 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 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 coverage or earnings estimates by analysts;

• Sales of common stock by existing stockholders; 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 and

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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. See “Item 5: Market for Registrant’s Common Equity and Related Stockholder Matters,” for more information regarding fluctuations in the price of our common stock.

Delaware Law, Provisions in Our Charter and Our Stockholder Rights Plan Could Make the Acquisition of Our Company By Another Company More Difficult

Our stockholder rights plan and certain provisions of our certificate of incorporation and bylaws may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of our company. This could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Some provisions of our certificate of incorporation and bylaws allow us to issue preferred stock without any vote or further action by the stockholders, to eliminate the right of stockholders to act by written consent without a meeting, to specify procedures for director nominations by stockholders and submission of other proposals for consideration at stockholder meetings, and to eliminate cumulative voting in the election of directors. Some provisions of Delaware law applicable to us could also delay or make more difficult a merger, tender offer or proxy contest involving us, including Section 203, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. Our stockholder rights plan, the possible issuance of preferred stock, the procedures required for director nominations and stockholder proposals and Delaware law could have the effect of delaying, deferring or preventing a change in control of ArthroCare, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock.

We Must Obtain Governmental Clearances or Approvals Before We Can Sell Our Products; We must Continue To Comply With Applicable Laws and Regulations.

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. International sales of our products are also subject to strict regulatory requirements. For more information about the U.S. and foreign regulatory requirements, see information under the heading “Government Regulation” above.

Information pertaining to our products and indications before they can be commercialized can be found under the heading “Government Regulations” in Item 1, above.

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ITEM 2.    PROPERTIES

Information pertaining to our properties can be found under the heading “Facilities” in Item 1, above.

ITEM 3.    LEGAL PROCEEDINGS

On July 25, 2001, ArthroCare filed a lawsuit against Smith & Nephew, Inc. (“the Defendant”) in the United States District Court of Delaware. The lawsuit alleges, among other things, that the Defendant has been, and is currently, infringing three patents issued to ArthroCare. Specifically, the Defendant uses, imports, markets and sells an electrosurgical system under the name Dyonics Control RF System that infringes these patents. ArthroCare seeks the following remedies: (1) a judgment that the Defendant has infringed these patents; (2) a permanent injunction precluding the Defendant from using, importing, marketing and selling the Dyonics Control FR System; and (3) an award of damages (including attorneys’ fees) to compensate us for lost profits and Defendant’s use of our inventions with the damages to be trebled because of the Defendant’s willful infringement. This lawsuit is pending and a jury trial is scheduled to commence in April 2003.

In conjunction with a medial malpractice suit against a physician, a product liability suit was brought against us in the Superior Court Arizona, county of Yavapai on August 24, 2001. The lawsuit alleges that a patient, D. Earl, suffered internal and external injury to the patient’s knee as a result of a defective ArthroCare probe used in an arthroscopy procedure on the patient. ArthroCare believes these claims to be without merit and intends to defend itself vigorously.

In April 2002, a product liability suit was brought against us in the United States District Court, District of Maine. The lawsuit includes a claim for punitive damages. Punitive damages, if awarded, are not covered by our insurance policies, and we would be required to pay any such punitive damages that were awarded. ArthroCare believes these claims to be without merit and is defending itself vigorously.

In September 2002, a product liability suit was brought against us in the 269th Judicial District Court, Harris County, Texas. ArthroCare believes these claims to be without merit and intends to defend itself vigorously.

In October 2002, ArthroCare acquired all the outstanding shares of Atlantech Medical Devices, Ltd. (“Atlantech”), a distributor of medical device products in the United Kingdom. Atlantech was involved in litigation with a former reseller regarding termination of a purported distribution agreement and seeks damages for alleged breach of contract. This lawsuit was settled in February 2003.

We believe that we have meritorious defenses against the above claims and intend to vigorously contest them. The outcomes of the outstanding litigation matters discussed above are not considered probable or cannot be reasonably estimated. Also, except as otherwise described above, ArthroCare has product liability insurance coverage in amounts it considers necessary to prevent material losses. We record a liability when a loss is known or considered probable and the amount can be reasonably estimated. If a loss is not probable or a probable loss cannot be reasonably estimated, a liability is not recorded. While it is not possible to predict the outcome of the actions discussed above, we believe that costs associated with them will not have a material adverse impact on our financial position or liquidity, but could be material to the consolidated results of operations of any one period.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock trades publicly on the Nasdaq Stock market under the symbol ARTC. The following table sets forth, for the periods indicated, the quarterly high and low closing sales prices of the common stock on The Nasdaq Stock Market.

	Fiscal 2002
	Quarter 1		Quarter 2		Quarter 3		Quarter 4
High	$	18.70	$	18.20	$	13.88	$	12.97
Low		13.16		9.16		10.15		9.45
	Fiscal 2001
	Quarter 1		Quarter 2		Quarter 3		Quarter 4
High	$	24.50	$	28.51	$	32.60	$	24.68
Low		12.06		13.75		19.56		16.15

As of March 14, 2003, there were no outstanding shares of Preferred Stock and 238 holders of record of 21,219,789 shares of outstanding Common Stock. The company has not paid any cash dividends since its inception and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. In June 2000, we approved a two-for-one stock split of our common stock which was paid on, and began trading as of July 5, 2000.

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ITEM 6.    SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included in this Annual Report on Form 10-K. The statements of operations data for the years ended December 31, 2002, 2001 and 2000 and the balance sheet data as of December 31, 2002 and 2001 have been derived from audited consolidated financial statements included elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 1999 and 1998 and the balance sheet data as of December 31, 2000, 1999 and 1998 have been derived from audited consolidated financial statements that are not included in this report. The historical results are not necessarily indicative of the results of operations to be expected in the future.

	Year Ended December 31,
	2002		2001		2000			1999		1998
	(in thousands, except per share data)
Statements of Operations Data:
Product sales	$	84,965	$	70,300	$	62,164		$	44,219	$	24,624
Royalties, fees and other		3,822		8,075		3,615			4,857		3,292
Total revenues		88,787		78,375		65,779			49,076		27,916
Gross profit		55,378		50,684		40,117			29,891		15,548
Operating expenses		56,225		42,994		32,619			25,242		18,625
Net income (loss) before cumulative effect of change in accounting principle		1,132		10,060		15,845			5,543		(2,141	)
Cumulative effect on prior years of the application of SAB 101		—		—		(4,300	)		—		—
Net income (loss)		1,132		10,060		11,545			5,543		(2,141	)
Basic net income (loss) per share	$	0.05	$	0.45	$	0.53		$	0.29	$	(0.12	)
Diluted net income (loss) per share	$	0.05	$	0.43	$	0.50		$	0.27	$	(0.12	)
	December 31
	2002		2001		2000			1999		1998
	(in thousands, except per share data)
Balance Sheet Data:
Cash, cash equivalents and available-for-sale securities (including long-term portion)	$	52,851	$	76,695	$	86,814		$	79,607	$	8,058
Working capital		72,939		98,642		97,013			85,118		16,973
Total assets		135,952		133,697		140,462			110,039		27,760
Total stockholders’ equity(1)		118,163		125,093		126,345			102,883		22,305

(1) We have not declared any cash dividends on our common stock since our inception and we do not anticipate paying cash dividends in the foreseeable future.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. Statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this annual report on Form 10-K which express that we “believe,” “anticipate,” “expect” or “plan to” as well as other statements which are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual events or results may differ materially as a result of the risks and uncertainties described herein and elsewhere including, but not limited to, those factors discussed in “Additional Factors That May Affect Future Results” set forth in Part I of this Report as well as other risks and uncertainties in the documents incorporated herein by reference.

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Overview

We are a medical device company that develops, manufactures and markets products based on our patented Coblation technology. Our products allow surgeons to operate with increased precision and accuracy, limiting damage to surrounding tissue thereby reducing pain and speeding recovery for the patient. Our products operate at lower temperatures than traditional electrosurgical or laser surgery tools and enable surgeons to ablate, shrink, sculpt, cut, or aspirate soft-tissue surgery procedures with one multi-purpose surgical system.

We have organized our marketing and sales efforts into business units based on product markets. These business units are comprised of the following: Arthroscopy (shoulder and knee arthroscopic products), ENT (to include ear, nose, throat and the Visage^® cosmetic products), ArthroCare Spine^™ (to include spinal and neuro surgery products) and Coblation Technology (to include gynecology, urology, laparoscopic, general surgical and cardiology products).

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, ENT surgery, general surgery, gynecology, urology and various cardiology applications.

In April 1998, we announced that we had entered the cosmetic surgery market and formed a business unit called Visage to commercialize Coblation technology in this field. In early 1999, we entered into a license and distribution agreement with Collagen Aesthetics, Inc., which was subsequently purchased by Inamed Corporation. Under this agreement, Inamed Corporation acquired exclusive, worldwide, marketing right for our cosmetic surgery line of products for the dermatology and cosmetic surgery markets. In March 2001, we terminated this contract, alleging breach by Inamed of certain terms of the contract. We signed a settlement agreement with Inamed mutually releasing all claims against each other in 2002. In April 2001, we began marketing and selling our cosmetic surgery product line through a network of distributors and direct sales representatives.

In May 1998, we announced that we had entered the ear, nose and throat market and had formed a business unit called ENTec to commercialize Coblation technology in this field.

In early 1998, we formed a business unit, AngioCare^™, for the purpose of further developing and 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 under which Boston Scientific Corporation would help develop, obtain regulatory approval for and market products based on Coblation technology for myocardial revascularization procedures. In 2001 we terminated this agreement and now retain all rights to Coblation technology in this field.

In September 1999, we announced that we had entered the spinal surgery market. In February 2000, we announced that we were expanding our marketing efforts for our spinal surgery system to specifically address selected applications in neurosurgery. We are marketing and selling our spinal surgery products through a network of independent distributors and direct sales representatives supported by regional managers worldwide.

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 Arthroscopy System is CE marked for use in arthroscopic surgery. 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 and neurosurgery. Our ENT Surgery System has received 510(k) clearance in the United States and is CE marked for general head, neck and oral surgical procedures, including tonsillectomy, adenoidectomy, snoring and the treatment of hypertrophic nasal turbinates and submucosal tissue channeling and shrinkage. Our Cosmetic Surgery System is CE marked for general dermatology and skin resurfacing for the purpose of wrinkle reduction procedures and we have received 510(k) clearance for use of our

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Cosmetic Surgery System in general dermatology procedures and for skin resurfacing for the purpose of wrinkle reduction in the United States. We have received 510(k) clearance to market coblation technology for general surgery, gynecology and urology.

In December 1995, we introduced our Arthroscopy 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, placing controllers at customer sites at no cost or in return for a commitment to purchase a minimum number of surgical wands, to generate future disposable product 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, gynecology, urology, cosmetic surgery, ear, nose and throat surgery, cardiology and general surgery. We have received 510(k) clearance for use of our technology in several 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.

Results of Operations

ArthroCare Corporation Statements of Operation:

	Year Ended December 31,
	2002			2001		2000
Revenues:
Product sales	$	84,965		$	70,300	$	62,164
Royalties, fees and other		3,822			8,075		3,615
Total revenues		88,787			78,375		65,779
Cost of product sales		33,409			27,691		25,662
Gross profit		55,378			50,684		40,117
Operating expenses:
Research and development		8,826			8,036		7,145
Sales and marketing		36,519			29,652		20,624
General and administrative		10,880			5,306		4,850
Total operating expenses		56,225			42,994		32,619
Income (loss) from operations		(847	)		7,690		7,498
Interest income and other, net		2,545			8,047		4,903
Income before income tax provision		1,698			15,737		12,401
Income tax provision/ (benefit)		566			5,677		(3,444	)
Income before cumulative effect of a change in accounting principle		1,132			10,060		15,845
Cumulative effect on prior years of application of SAB 101 “Revenue Recognition in Financial Statements”		—			—		(4,300	)
Net income	$	1,132		$	10,060	$	11,545

Reclassifications

On January 1, 2002 we implemented EITF 01-09, which relates to the consideration from a vendor to a customer or reseller of the vendor’s product which stipulates that commissions we pay to stocking distributors be reflected as a reduction of revenues in the statement of income. Prior year amounts have been reclassified to conform to this new standard. This reclassification resulted in a $4.9 million decrease in fiscal 2001 revenues and a $1.8 million decrease in fiscal 2000 revenues. These revenue reductions were offset by decreases in sales and marketing expenses, thereby having no impact on the Company’s previously reported net income.

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Revenues

Total revenues for fiscal 2002 were $88.8 million compared to $78.4 million and $65.8 million for fiscal 2001 and fiscal 2000, respectively. In fiscal 2002, total revenues included $2.8 million due to Atlantech Medical Devices, Ltd. and Atlantech GmbH, (collectively referred to as “Atlantech”), which we acquired in the fourth quarter of fiscal 2002. Product sales for 2002 were $85.0 million, an increase of 21%, from $70.3 million for 2001. Product sales in 2001 were 13% higher than the $62.2 million in 2000. Several years ago, ArthroCare began aggressively transitioning its distribution channel away from stocking distributors to a more direct sales model. The execution of this strategy is now substantially complete. As a result, the company recorded $0.7 million in revenue reduction adjustments and charges in 2002 due to termination of stocking distributor agreements. The company shipped approximately 499,000 disposable devices in fiscal 2002 compared to approximately 460,000 units in fiscal 2001 and approximately 413,000 units in fiscal 2000. All commercial business units posted sales increases in 2002 compared to 2001. The company’s Arthroscopy business unit contributed $65.1 million in net product sales in 2002 as compared to $58.1 million in 2001 and $52.5 million in 2000. The company’s ear, nose and throat (ENT) business unit contributed $10.2 million in net product sales in 2002 as compared to $7.6 million in 2001 and $7.0 million in 2000. The company’s spinal surgery (ArthroCare Spine) business unit contributed $8.7 million in net product sales in 2002 as compared to $4.2 million in 2001 and $2.1 million in 2000. The company’s Coblation Technologies business unit contributed $1.0 million in net product sales in 2002 as compared to $0.4 million in 2001 and $0.6 million in 2000. International sales grew by $4.1 million during fiscal 2001.

The increase in direct sales presence, which was begun in 2001, continued to have a positive effect on sales in 2002, as did the execution of our strategic plan to build market share through continued promotional programs of controller placements, commercialization of our technology in fields outside of arthroscopy and introduction of new products designed to address surgical procedures that have traditionally been difficult to perform.

Overall, disposable devices are consistently sold at or near list price, except for sales to international distributors and marketing partners, which are sold at discounted prices. We expect these discounts to continue in the future. For fiscal years 2002, 2001 and 2000, disposable device sales comprised approximately 98%, 95% and 90%, respectively, of our product sales. We anticipate that disposable device sales will remain the primary component of our product sales in the near future. International product sales were $14.9 million, or 18% of total product sales, in 2002 as compared to $12.4 million, or 18% of total product sales, in 2001 and $8.8 million, or 14% of total product sales, in 2000.

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 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 seven years of product shipments, we have penetrated 30% to 35% of the hospitals that perform arthroscopic procedures in the United States. We believe that approximately 45% of our arthroscopy product sales are being generated by the sale of disposables for use in knee procedures.

Royalties, fees, and other revenues decreased to $3.8 million for fiscal 2002, from $8.1 million for fiscal 2001. During fiscal 2000 royalties, fees, and other revenues was $3.6 million. Royalties, fees, and other revenues decreased in 2002 primarily due to the cancellation of agreements in 2001 with distribution partners resulting in recognition of $5.5 million in fees that previously had been deferred. During fiscal year 2000, we adopted SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements” (“SAB 101”) and changed our method of accounting for license fees and milestones from business partners to recognize such revenues over the term of the associated agreement unless the fee or milestones is in exchange for products delivered or services performed that represent the culmination of a separate earnings process. Amounts received prior to revenue recognition are recorded as deferred revenue. The cumulative effect of the change of $4.3 million in

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fiscal 2000 was reported as a cumulative effect of a change in accounting principle, retroactive to January 1, 2000. The cumulative effect of the change in accounting principle included license fee revenues and deferred revenues that would be recognized over the lives of the associated agreements.

During fiscal year 2002, 2001 and 2000, we recognized $1.4 million, $0.6 million and $0.6 million, respectively, of royalties, fees and other revenues in accordance with our agreement with Ethicon, Inc. In February 1998, we entered into a license agreement under which Boston Scientific Corporation was granted an exclusive right to develop and market products based on Coblation technology for myocardial revascularization procedures. Boston Scientific Corporation pays license fees to us upon achievement of designated milestones and royalties on sales of resulting products, if any. During fiscal 2000 we recognized $0.4 million of such payments as license fees and royalties. In January 1999, we entered into a license and distribution agreement with Inamed Corporation, which was expanded in February 1999, whereby Inamed Corporation acquired exclusive, worldwide, marketing rights for our patented Coblation technology in the cosmetic surgery market. Under the terms of the agreement, Inamed Corporation paid us license fees based upon the achievement of certain milestones and royalties on sales of product to end-users. During fiscal 2000 we recognized $0.5 million of these payments as royalties, fees, and other revenues.

Cost of Product Sales

Cost of product sales for fiscal 2002 was $33.4 million, or 39% of product sales, compared with $27.7 million, or 39% of product sales, for fiscal 2001. During fiscal 2000, cost of product sales was $25.7 million, or 41% of product sales. The $5.7 million increase in cost of product sales for fiscal 2002 over fiscal 2001 resulted from the sale of 39,000 more disposable units which led to an approximate $3.1 million increase in costs, $1.0 million increase in controller placement costs and $1.6 million in Atlantech cost of sales. The $2.0 million increase for fiscal 2001 over fiscal 2000 resulted from the sale of 47,000 more disposable units, partially offset by a lower number of controllers sold as part of the expansion of our controller placement program. In addition, we continued controller placements under a program whereby we maintain ownership of the controller, which resulted in the cost being capitalized and amortized into cost of sales over future periods rather than expensing the entire cost at the time of placement. During the second half of fiscal 2002, the company significantly lowered its manufacturing costs by relocating the majority of its production to a new facility in Costa Rica. This required the company to revalue its existing inventory downward by $2.5 million to bring it in line with the new, lower manufacturing cost structure. The company closed the acquisition of Atlantech during fiscal 2002 which resulted in $0.3 million of incremental cost of sales relating to purchase price adjustments to inventory as acquired inventory must be valued to yield a distributors as opposed to a manufacturers profit margin.

The increase in gross product margin as a percentage of product sales to 60.7% in fiscal 2002 from 60.6% in fiscal 2001 is mainly attributable to increased average selling prices of disposable devices, increased manufacturing efficiency and increased production volume which was partially offset by the increased controller placement costs and the lower gross margin on Atlantech sales. The increase in gross product margin as a percentage of product sales in 2001 as compared to 2000 is mainly attributable to an increase in average selling prices of disposable devices, increased manufacturing efficiency and increased production volume. In fiscal 2000, the gross product margin as a percentage of product sales was 58.7%. As planned, the company’s new Costa Rica facility continued shipping sub-assemblies to the Sunnyvale facility in fiscal 2002 and is expected to contribute to gross margin improvements in the future.

Operating Expenses

Research and development expense increased to $8.8 million in fiscal 2002, or 10% of product sales, from $8.0 million in fiscal 2001, or 11% of product sales, and from $7.1 million, or 12% of product sales in fiscal 2000. In 2002, Atlantech had no research and development expense. The $0.8 million and $0.9 million increases in spending between fiscal years 2002 and 2001 and between 2001 and 2000, respectively, are attributed

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primarily to continued development of new products in our currently commercialized markets and continued maintenance and development of our patent position. Compensation and related expenses increased by $0.1 million in fiscal 2002 due to increasing headcount and increased by $0.6 million in fiscal 2001 due to increasing headcount to support research and development efforts. Development prototype materials increased by $0.1 million and $0.7 million in fiscal years 2002 and 2001, respectively. Facility and information system costs increased $0.5 million in fiscal year 2002 in conjunction with expanding our infrastructure. Other expenses increased by $0.1 million in fiscal 2002 in support of development activities. In fiscal year 2001, other expenses decreased by $0.4 million mainly due to a decrease in the research and development efforts conducted on behalf of business partners and a reduction of expenses incurred by the company for non-employee stock options. We believe that investment in our Coblation technology is essential for us to maintain our competitive position. We expect to increase the dollar amount of research and development expenses through continued expenditures on new product development, regulatory affairs, clinical studies and patents, but anticipate expenses to decrease slightly as a percentage of product sales.

Sales and marketing expense increased to $36.5 million, or 43% of product sales, in fiscal year 2002, from $29.7 million, or 42% of product sales, in fiscal year 2001, and from $20.6 million, or 33% of product sales, in fiscal year 2000. In fiscal 2002, sales and marketing expense included $0.7 million due to Atlantech. Increased expenses associated with hiring a direct sales force for certain of our business and expenses with canceling distributors accounted for $2.0 million and $2.7 million in fiscal 2002 and 2001, respectively. Commission expense increased $3.0 million and $2.2 million in fiscal 2002 and 2001, respectively, as a result of increased sales. Increased sales and marketing activity in our businesses other than arthroscopy and our expanded international operations resulted in an increase of $1.2 million and $3.9 million in fiscal 2002 and 2001, respectively. We anticipate that sales and marketing spending will continue to increase in absolute dollars as a result of expansion of our distribution capabilities to address the spinal surgery, ear, nose and throat and cosmetic surgical markets, higher dealer commissions from increased sales, the additional cost of penetrating international markets, higher promotional, demonstration and sample expenses, and additional investments in the sales, marketing and support staff necessary to market products and to commercialize future products. We have entered into a strategic relationship with the Gynecare division of Ethicon, Inc. to commercialize Coblation-based products for laparoscopic and open surgical procedures for gynecological applications. We have also entered into a strategic relationship with ACMI, under which ACMI will market and sell our products for urologic indications, including transurethral resection of the prostrate (TURP).

General and administrative expense increased to $10.9 million, or 13% of product sales, in fiscal year 2002, from $5.3 million, or 8% of product sales, in fiscal year 2001 and from $4.9 million, or 8% of product sales in fiscal year 2000. In 2002, general and administrative expense included $0.1 million due to Atlantech. The $5.6 million increase in fiscal 2002 general and administrative expenses was primarily due to a $1.0 million increase in staffing and salaries, a $2.1 million increase in the cost of general and patent-related legal services and approximately $2.4 million increase due to increases in business development activities, insurance and other expenditures necessary to expand our corporate infrastructure. The $0.5 million increase in fiscal 2001 general and administrative expenses was attributable to a $0.3 million increase in staffing and salaries, increases in the cost of general and patent-related legal services, business development activities, insurance and international accounting and tax related expenditures necessary to expand our corporate infrastructure. We expect that general and administrative expenses will decrease as a percentage of product sales, but will increase in dollar amounts as we incur additional legal expenses and continue business development activities.

Interest and Other Income, net

Interest and other income, net, decreased to $2.5 million in fiscal 2002 from $8.0 million and $4.9 million in fiscal 2001 and fiscal 2000, respectively. The $5.5 million decrease in interest and other income in fiscal 2002 was primarily due to a $1.6 million decrease in interest income as a result of a decrease in the amount of cash and investment balance resulting from our investing and financing activities, declining interest rates throughout 2002, and a $4.4 million gain on the sale of an investment in fiscal 2001 as opposed to a gain of $0.9 million in 2002.

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In fiscal 2001, the $3.1 million increase in interest and other income included a $4.4 million gain on the sale of an investment which was partially offset by a reduction of $1.3 million in interest earned as a result of declining interest rates throughout 2001 and a lower cash and investment balance resulting from our investing and financing activities. At the end of fiscal 2002, we had $52.9 million in cash, cash equivalents, and available-for-sale securities as compared to $76.7 million at the end of fiscal 2001 and to $86.8 million at the end of fiscal 2000.

Income Tax Provision / (Benefit)

The provision / (benefit) for income taxes was $0.6 million for fiscal year 2002 as compared to $5.7 million for fiscal year 2001 and ($3.4) million in fiscal year 2000. The fiscal 2002 effective rate was 33% as compared to 36% in fiscal 2001. The primary difference between 2001 and 2000 relates to the release of the valuation allowance in fiscal 2000. Historically, we have established deferred tax assets arising from federal net operating loss carryforwards, federal tax credit carryforwards as well as from other timing differences. These deferred tax assets have been offset in total by a valuation allowance due to the uncertainty surrounding the realization of such assets. During fiscal 2000, we decreased the valuation allowance and recognized a tax benefit relating to the recognition of deferred tax assets of $4.9 million. The decrease in the valuation allowance and the resulting recognition of a deferred tax benefit in the year was based on management’s belief that it is more likely than not that these deferred tax assets will be realized.

Liquidity and Capital Resources

At the end of fiscal 2002, we had $72.9 million in working capital compared to $98.6 million at the end of fiscal 2001. Our principal sources of liquidity consisted of $52.9 million in cash, cash equivalents, and short-term and long-term available-for-sale securities. The cash equivalents are highly liquid with original maturities of ninety days or less.

Cash generated by operating activities was $9.5 million for fiscal 2002 which was mainly attributable to net income before depreciation of $8.7 million, and changes in accounts receivable, accounts payable and accrued liabilities of $6.1 million which was partially offset by changes in inventory of $5.8 million.

Accounts receivable, net of allowances, decreased slightly to $18.4 million at the end of fiscal 2002 from $18.6 million at the end of fiscal 2001 and $16.2 million at the end of fiscal 2000. The decrease in accounts receivable in fiscal 2002 was due to significant increase in sales that was offset by an improvement in the collection times. The increase in accounts receivable in fiscal 2001 was due to the increase in sales and the impact of longer payment terms relating primarily to increasing sales to international customers.

Inventories increased to $22.7 million at the end of fiscal 2002 compared to $14.2 million and $13.7 million at the end of fiscal 2001 and 2000, respectively. The increase in inventory was in order to support anticipated increasing product sales activity, lower-than-expected sales at the end of fiscal 2002 and 2001, safety stock for our move of the manufacturing operations into our new facility in Costa Rica in early 2002 and the introduction levels required to grow and support sales volume increases. We expect future inventory levels to increase in absolute dollar value in order to support sales volume increases, to provide safety stock and support our expansion into additional markets.

Cash used in investing activities was $1.7 million for fiscal 2002, compared to $6.8 million provided in fiscal 2001 and $25.7 million used in fiscal 2000. Cash was used in investing activities in fiscal 2002 because the sales of available-for-sale securities was more than offset by the purchases of other available-for-sale securities, the acquisition of Atlantech, and property and equipment additions. In fiscal 2001, cash was provided by investing activities because the sales of available-for-sale securities was only partially offset by the purchases of other available-for-sale securities and property and equipment. Cash was provided by financing activities in fiscal 2000 primarily due to the sales of available-for-sale securities.

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Purchases of property and equipment increased to $12.2 million for fiscal year 2002 compared to $9.4 million and $6.2 million in fiscal years 2001 and 2000, respectively. The increase in fiscal 2002 was primarily due to the $5.5 million capitalization of controllers placed under various promotional programs, acquisition of land and building in Costa Rica for $2.1 million, an increase in computer equipment and software for $1.9 million and leasehold improvements of $1.8 million in our new headquarters.

Cash used in financing activities was $9.5 million for fiscal year 2002, compared to cash used of $13.6 million and cash provided of $5.2 million in fiscal years 2001 and 2000, respectively. The decrease in both fiscal 2002 and 2001 was primarily due to the purchase of treasury stock and the partial offset by the proceeds from the exercise of common stock options. The increase in fiscal 2000 was primarily due to the proceeds from the exercise of common stock options.

The following summarizes our contractual obligations at December 31, 2002 and the effect such obligations have on future cash flows (in thousands):

Non cancelable lease obligations, less than 1 year	$	1,604
Non cancelable lease obligations, 1-2 years		3,172
Non cancelable lease obligations, 3-4 years		1,830
Non cancelable lease obligations, greater than 4 years		—
	$	6,606

We plan to finance our future operating and capital needs principally with cash from product sales, cash, cash equivalents, and available-for-sale securities and related interest, and existing capital resources which we believe will be sufficient to fund our operations at least through fiscal year 2004. Our future liquidity and capital requirements will depend on numerous factors, including our success in commercializing our products, development and commercialization of products in fields other than arthroscopy, the ability of our suppliers to continue to meet our demands at current prices, obtaining and enforcing patents important to our business, the status of regulatory approvals and competition.

At the end of fiscal 2002, we had approximately $9.7 million of federal net operating loss carryforwards and approximately $3.1 million of state net operating loss carryforwards. The federal and state net operating loss carryforwards will begin to expire in the year 2011 and 2002, respectively, if not utilized.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, inventory allowances, warranty costs, goodwill impairments, contingencies and other special charges, and taxes. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements.

Allowance for Doubtful Accounts

The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our statement of operations.

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A reserve for sales returns is established based on historical trends in product return rates. If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected.

Inventory Allowance

Inventory purchases and commitments are based upon future demand forecasts. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase our inventory allowances and our gross margins could be adversely affected.

Warranty Costs

We accrue for warranty costs based on historical trends in product return rates and the expected material and labor costs to provide warranty services. If we were to experience an increase in warranty claims compared with our historical experience, or costs of servicing warranty claims were greater than the expectations on which the accrual had been based, our gross margins could be adversely affected.

Goodwill Impairment

We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing, or otherwise exiting businesses, which could result in an impairment of goodwill.

Contingencies

We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted.

Recent Accounting Pronouncements

In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The company has complied with the disclosure requirements and is currently in the process of determining the financial effects, if any, of adopting the recognition and measurement provisions on the consolidated financial statements.

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal

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periods beginning after June 15, 2003. The company is in the process of determining the financial effects, if any, on its consolidated financial statements.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”), “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods ending after December 15, 2002. The company has complied with the disclosure requirements of SFAS No. 148.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The company is in the process of determining the financial effects, if any, on its consolidated financial statements.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio.

We are subject to fluctuating interest rates that may impact, adversely or otherwise, our results of operations or cash flows for our cash and cash equivalents and our short-term investments.

The table below presents principal amounts and related weighted average interest rates as of December 31, 2002 for our cash and cash equivalents and short-term investments.

Cash, cash equivalents and short-term investments	$	46,455,000
Average interest rate		1.9%
Long-term available-for-sale securities	$	6,396,000
Average interest rate		6.1%

Although payments under the operating leases for our facility are tied to market indices, we are not exposed to material interest rate risk associated with operating leases.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Certain information required by this Item is included in Item 6 of Part II of this Report and is incorporated herein by reference. All other information required by this Item is included on pages 48 to 69 in Item 15 of this Report and is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

41

PART III

ITEM 10.    EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT

Information regarding the directors and executive officers of ArthroCare is incorporated by reference to the information set forth under the headings “Proposal No. 1: Election of Directors,” “Executive Officers of the Company” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the proxy statement relating to our 2003 Annual Meeting of Stockholders (the “2003 Proxy Statement”), to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934.

ITEM 11.    EXECUTIVE COMPENSATION

Information appearing under the headings “Executive Officer Compensation,” “Director Compensation,” “Employment and Change of Control Agreements,” “Compensation Committee Interlocks and Insider Participation,” “Report of the Compensation Committee” and “Performance Graph” in the 2003 Proxy Statement is incorporated by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information appearing under the headings “Equity Compensation Plan Information” and “Security Ownership of Directors, Officers and Certain Beneficial Owners” in the 2003 Proxy Statement is incorporated by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information appearing under the heading “Certain Relationships and Related Transactions” in the 2003 Proxy Statement is incorporated by reference.

42

PART IV

ITEM 14.    CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures (as defined in Securities Exchange Act 1934 Rules 13a-14(c) and 15d-14(c)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Within 90 days prior to the date of this annual report, we carried out an evaluation, under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

There have been no significant changes in our internal controls or in other factors that could significantly affect the internal controls subsequent to the date we completed our evaluation. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  The following documents are filed as part of this Report.

1.  Financial Statements.    The following financial statements of the company and the Report of Independent Accountants are included in this Report on the pages indicated.

	Page
Report of Independent Accountants on financial statements and supplemental schedule	47
Consolidated Balance Sheets as of December 31, 2002 and December 31, 2001	48
Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000	49
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2002, 2001, and 2000	50
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000	51
Notes to the Consolidated Financial Statements	52

2.  Financial Statement Schedule.    The following financial statement schedule of the company as of and for the years ended December 31, 2002, 2001 and 2000, is included in Part IV of this Report on the pages indicated. This financial statement schedule should be read in conjunction with the Financial Statements, and notes thereto, of the company.

Schedule	Title	Page
II	Valuation and Qualifying Accounts	69

Schedules not listed above have been omitted because they are not applicable, not required, or the information required to be set forth therein is included in the Financial Statements or notes thereto.

43

3.  Exhibits (in accordance with Item 601 of Regulation S-K).

3.1	Restated Certificate of Incorporation of the Registrant. (Incorporated herein by reference to Exhibit 3.1 filed previously with the Registrant’s Annual Report on Form 10-K for the period ended December 30, 2000).
3.2	Amended and Restated By laws of the Registrant. (Incorporated herein by reference to Exhibit 3.2 filed previously with the Registrant’s Quarterly Report on Form 10-Q for the period ended October 3, 1998).
4.1	Specimen Common Stock Certificate. (Incorporated herein by reference to Exhibit 4.1 filed previously with the Registrant’s Registration Statement on Form 8-A (Registration No. 000-27422)).
10.1*	Form of indemnification Agreement between the registrant and each of its directors and officers. (Incorporated herein by reference to Exhibit 10.1 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.2*	Incentive Stock Plan and form of Stock Option Agreement thereunder. (Incorporated herein by reference to Exhibit 10.2 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.3*	Director Option Plan and form of Director Stock Option Agreement thereunder. (Incorporated herein by reference to Exhibit 10.3 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.4*	Employee Stock Purchase Plan and forms of agreements thereunder. (Incorporated herein by reference to Exhibit 10.4 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.5	Form of Exclusive Distribution Agreement. (Incorporated herein by reference to Exhibit 10.5 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.6	Form of Exclusive Sales Representative Agreement. (Incorporated herein by reference to Exhibit 10.6 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.7	Consulting Agreement, dated May 10, 1993, between the Registrant and Philip E. Eggers, and amendment thereto. (Incorporated herein by reference to Exhibit 10.7 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.8	Consulting Agreement, dated May 20, 1993, between the Registrant and Eggers & Associates, Inc., and amendment thereto. (Incorporated herein by reference to Exhibit 10.8 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.9	Lease Agreement, dated May 20, 1993, between the Registrant and Eggers & Associates, Inc., and amendment thereto. (Incorporated herein by reference to Exhibit 10.9 filed previously with the Registrant’s Registration Statement on Form S-1 (registration No. 33-80453)).
10.10	Amended and Restated Stockholder Right Agreement, dated October 16, 1995, between the Registrant and certain holders of the Registrant’s securities. (Incorporated herein by reference to Exhibit 10.20 filed previously with the Registrant’s Registration Statement on form S-1 (Registration No. 33-80453)).
10.11	Contribution Agreement, dated March 31, 1995, by and among Philip E. Eggers, Robert S. Garvie, Anthony J. Manlove, Hira V. Thapliyal and the Registrant. (Incorporated herein by reference to Exhibit 10.21 filed previously with the Registrant’s Registration Statement on Form S-1 (Registration No. 33-80453)).
10.12	Amended and Restated Stockholder Rights Agreement, dated October 2, 1998, between the Registrant and Norwest Bank Minnesota, N.A. (Incorporated herein by reference to Exhibit 10.20 filed previously with the Registrant’s Registration Statement on Form 8-A filed October 21, 1998 (Registration No. 000-27422)).

44

10.13	Exclusive Distributor Agreement, dated August 21, 1997, between the Registrant and Kobyashi Pharmaceutical Company, Ltd. (Incorporated herein by reference to Exhibit 10.25 filed previously with the Registrant’s Quarterly Report on Form 10-Q for the period ended September 27, 1997).
10.14	License Agreement dated February 9, 1998, between the Registrant and Boston Scientific Corporation. (Incorporated herein by reference to Exhibit 10.26 filed previously with the Registrant’s Annual Report on form 10-K for the period ended January 3, 1998).
10.15	Development and Supply Agreement dated February 9, 1998, between the Registrant and Boston Scientific Corporation. (Incorporated herein by reference to Exhibit 10.27 filed previously with the Registrant’s Annual report on form 10-K for the period ended January 3, 1998).
10.16*	Change of control Agreement between the Registrant and the CEO. (Incorporated herein by reference to Exhibit 10.28 filed previously with the Registrant’s Annual Report on Form 10-K for the period ended January 2, 1999).
10.17*	The form of “VP continuity Agreement” between the Registrant and its Vice Presidents. (Incorporated herein by reference to Exhibit 10.29 filed previously with the Registrant’s Annual Report on Form 10-K for the period ended January 2, 1999).
10.18	Letter Agreement dated February 9, 1999 between the Registrant and Collagen Aesthetics. (Incorporated herein by reference to Exhibit 10.30 filed previously with the Registrant’s Annual Report on Form 10-K/A for the period ended January 2, 1999).
10.19*	Employment Letter Agreement, between the Registrant and John R. Tighe dated January 26, 1999. (Incorporated herein by reference to Exhibit 10.30 filed previously with the registrant’s Quarterly Report on Form 10-Q for the period ended April 3, 1999).
10.20*	Employment Letter Agreement, between the Registrant and Christine Hanni amended May 19, 1999. (Incorporated herein by reference to Exhibit 10.31 filed previously with the Registrant’s Quarterly Report on Form 10-Q for the period ended April 3, 1999).
10.21*	Employment Letter Agreement, between the Registrant and Bruce P. Prothro amended May 19, 1999. (Incorporated herein by reference to Exhibit 10.32 filed previously with the Registrant’s Quarterly Report on Form 10-Q for the period ended April 3, 1999).
10.22†	Litigation Settlement Agreement, between the Registrant and ETHICON Inc. dated June 24, 1999 (Incorporated herein by reference to Exhibit 10.33 previously filed with the Registrant’s Quarterly Report on Form 10-Q for the period ended July 3, 1999).
10.23	Relocation Loan Agreement, between the Registrant and John. R. Tighe dated May 1, 1999. (Incorporated herein by reference to Exhibit 10.34 previously filed with the Registrant’s Quarterly Report on Form 10-Q for the period ended July 3, 1999).
10.24	Line of Credit Agreement with Silicon Valley Bank dated June 11, 1999 filed herewith. (Incorporated herein by reference to Exhibit 10.35 previously filed with the Registrant’s Quarterly Report on Form 10-Q for the period ended July 3, 1999).
10.25†	Amendment to License Agreement between ArthroCare Corporation and Inamed Corporation dated October 1, 1999. (Incorporated herein by reference to Exhibit 10.33 previously filed with the Registrant’s Registration Statement on Form S-3 (Registration No. 333-87187)).
10.26	First Amendment to Rights Agreement between the ArthroCare Corporation and Norwest Bank Minnesota, N.A. (the “Rights Agent”) dated March 10, 2000. (Incorporated herein by reference to Exhibit 99.1 previously filed with the Registrant’s Form 8-K filed March 10, 2000.)
10.27*	Nonstatuatory Stock Option Plan and form of Stock Option Agreement thereunder. (Incorporated herein by reference to Exhibit 10.35 filed previously with this the Registrant’s Annual Report on Form 10-K for the period ended December 31, 1999).
10.28†	License Agreement between ArthroCare Corporation and Stryker Corporation, dated June 28, 2000. (Incorporated herein by reference to Exhibit 10.36 filed previously with this the Registrant’s Quarterly Report on Form 10-Q for the period ended July 1, 2000).

45

10.29*	Change of Control Agreement between the Registrant and Michael Baker, CEO, dated September 25, 2001. (Incorporated herein by reference to Exhibit 10.37 filed previously with the Registrant’s Quarterly Report on Form 10-Q for the period ended September 29, 2001).
10.30*	Amendment to the 1993 Incentive Plan (Incorporated herein by reference to Exhibit 4.2 to the Registrant’s Registration Statement on Form S-8 filed on August 8, 2000).
10.31*	Amendment to the 1995 Director Option Plan (Incorporated herein by reference to Exhibit 4.3 to the Registrant’s Statement on Form S-8 filed on August 8, 2000).
10.32††	Share Purchase Agreement relating to the entire issued share capital of Atlantech Medical Devices Limited and Atlantech Medical Devices (UK), Limited, dated October 21, 2002.
21.1	Subsidiaries of the Registrant.
23.1	Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1	Power of Attorney (see Page 74).

† Confidential treatment has been granted as to portions of this exhibit.

†† Confidential treatment has been requested as to portions of this exhibit.

* Management contract or compensatory plan or arrangement.

(b)  Reports on Form 8-K.

On November 26, 2002, the Company filed a current report on Form 8-K relating to a change in its fiscal year.

46

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of ArthroCare Corporation:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)1 on page 43 present fairly, in all material respects, the financial position of ArthroCare Corporation and its subsidiaries (the “Company”) at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)2 on page 43 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/    PricewaterhouseCoopers LLP

San Jose, California

February 5, 2003

47

ARTHROCARE CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31,
	2002			2001
ASSETS
Current assets:
Cash and cash equivalents	$	40,753		$	41,507
Available-for-sale securities		5,702			26,662
Accounts receivable, net of allowances of $1,073 in 2002 and $776 in 2001		18,380			18,567
Inventories		22,651			14,207
Deferred tax asset		1,184			4,079
Prepaid expenses and other current assets		1,897			2,171
Total current assets		90,567			107,193
Available-for-sale securities		6,396			8,526
Property and equipment, net		18,123			13,068
Related party receivables		1,205			1,205
Deferred tax asset		4,130			3,415
Intangible assets		5,102			—
Goodwill		10.040			—
Other assets		389			290
Total assets	$	135,952		$	133,697
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	8,074		$	3,142
Accrued liabilities		5,876			1,111
Accrued compensation		3,678			3,837
Income taxes payable		—			461
Total current liabilities		17,628			8,551
Loan payable		47			—
Deferred rent		114			53
Total liabilities		17,789			8,604
Commitments and contingencies: (Note 9)
Preferred stock, par value $0.001:
Authorized: 5,000 shares;
Issued and outstanding: none		—			—
Common stock, par value $0.001:
Authorized: 75,000 shares;
Issued and outstanding: 21,172 shares in 2002 and 21,855 shares in 2001		21			22
Treasury stock: 1,978 shares in 2002 and 951 shares in 2001		(31,104	)		(18,987	)
Additional paid-in capital		149,397			146,081
Accumulated other comprehensive loss		(984	)		(1,724	)
Retained earnings/(accumulated deficit)		833			(299	)
Total stockholders’ equity		118,163			125,093
Total liabilities and stockholders’ equity	$	135,952		$	133,697

The accompanying notes are an integral part of these consolidated financial statements.

48

ARTHROCARE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Year Ended December 31,
	2002			2001			2000
Revenues:
Product sales	$	84,965		$	70,300		$	62,164
Royalties, fees and other		3,822			8,075			3,615
Total revenues		88,787			78,375			65,779
Cost of product sales		33,409			27,691			25,662
Gross profit		55,378			50,684			40,117
Operating expenses:
Research and development		8,826			8,036			7,145
Sales and marketing		36,519			29,652			20,624
General and administrative		10,880			5,306			4,850
Total operating expenses		56,225			42,994			32,619
Income (loss) from operations		(847	)		7,690			7,498
Interest income		1,828			3,434			4,845
Interest expense		(94	)		(53	)		—
Other income		811			4,666			58
Income before income taxes		1,698			15,737			12,401
Income tax provision/ (benefit)		566			5,677			(3,444	)
Income before cumulative effect of a change in accounting principle		1,132			10,060			15,845
Cumulative effect on prior years of the adoption of SAB 101, “Revenue Recognition in Financial Statements”		—			—			(4,300	)
Net income	$	1,132		$	10,060		$	11,545
Net income per share—basic:
Income per share before cumulative effect of a change in accounting principle	$	0.05		$	0.45		$	0.72
Cumulative effect on prior years of the adoption of SAB 101, “Revenue Recognition in Financial Statements”		—			—			(0.19	)
Basic net income per share	$	0.05		$	0.45		$	0.53
Shares used in computing basic net income per share		21,467			22,222			21,923
Net income per share—diluted:
Income per share before cumulative effect of a change in accounting principle	$	0.05		$	0.43		$	0.68
Cumulative effect on prior years of the adoption of SAB 101, “Revenue Recognition in Financial Statements”		—			—			(0.18	)
Diluted net income per share	$	0.05		$	0.43		$	0.50
Shares used in computing diluted income per share		22,330			23,182			23,167

The accompanying notes are an integral part of these consolidated financial statements.

49

ARTHROCARE CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except per share data)

	Common Stock Shares		Common Stock Amount			Treasury Stock Amount			Additional Paid-In Capital		Notes Receivable From Stock- holder			Accumulated Other Compre- hensive Income/ (Loss)			Accum- ulated Deficit			Total Stock- holders’ Equity			Compre- hensive Income/ (Loss)
Balances, December 31, 1999	21,382		$	21		$	—		$	125,190	$	(273	)	$	(151	)	$	(21,904	)	$	102,883		$	5,431
Issuance of common stock through:
Exercise of options	791			1			—			4,632		—			—			—			4,633			—
Employee stock purchase plan	18			—			—			398		—			—			—			398			—
Employee bonus	6			—			—			163		—			—			—			163			—
Restricted stock expense	19			—			—			428		—			—			—			428			—
Stock compensation	—			—			—			246		—			—			—			246			—
Income tax benefit resulting from exercise of stock options	—			—			—			6,245		—			—			—			6,245			—
Repayment of notes receivable from stockholder	—			—			—			—		273			—			—			273			—
Change in unrealized gain on available-for-sale securities	—			—			—			—		—			(160	)		—			(160	)		(160	)
Currency translation adjustment	—			—			—			—		—			(309	)		—			(309	)		(309	)
Net income	—			—			—			—		—			—			11,545			11,545			11,545
Balances, December 31, 2000	22,216			22			—			137,302		—			(620	)		(10,359	)		126,345		$	11,076
Issuance of common stock through:
Exercise of options	559			—			—			4,961		—			—			—			4,961			—
Employee stock purchase plan	30			—			—			493		—			—			—			493			—
Employee bonus	1			—			—			21		—			—			—			21			—
Restricted stock expense	—			—			—			232		—			—			—			232			—
Stock compensation	—			—			—			268		—			—			—			268			—
Income tax benefit resulting from exercise of stock options	—			—			—			2,804		—			—			—			2,804			—
Change in unrealized gain on available-for-sale securities	—			—			—			—		—			308			—			308			308
Currency translation adjustment	—			—			—			—		—			(1,412	)		—			(1,412	)		(1,412	)
Purchase of common stock	(951	)		—			(18,987	)		—		—			—			—			(18,987	)		—
Net income	—			—			—			—		—			—			10,060			10,060			10,060
Balances, December 31, 2001	21,855			22			(18,987	)		146,081		—			(1,724	)		(299	)		125,093		$	8,956
Issuance of common stock through:
Exercise of options	293			—			—			1,989		—			—			—			1,989			—
Employee stock purchase plan	51			—			—			542		—			—			—			542			—
Restricted stock expense	—			—			—			23		—			—			—			23			—
Stock compensation	—			—			—			83		—			—			—			83			—
Income tax benefit resulting from exercise of stock options	—			—			—			679		—			—			—			679			—
Change in unrealized gain on available-for-sale securities	—			—			—			—		—			(80	)		—			(80	)		(80	)
Currency translation adjustment	—			—			—			—		—			820			—			820			820
Purchase of common stock	(1,027	)		(1	)		(12,117	)		—		—			—			—			(12,118	)		—
Net income	—			—			—			—		—			—			1,132			1,132			1,132
Balances, December 31, 2002	21,172		$	21		$	(31,104	)	$	149,397	$	—		$	(984	)	$	833		$	118,163		$	1,872

The accompanying notes are an integral part of these consolidated financial statements.

50

ARTHROCARE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2002			2001			2000
Cash flows from operating activities:
Net income	$	1,132		$	10,060		$	11,545
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		7,589			5,752			4,136
Provision for doubtful accounts receivable and product returns		297			216			(123	)
Provision for excess and obsolete inventory		143			(323	)		(390	)
Non cash stock compensation expense		106			500			674
Issuance of common stock for employees bonuses		—			21			163
Income tax benefit relating to employee stock options		679			2,804			6,245
Deferred rent		61			(32	)		(49	)
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
Accounts receivable		2,000			(3,238	)		(2,169	)
Inventories		(5,832	)		(330	)		(6,352	)
Deferred tax asset		—			3,648			(11,142	)
Prepaid expenses and other current assets		437			(597	)		(960	)
Accounts payable		2,619			(1,002	)		1,055
Accrued liabilities		1,501			459			566
Income taxes payable		(1,144	)		461			—
Deferred revenue		—			(5,476	)		5,454
Other assets		(99	)		(48	)		23
Net cash provided by operating activities		9,489			12,875			8,676
Cash flows from investing activities:
Purchases of property and equipment		(12,235	)		(9,351	)		(6,239	)
Payment for purchase of Atlantech, net of cash acquired		(12,506	)		—			—
Purchases of available-for-sale securities		(133,516	)		(62,931	)		(65,148	)
Sales or maturities of available-for-sale securities		156,526			79,083			45,688
Net cash provided by (used in) investing activities		(1,731	)		6,801			(25,699	)
Cash flows from financing activities:
Purchase of treasury stock		(12,118	)		(18,987	)		—
Repayment of capital leases		—			(82	)		(65	)
Repayment of notes receivable from stockholder		—			—			273
Proceeds from loan from bank		47			—			—
Proceeds from issuance of common stock net of issuance costs		542			493			398
Proceeds from exercise of options to purchase common stock		1,989			4,961			4,633
Net cash provided by (used in) financing activities		(9,540	)		(13,615	)		5,239
Effect of exchange rate on cash and cash equivalents		1,028			(336	)		(309	)
Net increase (decreases) in cash and cash equivalents		(754	)		5,725			(12,093	)
Cash and cash equivalents, beginning of year		41,507			35,782			47,875
Cash and cash equivalents, end of year	$	40,753		$	41,507		$	35,782
Supplemental disclosure of cash flow information:
Cash paid for interest		5			13			10
Cash paid for income tax		4			95			300

The accompanying notes are an integral part of these consolidated financial statements.

51

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1.    FORMATION AND BUSINESS OF THE COMPANY:

ArthroCare Corporation (“we” or the “company”) was incorporated on April 29, 1993 and our principal operations commenced in August 1995. We design, develop, manufacture and market medical devices for use in soft-tissue surgery. Our products are based on our patented soft-tissue surgical controlled ablation technology, which we call Coblation technology. Coblation technology involves an innovative use and the capability of performing at temperatures lower than traditional electrosurgical tools. Our strategy includes applying Coblation technology to a broad range of soft-tissue surgical markets, including arthroscopy, spinal surgery, neurosurgery, cosmetic surgery, ear, nose and throat (ENT) surgery, gynecology, urology, general surgery and various cardiology applications. We are a global company with manufacturing facilities in the United States and Costa Rica and sales offices throughout the United States and Europe.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation.    For fiscal 2000 and 2001, we maintained a fifty-two/fifty-three week fiscal year cycle ending on a Saturday. Fiscal 2000 and 2001 each consisted of 52 weeks. In 2002, we changed our fiscal year to conform to the calendar year. For presentation purposes all year end dates in the accompanying consolidated financial statements are shown as December 31.

Use of Estimates.    The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities in the consolidated financial statements and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Principles of Consolidation.    The consolidated financial statements include the accounts of ArthroCare and all of its wholly-owned subsidiaries. All significant inter-company transactions and accounts have been eliminated.

Cash and Cash Equivalents and Available-for-Sale Securities.    We consider all highly liquid investments purchased with original maturities of ninety days or less to be cash equivalents. Cash and cash equivalents include money market funds and various deposit accounts.

We have classified our investments as “available-for-sale.” Such investments are recorded at fair value and unrealized gains and losses are recorded as a separate component of other comprehensive income until realized. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to interest income. Realized gains and losses, if any, are determined using the specific identification method.

Inventories.    Our inventories are stated at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis.

Property and Equipment.    Property and equipment, including equipment under capital leases, is stated at cost and is depreciated on a straight-line basis over the estimated useful lives of three to five years. We place the majority of our controller units with customers in order to facilitate the sale of disposable devices. Controller units placed with customers are capitalized at cost and amortized over a three-year period to cost of goods sold. Leasehold improvements are amortized over the shorter of the estimated useful lives or the lease term. Maintenance and repair costs are charged to operations as incurred.

Revenue Recognition.    We recognize product and royalty revenue upon shipment of our products to customers, upon fulfillment of acceptance terms, if any, when no significant contractual obligations remain and

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collection of the related receivable is reasonably assured. Revenue is reported net of a provision for estimated product returns. Revenue related to collaborative research and development contracts is recognized as the related work is performed. We recognize license fee and milestone revenue from business partners over the term of the associated agreement unless the fee or milestone is in exchange for products delivered or services performed that represent the culmination of a separate earnings process.

Amounts billed to customers relating to shipping and handling costs have been classified as royalties, fees and other revenues and related costs are classified as cost of product sales on the accompanying statement of operations.

During the quarter ended September 30, 2000, effective January 1, 2000, we adopted SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), and changed our method of accounting for license fees and milestones to recognize such revenues over the term of the associated agreement unless the fee or milestone is in exchange for products delivered or services performed that represent the culmination of a separate earnings process. Amounts received prior to revenue recognition are recorded as deferred revenue. The cumulative effect of the change in accounting principle of $4.3 million (or $0.19 and $0.18 per share basic and diluted, respectively) was reported as a cumulative effect of a change in accounting principle, retroactive to January 1, 2000. The cumulative effect of the change in accounting principle includes license fee revenues and deferred revenues that were recognized over the lives of the associated agreements.

We previously recognized commissions to stocking distributors as sales and marketing expenses at the time the related revenue was recognized. On January 1, 2002, we adopted Emerging Issues Task Force (“EITF”) Issue No. 01-09, “Accounting for Consideration Given by a Vendor (including a Customer of a Reseller of the Vendor’s products),” and changed our method of accounting for commissions to stocking distributors, to record such consideration as a reduction of revenue. All periods presented have been reclassified to conform to the current period. The impact of this change was a $4.9 million and $1.8 million reduction of both revenue and sales and marketing expense in fiscal 2001 and 2000, respectively.

Goodwill.    We adopted Statement of Accounting Standards (“SFAS”) No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002. Accordingly, goodwill is not amortized, but rather tested for impairment on an annual basis, and in the interim if events and circumstances indicate that goodwill may be impaired. Impairment is measured by the difference between the recorded value of goodwill and its implied fair value when the fair value of the reporting unit is less than its net book value. Through December 31, 2002, no goodwill impairment losses were required.

Impairment of Long-Lived Assets.    Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally one to five years.

Research and Development.    Research and development costs are charged to operations as incurred.

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Stock-Based Compensation.    We account for stock-based employee compensation using the intrinsic value method of accounting. Under the intrinsic value method of accounting, employee stock-based compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price of the award. We account for stock options issued to non-employees using the fair value method of accounting. Assumptions used in determining the fair value of non-employee stock option grants, in 2002, using the Black-Scholes pricing model, were: risk-free interest rate of 3.75%, expected life of 5 years, expected dividends of zero, and expected volatility of 70%.

Had employee stock-based compensation been determined based on the fair value at the grant date for awards in fiscal years 2002, 2001, and 2000, the company’s net income per share and fully diluted net income per share for the years ended December 31, 2002, 2001, and 2000 would have been as indicated below:

	Year Ended December 31,
	2002			2001			2000
	(in thousands, except per share data)
Net income—as reported	$	1,132		$	10,060		$	11,545
Employee stock-based compensation expense determined under the fair value method, net of related tax effects		(12,236	)		(12,735	)		(7,770	)
Pro forma net income (loss)	$	(11,104	)	$	(2,675	)	$	3,775
Earnings per share:
Basic—as reported	$	0.05		$	0.45		$	0.53
Basic—pro forma	$	(0.52	)	$	(0.12	)	$	0.17
Diluted—as reported	$	0.05		$	0.43		$	0.50
Diluted—pro forma	$	(0.52	)	$	(0.12	)	$	0.16

In determining the proforma net income (loss), the fair value of each employee option grant was estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions:

Stock Option Plans

	Year Ended December 31,
	2002	2001	2000
Risk-free interest rate	2.62-4.97%	3.61-5.08%	4.98-7.13%
Expected life	5 years	5 years	5 years
Expected dividends	—	—	—
Expected volatility	70%	70%	80%

Employee Stock Purchase Plan

	Year Ended December 31,
	2002	2001	2000
Risk-free interest rate	1.06-2.20%	1.80-4.06%	5.96-7.18%
Expected life	0.5 years	0.5 years	0.5 years
Expected dividends	—	—	—
Expected volatility	70%	70%	96%

The weighted average fair value of options granted to employees during the year ended December 31, 2002 was $6.56 per share.

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Foreign Currency Translation.    The functional currency of Atlantech Medical Devices, Ltd. and Atlantech GmbH (together “Atlantech”) is the UK Pound and the Euro respectively. Accordingly, all balance sheet accounts of this operation are translated into U.S. dollars using the current exchange rate in effect at the balance sheet date, and revenues and expenses are translated using the average exchange rate in effect during the period. The gains and losses from foreign currency translation of Atlantech’s financial statements are recorded directly into a separate component of stockholders’ equity under the caption Accumulated other comprehensive income.

The functional currency of all other non-U.S. operations is the U.S. dollar. Accordingly, all monetary assets and liabilities of these foreign operations are translated into U.S. dollars at current period-end exchange rates and non-monetary assets and related elements of expense are translated using historical rates of exchange. Income and expense elements are translated to U.S. dollars using average exchange rates in effect during the period. Gain and losses from foreign currency transactions of these subsidiaries’ financial statements are recorded as other income or loss in the statement of operations.

Concentration of Risks and Uncertainties.    Substantially all of our cash and cash equivalents are maintained at financial institutions in the United States. Deposits at these institutions may exceed the amount of insurance provided on such deposits. We have not experienced any losses on our deposits of cash and cash equivalents.

We purchase certain key components of our products, from sole, single or limited source suppliers. For some of these components there are few alternative sources. A reduction or stoppage in supply of sole-source components would limit our ability to manufacture certain products. There can be no assurance that an alternate supplier could be established if necessary or that available inventories would be adequate to meet our production needs during any prolonged interruption of supply.

Our products require approval from the United States Food and Drug Administration (FDA) and international regulatory agencies prior to the commencement of commercial sales. There can be no assurance that our products will receive any of these required approvals. If we were denied such approvals, or if such approvals were delayed, it would have a material adverse impact on our business.

Sales to both international and domestic customers are generally made on open credit terms. Management performs ongoing credit evaluations of the company’s customers and maintains an allowance for potential credit losses when needed but historically has not experienced any significant losses related to individual customers or a group of customers in any particular geographic area. See Note 14 for further discussion of international sales.

Fair Value of Financial Instruments.    The carrying value of our financial instruments approximate fair value.

Income Taxes.    We account for income taxes under the liability method whereby deferred tax asset or liability account balances are determined based on the difference between the financial statement and the tax bases of assets and liabilities using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Recent Accounting Pronouncements.    In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures

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about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The company has complied with the disclosure requirements and is currently in the process of determining the financial effects, if any, of adopting the recognition and measurement provisions on the consolidated financial statements.

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The company is in the process of determining the financial effects, if any, on its consolidated financial statements.

In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods ending after December 15, 2002. The company has complied with the disclosure requirements of SFAS No. 148.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The company is in the process of determining the financial effects, if any, on its consolidated financial statements.

Reclassification.    Certain amounts in the prior financial statements have been reclassified to conform to the current year presentation. These reclassifications did not impact previously reported total assets, liabilities, stockholders’ equity or net income.

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3.    COMPUTATION OF NET INCOME PER SHARE:

Basic net income per common share is computed using the weighted average number of shares of common stock outstanding. Diluted net income per common share is computed using the weighted average number of shares of common stock outstanding and potential shares of common stock when they are dilutive. The following is a reconciliation of the numerator (net income) and the denominator (number of shares) used in the calculation of basic and diluted net income per share (in thousands, except per share data):

	Year Ended December 31,
	2002		2001		2000
Income before cumulative effect of a change in accounting principle	$	1,132	$	10,060	$	15,845
Cumulative effect on prior years of the change in accounting principle		—		—		(4,300	)
Net income	$	1,132	$	10,060	$	11,545
Basic:
Weighted average common shares outstanding		21,467		22,222		21,923
Income per share before cumulative effect of a change in accounting principle	$	0.05	$	0.45	$	0.72
Net income per share	$	0.05	$	0.45	$	0.53
Diluted:
Weighted average common shares outstanding used in basic calculation		21,467		22,222		21,923
Options		832		883		1,174
Warrants		31		77		70
Total weighted common stock and common stock equivalents		22,330		23,182		23,167
Income per share before cumulative effect of a change in accounting principle	$	0.05	$	0.43	$	0.68
Net income per share	$	0.05	$	0.43	$	0.50
Antidilutive securities:
Options to purchase common stock		4,359		397		41

Options to purchase 4,359,000 shares of common stock at prices ranging from $13.42-$48.56 per share outstanding at the end of 2002 were not included in the computation of diluted net income per share because their effects are anti-dilutive. Options to purchase 397,000 shares of common stock at prices ranging from $25.03-$48.56 per share outstanding at the end of 2001 were not included in the computation of diluted net income per share because their effects are anti-dilutive. Options to purchase 41,000 shares of common stock at prices ranging from $36.12-$48.56 per share outstanding at the end of 2000 were not included in the computation of diluted net income per share because their effects are anti-dilutive.

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4.    AVAILABLE-FOR-SALE SECURITIES:

The following summarizes our available-for-sale securities at December 31 (in thousands):

	2002
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Market Value
Maturity date less than 1 year:
Corporate notes and bonds	$	5,864	$	—	$	(162	)	$	5,702
Maturity date greater than 1 year but less than 5 years:
Corporate notes and bonds		6,202		194		—			6,396
Total	$	12,066	$	194	$	(162	)	$	12,098
	2001
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Market Value
Maturity date less than 1 year:
Commercial paper	$	10,124	$	49	$	—		$	10,173
Corporate notes and bonds		16,483		12		(6	)		16,489
Maturity date greater than 1 year but less than 5 years:
Corporate notes and bonds		8,471		72		(17	)		8,526
Total	$	35,078	$	133	$	(23	)	$	35,188

Realized gains were $0.9 million, $4.4 million and $0 million in 2002, 2001 and 2000, respectively, and included in other income on the consolidated financial statements.

5.    INVENTORY:

The following summarizes our inventories at December 31 (in thousands):

	December 31,
	2002		2001
Inventories
Raw materials	$	6,937	$	5,678
Work-in-progress		4,519		2,692
Finished goods		11,195		5,837
	$	22,651	$	14,207

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6.    PROPERTY AND EQUIPMENT:

The following summarizes our property and equipment at December 31 (in thousands):

	December 31,
	2002			2001
Property and equipment:
Machinery and equipment	$	2,667		$	1,787
Land		760			—
Building and improvements		1,300			—
Construction in process		1,622			2,414
Tooling and molds		1,487			906
Computer equipment		6,098			4,189
Controller placements		22,798			17,315
Furniture and fixtures		954			386
Leasehold improvements		2,107			350
		39,793			27,347
Less accumulated depreciation and amortization		(21,670	)		(14,279	)
Property and equipment, net	$	18,123		$	13,068

Depreciation and amortization expense related to our property and equipment was $7.4 million, $5.8 million and $4.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.

7.    INTANGIBLE ASSETS:

Intangible assets, resulting from the acquisition of Atlantech, are estimates based on independent fair value assessments. Intangible assets consist of the following (in thousands):

Distribution/customer network	$	2,900
OEM contractual agreements		1,100
Patents		200
Trade name/trademarks		700
Employment agreements		300
Non-competition agreements		100
	$	5,300
Accumulated amortization		(198	)
Net intangible assets	$	5,102

Intangible assets are amortized on a straight-line basis over the periods benefited, which range between one and five years. The estimated amortization expense for the next 5 years is $1,163,000 in 2003, $1,080,000 in 2004, $1,063,000 in 2005, $980,000 in 2006 and $816,000 in 2007.

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8.    ACCRUED LIABILITIES:

The following summarizes our accrued liabilities at December 31 (in thousands):

	December 31,
	2002		2001
Accrued liabilities:
Accrued professional fees	$	380	$	103
Accrued warranty		243		238
Uninvoiced receipts		2,432		617
Purchase consideration payable for acquired business		1,873		—
Other		948		153
	$	5,876	$	1,111

9.    COMMITMENTS AND CONTINGENCIES:

Operating Leases

We lease our facilities and certain equipment under operating leases. The company recognizes rent expense on a straight-line basis over the lease term. At December 31, 2002, total future minimum lease payments are as follows (in thousands):

2003	$	1,604
2004		1,624
2005		1,548
2006		1,568
2007		262
Thereafter		—
	$	6,606

Warranties

The Company generally provides customers with a limited 90-day warranty on products sold and a limited 1-year warranty on loaned controller units. We accrue for the estimated cost of product warranties at the time revenue is recognized. Our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. We periodically evaluate and adjust the warranty reserve to the extent actual warranty expense varies form the original estimates. The following table describes the activity in our warranty accrual for the year ended December 31, 2002 (in thousands):

Balance at beginning of year	$	238
Accruals for warranties issued during the period		482
Settlements made during the period		(477	)
Balance at end of year	$	243

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Litigation

On July 25, 2001, ArthroCare filed a lawsuit against Smith & Nephew, Inc. (“the Defendant”) in the United States District Court of Delaware. The lawsuit alleges, among other things, that the Defendant has been, and is currently, infringing three patents issued to ArthroCare specifically, the Defendants use, import, market and sell an electrosurgical system under the name Dyonics Control RF System that infringes these patents. ArthroCare seeks the following remedies: (1) a judgment that the Defendant has infringed these patents; (2) a permanent injunction precluding the Defendant from using, importing, marketing and selling the Dyonics Control RF System; and (3) an award of damages (including attorneys’ fees) to compensate us for lost profits and Defendant’s use of our inventions, with the damages to be trebled because of the Defendant’s willful infringement. This lawsuit is pending and a jury trial is scheduled to commence in April 2003.

In conjunction with a medial malpractice suit against a physician, a product liability suit was brought against us in the Superior Court Arizona, county of Yavapai on August 24, 2001. The lawsuit alleges that a patient, D. Earl suffered internal and external injury to the patient’s knee as a result of a defective ArthroCare probe used in an arthroscopy procedure on the patient. ArthroCare believes these claims to be without merit.

In April 2002, a product liability suit was brought against us in the United States District Court, District of Maine. The lawsuit includes a claim for punitive damages. Punitive damages, if awarded, are not covered by our insurance policies, and we would be required to pay such punitive damages that were awarded. ArthroCare believes these claims to be without merit and is defending itself vigorously.

In September 2002, a product liability suit was brought against us in the 269th Judicial District Court, Harris County, Texas. ArthroCare believes these claims to be without merit and intends to defend itself vigorously.

In October 2002, ArthroCare acquired all of the outstanding shares of Atlantech Medical Devices, Ltd. (“Atlantech”), a distributor of medical device products in the United Kingdom. Atlantech was involved in litigation with a former reseller regarding termination of a purported distribution agreement and seeks damages for alleged breach of contract. The lawsuit was settled in February 2003.

We believe that we have meritorious defenses against the above unsettled claims and intend to vigorously contest them. The outcomes of the outstanding litigation matters discussed above are not considered probable or cannot be reasonably estimated. Also, except as otherwise described above, ArthroCare has product liability insurance coverage in amounts its considers necessary to prevent material losses. We record a liability when a loss is known or considered probable and the amount can be reasonably estimated. If a loss is not probable or a probable loss cannot be reasonably estimated, a liability is not recorded. While it is not possible to predict the outcome of the actions discussed above, we believe that costs associated with them will not have a material adverse impact on our financial position or liquidity, but could be material to the consolidated results of operations of any one period.

10.    STOCKHOLDERS’ EQUITY:

Stock Split.    In March 2000, our Board of Directors approved a two-for-one stock split of our common stock, effective for stockholders of record as of June 19, 2000. Our common stock began trading on a post-split basis on July 5, 2000. All references in the accompanying consolidated financial statements to the number of common shares have been restated to give the effect to the stock split.

Preferred Stock.    Under our Certificate of Incorporation, we are authorized to issue preferred stock. At December 31, 2002, 5,000,000 shares of preferred stock were authorized and no preferred stock was issued and

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outstanding as the previously outstanding preferred stock was converted into common stock in connection with our initial public offering in 1996.

Treasury Stock.    In April 2001, the Board of Directors authorized the repurchase of up to 1,000,000 shares of our common stock, subject to certain limitations and conditions. In June of 2002, the Board of Directors authorized an additional 2,000,000 shares to be repurchased, for a total of 3,000,000 shares to be repurchased. In 2002, we repurchased 49,000 shares in the quarter ended March 30, 2002, at a cost of $0.7 million, 51,700 shares in the quarter ended June 29, 2002, at a cost of $0.6 million and 926,041 shares in the quarter ended September 28, 2002, at a cost of $10.8 million. In fiscal 2001, we repurchased 154,000 shares in the quarter ended June 30, 2001 at a cost of $2.7 million, 647,000 shares in the quarter ended September 30, 2001 at a cost of $13.6 million, and 150,000 shares in the quarter ended December 31, 2001 at a cost of $2.7 million. The shares will be used to offset the potentially dilutive effect of employee incentive programs and may be used for other purposes that we deem appropriate.

Stock Option Plans.    In May 1993, we approved the 1993 Stock Plan (1993 Plan) under which the Board of Directors is authorized and directed to enter into stock option agreements with selected individuals. 272,000 shares were authorized at the inception of the 1993 Plan with 500,000, and 2,300,050 additional shares authorized in 1994, and 1995, respectively. In May 1998, and June 2000, our stockholders approved increases in the number of shares reserved for issuance under the 1993 Plan by an aggregate of 1,500,000 and 800,000, respectively, for a total of 5,372,050. In October 2002, the Board of Directors authorized an increase of 900,000 shares to the 1999 Stock Option plan. Options granted under the 1993 Plan generally become exercisable over a 48-month period. In August 1999, we granted 38,000 shares of restricted stock in accordance with the terms of the 1993 Plan, which vested every six months over two years. At the end of 2002, 2001, and 2000, there were 1,765,000, 1,496,000, and 1,228,000 options, respectively, exercisable under the 1993 Plan.

Activity under the 1993 Plan is as follows (in thousands, except per share data):

	Outstanding Options
	For Grant		Number of Shares		Weighted- Average Exercise Price
Balances, December 31, 1999	515		2,874		$	6.90
Additional shares authorized	800		—
Options granted	(352	)	353		$	21.47
Options exercised	—		(730	)	$	5.62
Options canceled	18		(18	)	$	9.92
Balances, December 31, 2000	981		2,479		$	9.45
Options granted	(400	)	400		$	27.75
Options exercised	—		(402	)	$	24.65
Options cancelled	46		(47	)	$	8.76
Balances, December 31, 2001	627		2,430		$	12.82
Additional shares authorized	250		—
Options granted	(691	)	691		$	12.17
Options exercised	—		(250	)	$	6.33
Options cancelled	18		(18	)	$	10.00
Balances, December 31, 2002	204		2,853		$	13.25

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The options outstanding and currently exercisable by exercise price for all plans at December 31, 2002 were as follows (in thousands, except per share data and contractual life):

Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable As of December 31, 2002	Weighted Average Exercise Price
$  0.1000-$  5.5625	653,083	4.15	$	3.9995	653,083	$	3.9995
5.7500-  10.0000	675,344	6.66		8.3090	516,109		7.8989
10.2500-  11.5100	597,900	9.51		10.9563	34,143		10.8163
11.7000-  13.7500	694,514	9.21		12.8415	176,723		13.1129
14.0400-  16.7500	721,394	8.90		15.3145	144,103		15.8401
17.3000-  20.6250	621,783	7.43		18.1705	392,994		17.9384
20.8800-  23.0000	904,389	7.49		22.5742	556,032		22.5432
23.4100-  27.5600	715,316	8.47		26.9003	301,121		26.4369
27.7500-  46.6250	348,334	7.49		37.1102	238,288		38.0774
48.5625-  48.5625	500	7.21		48.5625	500		48.5625
	5,932,557	7.72	$	16.6282	3,013,096	$	16.0306

In December 1995, we adopted the Director Option Plan (“Director Plan”) and reserved 200,000 shares of common stock for issuance to directors under this plan. The plan allows for an initial grant and automatic annual grants of options to outside directors of the company. In May 2002, our shareholders approved an amendment to the Director Plan to increase the number of shares available for issuance by 100,000 shares. In June 2000, our shareholders approved an amendment to the Director Plan to increase the number of shares available for issuance by 290,000 shares for a total of 490,000. For fiscal years, 2002, 2001 and 2000 outstanding options under the Director Plan were 398,000, 310,000 and 153,000, respectively, with 266,000 options exercisable as of December 31, 2002. Shares exercised in 2002 were 42,000.

Nonstatutory Option Plan.    In August 1999, we approved the Nonstatutory Option Plan (“1999 Plan”). In June 2001 we authorized an amendment, effective April 26, 2001, maximizing the aggregate numbers of shares authorized under the plan to be 2,150,000. In October 2002, the Board of Directors authorized an increase of 900,000 shares to the plan. For fiscal years 2002, 2001 and 2000 there were 2,681,000, 1,917,000, and 1,283,000 options outstanding, respectively with 982,000 options exercisable as of December 31,2002. Shares exercised in 2002 were 600.

Employee Stock Purchase Plan.    In December 1995, we approved the Employee Stock Purchase Plan and reserved 300,000 shares of common stock for issuance under this plan. For fiscal years 2002, 2001 and 2000, 51,000 shares, 30,000 shares and 18,000 shares of common stock were sold under the Employee Stock Purchase Plan, respectively. Under the plan, regular full-time employees (subject to certain exceptions) may contribute up to 10% of base compensation to the semi-annual purchase of shares of ArthroCare common stock. The purchase price is 85% of the fair market value at certain plan-defined dates.

Warrants.    In January 1998, we issued a warrant to purchase 160,000 shares of common stock at a purchase price of $6.00 per share to certain international employees. The warrant became exercisable over a four-year period. In March 1999, we issued warrants to purchase 80,000 shares of our common stock at a purchase price of $7.00 per share to certain international employees. The warrant became exercisable over a four-year period. Warrants to purchase 15,000, 93,000 and 153,000 shares of our common shares were outstanding during each of fiscal years 2002, 2001, and 2000, respectively, of which 15,000, 67,000 and 47,000 were exercisable at the end of 2002, 2001 and 2000, respectively.

63

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Stockholders Rights Plan.    In November 1996, our Board of Directors approved a Stockholders Rights Plan declaring a dividend distribution of one Preferred Share Purchase Right for each outstanding share of our common stock, which would issue on certain triggering events. This Plan was amended in January 2000. Each right will entitle stockholders to buy one-thousandth of one share of our Series A Participating Preferred Stock at an exercise price of $185.00. This Plan was designed to assure that our stockholders receive fair and equal treatment in the event of any proposed takeover of the company and to guard against partial tender offers and other abusive tactics to gain control of the company without paying all stockholders the fair value of their shares, including a “control premium.”

11.    RELATED PARTIES:

In connection with the formation of ArthroCare, several of the founders and a partnership of the founders entered into a licensing agreement to facilitate patent transfers. As a result, we acquired an exclusive worldwide perpetual royalty-free license, with right of sublicense, to make, use and sell products and use patent methods covered by the patent rights limited to surgical orthopedic and arthroscopic applications.

In June 1997, we loaned an officer $500,000 pursuant to a provision in the officer’s employment agreement. The promissory note, which bears no interest, is collateralized by a mortgage on the officer’s residence and is due and payable upon either the officer’s termination of employment or the sale of the officer’s residence. If the officer is terminated by us, or if we are acquired, the loan is due and payable within 12 months thereafter. As of December 31, 2002, $500,000 of principal was outstanding on this note.

In November 1997, we issued a relocation loan of $130,000 to an employee. This loan is collateralized by the employee’s residence and is due and payable upon either the sale or transfer of the property or the termination of the officer’s employment with us and bears no interest. As of December 31, 2002, $130,000 of principal was outstanding on this loan.

In April 1999, we loaned an officer $225,000 pursuant to a provision in the officer’s employment agreement. The promissory note, which bears no interest, is collateralized by a mortgage on the officer’s residence and is due and payable upon either the officer’s termination of employment or the sale of the officer’s residence. If the officer is terminated by us or if we are acquired, the loan is due and payable within 12 months thereafter. As of December 31, 2002, $225,000 of principal was outstanding on this note.

In May 1999, we loaned an officer $350,000 pursuant to a provision in the officer’s employment agreement. The promissory note, which bears no interest, is collateralized by a mortgage on the officer’s residence and is due and payable upon either the officer’s termination of employment or the sale of the officer’s residence. If the officer is terminated by us or if we are acquired, the loan is due and payable within 12 months thereafter. As of December 31, 2002, $350,000 of principal was outstanding on this note.

64

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

12.    INCOME TAXES:

The income tax provision (benefit) consisted of the following:

	December 31, 2002			December 31, 2001		December 31, 2000
Current
Federal	$	576		$	1,400	$	691
State		58			147		300
Foreign		—			482		84
Total current		634			2,029		1,075
Deferred
Federal		71			2,465		(2,091	)
State		(132	)		1,000		(1,797	)
Foreign		(7	)		183		(631	)
Total deferred		(68	)		3,648		(4,519	)
Total income tax provision/(benefit)	$	566		$	5,677	$	(3,444	)

The income tax provision (benefit) differed from a provision (benefit) computed at the U.S. statutory tax rate as follows:

	2002					2001					2000
Statutory rate tax provision	$	588		35	%	$	5,508		35	%	$	4,340		35	%
Foreign research and development cost share		204		12	%		482		3	%		3,029		24	%
Differences in foreign tax rates		12		1	%		(85	)	(1	)%		62		1	%
Foreign sales corporation benefit		—		—			—		—			(157	)	(1	)%
State income taxes		97		5	%		624		4	%		712		6	%
Nondeductible expenses		114		7	%		104		1	%		278		2	%
Research and development credits		(449	)	(27	)%		(469	)	(3	)%		(809	)	(7	)%
Change in valuation allowance		—		—			—		—			(11,238	)	(91	)%
Other		—		—			(487	)	(3	)%		339		3	%
Total income tax provision/(benefit)	$	566		33	%	$	5,677		36	%	$	(3,444	)	(28	)%

In accordance with generally accepted accounting principles, a valuation allowance must be established for a deferred tax asset if it is more likely than not that a tax benefit may not be realized from the asset in the future. At December 31, 2000 the Company evaluated its net operating losses and other deferred tax assets and liabilities in relation to the Company’s recent earnings history and its projected future earnings. As a result of this review, the Company determined that a valuation allowance was no longer required.

At December 31, 2002, the Company had federal and state net operating loss carryforwards of approximately $9,700,000 and $3,100,000, respectively, which expire at various dates beginning in the year 2004 for California purposes. In addition, the Company has approximately $2,200,000 and $1,700,000 of federal and state research and development credit carryforwards available to offset future income taxes. These federal credits begin to expire in 2008.

Under the Internal Revenue Code, certain substantial changes in the Company’s ownership could result in an annual limitation on the amount of net operating loss carryforwards and income tax credits which can be utilized in future taxable income.

65

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Our deferred tax assets and liabilities consist of the following (in thousands):

	December 31, 2002			December 31, 2001
Deferred tax assets:
Net operating loss carryforwards	$	4,051		$	6,670
Capitalized research and development costs		271			275
Research and development credit		3,289			3,415
Allowances and reserves		1,184			824
Non-goodwill intangibles		(2,078	)		—
Research and development cost share and other		(1,403	)		(3,690	)
Net deferred tax assets	$	5,314		$	7,494

13.    EMPLOYEE BENEFIT PLAN:

We maintain a Retirement Savings and Investment Plan (401(k) Plan) which covers United States based all employees. Eligible employees may defer salary (before tax) up to a federally specified maximum. Management, at its discretion, may make matching contributions on behalf of the participants in the 401(k) Plan. We matched approximately $106,000, $95,000 and $54,000 of employee contributions to the 401(k) Plan in fiscal 2002, 2001 and 2000, respectfully.

14.    SEGMENT INFORMATION:

We have organized our marketing and sales efforts into business units based on product markets. These business units are comprised of the following: Arthroscopy (shoulder and knee arthroscopic products), ENTec^®, (to include ear, nose, throat and the Visage^® cosmetic products), ArthroCare Spine^™ (to include spinal and neuro surgery products) and Coblation Technology (to include gynecology, urology, laparoscopic, general surgical and cardiology products). Our reportable segments include Arthroscopy, ENTec, ArthroCare Spine and Coblation Technology. Product sales are summarized in the table below (in thousands):

	2002		2001		2000
Product sales:
Arthroscopy	$	65,115	$	58,138	$	52,529
ENT		10,231		7,592		7,025
ArthroCare Spine		8,660		4,218		2,051
Coblation Technology		959		352		559
Total	$	84,965	$	70,300	$	62,164

66

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Internationally, the Company markets and supports its products primarily through its subsidiaries and various distributors. Revenues attributed to geographic areas are based on the country in which subsidiaries are domiciled. The following table represents a summary of product sales and long-lived assets by geographical region (in thousands):

	2002		2001		2000
Product sales:
United States	$	70,088	$	57,927	$	53,337
International		14,877		12,373		8,827
Total product sales	$	84,965	$	70,300	$	62,164
Property and equipment:
United States	$	12,269	$	11,092	$	8,805
International		5,854		1,976		664
Total property and equipment	$	18,123	$	13,068	$	9,469

15.    ACQUISITION OF ATLANTECH MEDICAL DEVICES, LTD. AND ATLANTECH GMBH:

On October 21, 2002, the Company acquired all of the outstanding common stock of Atlantech Medical Devices, Ltd. and on November 11, 2002 acquired all of the outstanding common stock of Atlantech GmbH (together, “Atlantech”) in a cash acquisition of $14.4 million, net of cash acquired. Prior to this acquisition, Atlantech served as one of our distributors in the United Kingdom and Germany and also distributed a line of sports medicine products. The Company intends to expand their international base of operations through this acquisition and this purchase of our distributors in the United Kingdom and Germany is for the purpose of expanding our international base of operations. The addition of their complementary line of sports medicine products will allow us to compete across a broader base of the sports medicine market in selected geographies. The purchase price of $14.4 million, which includes the original purchase price and contingent consideration based upon the net assets of the acquired business and on revenue targets for 2002, was accounted for using the purchase method of accounting. Under the purchase method of accounting, the purchase price was allocated to the assets acquired, including intangible assets and liabilities assumed based on the estimated fair values at the date of the acquisition. Such estimated values are preliminary and may change as more facts become known. The excess of the purchase price over the fair value of assets acquired and liabilities assumed has been recorded as goodwill. Operating results from the acquired businesses are included in the consolidated statements of operations from the date of acquisition. The fair value of the assets of Atlantech and a summary of the consideration exchanged for these assets is as follows (in thousands):

Assets acquired:
Tangible assets (primarily accounts receivable and inventory)	$	5,451
Intangible assets		5,300
Deferred tax liabilities		(2,160	)
Goodwill		10,040
Liabilities assumed		(4,252	)
Total purchase price	$	14,379

67

ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Additional payments to the former owners of Atlantech are contingent upon the future financial performance of Atlantech through 2003. This amount will be recorded as an adjustment to the total purchase price once the contingency is achieved. Additional payment to the former owners of Atlantech are contingent upon the continued employment of those former owners. This amount is being recognized as compensation expense over the period benefited through 2004.

16.    QUARTERLY FINANCIAL INFORMATION (Unaudited):

The following tables present certain unaudited consolidated quarterly financial information for each of the eight quarters ended December 31, 2002 (in thousands, except per share data). In our opinion, this quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments necessary to present fairly the information for the periods presented.

2002	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Total revenue	$	20,077	$	22,095	$	22,211	$	24,404
Gross profit		12,501		14,894		14,230		13,753
Net income (loss)		372		1,171		646		(1,057	)
Basic net income per share		0.02		0.05		0.03		(0.05	)
Diluted net income per share		0.02		0.05		0.03		(0.05	)
2001	Quarter 1		Quarter 2		Quarter 3		Quarter 4
Total revenue	$	18,014	$	22,304	$	20,262	$	17,795
Gross profit		11,359	$	15,091		12,740		11,494
Net income		1,982		3,222		2,591		2,265
Basic net income per share		0.09		0.14		0.12		0.10
Diluted net income per share		0.09		0.14		0.11		0.10

In the fourth quarter of fiscal 2002 the Company recorded $0.5 million for legal and settlement fees and $0.7 million for accounts receivable allowances.

68

ARTHROCARE CORPORATION

VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

	Balance at Beginning of Period		Additional Charged to Costs and Expenses		Deduction			Balance at End of Period
Year Ended December 31, 2002
Deducted from asset accounts:
Allowance for doubtful accounts and product returns	$	776	$	683	$	(386	)	$	1,073
Allowance for excess and obsolete inventory		440		143		—			583
Year Ended December 31, 2001
Deducted from asset accounts:
Allowance for doubtful accounts and product returns	$	560	$	216	$	—		$	776
Allowance for excess and obsolete inventory		763		—		(323	)		440
Year Ended December 31, 2000
Deducted from asset accounts:
Allowance for doubtful accounts and product returns	$	683	$	—	$	(123	)	$	560
Allowance for excess and obsolete inventory		1,153		—		(390	)		763

69

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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
By:	/s/    MICHAEL A. BAKER
	Michael A. Baker President and Chief Executive Officer

Date: March 31, 2003

70

POWER OF ATTORNEY

Know All Persons By These Presents, that each person whose signature appears below constitutes and appoints each of Michael A. Baker and Fernando Sanchez as his or her attorney-in-fact for him, in any and all capacities, to sign each amendment to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact or his substitute or substitutes may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

Signature	Title	Date
/s/    MICHAEL A. BAKER         Michael A. Baker	President, Chief Executive Officer and Director (Principal Executive Officer)	March 31, 2003
/s/    FERNANDO SANCHEZ         Fernando Sanchez	Senior Vice President Finance, Chief Financial Officer and Assistant Secretary (Principal Financial and Accounting Officer)	March 31, 2003
/s/    ANNETTE J. CAMPBELL-WHITE         Annette J. Campbell-White	Director	March 31, 2003
/s/    JAMES FOSTER         James Foster	Director	March 31, 2003
/s/    PETER L. WILSON         Peter L. Wilson	Director	March 31, 2003
/s/    JERRY P. WIDMAN         Jerry P. Widman	Director	March 31, 2003
/s/    TORD B. LENDAU         Tord B. Lendau	Director	March 31, 2003

71

CERTIFICATIONS

I, Michael Baker, certify that:

1.    I have reviewed this annual report on Form 10-K of ArthroCare Corporation;

2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.    The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)  Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)  Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c)  Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.    The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)  All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)  Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.    The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003	By:	/s/    MICHAEL A. BAKER
		Michael A. Baker President, Chief Executive Officer

72

I, Fernando Sanchez, certify that:

1.    I have reviewed this annual report on Form 10-K of ArthroCare Corporation;

2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.    The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)  Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)  Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c)  Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.    The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)  All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)  Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.    The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003	By:	/s/    FERNANDO SANCHEZ
		Fernando Sanchez Senior Vice President and Chief Financial Officer

73

ARTHROCARE CORPORATION

Report on Form 10-K for

the year ended December 31, 2002

INDEX TO EXHIBITS*

Exhibit Number	Exhibit Name
10.32††	Share Purchase Agreement relating to the entire issued share capital of Atlantech Medical Devices Limited and Atlantech Medical Devices (UK), Limited, dated October 21, 2002.
21.1	Subsidiaries of the Registrant.
23.1	Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1	Power of Attorney (see page 71).

* Only exhibits actually filed are listed. Exhibits incorporated by reference are set forth in the exhibit listing included in Item 15 of the Report on Form 10-K.

†† Confidential treatment has been requested as to portions of this exhibit.

74

EX-10.32

                                                                   Exhibit 10.32

                              DATED 21 OCTOBER 2002

                    (1) THOSE PERSONS SET OUT IN SCHEDULE ONE

                                      -AND-

                          (2) ARTHROCARE CAYMAN LIMITED

                                      -AND-

                           (3) ARTHROCARE CORPORATION

- --------------------------------------------------------------------------------

                            SHARE PURCHASE AGREEMENT

                                   relating to
                       the entire issued share capital of
                        Atlantech Medical Devices Limited
                                       and
                     Atlantech Medical Devices (UK) Limited

- --------------------------------------------------------------------------------

                           [LOGO OF LATHAM & WATKINS]

                                    London

                                 99 Bishopsgate
                                 London EC2M 3XF
                            (44) 020 7710 1000 (Tel)
                            (44) 020 7374 4460 (Fax)
                                   www.lw.com

Confidential treatment has been requested for portions of this exhibit. The copy
filed herewith omits the information subject to the confidentiality request.
Omissions are designated as * * *. A complete version of this exhibit has been
filed separately with the Securities and Exchange Commission.



THIS AGREEMENT is made the      21st     day of  October 2002.

BETWEEN:

(1)       THOSE PERSONS SET OUT AT SCHEDULE ONE (the "Vendors");

(2)       ARTHROCARE CAYMAN LIMITED a company incorporated under the laws of the
          Cayman Islands with offices at c/o Chartered Trust Services, Ltd., One
          Capital Place, Shedden Road, P.O. Box 1034 GT, Grand Cayman, Cayman
          Islands (the "Purchaser"); and

(3)       ARTHROCARE CORPORATION a company incorporated under the laws of the
          State of California, USA with offices at 680 Vaqueros Avenue
          Sunnyvale, California 94085-3523. USA (the "Guarantor").

WHEREAS:

(A)       Atlantech Medical Devices Limited ("Atlantech"), a company registered
          in England with number 3071270, has at the date of this Agreement an
          authorised share capital of (pound)50,000 divided into 39,000 ordinary
          A shares of (pound)1 each and 11,000 ordinary B shares of (pound)1
          each of which 15,678 of the said ordinary A shares and 4,221 of the
          said ordinary B shares are issued and fully paid or credited as fully
          paid and are owned by the Vendors in the proportions set out in
          schedule 1.

(B)       Atlantech Medical Devices (UK) Limited ("Atlantech UK"), a company
          registered in England with number 3156447, has at the date of this
          Agreement an authorised share capital of (pound)200 divided into 200
          ordinary shares of (pound)1 each of which 160 of the said ordinary
          shares are issued and fully paid or credited as fully paid and are
          owned by the Vendors in the proportions set out in schedule 1 (each of
          those companies mentioned at Recitals (A) and (B) being a "Company"
          and together, the "Companies").

(C)       The Vendors have agreed to sell the Shares to the Purchaser (a wholly
          owned subsidiary of the Guarantor) and the Purchaser has agreed to
          purchase the Shares in reliance (inter alia) upon the warranties and
          undertakings in this Agreement, for the consideration and otherwise
          upon and subject to the terms and conditions of this Agreement.

WHEREBY IT IS AGREED as follows:

1.   DEFINITIONS AND INTERPRETATION

1.1       In this Agreement the following words and expressions have the
          meanings set opposite them:

          "Accounts"                    the audited balance sheet as at the
                                        Balance Sheet Date and the audited
                                        profit and loss account for the last
                                        accounting reference period ended on the
                                        Balance Sheet Date of each Company and
                                        the notes, reports, statements and other
                                        documents which are required by law to
                                        be annexed to the Accounts of the
                                        company concerned and to be sent or made
                                        available to members for such Financial
                                        Year, a copy of each of which is
                                        enclosed in the Disclosure Documents;

          "Accounting Standards"        statements of standard accounting
                                        practice (including financial reporting
                                        standards) issued pursuant to section
                                        256, CA 85 by the ASB;

                                        1



          "Additional Consideration"    the consideration payable for the Shares
                                        as specified in clause 3.3;

          "Additional Revenue           consideration payable for the Shares as
          Related Consideration"        specified in clause 3.4;

          ***                           ***

          "ASB"                         Accounting Standards Board Limited (no.
                                        2526824) or such other body prescribed
                                        by the Secretary of State from time to
                                        time pursuant to section 256, CA 85;

          "Affiliate"                   in relation to any body corporate, any
                                        Holding Company or subsidiary
                                        undertaking of such body corporate or
                                        any subsidiary undertaking of a Holding
                                        Company of such body corporate;

          "Agreement"                   this Agreement including its recitals
                                        and the schedules but not the Tax Deed;

          "Associated                   a company in which a Company or
          Company"                      any Subsidiary holds shares conferring
                                        the right to exercise 20% or more of the
                                        votes which could be cast on a poll at a
                                        general meeting of such company and
                                        which is not a subsidiary of any of the
                                        companies in the Group and which is more
                                        particularly listed in schedule 2 under
                                        the heading "The Associated Companies";

          "Atlantech Products"          means those products: (a) available for
                                        purchase by third parties from either of
                                        the Companies immediately prior to the
                                        date of this Agreement; or (b) made
                                        available for purchase to third parties
                                        from either of the Companies on or
                                        following the date of this Agreement
                                        which have been developed or otherwise
                                        acquired by either of the Companies or
                                        any of the Warrantors in each case
                                        without material assistance from the
                                        Purchaser or any member of the
                                        Purchaser's Group PROVIDED THAT
                                        "Atlantech Products" shall not under any
                                        circumstances include any products
                                        manufactured or developed by the
                                        Purchaser or any Affiliate of the
                                        Purchaser (other than, following
                                        Completion, the Companies) or by either
                                        of the Companies or any of the
                                        Warrantors with material assistance from
                                        the Purchaser or the Purchaser's Group;

          "Balance Sheet Date"          in the case of (i) Atlantech Medical
                                        Devices Limited 31 December 2001 and
                                        (ii) Atlantech Medical Devices (UK)
                                        Limited 30 September 2001;
__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                        2



          "Business"                    collectively the business of the sale of
                                        medical devices carried on by the
                                        Companies and each of the Subsidiaries
                                        at the date hereof;

          "Business Day"                a day (other than a Saturday or Sunday)
                                        when banks are open for business in
                                        London;

          "CA 85"                       Companies Act 1985;

          "CAA"                         Capital Allowances Act 1990;

          "Change of Control"           shall be deemed to occur where any
                                        person acquires after Completion more
                                        than fifty (50) percent. of the issued
                                        share capital (or voting rights attached
                                        to such share capital) of the Purchaser,
                                        any Holding Company of the Purchaser,
                                        either Company or the Guarantor
                                        entitling the holder thereof to attend
                                        and vote on all matters in general
                                        meeting provided that a Change of
                                        Control shall not include an internal
                                        reorganisation of the Purchaser's Group,
                                        re-capitalisation or management buy-out
                                        of the Guarantor or any of its
                                        subsidiary companies provided that the
                                        management personnel to whom the
                                        Warrantors report remains the same
                                        immediately following such
                                        reorganisation, re-capitalisation or
                                        management buy-out as immediately prior
                                        thereto;

          "Claim"                       any claim by the Purchaser in connection
                                        with the Warranties;

          "Companies Acts"              as defined in section 744, CA 85
                                        together with the Companies Act 1989;

          "Competent Authority"         means any person or legal
                                        entity (including any government or
                                        government agency) having regulatory
                                        authority under Environmental Laws
                                        and/or any court of law or tribunal;

          "Completion"                  completion of the sale and purchase of
                                        the Shares pursuant to this Agreement;

          "Completion Accounts"         the accounts referred to in clause
                                        6.1.2, prepared in accordance with
                                        schedule 5;

          "Confidential Information"    all information received or
                                        obtained as a result of entering into or
                                        performing, or supplied by or on behalf
                                        of a party in the negotiations leading
                                        to, this Agreement and which relates to:

                                        (i)   either Company or any of the
                                              Subsidiaries and their respective
                                              Affiliates;

                                        (ii)  any aspect of the Business;

                                        (iii) the provisions of this Agreement;

                                        3



                                        (iv)  the negotiations relating to this
                                              Agreement;

                                        (v)   the subject matter of this
                                              Agreement; or

                                        (vi)  the Purchaser;

          "Connected Person"            a person connected with the Vendors or
                                        the Directors (or any former director of
                                        either Company or any of the
                                        Subsidiaries) within the meaning of
                                        section 839, ICTA 1988;

          "Consideration"               the aggregate consideration for the
                                        Shares set out in clauses 3 and 6;

          "Contingent Claim Amount"     an amount in respect of a Claim or claim
                                        under or pursuant to the Tax Deed by the
                                        Purchaser against the Warrantors not
                                        being a liability of the Warrantors
                                        determined or quantified in accordance
                                        with the terms of sub-clause 7.5.2 and
                                        being a bona fide estimate of the
                                        quantum of such liability by the
                                        Purchaser;

          "Copyright"                   copyright, design rights, topography
                                        rights and database rights whether
                                        registered or unregistered (including
                                        any applications for registration of any
                                        such thing) and any similar or analogous
                                        rights to any of the foregoing whether
                                        arising or granted under the law of
                                        England or of any other jurisdiction;

          "Directors"                   the directors of each of the Companies
                                        named in schedule 2;

          "Disclosed"                   fairly disclosed by the Disclosure
                                        Documents or fairly disclosed by the
                                        disclosures contained in the Disclosure
                                        Letter and "Disclosure" shall be
                                        construed accordingly;

          "Disclosure Documents"        the Disclosure Letter and the two
                                        identical bundles of documents collated
                                        by or on behalf of the Warrantors, the
                                        outside covers of each of which have
                                        been signed for identification by or on
                                        behalf of the Warrantors and the
                                        Purchaser;

          "Disclosure Letter"           the letter described as such of even
                                        date herewith addressed by the
                                        Warrantors to the Purchaser;

          "Encumbrance"                 any interest or equity of any person
                                        (including any right to acquire, option
                                        or right of pre-emption) or any
                                        mortgage, charge, pledge, lien,
                                        assignment, hypothecation, security
                                        interest, title retention or any other
                                        security agreement or arrangement;

          "Environment"                 any and all organisms (including man),
                                        ecosystems, property and the following
                                        media: air (including the air within
                                        buildings and the air within other
                                        natural

                                        4



                                        or man-made structures whether above or
                                        below ground); water (including water
                                        under or within land or in drains or
                                        sewers and coastal and inland waters);
                                        and land (including land under water);

          "Environmental Laws"          any and all laws, whether civil,
                                        criminal or administrative, which have
                                        as a purpose or effect the protection of
                                        the Environment, and/or the mitigation,
                                        abatement, containment or prevention of
                                        Harm and/or the provision of remedies in
                                        respect of Harm; statutes and
                                        subordinate legislation; regulations,
                                        orders, ordinances; Permits, common law,
                                        local laws and bye-laws; judgments,
                                        notices, orders of any Competent
                                        Authority;

          "Environmental Liability"     liability (including liability in
                                        respect of Remedial Action) on the part
                                        of either Company and/or any
                                        of their directors or officers or
                                        shareholders under Environmental Laws;

          "ERA"                         Employment Rights Act 1996;

          "Event"                       any payment, transaction, act, omission
                                        or occurrence of whatever nature whether
                                        or not either Company or the Purchaser
                                        is a party thereto and including:

                                        the execution of this Agreement and
                                        completion of the sale of the Shares to
                                        the Purchaser; and

                                        the death of any person;

                                        and references to an Event occurring on
                                        or before Completion shall include an
                                        Event deemed, pursuant to any Taxation
                                        Statute, to occur or be treated or
                                        regarded as occurring on or before
                                        Completion;

          "FA"                          Finance Act;

          "FRSs"                        a financial reporting standard adopted
                                        or issued by the ASB;

          "Financial Year"              a financial year within the meaning
                                        ascribed to such expression by section
                                        223, CA 85;

          "Group"                       together the Companies and the
                                        Subsidiaries (but for these purposes not
                                        including Atlantech Italia Srl);

          "Hardware"                    any and all computer, telecommunications
                                        and network equipment;

          "Harm"                        harm or damage to or other interference
                                        with the Environment;

                                        5



          "Hazardous Matter"            any and all matter (whether alone or in
                                        combination with other matter) including
                                        electricity, heat, vibration, noise or
                                        other radiation which may or is liable
                                        to cause Harm;

          "Holding Company"             a holding company within the meaning
                                        ascribed to such expression by sections
                                        736 and 736A, CA 85;

          "ICTA 1988"                   Income and Corporation Taxes Act 1988;

          "Indemnities"                 the indemnities given by the Vendors in
                                        clause 9;

          "Intellectual Property"       Patents, design rights, moral rights,
                                        registered designs, Know-How, Copyright
                                        (including rights in Software), Trade
                                        Marks and rights arising in domain
                                        names;

          "Intellectual Property        agreements or arrangements relating to
          Agreements"                   the Proprietary Intellectual Property or
                                        Third Party Intellectual Property;

          "Investments"                 the companies listed in schedule 2 under
                                        the heading "Investments";

          "IT Contracts"                any agreements or arrangements with
                                        third parties relating to IT Systems or
                                        IT Services, including all hire purchase
                                        contracts or leases of Hardware used by
                                        either Company or any of the
                                        Subsidiaries, licences of Software used
                                        by each Company or any of the
                                        Subsidiaries, and other IT procurement;

          "IP Materials"                all documents, records, tapes, discs,
                                        diskettes and any other
                                        materials whatsoever containing
                                        Copyright works, Know-How or Software;

          "IT Services"                 any services provided by a third party
                                        relating to the IT Systems or to any
                                        other aspect of either Company's or any
                                        of the Subsidiaries' data processing or
                                        data transfer requirements, including
                                        facilities management, bureau services,
                                        hardware maintenance, software
                                        development or support, consultancy,
                                        source code deposit, recovery and
                                        network services;

          "IT Systems"                  Hardware and/or Software owned or used
                                        by each Company;

          "ITA"                         Inheritance Tax Act 1984;

          "Know-How"                    trade secrets and confidential business
                                        information including confidential
                                        details of supply arrangements, customer
                                        lists and pricing policy; sales targets,
                                        sales statistics, market share
                                        statistics, marketing surveys and
                                        reports; marketing research; unpatented
                                        technical and other information
                                        including

                                        6



                                        inventions, discoveries, processes and
                                        procedures, ideas, concepts, formulae,
                                        specifications, procedures for
                                        experiments and tests and results of
                                        experimentation and testing; information
                                        comprised in Software; together with all
                                        common law or statutory rights
                                        protecting the same including by any
                                        action for breach of confidence and any
                                        similar or analogous rights to any of
                                        the foregoing whether arising or granted
                                        under the law of England or any other
                                        jurisdiction;

          "Legal and Beneficial Title"  full and unrestricted title with the
                                        benefit of quiet possession and free
                                        from lawful interruption and
                                        disturbance;

          ***                           ***

          "Minority Vendors"            ***

          ***                           ***

          "Management Accounts"         means the management accounts of each of
                                        the Companies for the period from the
                                        relevant Balance Sheet Date to 31 August
                                        2002, copies of which are annexed to the
                                        Disclosure Letter;

          "Net Assets"                  in relation to each Company, its fixed
                                        assets plus its current assets less its
                                        liabilities as more fully described at
                                        Part I of schedule 5 as at Completion
                                        and as set out in the Audited Completion
                                        Accounts;

          "Patents"                     patents and applications for a patent in
                                        the UK or any other jurisdiction;

          "Permits"                     any and all licences, consents, permits,
                                        authorisations or the like, made or
                                        issued pursuant to or under, or required
                                        by, Environmental Laws in relation to
                                        the carrying on of the Business;

          "Proceedings"                 any proceeding, suit or action arising
                                        out of or in connection with this
                                        Agreement;

          "Properties"                  the properties of which short
                                        particulars are set out in Part 1 of
                                        schedule 4 and the expression "Property"
                                        shall mean, where the context so admits,
                                        any one or more of such properties and
                                        any part or parts thereof;

          "Proprietary Intellectual     Intellectual Property owned by the
          Property"                     Company;

          "Provisional Consideration"   the consideration payable for the Shares
                                        as specified in clause 3.1;

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                        7



          "Purchaser's Accountants"     PricewaterhouseCoopers, LLP;

          "Purchaser's Group"           the Purchaser and its Affiliates;

          "Purchaser's Solicitors"      Latham & Watkins of 99 Bishopsgate,
                                        London EC2M 3XF;

          "Registered Proprietary       Proprietary Intellectual Property listed
          Intellectual Property"        in Part 1 of schedule 7;

          "Remedial Action"             (i)   preventing, limiting, removing,
                                        remedying, cleaning-up, abating or
                                        containing the presence or effect of any
                                        Hazardous Matter in the Environment
                                        (including the Environment at the
                                        Property); or (ii) carrying out
                                        investigative work and obtaining legal
                                        and other professional advice as is
                                        reasonably required in relation to (i);

          "RTPA"                        Restrictive Trade Practices Act 1976;

          "Service                      Agreements" the service agreements in
                                        the agreed terms between each of
                                        Nicholas Woods, Clive Reay-Young,
                                        Jennifer Garman and Simon Mifsud;

          "Shareholders' Agreements"     *** Clive Reay-Young, Nicholas Paul
                                        Woods, Jennifer Maureen Garman *** Simon
                                        Misfud *** Clive Reay-Young, Nicholas
                                        Paul Woods, Jennifer Maureen Garman,
                                        Simon David Misfud ***

          "Shares"                      all of the issued shares in the capital
                                        of Atlantech and all of the issued
                                        shares in the capital of Atlantech UK;

          "Software"                    any and all computer programs in both
                                        source and object code form, including
                                        all modules, routines and sub-routines
                                        thereof and all source and other
                                        preparatory materials relating thereto,
                                        including user requirements, functional
                                        specifications and programming
                                        specifications, ideas, principles,
                                        programming languages, algorithms, flow
                                        charts, logic, logic diagrams,
                                        orthographic representations, file
                                        structures, coding sheets, coding and
                                        including any manuals or other
                                        documentation relating thereto and
                                        computer generated works;

          "SSAP"                        a statement of standard accounting
                                        practice or financial reporting standard
                                        in force at the date hereof as issued by
                                        the Institute of Chartered Accountants
                                        in England and Wales and adopted by the
                                        ASB as an Accounting Standard;
__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                        8



          ***                           ***

          "subsidiary"                  a subsidiary within the meaning ascribed
                                        to such expression by sections 736 and
                                        736A, CA 85;

          "subsidiary undertaking"      a subsidiary undertaking within the
                                        meaning ascribed to such expression by
                                        section 258, CA 85;

          "Subsidiary"                  the subsidiary of Atlantech named in
                                        schedule 2 under the heading "The
                                        Subsidiary";

          "Taxation" or "Tax"           as defined in the Tax Deed;

          "Taxation Authority"          as defined in the Tax Deed;

          "Tax Deed"                    the deed in the agreed terms of even
                                        date herewith containing certain
                                        taxation covenants and indemnities
                                        between the Covenantors (as defined
                                        therein) and the Purchaser;

          "Taxation Statute"            any directive, statute, enactment, law
                                        or regulation, wheresoever enacted or
                                        issued, coming into force or entered
                                        into providing for or imposing any
                                        Taxation and shall include orders,
                                        regulations, instruments, bye-laws or
                                        other subordinate legislation made under
                                        the relevant statute or statutory
                                        provision and any directive, statute,
                                        enactment, law, order, regulation or
                                        provision which amends, extends,
                                        consolidates or replaces the same or
                                        which has been amended, extended,
                                        consolidated or replaced by the same;

          "Tax Warranties"              the warranties set out in Part 2 of
                                        schedule 3;

          "TCGA"                        Taxation of Chargeable Gains Act 1992;

          "Third Party                  means all Intellectual Property licensed
          Intellectual Property"        to the Company by a third party;

          "TMA"                         Taxes Management Act 1970;

          "Trade Marks"                 trade or service mark applications or
                                        registered trade or service marks,
                                        registered protected designations of
                                        origin, registered protected geographic
                                        origins, refilings, renewals or reissues
                                        thereof, unregistered trade or service
                                        marks, get-up and company names in each
                                        case with any and all associated
                                        goodwill and all rights or forms of
                                        protection of a similar or analogous
                                        nature including rights which protect
                                        goodwill whether arising or granted
                                        under the law of England or of any other
                                        jurisdiction;

          "Trade Union"                 as defined in section 1, TULRCA;

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                        9



          "TULRCA"                      Trade Union and Labour Relations
                                        (Consolidation) Act 1992;

          "TUPE"                        Transfer of Undertakings (Protection of
                                        Employment) Regulations 1981 as amended;

          "UK GAAP"                     applicable accounting standards,
                                        principles and practices generally
                                        accepted in the United Kingdom;

          "Unregistered Proprietary     Proprietary Intellectual Property other
          Intellectual Property"        than Registered Proprietary Intellectual
                                        Property;

          "US GAAP"                     applicable accounting standards,
                                        principles and practices generally
                                        accepted in the United States of
                                        America;

          "US Property"                 the property, brief particulars of which
                                        are set out in part 2 of schedule 4;

          "VAT"                         value added tax;

          "VATA"                        Value Added Tax Act 1994;

          "Vendors' Accountants"        Brown Butler of Yorkshire Bank Chambers,
                                        Infirmary Street, Leeds, West Yorkshire,
                                        LS1 2JT;

          "Vendors' Solicitors"         DLA of Victoria Square House, Victoria
                                        Square, Birmingham B2 4DL;

          "Warranties"                  the warranties set out in clause 7 and
                                        schedule 3;

          "Warrantors"                  means each of Nicholas Woods, Clive
                                        Reay-Young, Mrs. Jennifer Garman and
                                        Simon Mifsud whose addresses are set out
                                        in schedule 1 provided that Simon Mifsud
                                        shall only give Warranties relating to
                                        Atlantech UK and shall only be a
                                        Warrantor for such purposes;

          "in the agreed terms"         in the form agreed between the Vendors
                                        and the Purchaser and signed for the
                                        purposes of identification by or on
                                        behalf of each party.

1.2       The table of contents and headings in this Agreement are inserted for
          convenience only and shall not affect its construction.

1.3       Unless the context otherwise requires words denoting the singular
          shall include the plural and vice versa, references to any gender
          shall include all other genders and references to persons shall
          include bodies corporate, unincorporated associations and
          partnerships, in each case whether or not having a separate legal
          personality. References to the word "include" or "including" are to be
          construed without limitation.

1.4       References to recitals, schedules and clauses are to recitals and
          schedules to and clauses of this Agreement unless otherwise specified
          and references within a schedule to paragraphs are to paragraphs of
          that schedule unless otherwise specified.

                                       10



1.5       Save to the extent by which the liability of any party would thereby
          be extended or increased, references in this Agreement to any statute,
          statutory provision or EC Directive include a reference to that
          statute, statutory provision or EC Directive as amended, extended,
          consolidated or replaced from time to time (whether before or after
          the date of this Agreement) and include any order, regulation,
          instrument or other subordinate legislation made under the relevant
          statute, statutory provision or EC Directive.

1.6       Words and expressions defined in the Tax Deed shall to the extent not
          inconsistent bear the same meanings in this Agreement.

1.7       References to any English legal term for any action, remedy, method of
          judicial proceeding, legal document, legal status, court, official or
          any legal concept, state of affairs or thing shall in respect of any
          jurisdiction other than England be deemed to include that which most
          approximates in that jurisdiction to the English legal term.

1.8       Any reference to "writing" or "written" includes faxes and any
          non-transitory form of visible reproduction of words.

1.9       Any agreement, covenant, representation, warranty, undertaking or
          liability arising under this Agreement on the part of two or more
          persons shall be deemed to be made or given by such persons jointly
          and severally, unless otherwise expressly agreed.

1.10      In schedule 3, references to the Company shall be deemed to include a
          reference to each of Atlantech and Atlantech UK and each of them
          severally.

1.11      References to times of the day are to London time and references to a
          day are to a period of 24 hours running from midnight.

2.   SALE AND PURCHASE

2.1       Obligation to sell and purchase

          Subject to the terms of this Agreement, each of the Vendors severally
          shall sell, with full title guarantee, the number of Shares set
          opposite his name in column (B) and/or (C), as appropriate, of
          schedule 1 and the Purchaser shall purchase such interests in the same
          together with all rights attaching thereto at the date of this
          Agreement.

2.2       Dividends and distributions

          The Purchaser shall be entitled to receive all dividends and
          distributions declared, paid or made by the Company on or after the
          date of this Agreement.

2.3       Sale of all Shares

          The Purchaser shall not be obliged to complete the purchase of any of
          the Shares unless the purchase of all the Shares is completed
          simultaneously.

2.4       Declaration of Trust

          Each of the Vendors severally acknowledge and undertake that pending
          registration of the transfers of his shares (referred to in clause 2.1
          above), he holds such Shares on trust for the Purchaser.

2.5       Power of Attorney

                                       11



          Each Vendor hereby severally and irrevocably appoints the Purchaser as
          his attorney for the purpose of exercising any rights, privileges or
          duties attaching to his shares (as referred to in clause 2.1 above)
          including receiving of notices of and attending and voting at all
          meetings of the members of the Company from Completion to the day on
          which the Purchaser or its nominee is entered in the register of
          members of the Company as the holder of such shares, in each case in
          such manner as the Purchaser shall in its discretion decide.

2.6       Specific Authorisation

          For the purpose of sub-clause 2.5, each Vendor severally authorises:

          2.6.1     the Company to send any notices in respect of his share
                    holdings (as referred to in clause 2.1 above) to the
                    Purchaser;

          2.6.2     the Purchaser to complete and return proxy cards, consents
                    to short notice and any other document required or permitted
                    to be signed by such Vendor as a member.

3.   CONSIDERATION

          The aggregate consideration payable by the Purchaser to the Vendors
          (or, in the case of the *** and Additional Revenue Related
          Consideration, to the Warrantors only) for the purchase of the Shares
          shall be:

3.1       Provisional Consideration

          The sum of *** which shall be apportioned between the Vendors in the
          amounts set out opposite their respective names in column (E) of
          schedule 1 (subject to adjustment as provided in clause 6.2).

3.2       ***

          ***

3.3       Additional Consideration

          ***

          (each such payment being an "Additional Consideration Payment" and
          each such date being a "Payment Date")

          in each case subject to the terms of clauses 7.5 and 9 and payable to
          each of the Vendors in cash on the relevant Payment Date in an amount
          equal to their pro rata entitlement as set out opposite their
          respective names in column (D) of schedule 1 ("Pro Rata Entitlement")
          to such Additional Consideration Payment PROVIDED THAT no Additional
          Consideration shall become payable to a Defaulting Vendor and the
          relevant Additional Consideration Payment shall be reduced by an
          amount equal to the aggregate of any Defaulting Vendors' Pro Rata
          Entitlement to the relevant Additional Consideration Payment and the
          balance of the Additional Consideration Payment shall be payable to
          the remaining Vendors.

          For the purpose of this clause 3.3 a Vendor shall be a "Defaulting
          Vendor" if:

          (a)  *** or

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       12



          (b)  in the case of each of *** on or prior to the relevant Payment
               Date circumstances exist which ***;

          (c)  FURTHER PROVIDED THAT where at any time any of *** shall be
               subject to and calculated in accordance with the following
               calculation:

          (A + B + C) x  X = Y

          where:

          A = the relevant applicable reduction *** applicable in the event of
                the further proviso above being relevant to ***

          B = the *** applicable in the event of the further proviso above being
                relevant to ***

          C = the *** applicable in the event of the further proviso above being
                relevant to ***

          X = the applicable proposed Additional Consideration Payment

          Y = the amount of the total aggregate deduction to be deducted from
                the applicable Additional Consideration Payment

          and for the avoidance of doubt this calculation shall be made on each
          subsequent Payment Date taking into account each of A, B and C as
          appropriate. For example, where A is applicable to that Payment Date
          set out at sub-clause 3.2.1 it shall also be applied in relation to
          Payment Dates applicable to sub-clauses 3.2.2 and 3.2.3.

          The resulting Additional Consideration Payment (if any) on the
          relevant Payment Date shall be paid by the Purchaser by way of
          electronic transfer for same day value to the Vendors' Solicitors who
          are irrevocably authorised to receive the same and whose receipt shall
          be an effective discharge of the Purchaser's obligation to pay such
          sum and the Purchaser shall not be concerned to see to the application
          or be answerable for the loss or misapplication by the Vendors'
          Solicitors of such sum. The Vendors' Solicitors shall distribute any
          Additional Consideration Payment to the Vendors *** in amounts
          calculated by reference to their Pro Rata Entitlement recalculated to
          disregard the Pro Rata Entitlement of any Defaulting Vendor *** in the
          circumstances referred to;

3.4       Additional Revenue Related Consideration

          further additional payments on the following terms:

          3.4.1     in the event that *** to be apportioned among the Warrantors
                    in the *** set out opposite their respective names
                    in column (G) of schedule 1 ("***") PROVIDED THAT if the ***
                    then the aggregate amount payable to the Warrantors shall be
                    calculated as follows:

                    ***

                    ***For the avoidance of doubt where *** no additional
                    payment shall be payable to the Warrantors (or repayable by
                    the Warrantors) under this sub-clause 3.4.1; and

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       13



          3.4.2     in the event that *** the Warrantors shall be entitled to
                    further consideration in the amount of *** to be apportioned
                    among the Warrantors in their Warrantor Percentages PROVIDED
                    THAT if the ***, provided that, in the event that this
                    results in a negative amount no additional payment shall be
                    made to (or be payable or repayable by) the Warrantors under
                    this sub-clause 3.4.2.

                    The parties agree and shall each use reasonable endeavours
                    to procure that at least *** constituting the *** PROVIDED
                    THAT where there shall be less than such percentage actually
                    achieved an amount equal to the *** shall be added to ***
                    for the purposes of calculation of further consideration
                    under this sub-clause 3.4.2.

          3.4.3     in the case of sub-clauses 3.4.1 and 3.4.2 calculations of
                    ***:

                    (a)  by the Chief Financial Officer of the Guarantor based
                         upon information prepared by the Company auditors such
                         officer to issue to the Purchaser and the Warrantors a
                         certificate evidencing the same as soon as practicable
                         following 31 December in each relevant year and in any
                         event not later than 28 February next following. The
                         Purchaser and the Warrantors shall have 30 days
                         following receipt of the certificate within which to
                         notify each other in writing of any disagreement or
                         difference of opinion relating to the auditor's
                         certificate (a "***") and the provisions of sub-clauses
                         6.1.4, 6.1.5, 6.1.6 and 6.1.7 shall apply mutatis
                         mutandis save that references to "***" shall be treated
                         as references to "***" and the reference in sub-clause
                         6.1.7 to "clause 6" shall be treated as a reference to
                         "clause 3.4". Failing such notice, the parties shall be
                         deemed to have accepted the auditor's certificate as
                         final and binding; and

                    (b)  in accordance with US GAAP;

          3.4.4     Payments (if any) to be made to the Warrantors under this
                    sub-clause 3.4 shall be made (subject always to the terms of
                    clause 7.5) on the earlier of *** as the case may be, or on
                    the next following Business Day should such date not fall on
                    a Business Day; and (ii) the date 10 Business Days following
                    acceptance, deemed acceptance or determination by the
                    Independent Accountant of the certificate of the Guarantor's
                    Chief Financial Officer in accordance with sub-clause
                    3.4.3(a) above. Any such payments shall be made by the
                    Purchaser by way of electronic transfer for same day value
                    to the Vendors' Solicitors who are irrevocably authorised to
                    receive the same and whose receipt shall be an effective
                    discharge of the Purchaser's obligation to pay such sum and
                    the Purchaser shall not be concerned to see to the
                    application or be answerable for the loss or misapplication
                    by the Vendors' Solicitors of such sum. Unless otherwise
                    paid by the Purchaser on or prior to 1 February in any
                    relevant year interest shall be calculated on the amount so
                    certified by the Chief Financial Officer as being *** (and
                    not more than such amount) from such date to the date of
                    payment at the rate of 1% above the base lending rate from
                    time to time of Barclays Bank plc.

3.5       In the event of a Change of Control at any time prior to ***, the
          Vendors shall (subject always (i) in relation to payments of ***, to
          the provisos at clause 3.3 on the facts as at the date of the Change
          of Control, and (ii) to the terms of clauses 7.5 and 9) be ***.

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3.6       *** the Additional Revenue Related Consideration for the Shares
          pursuant to clause 3.4 is to be determined) the future conduct of the
          Business will have an effect on the *** for each of the calendar years
           *** (the "Consideration Years"). Accordingly, the Purchaser
          undertakes with each Warrantor that during the Consideration Years it
          will not *** Additional Revenue Related Consideration.

3.7       Each of the Vendors hereby: (i) confirms and acknowledges to each of
          the parties to this Agreement his agreement that the Consideration to
          be paid to him for the shares set opposite his name in column (B)
          and/or (C), as appropriate, of schedule 1 being sold pursuant to
          clause 2 above is, as between each of the Vendors, fair and
          reasonable; and (ii) irrevocably waives any and all claims which he
          may have against any party to this Agreement for a different
          allocation of the Consideration.

3.8       Where any reorganisation, amalgamation, reconstruction, merger or
          other transaction in relation to the business of either Company shall
          have (or is likely to have) the effect of making the ***, the
          Purchaser and the Warrantors agree to consult in good faith with a
          view to formulating (and shall use best endeavours to agree in good
          faith) such arrangements or treatment as shall be reasonably necessary
          to resolve such effect.

4.   WAIVERS OF PRE-EMPTION

4.1       Each of the Vendors hereby severally waives all rights of pre-emption
          or other rights over any of the Shares conferred on him either by the
          articles of association of the Company or under either Shareholders'
          Agreement or in any other way.

4.2       Each of the Vendors hereby severally agrees that as at and with effect
          from Completion each Shareholders' Agreement shall terminate without
          further liability of any party thereto without prejudice to any
          outstanding claims at Completion not being claims against either of
          the Companies. For the avoidance of doubt, each party releases each
          Company (as applicable) from all and any liability whatsoever under or
          pursuant to the Shareholders' Agreements with immediate effect from
          Completion.

5.   COMPLETION

5.1       Warrantors' obligations

          At Completion:

          5.1.1     the Warrantors shall deliver to the Purchaser each of the
                    documents listed in Part 1 of schedule 6; and

          5.1.2     the Warrantors shall procure that all necessary steps are
                    taken properly to effect the matters listed in Part 2 of
                    schedule 6 at board meetings of each Company and the
                    Subsidiary and shall deliver to the Purchaser duly signed
                    minutes of all such board meetings.

5.2       Purchaser's obligations

          Subject to the Warrantors complying with their obligations under
          sub-clause 5.1 above the Purchaser shall at Completion:

          5.2.1     pay the Provisional Consideration *** together with *** in
                    respect of its liability pursuant to clause 16.1.2 and ***
                    in respect of the repayment of loans to Atlantech

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                    from the directors by way of electronic transfer for same
                    day value to the Vendors' Solicitors who are irrevocably
                    authorised to receive the same and whose receipt shall be an
                    effective discharge of the Purchaser's obligation to pay
                    such sum and the Purchaser shall not be concerned to see to
                    the application or be answerable for the loss or
                    misapplication by the Vendors' Solicitors of such sum; and

          5.2.2     ***and

          5.2.3     deliver to the Warrantors a counterpart Tax Deed duly
                    executed by the Purchaser.

          Within 2 Business Days following Completion the Purchaser shall
          deliver to the Warrantors a copy of the minutes of a meeting of the
          directors of the Purchaser and Guarantor authorising the execution by
          the Purchaser and Guarantor of this Agreement, Tax Deed and any other
          documents in the agreed terms executed by the Purchaser and Guarantor
          (such copy minutes being certified as correct by the secretary of the
          Purchaser and Guarantor).

5.3       Company records

          Forthwith following Completion each Warrantor severally shall, and
          shall procure that any other Vendor shall, without delay send to the
          Purchaser at its registered office for the time being, all records,
          correspondence, documents, files, memoranda and other papers relating
          to the Companies and each of the Subsidiaries or the Business which
          are in their possession or control and not kept at any of the
          Properties, save for those required for the purpose of preparing the
          Completion Accounts which shall be sent to the Purchaser with the
          Completion Accounts in accordance with clause 6.1.1.

6.   COMPLETION ACCOUNTS

6.1       Preparation of Completion Accounts

          6.1.1     Prior to or on 30 November 2002, the Warrantors shall
                    procure that the Vendors' Accountants shall provide to the
                    Purchaser and the Purchasers' Accountants the Completion
                    Accounts together with all relevant schedules and relevant
                    information and working papers supporting the balances in
                    the individual Company accounts as set out in the Completion
                    Accounts. Prior to or on 1 February 2003, the Chief
                    Financial Officer of the Guarantor shall prepare and issue
                    to the Warrantors a certificate, evidencing and based upon
                    the review carried out by the Purchaser's Accountants,
                    setting out a closing balance sheet audit of the Completion
                    Accounts (the "Audited Completion Accounts"). The Warrantors
                    shall cooperate with and provide (or otherwise procure) all
                    information and documents reasonably requested by the said
                    officer and/or Purchaser's Accountants in connection with
                    the preparation of the Audited Completion Accounts. ***

          6.1.2     The Completion Accounts shall consist of a balance sheet for
                    each Company as at the close of business on the date of
                    Completion and shall be prepared in accordance with the form
                    and principles set out in schedule 5.

          6.1.3     The Warrantors shall have 30 Business Days after receipt of
                    the Audited Completion Accounts pursuant to sub-clause 6.1.1
                    within which to notify the Purchaser in writing of their
                    agreement or any disagreement or difference of opinion
                    relating to the Audited Completion Accounts. Failing any
                    such notice, the parties shall be deemed

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                    to have accepted such accounts as accurate and such accounts
                    shall be deemed final and binding.

          6.1.4     If within the period of 30 Business Days referred to in
                    sub-clause 6.1.3 above the Warrantors notify the Purchaser
                    of any disagreement or difference of opinion relating to the
                    Audited Completion Accounts ("Notice of Disagreement") and
                    if the parties are able to resolve such disagreement or
                    difference of opinion within 10 Business Days of the Notice
                    of Disagreement, the parties shall be deemed to have
                    accepted such accounts (as agreed) as accurate.

          6.1.5     If the Purchaser and Warrantors are unable to reach
                    agreement within 10 Business Days of the Notice of
                    Disagreement, the matter in dispute shall be referred to an
                    independent chartered accountant (the "Independent
                    Accountant") to be appointed (in default of nomination by
                    agreement between the Warrantors and the Purchaser within 15
                    Business Days of the date of the Notice of Disagreement) by
                    the President for the time being of the Institute of
                    Chartered Accountants in England and Wales.

          6.1.6     The Independent Accountant shall act as an expert and not as
                    an arbitrator, the Arbitration Act 1996 shall not apply and
                    his decision shall (in the absence of manifest error) be
                    final and binding on the Vendors and the Purchaser for all
                    the purposes of this Agreement. The costs of the Independent
                    Accountant shall be apportioned between the Vendors and the
                    Purchaser as the Independent Accountant shall decide but
                    each party shall be responsible for its own costs of
                    presenting its case to the Independent Accountant.

          6.1.7     Each of the Warrantors and the Purchaser shall, and shall
                    direct that their respective advisors shall, give all
                    assistance and access to all additional information to each
                    other that they may reasonably require to assist them to
                    make decisions and resolve any disputes under this clause 6
                    expeditiously.

6.2       Adjustment of Provisional Consideration

          The Provisional Consideration shall be adjusted after Completion in
          accordance with the following provisions of this sub-clause 6.2.

          6.2.1     ***

          6.2.2     Any amounts to be paid under sub-clause 6.2.1 shall:

                    (a)  be paid within 15 Business Days after the date on which
                         the Audited Completion Accounts have been agreed or
                         settled (whether under sub-clause 6.1.3 or 6.1.4 or by
                         virtue of a decision of the Independent Accountant or
                         otherwise) together with interest on the amount to be
                         paid calculated at the rate of *** from 1 February 2003
                         until the date of actual payment; and

                    (b)  be made to the Vendors' Solicitors or the Purchaser's
                         Solicitors (as the case may be) who are irrevocably
                         authorised to receive the same and whose receipt shall
                         be an effective discharge of the Vendor's or
                         Purchaser's obligation to pay such sum and the Vendors
                         or Purchaser (as the case may be) shall not be
                         concerned to see to the application or be answerable
                         for the loss or misapplication of such sums by the
                         Vendors' Solicitors or the Purchaser's Solicitors, as
                         the case may be.

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7.   WARRANTIES

7.1       Extent of Warranties

          In consideration of the Purchaser agreeing to purchase the Shares on
          the terms contained in this Agreement, each of the Warrantors hereby
          in relation to each of (a) the Companies and (b) the Subsidiary and
          Atlantech Italia Srl, jointly and severally warrants and undertakes to
          the Purchaser in the terms set out in Schedule 3 and Schedule 9
          respectively.

7.2       Obligation to make enquiries

          Where any of the Warranties is made or given "so far as the Warrantors
          are aware", such Warranty shall be deemed to be given to the best of
          the knowledge, information and belief of each of Nicholas Woods, Clive
          Reay-Young, Jennifer Garman and, in relation to Atlantech UK only,
          Simon Mifsud.

7.3       Information supplied by the Companies and Subsidiaries

          Any information supplied by or on behalf of any of the Companies or on
          behalf of any of the Subsidiaries (or by any officer, employee or
          agent of any of them) to the Warrantors or their advisers in
          connection with the Warranties, the Indemnities or the Tax Deed or the
          information Disclosed in the Disclosure Documents shall not constitute
          a warranty, representation or guarantee as to the accuracy of such
          information in favour of the Warrantors and each of the Warrantors
          hereby undertake to the Purchaser to waive irrevocably any and all
          claims which it might otherwise have against the Companies or any of
          the Subsidiaries or against any officer, employee or agent of any of
          them in respect of such claims other than in the case of fraud.

7.4       Separate and independent warranties

          Each of the Warranties set out in the separate paragraphs of schedule
          3 shall be separate and independent and save as expressly otherwise
          provided shall not be limited by reference to any other such Warranty
          or by anything in this Agreement, the Disclosure Documents or the Tax
          Deed.

7.5       Set-off by Purchaser

          7.5.1     The Purchaser shall (without prejudice to its other rights
                    hereunder) be entitled in its discretion to set off against
                    any amount otherwise due and payable to each Warrantor under
                    any of the provisions of clauses 3.3, 3.4 or 6.2 any amount
                    due by such Warrantor to the Purchaser (a) under clause 6.2
                    or clause 9 of this Agreement; (b) under the Tax Deed;
                    and/or (c) pursuant to a Claim in respect of (i) any
                    liability which has been finally determined in accordance
                    with sub-clause 7.5.2 below, and/or (ii) any applicable
                    Contingent Claim Amount provided that the Purchaser has
                    provided the Warrantor with an opinion of counsel of at
                    least 10 years' call that, were such Claim to be the subject
                    of judicial proceedings, the Purchaser would have a
                    reasonable prospect of success in respect thereof. The
                    Purchaser agrees that where it determines to exercise its
                    rights of set-off under this sub-clause 7.5 it shall (save
                    in respect of any sum due to the Purchaser under the Tax
                    Deed or clause 6.2 of this Agreement and without prejudice
                    to its right (as set out above) to set off against any
                    payment due to the Warrantor under sub-clause 6.2) first
                    apply such rights against payment of consideration otherwise
                    due to the Warrantor pursuant to sub-clauses 3.3.3, 3.3.2
                    and 3.3.1 respectively and in such order of priority.

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          7.5.2     For the purposes of sub-clause 7.5.1 a liability of a
                    Warrantor shall be deemed to be finally determined when
                    either (i) judgement has been given by a court of competent
                    jurisdiction and the time limit for appeal has expired, or
                    (ii) final appellate judgement has been given with no
                    further right of appeal or (iii) the claim has been settled
                    by agreement in writing between the Purchaser and the
                    (including, in relation to any payment due by the Warrantor
                    to the Purchaser under sub-clause 6.2.1. as determined
                    pursuant to sub-clause 6.1.3, 6.1.4 or by virtue of a
                    decision of the Independent Accountant).

          7.5.3     If a claim in respect of which the Purchaser has set off a
                    Contingent Claim Amount is finally determined in accordance
                    with sub-clause 7.5.2 for a lesser amount than the
                    Contingent Claim Amount, the balance of the Contingent Claim
                    Amount in excess of the amount payable as finally determined
                    shall be paid within 5 Business Days to the relevant
                    Warrantor.

7.6       Reliance

          The Purchaser has entered into this Agreement upon the basis of and in
          reliance upon the Warranties and the Indemnities.

7.7       Payments by Warrantors

          Any payment made by the Warrantors in respect of a breach of any
          Warranties or payment made under the Indemnities or the Tax Deed, or
          any other payment made pursuant to this Agreement, shall be and shall
          be deemed to be pro tanto a reduction in the price paid for the Shares
          under this Agreement.

7.8       Minority Vendor Warranties

          7.8.1     Each of the Minority Vendors severally warrants and
                    undertakes to the Purchaser that:

                    (a)  he or she has full power to enter into and perform this
                         Agreement and this Agreement constitutes binding
                         obligations on him/her in accordance with its terms;

                    (b)  there is no Encumbrance or any form of agreement
                         (including conversion rights and rights of pre-emption)
                         on, over or affecting the Shares held by him/her and
                         there is no agreement or commitment to give or create
                         any of the foregoing. No claim has been made by any
                         person to be entitled to any of the foregoing; and

                    (c)  he/she is entitled to sell and transfer the Shares held
                         by him/her to the Purchaser with full title guarantee
                         and otherwise on the terms set out in this Agreement.

          7.8.2     ***

          7.8.3     ***

7.9       The only warranties (including the Warranties) given in relation to
          intellectual property, real property, information technology and
          telecommunications, and environmental matters are

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          those warranties contained in paragraphs 18, 8, 19 and 9 respectively
          of part 1 of schedule 3 and no other warranties (including the
          Warranties) shall be given in relation to the same.

7.10      Purchaser's and Guarantor's warranties

          The Purchaser and the Guarantor each severally warrant to each Vendor
          that it has full power and capacity to enter into and perform this
          Agreement, the Tax Deed and each of the documents in the agreed terms
          to which it is a party and this Agreement constitutes, and the Tax
          Deed and each other document in agreed terms to which it is a party
          when executed will constitute binding obligations on it in accordance
          with their terms.

8.   LIMITATION OF WARRANTORS' LIABILITY

8.1       Limitations on liability

          The liability of the Warrantors:

          8.1.1     in respect of any claim under the Warranties shall be
                    limited as provided in schedule 8

          but so that the limitations on the liability of the Warrantors under
          this sub-clause 8.1 and schedule 8 shall not apply in relation to the
          Warranties set out in paragraphs 1.2 and 2.4.1 of schedule 3.

8.2       Exclusions from clause 8

          Notwithstanding any other provision of this Agreement, the provisions
          of this clause 8 and schedule 8 shall not apply to any claim:

          8.2.1     made against the Warrantors in the case of any fraud,
                    dishonesty, wilful misstatement or wilful omission by or on
                    behalf of the Warrantors provided that the Warrantors shall
                    be solely responsible for their own fraudulent, dishonest
                    acts or omissions or wilful misstatements or omissions; or

          8.2.2     made under the Indemnities, other than paragraphs 6.3 and
                    6.5 of part 2 of schedule 8 which shall apply thereto.

8.3       The parties agree that rescission shall not be available as a remedy
          for any breach of this Agreement and agree not to claim this remedy.

9.   INDEMNITY

9.1       The Warrantors undertake to indemnify and keep the Purchaser
          indemnified (contracting for itself and as trustee for its officers,
          directors, agents and employees) from and against and in respect of
          *** which may be suffered or incurred by the Purchaser or the
          Companies PROVIDED THAT in the event that *** is less than *** add
          such amount to the Additional Consideration Payment due on such date.
          Without prejudice to the Warrantors' obligation under this indemnity,
          the Purchaser agrees that any amount due and payable hereunder from
          the Warrantors to the Purchaser shall first (to the full extent
          possible) be set off and deducted from any amount payable to the
          Warrantors under sub-clauses 3.3.3, 3.3.2 and 3.3.1 and in such order
          of priority.

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9.2       Any amount payable under the provisions of clause 9.1 shall be made to
          the Vendors' Solicitors or the Purchaser's Solicitors (as the case may
          be) who are irrevocably authorised to receive the same and whose
          receipt shall be an effective discharge of the Vendor's or Purchaser's
          obligation to pay such sum and the Vendors or Purchaser (as the case
          may be) shall not be concerned to see to the application or be
          answerable for the loss or misapplication of such sums.

9.3       For the purpose of clause 9.1 the ***.

9.4       For the avoidance of doubt, the provisions of clause 8 and schedule 8
          shall not apply to this clause 9, other than paragraphs 6.3 and 6.5 of
          part 2 of schedule 8, which shall apply.

9.5       The Purchaser agrees and undertakes to the Warrantors to *** and
          further agrees in good faith to ***.

10.  PROTECTION OF GOODWILL

10.1      Covenants

          As further consideration for the Purchaser agreeing to purchase the
          Shares on the terms contained in this Agreement and with the intent of
          assuring to the Purchaser the full benefit and value of the goodwill
          and connections of the Group and as a constituent part of the sale of
          the Shares, each of Nicholas Woods, Clive Reay-Young, Jennifer Garman
          and Simon Mifsud (the "Covenantors") hereby undertake to the Purchaser
          (contracting for itself and on behalf of each Company and of each of
          the Subsidiaries) that (except whilst an employee of the Group acting
          in that capacity or with the written consent of the Purchaser) they
          shall not whether on their own behalf or with or on behalf of any
          person and whether directly or indirectly by any person or business
          controlled by them or any Connected Person:

          10.1.1    in the period from Completion to the date falling three
                    years after Completion, carry on or be employed, engaged,
                    concerned, interested or in any way assist within the United
                    Kingdom in any business which may in any way be in
                    competition with all or part of the Business provided that
                    nothing in this sub-clause 10.1.1 shall prevent the
                    Covenantors from holding for investment purposes only any
                    units of an authorised unit trust and/or not more than five
                    (5) per cent. of any class of the issued share or loan
                    capital of any company quoted on a recognised investment
                    exchange (as defined in the Financial Services and Markets
                    Act 2000);

          10.1.2    in the period from Completion to the date falling three
                    years after Completion, canvass, solicit or approach or
                    cause to be canvassed, solicited or approached (in relation
                    to a business which may in any way compete with all or part
                    of the Business) the custom of any person who at any time
                    during the 12 months preceding Completion shall have been a
                    client or customer of the Company or of any of the
                    Subsidiaries;

          10.1.3    in the period from Completion to the date falling three
                    years after Completion, interfere or seek to interfere or
                    take such steps as may interfere with supplies to the
                    Company and/or any of the Subsidiaries from any suppliers
                    who shall have been supplying goods or services to the
                    Company or to any of the Subsidiaries for use in connection
                    with the Business at any time during the period of 12 months
                    prior to the date of Completion;

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          10.1.4    in the period from Completion to the date falling three
                    years after Completion, offer employment to or employ or
                    offer to conclude any contract of services with senior
                    employees of the Company or of any of the Subsidiaries
                    employed in the capacity of director or manager of any
                    technical, IT, financial, sales, marketing, business
                    development or other managerial role with a view to using
                    the knowledge or skills of such person in connection with
                    any business which is intended to be competitive with the
                    Business or procure or facilitate the making of such an
                    offer by any person, firm or company or entice or endeavour
                    to entice any such employees of the Company or of any of the
                    Subsidiaries to terminate their employment with the Company
                    or any of the Subsidiaries;

          10.1.5    at any time after Completion use as a trade or business name
                    or mark or carry on a business under a title containing the
                    word "Atlantech" or any other word(s) which is deliberately
                    calculated to resemble the same; or

          10.1.6    at any time after Completion disclose to any person
                    whatsoever or use to the detriment of the Company or any
                    Subsidiary or otherwise make use of, or through any failure
                    to exercise all due care and diligence cause any
                    unauthorised use of, any Confidential Information including
                    Know-How relating or belonging to the Company or to any of
                    the Subsidiaries or in respect of which the Company or any
                    of the Subsidiaries is bound by an obligation of confidence
                    to a third party save as required by law or by any court of
                    competent jurisdiction.

          Each undertaking contained in this sub-clause 10.1 shall be read and
          construed independently of the other undertakings herein as an
          entirely separate and severable undertaking.

10.2      Severability of covenants

          Whilst the undertakings in sub-clause 10.1 are considered by the
          parties to be reasonable in all the circumstances, if any one or more
          should for any reason be held to be invalid but would have been held
          to be valid if part of the wording thereof was deleted or the period
          thereof reduced or the range of activities or area covered thereby
          reduced in scope, the said undertakings shall apply with the minimum
          modifications necessary to make them valid and effective.

10.3      Information in the public domain

          The restriction contained in sub-clause 10.1.6 shall not extend to any
          confidential or secret information which may come into the public
          domain otherwise than through the default of the Warrantors.

11.  ANNOUNCEMENTS

11.1      Restrictions on announcements

          Each Vendor severally agrees that no press conference, announcement or
          other communication concerning Confidential Information or the
          transactions referred to in this Agreement, or in connection with the
          Group or otherwise relating to the financial condition or trading or
          financial prospects of the Group, shall be made or despatched by such
          Vendor or his agents, employees or advisers to any third party without
          the prior written consent of the Purchaser save as may be required by
          any:

          11.1.1    law; or

          11.1.2    existing contractual arrangements;

                                       22



          provided such communication shall be made only after consultation with
          the Purchaser.

11.2      Time limit

          The restrictions contained in this clause 11 shall continue to apply
          after Completion without limit in time.

12.  FURTHER ASSURANCE

          The Warrantors shall, from time to time on being required to do so by
          the Purchaser, now or at any time in the future, do or procure the
          doing of all such acts and/or execute or procure the execution of all
          such documents in a form satisfactory to the Purchaser as the
          Purchaser may reasonably consider necessary for giving full effect to
          this Agreement and securing to the Purchaser the full benefit of the
          rights, powers and remedies conferred upon the Purchaser in this
          Agreement.

13.  ASSIGNMENT

13.1      Limited assignment

          No party may assign the benefit of this Agreement whether absolutely
          or by way of security except (in the case of the Purchaser only) by
          way of an absolute assignment to an Affiliate, provided always that
          (a) such assignee executes a deed of adherence to this Agreement in a
          form reasonably satisfactory to the Warrantors, (b) if such assignee
          ceases to be an Affiliate of the Purchaser it shall forthwith execute
          an assignment to an Affiliate of the Purchaser and (c) the Vendors'
          liabilities under this Agreement are not thereby increased; save that
          a party may assign such benefit absolutely or by way of security to a
          person (other than to an Affiliate of the Purchaser as aforesaid) with
          the prior consent in writing of the other parties, such consent not to
          be unreasonably withheld or delayed and any purported assignment in
          contravention of this clause shall be ineffective.

13.2      Successors in title

          Subject to sub-clause 13.1, this Agreement shall be binding upon and
          enure for the benefit of the personal representatives and assigns and
          successors in title of each of the parties and references to the
          parties shall be construed accordingly.

14.  ENTIRE AGREEMENT: REMEDIES

14.1      Entire agreement

          This Agreement and the documents referred to herein as being in the
          agreed terms constitutes the whole and only agreement between the
          parties relating to the subject matter hereof and supersedes and
          extinguishes any prior drafts, previous agreements, undertakings,
          representations, warranties and arrangements of any nature whatsoever,
          whether or not in writing between the parties, in connection with the
          subject matter hereof.

14.2      Remedies

          The rights of any party under this Agreement are, except where
          otherwise stated, independent, cumulative and without prejudice to all
          other rights available to it whether as a matter of common law,
          statute, custom or otherwise.

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14.3      Non-exclusion of fraud

          Nothing in this Agreement, the Tax Deed or in any other document
          referred to herein shall be read or construed as excluding any
          liability or remedy as a result of fraud.

15.  WAIVER, VARIATION AND RELEASE

15.1      No waiver by omission, delay or partial exercise

          No omission to exercise or delay in exercising on the part of any
          party to this Agreement any right, power or remedy provided by law or
          under this Agreement shall constitute a waiver of such right, power or
          remedy or any other right, power or remedy or impair such right, power
          or remedy. No single or partial exercise of any such right, power or
          remedy shall preclude or impair any other or further exercise thereof
          or the exercise of any other right, power or remedy provided by law or
          under this Agreement.

15.2      Specific waivers to be in writing

          Any waiver of any right, power or remedy under this Agreement must be
          in writing and may be given subject to any conditions thought fit by
          the grantor. Unless otherwise expressly stated, any waiver shall be
          effective only in the instance and only for the purpose for which it
          is given.

15.3      Variations to be in writing

          No variation to this Agreement shall be of any effect unless it is
          agreed in writing and signed by or on behalf of each party.

16.  COSTS AND EXPENSES

16.1      Payment of costs

          16.1.1    Subject to clause 16.1.2 and save as otherwise stated in
                    this Agreement, each party shall pay its own costs and
                    expenses in relation to the negotiation, preparation,
                    execution and carrying into effect of this Agreement and
                    other agreements forming part of the transaction.

          16.1.2    The Purchaser shall, upon delivery of copy invoices to
                    demonstrate the amount of fees incurred by the Warrantors in
                    connection with the transaction contemplated by this
                    Agreement,***.

16.2      Company and Subsidiaries to pay no costs

          For the avoidance of doubt, neither the Company nor any of the
          Subsidiaries shall pay any legal or other professional charges and
          expenses in connection with any investigation of the affairs of the
          Group or the negotiation, preparation, execution and carrying into
          effect of this Agreement.

17.  PAYMENTS

          Save as envisaged in clause 7.5, all payments to be made under this
          Agreement shall be made in full without any set-off or counterclaim
          and free from any deduction or withholding save as

__________
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the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       24



          may be required by law in which event such deduction or withholding
          shall not exceed the minimum amount which it is required by law to
          deduct or withhold and the payer will simultaneously pay to the payee
          such additional amounts as will result in the receipt by the payee of
          a net amount equal to the full amount which would otherwise have been
          receivable had no such deduction or withholding been required save
          that in the case of a payment by a Warrantor or Vendor in respect of a
          Claim any such deduction or withholding shall be treated as having
          already been taken into account in the quantification of damages
          pursuant to such Claim and provided always that in any event each
          Warrantor's and each Vendor's liability in respect of this clause,
          when aggregated with all other payments made by that Warrantor or
          Vendor under this Agreement and the Tax Deed, will not exceed the
          amount of Provisional Consideration received by him/her as set out
          opposite his/her name in column (E) of schedule 1.

18.  NOTICES

18.1      Form of notices

          Any communication to be given in connection with the matters
          contemplated by this Agreement shall except where expressly provided
          otherwise be in writing and shall either be delivered by courier post
          or facsimile transmission.

18.2      Address and facsimile

          Such communication shall be sent to the address of the relevant party
          referred to in this Agreement or the facsimile number set out below or
          to such other address or facsimile number as may previously have been
          communicated to the other party in accordance with this clause. Each
          communication shall be marked for the attention of the relevant
          person.

          (a)  Vendors /Warrantors- facsimile number ***. For the attention of
               Nicholas Woods (copied to DLA on facsimile number *** for the
               attention of David Glover).

          (b)  Purchaser - facsimile number 001 408 530 9143. For the attention
               of the General Counsel.

          (c)  Guarantor - facsimile number 001 408 530 9143. For the attention
               of the General Counsel.

          And in the case of each of (b) and (c) above, copies to Latham &
          Watkins, attention Mike Hall of facsimile number 001 650 463 2600.

18.3      Deemed time of service

          A communication shall be deemed to have been served:

          18.3.1    if delivered by courier at the address referred to in
                    sub-clause 18.2, at the time of delivery; and

          18.3.2    if sent by facsimile to the number referred to in sub-clause
                    18.2, at the time of completion of transmission by the
                    sender.

          If a communication would otherwise be deemed to have been delivered
          outside normal business hours (being 9:30 a.m. to 5:30 p.m. on a
          Business Day) in the time zone of the
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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
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                                       25



          territory of the recipient under the preceding provisions of this
          clause, it shall be deemed to have been delivered at the next opening
          of such business hours in the territory of the recipient.

18.4      Proof of service

          In proving service of the communication, it shall be sufficient to
          show that delivery by courier was made or that the facsimile was
          despatched and a confirmatory transmission report received.

18.5      Change of details

          A party may notify the other parties to this Agreement of a change to
          its name, relevant person, address or facsimile number for the
          purposes of sub-clause 18.1 provided that such notification shall only
          be effective on:

          18.5.1    the date specified in the notification as the date on which
                    the change is to take place; or

          18.5.2    if no date is specified or the date specified is less than
                    five clear Business Days after the date on which notice is
                    deemed to have been served, the date falling five clear
                    Business Days after notice of any such change is deemed to
                    have been given.

18.6      Non-applicability to Proceedings

          For the avoidance of doubt, the parties agree that the provisions of
          this clause 18 shall not apply in relation to the service of any writ,
          summons, order, judgment or other document relating to or in
          connection with any Proceedings.

19.  COUNTERPARTS

19.1      Execution in counterparts

          This Agreement may be executed in any number of counterparts and by
          the parties on different counterparts, but shall not be effective
          until each party has executed at least one counterpart.

19.2      One agreement

          Each counterpart shall constitute an original of this Agreement but
          all the counterparts shall together constitute one and the same
          agreement.

20.  INVALIDITY

          Each of the provisions of this Agreement is severable. If any such
          provision is or becomes illegal, invalid or unenforceable in any
          respect under the law of any jurisdiction, the legality, validity or
          enforceability in that jurisdiction of the remaining provisions of
          this Agreement shall not in any way be affected or impaired thereby.

21.  AGREEMENT TO CONTINUE IN FULL FORCE AND EFFECT

          This Agreement together with the Tax Deed shall, to the extent that it
          remains to be performed, continue in full force and effect
          notwithstanding Completion.

22.  CONFIDENTIALITY

22.1      Prohibition on disclosure

                                       26



          The Warrantors each hereby undertake with the Purchaser that they
          shall both during and after the term of this Agreement preserve the
          confidentiality of, and not directly or indirectly reveal, report,
          publish, disclose or transfer or use for their own or any other
          purposes Confidential Information except:

          22.1.1    in the circumstances set out in sub-clause 22.2 below;

          22.1.2    to the extent otherwise expressly permitted by this
                    Agreement; or

          22.1.3    with the prior consent in writing of the party to whose
                    affairs such Confidential Information relates.

22.2      Permitted disclosures

          The circumstances referred to in sub-clause 22.1.1 above are:

          22.2.1    where the Confidential Information, before it is furnished
                    to the Warrantors, is in the public domain;

          22.2.2    where the Confidential Information, after it is furnished to
                    the Warrantors, enters the public domain otherwise than as a
                    result of (i) a breach by the Warrantors of their
                    obligations in this clause 22 or (ii) a breach by the person
                    who disclosed that Confidential Information of a
                    confidentiality obligation and the Warrantors are aware of
                    such breach;

          22.2.3    if and to the extent the Warrantors makes disclosure of the
                    Confidential Information to any person in compliance with
                    any requirement of law provided that any such information
                    disclosable shall be disclosed only to the extent required
                    by law and only after consultation with the Purchaser.

22.3      No time limit

          The restrictions contained in this clause shall continue to apply
          after Completion without limit in time.

22.4      The Purchaser agrees and undertakes that, in so far as it is able
          under law, it shall, in circumstances where public disclosure of this
          Agreement is required under regulation, endeavour to limit any
          disclosure of and keep confidential provisions of this Agreement
          relating to ***.

23.  GUARANTEE

23.1      In consideration of the Vendors' obligations under this Agreement, the
          Guarantor unconditionally and irrevocably guarantees to the Vendors
          the due and punctual performance by the Purchaser of the Purchaser's
          obligations under or pursuant to this agreement and the Tax Deed
          ("Guaranteed Obligations") and agrees to indemnify the Vendors against
          all losses, damages, costs and expenses (including reasonable legal
          costs and expenses) which the Vendors may suffer or incur arising
          directly from any breach by the Purchaser of the Guaranteed
          Obligations.

23.2      The Guarantor shall not in any way or to any extent be released from
          its obligations under this agreement by reason of any time or other
          indulgence, waiver, release or discharge granted by

__________
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the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       27



          the Vendors to the Purchaser or to any third party or by the
          acceptance of any composition from or the making of any arrangement
          with the Purchaser or any third party or any circumstances or any
          provision or rule of law, whether statutory or otherwise, affecting or
          preventing recovery from the Purchaser of any sum due or rendering any
          debt, obligation or liability of the Purchaser void or unenforceable
          and which but for this provision might operate to exonerate or
          discharge the Guarantor from its obligations to the Vendors under this
          agreement and/or the Tax Deed, and this guarantee shall continue in
          force until the Purchaser or the Guarantor on its behalf shall have
          fully performed and discharged all the Guaranteed Obligations. Any
          settlement or discharge between the Vendors and the Purchaser shall be
          subject to the condition that no security or payment to the Vendors by
          the Purchaser or any third party shall be avoided or reduced by virtue
          of any provision or enactment relating to bankruptcy, insolvency or
          liquidation for the time being and from time to time in force.

23.3      Without prejudice to the rights of the Vendors against the Purchaser
          as principal debtor, the Guarantor shall as between the Vendors and
          the Guarantor be deemed principal debtor in respect of the Guaranteed
          Obligations and not merely a surety and accordingly it shall not be
          necessary for the Vendors before seeking to enforce this guarantee to
          seek to enforce any security or lien they may hold from the Purchaser
          or any third party or otherwise to take any steps or proceedings
          against the Purchaser.

24.  GOVERNING LAW AND JURISDICTION

24.1      English law

          This Agreement shall be governed by and construed in accordance with
          English law.

24.2      Courts of England and Wales

          24.2.1    The parties to this Agreement irrevocably agree that the
                    courts of England shall have non-exclusive jurisdiction to
                    settle any dispute which may arise out of or in connection
                    with this Agreement and that accordingly any Proceedings may
                    be brought in such courts.

          24.2.2    The submission to the jurisdiction of the English courts
                    referred to in clause 24.2.1 above shall not (and shall not
                    be construed so as to) limit the right of any party to take
                    any action or proceedings which may arise out of or in
                    connection with this Agreement in any other court of
                    competent jurisdiction (including without limitation in the
                    United Sates of America) nor shall the taking of proceedings
                    in the English courts preclude the taking of any such action
                    or proceedings in any other court of competent jurisdiction
                    (whether concurrently or not) if and to the extent permitted
                    by applicable law.

24.3      The Purchaser and the Guarantor hereby appoint Latham & Watkins (Attn:
          Michael Bond) of 99 Bishopsgate, London EC2M 3XF to accept service on
          their behalf of any proceedings which may be commenced pursuant to
          this clause in the courts of England.

24.4      Each of the parties hereby irrevocably waives any objection which they
          might now or hereafter have to the courts referred to in this clause
          24 being nominated as the forum to hear and determine any proceedings
          and to settle any disputes and agree not to claim that any such court
          is not a convenient or appropriate forum.

24.5      A person who is not a party to this Agreement shall have no right
          under the Contracts (Right of Third Parties) Act 1999 to enforce any
          of its terms.

                                       28



          EXECUTED AS A DEED by the hands of the parties or their duly
          authorised representatives on the date first appearing at the head of
          this Agreement.

                                       29



                                   SCHEDULE 1

                                   THE VENDORS


- -----------------------------------------------------------------------------------------------------------------------------
            (A)                     (B)              (C)            (D)              (E)             (F)             (G)

           VENDOR                   ***              ***            ***           Provisional        ***             ***
                                                                                 Consideration
                                                                                    [Pound]
- -----------------------------------------------------------------------------------------------------------------------------
                                                                                              
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
Mrs. J. Garman                ***              ***              ***           ***                 ***           ***
***
- -----------------------------------------------------------------------------------------------------------------------------
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
Mr. CB Reay-Young             ***              ***              ***           ***                 ***           ***
***
- -----------------------------------------------------------------------------------------------------------------------------
Nicholas Woods                ***              ***              ***           ***                 ***           ***
***
- -----------------------------------------------------------------------------------------------------------------------------
Simon Mifsud                  ***              ***              ***           ***                 ***           ***
***
- -----------------------------------------------------------------------------------------------------------------------------
***                           ***              ***              ***           ***                 ***           ***
- -----------------------------------------------------------------------------------------------------------------------------
                              ***              ***              ***           ***
- -----------------------------------------------------------------------------------------------------------------------------


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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       30



                                   SCHEDULE 2

                                  THE COMPANIES

A.  ATLANTECH MEDICAL DEVICES LIMITED

Registered Number:                        3071270

Registered Office:                        Atlantech House, Freemans Way,
                                          Harrogate Business Park, Harrogate,
                                          North Yorkshire HG3 1DH

Date and place of incorporation:          22 June 1995, UK

Secretary:                                Jennifer Maureen Garman

VAT Number:                               664743216

Tax District and Reference Number:        318/A624 Harrogate

Accounting Reference Date:                31 December

Auditors:                                 Brown Butler, Yorkshire Bank Chambers,
                                          Infirmary Street, Leeds LS1 2JT

Solicitors:                               DLA,   Victoria   Square   House,
                                          Victoria Square,
                                          Birmingham B2 4DL

Authorised Share Capital:                 (pound)50,000

Issued and fully paid-up Share Capital:   (pound)19,899 consisting of 15,678
                                          ordinary "A" shares of (pound)1 each
                                          and 4,221 ordinary "B" shares of
                                          (pound)1 each

Loan Capital:                             None

Directors:                                Jennifer Garman
                                          ***

                                          Clive Reay-Young
                                          ***

                                          Nicholas Woods
                                          ***

*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       31



B.  ATLANTECH MEDICAL DEVICES (UK) LIMITED

Registered Number:                        3156447

Registered Office:                        Atlantech House, Freemans Way,
                                          Harrogate Business Park, Harrogate,
                                          North Yorkshire HG3 1DH
Date and place of incorporation:          1 February 1996, UK

Secretary:                                Jennifer Maureen Garman

VAT Number:                               664813713

Tax District and Reference Number:        318/A648 Harrogate

Accounting Reference Date:                30 September

Auditors:                                 Brown Butler, Yorkshire Bank Chambers,
                                          Infirmary Street, Leeds LS1 2JT

Solicitors:                               DLA, Victoria Square House, Victoria
                                          Square,Birmingham B2 4DL

Authorised Share Capital:                 (pound)200

Issued and fully paid-up Share Capital:   (pound)160 consisting of 160 ordinary
                                          shares of (pound)1 each

Loan Capital:                             None

Directors:                                Jennifer Garman
                                          ***

                                          Simon Mifsud
                                          ***

                                          Clive Reay-Young
                                          ***

                                          Nicholas Woods
                                          ***

                                 THE SUBSIDIARY

A.  Atlantech Medical Devices, (USA) Inc.

    Registered Number: P01000052983 Registered office: c/o James Schneider,
    Atlas Pearlman, P.A., 350 East Las Olas Boulevard, Suite 1700, Fort
    Lauderdale, Florida 33301

    Date and place of incorporation: Florida, 29 May 2001

    Authorised share capital: $100 (divided into 100,000 shares of $0.001 each).

    Issued and fully paid-up share capital: $100

    Directors: Nicholas Woods, Jennifer Garman and Clive Reay-Young

***Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       32



                            THE ASSOCIATED COMPANIES

A.  Atlantech Italia Srl

    Registered number: 03207310966

    Registered office: Via L. Manara, 4, 20059 Vimercate (MI), Italy

    Date and place of incorporation: Monza, Milan on 26 July 2002

    ***

    ***

    Directors: Dr Pier Alfeo Zanotti Cavazzoni (sole director)

B.  Atlantech Medizinsche Produckte GmbH

    Registered number: FN 182571

    Registered office: Kaufmannstrasse 16, 6020 Innsbruck

    Date and place of incorporation: Innsbruck, 3 May 1999

    ***

    Directors:  Gunter Ruhr, Clive Reay-Young

                                   INVESTMENTS

A.  ***

B.  ***

__________
***Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       33



                                   SCHEDULE 3

                                 THE WARRANTIES

          Note that under clause 1.10 references in this schedule 3 to the
          Company shall be deemed to apply to each of the Companies and each of
          them severally.

                                     PART 1

                               GENERAL WARRANTIES

1.        Preliminary

1.1       Information

          The facts set out in the recitals and schedules 1, 2 and 4 and all
          information contained in the Disclosure Documents are true and
          accurate and not misleading. There is no fact or matter which has not
          been disclosed which renders any such information untrue, inaccurate
          or misleading in any material respect.

1.2       Power to contract

          Each Warrantor has full power to enter into and perform this Agreement
          and the Tax Deed respectively and this Agreement constitutes, and the
          Tax Deed when executed will constitute, binding obligations on each
          Warrantor in accordance with their terms.

2.        The Company

2.1       Memorandum and articles of association

          The copy of the memorandum and articles of association of the Company
          which is comprised in the Disclosure Documents is true and complete in
          all respects and has embodied in it or annexed to it a copy of every
          such resolution and agreement as is referred to in section 380(4), CA
          85 and the Company has at all times carried on its business and
          affairs in all material respects in accordance with its memorandum and
          articles of association and all such resolutions and agreements.

2.2       Statutory returns

          The Company has complied in all material respects with the provisions
          of the Companies Acts and all returns, particulars, resolutions and
          other documents required to be filed with or delivered to the
          Registrar of Companies or to any other applicable regulatory or
          governmental authority by the Company have been correctly and properly
          prepared in all material respects and so filed or delivered.

2.3       Share capital

          2.3.1     The Shares constitute the whole of the issued share capital
                    of the Company. There is no Encumbrance or any form of
                    agreement (including conversion rights and rights of
                    pre-emption) on, over or affecting the Shares or any
                    unissued shares, debentures or other securities of the
                    Company and there is no agreement or commitment to give or
                    create any of the foregoing. No claim has been made by any
                    person to be entitled to any of the foregoing and no person
                    has the right (exercisable now or in the future and whether
                    contingent or not) to call for the issue of any share or
                    loan capital of the Company under any of the foregoing. The
                    Warrantors are entitled to sell and

                                       34



                    transfer  the Shares to the Purchaser with full title
                    guarantee and otherwise on the terms set out in this
                    Agreement.

          2.3.2     The Company has not at any time:

                    (a)  repaid, redeemed or purchased (or agreed to repay,
                         redeem or purchase) any of its own shares, or otherwise
                         reduced (or agreed to reduce) its issued share capital
                         or any class of it or capitalised (or agreed to
                         capitalise) in the form of shares, debentures or other
                         securities or in paying up any amounts unpaid on any
                         shares, debentures or other securities, any profits or
                         reserves of any class or description or passed (or
                         agreed to pass) any resolution to do so; or

                    (b)  directly or indirectly provided any financial
                         assistance for the purpose of the acquisition of shares
                         in the Company or any holding company of the Company or
                         for the purpose of reducing or discharging any
                         liability incurred in such an acquisition whether
                         pursuant to sections 155 and 156, CA 85 or otherwise.

2.4       Solvency

          The Company has not stopped payment and is not insolvent nor unable to
          pay its debts according to section 123, Insolvency Act 1986. No order
          has ever been made or petition presented or resolution passed for the
          winding up of the Company and no distress, execution or other process
          has ever been levied on any of its assets. No administrative or other
          receiver has been appointed by any person over the business or assets
          of the Company or any part thereof, nor has any order been made or
          petition presented for the appointment of an administrator in respect
          of the Company.

3.        Connected business

3.1       Subsidiaries, Associated Companies and Investments

          3.1.1     The shares in the Subsidiaries, the Associated Companies and
                    Investments are held by Atlantech (or, in the case of
                    Biocomposites, by Grindco 268 Limited) free from all
                    Encumbrances and with all rights now or hereafter attaching
                    thereto.

          3.1.2     No Group company is under any obligation of any kind to
                    further acquire or subscribe shares or securities in any
                    company or other entity or make any funding or financial
                    contribution to any company or other entity nor is it party
                    to any agreement or arrangement (written or oral) in
                    relation to any other Group company, other than in the
                    ordinary course of business.

3.2       Connected transactions

          The Company:

          3.2.1     is not and has not agreed to become the holder or other
                    owner of any class of any shares, debentures or other
                    securities of any other body corporate (whether incorporated
                    in the United Kingdom or elsewhere) other than the
                    Subsidiaries and the Associated Companies or Investments;

          3.2.2     has not agreed to become a subsidiary of any other body
                    corporate or under the control of any group of bodies
                    corporate or consortium;

                                       35



          3.2.3     is not and has not agreed to become a member of any
                    partnership, joint venture, consortium or other
                    unincorporated association other than a recognised trade
                    association or agreement or arrangement for sharing
                    commissions or other income;

          3.2.4     has no branch, place of business or substantial assets
                    outside England and Wales or any permanent establishment (as
                    that expression is defined in any relevant Order in Council
                    made pursuant to section 788, ICTA 1988) in any country
                    outside the United Kingdom; and

          3.2.5     save as otherwise disclosed pursuant to paragraphs 3.2.1 to
                    3.2.4, does not have any interest, legal or beneficial, in
                    any shares or other capital or securities or otherwise
                    howsoever in any other firm, company, association, venture
                    or legal person or entity.

4.        Accounts

4.1       General

          The Accounts:

          4.1.1     were prepared in accordance with the requirements of all
                    relevant statutes, with good accounting principles and
                    practices generally accepted at the date hereof in the
                    United Kingdom (including the Accounting Standards) on a
                    basis consistent with the two preceding accounting periods
                    of the Company;

          4.1.2     disclose a true and fair view of the assets, liabilities and
                    state of affairs of the Company as at the relevant Balance
                    Sheet Date and of its profits for the financial year ended
                    on such date;

          4.1.3     to the extent required by the CA 85 and the relevant FRSs,
                    contain provision or reserve for bad and doubtful debts,
                    obsolescent or slow-moving stocks and for depreciation on
                    fixed assets, which provision or reserve was when made
                    adequate;

          4.1.4     to the extent required by CA 85 and the relevant FRSs,
                    contain a note of all capital commitments of the Company at
                    the Balance Sheet Date, which note was when made adequate,
                    fair and not misleading;

          4.1.5     to the extent required by CA 85 and the relevant FRSs,
                    disclose, note or provide for all material liabilities of
                    the Company which were known, actual or contingent
                    (including material contingent liabilities to customers and
                    contingent liabilities for Taxation);

          4.1.6     the amount included in the Accounts in respect of
                    work-in-progress and stock-in trade is reasonable and has
                    been determined in accordance with SSAP 9; and

          4.1.7     to the extent required by CA 85 and all relevant FRSs,
                    reflect all the fixed and loose plant and machinery,
                    equipment, furniture, fittings and vehicles used by the
                    Company at the Balance Sheet Date and none has been acquired
                    for any consideration in excess of its net realisable value
                    at the date of such acquisition or otherwise than by way of
                    a bargain at arm's length.

4.2       Stock-in-trade and work-in-progress

          The basis of valuation for stock-in-trade and work-in-progress has
          remained in all material respects consistent with that adopted for the
          purpose of the Company's audited accounts in

                                       36



          respect of the beginning and end of each of the accounting periods of
          the Company for the previous two financial years.

4.3       Profits

          The profits of the Company for the three years ended on the Balance
          Sheet Date as shown by the Accounts and by the audited accounts of the
          Company for the previous two years delivered to the Purchaser and the
          trend of profits shown by them have not (except as disclosed in them)
          been affected to a material extent by inconsistencies of accounting
          practices, by the inclusion of non-recurring items of income or
          expenditure, by transactions entered into otherwise than on normal
          commercial terms or by any other factors rendering such profits for
          all or any of such periods exceptionally high or low.

4.4       Books of account

          All accounts, books, ledgers, financial and other necessary records of
          whatsoever kind of the Company (including all invoices and other
          records required for VAT purposes):

          4.4.1     have been properly maintained in accordance with applicable
                    law;

          4.4.2     do not as far as the Warrantors are aware contain or reflect
                    any material inaccuracies or discrepancies.

4.5       Management Accounts of the Companies

          The Management Accounts have been prepared in accordance with
          accounting policies consistent with those used in preparation of the
          Accounts with all due care and on a basis consistent with the
          management accounts of the relevant Company prepared in the preceding
          year. The cumulative profits, assets and liabilities of the relevant
          Company stated in the Management accounts have not been knowingly or
          wilfully misstated.

5.        Post-Balance Sheet Date events

5.1       Since the Balance Sheet Date, the Company:

          5.1.1     has carried on its business in the ordinary and usual course
                    and without entering into any transaction, assuming any
                    liability or making any payment not provided for in the
                    Accounts which is not in the ordinary course of business and
                    without any interruption or material alteration in the
                    nature, scope or manner of its business;

          5.1.2     has not experienced any material deterioration in its
                    financial position or turnover or suffered any diminution of
                    its assets by the wrongful act of any person and the Company
                    has not had its business or profitability materially and
                    adversely affected by the loss of any important customer or
                    source of supply;

          5.1.3     has not acquired or disposed of or agreed to acquire or
                    dispose of any material assets or assumed or incurred or
                    agreed to assume or incur any material liabilities (actual
                    or contingent) otherwise than in the ordinary course of
                    business;

          5.1.4     has not declared, made or paid any dividend, bonus or other
                    distribution of capital or income (whether a qualifying
                    distribution or otherwise) and (excluding fluctuations in
                    overdrawn current accounts with bankers) no loan or loan
                    capital of the Company has been repaid in whole or in part
                    or has become due or is liable to be declared due by reason
                    of either service of a notice or lapse of time or otherwise
                    howsoever;

                                       37



          5.1.5     has not made any change to the remuneration, terms of
                    employment, emoluments or pension benefits of any present or
                    former director, officer or employee of the Company who on
                    the Balance Sheet Date was entitled to remuneration in
                    excess of (pound)15,000 per annum and has not appointed or
                    employed any additional director, officer or employee
                    entitled as aforesaid;

          5.1.6     has received payment in full of all debts owing to the
                    Company shown in the Accounts (subject to any provision for
                    bad and doubtful debts made in the Accounts), has not
                    released any debts in whole or in part and has not written
                    off debts in an amount exceeding (pound)15,000 in the
                    aggregate;

          5.1.7     has not entered into contracts involving capital expenditure
                    in an amount exceeding(pound)20,000 in the aggregate;

          5.1.8     has not become aware that any event has occurred which would
                    entitle any third party to terminate any contract or any
                    benefit enjoyed by it or call in any money before the normal
                    due date therefor;

          5.1.9     has paid its creditors in accordance with the normal
                    practice of the Company and no claims have been made or are
                    pending under the Late Payment of Commercial Debts
                    (Interest) Act 1998 and does not have any debts outstanding
                    which are overdue for payment by more than eight weeks;

          5.1.10    has not borrowed or raised any money or taken any financial
                    facility (except such short term borrowings from bankers as
                    are within the amount of any overdraft facility which was
                    available to the Company at the Balance Sheet Date) or since
                    the Balance Sheet Date renegotiated or received any notice
                    from any banker that such banker wishes to renegotiate any
                    overdraft facility available to the Company at the Balance
                    Sheet Date;

          5.1.11    has not made any change to its accounting reference date and
                    no accounting period of the Company has ended since the
                    Balance Sheet Date;

          5.1.12    (including any class of its members) has not passed any
                    shareholders' resolution whether in general meeting or
                    otherwise.

6.        Transactions with the Vendors, Directors and Connected Persons

6.1       Loans and debts

          There is not outstanding:

          6.1.1     any indebtedness or other liability (actual or contingent)
                    owing by the Company to any Vendors or Director or any
                    Connected Person or owing to the Company by any Vendors or
                    Director or any Connected Person; or

          6.1.2     any guarantee or security for any such indebtedness or
                    liability as aforesaid.

6.2       Arrangements with Connected Persons

          6.2.1     There is not outstanding, and there has not at any time
                    during the last six years been outstanding, any agreement,
                    arrangement or understanding (whether legally enforceable or
                    not) to which the Company is a party and in which any
                    Vendors, Affiliate of any Vendors, Director or former
                    director of the Company or any Connected Person is or has
                    been interested whether directly or indirectly.

                                       38



          6.2.2     The Company is not a party to nor has its profits or
                    financial position during the last six years been affected
                    by any agreement or arrangement which is not entirely of an
                    arm's length nature.

6.3       Competitive interests

          6.3.1     No Warrantors, Affiliate of any Warrantors, Director, former
                    director of the Company nor any Connected Person, either
                    individually, collectively or with any other person or
                    persons, has any estate, right or interest, directly or
                    indirectly, in any business other than that now carried on
                    by the Company which is or is likely to be or become
                    competitive with any aspect of the Business of the Company
                    save as registered holder or other owner of any class of
                    securities of any company if such class of securities is
                    listed on any recognised investment exchange (as defined in
                    the Financial Services and Markets Act 2000) and if such
                    person (together with Connected Persons and Affiliates)
                    holds or is otherwise interested in less than five % of such
                    class of securities.

          6.3.2     None of the Warrantors either individually, collectively or
                    with any other person or persons is interested in any way
                    whatsoever in any Intellectual Property used and not wholly
                    owned by the Company.

6.4       Benefits

          No Connected Person of any Vendors, Director or former director of the
          Company is entitled to or has claimed entitlement to any remuneration,
          compensation or other benefit from the Company.

7.        Finance

7.1       Borrowings

          Particulars of all money currently borrowed by the Company have been
          Disclosed. The total amount borrowed by the Company from any source
          does not exceed any limitation on its borrowing contained in the
          articles of association of the Company or in any debenture or loan
          stock trust deed or instrument or any other document executed by the
          Company and the amount borrowed by the Company from each of its
          bankers does not exceed the overdraft facility agreed with such
          banker. The Company has no outstanding loan capital.

7.2       Debts owed to the Company

          None of the Company nor the Warrantors considers any of the debts
          owing to the Company (but which are not yet due) to be irrecoverable
          in whole or in part. The Company does not own the benefit of any debt
          (whether present or future) other than debts which have accrued to it
          in the ordinary course of business.

7.3       Bank accounts

          7.3.1     Particulars of the balances on all the Company's bank
                    accounts as at a date not more than three days before the
                    date of this Agreement have been Disclosed and the Company
                    has no other bank accounts. Since the date of such
                    particulars there have been no payments out of any such bank
                    accounts except for routine payments which have been
                    Disclosed.

                                       39



          7.3.2     All unpresented cheques drawn by the Company have been
                    Disclosed and there are no such unpresented cheques drawn
                    otherwise than in the normal course of business.

7.4       Financial facilities

          The Warrantors have Disclosed full details and true and correct copies
          of all documents relating to all debentures, acceptance lines,
          overdrafts, loans or other financial facilities outstanding or
          available to the Company and any Encumbrances provided for by such
          documents. As far as the Warrantors are aware, neither the Warrantors
          nor the Company have done anything whereby the continuance of any such
          facility or Encumbrance in full force and effect might be affected or
          prejudiced.

7.5       Grants

          Full details of all grants made to the Company in the last six years
          have been Disclosed. No act or transaction has been effected in
          consequence whereof the Company is or so far as the Warrantors are
          aware may be held liable to refund in whole or in part any investment
          grant, building grant or other such grant or loan received by virtue
          of any statute or in consequence whereof any such grant or loan for
          which application has been made by it will not or may not be paid or
          will or may be reduced.

7.6       Options and guarantees

          7.6.1     The Company is not responsible for the indebtedness of any
                    other person nor party to any option or pre-emption right or
                    any guarantee, suretyship or any other obligation (whatever
                    called) to pay, purchase or provide funds (whether by the
                    advance of money, the purchase of or subscription for shares
                    or other securities or the purchase of assets or services or
                    otherwise) for the payment of, or as an indemnity against
                    the consequence of default in the payment of, any
                    indebtedness of any other person.

          7.6.2     No person other than the Company or a Subsidiary has given
                    any guarantee of or security for any overdraft, loan or loan
                    facility granted to the Company or any Subsidiary.

8.        The Properties

8.1       General

          8.1.1     The Properties comprise all the land and premises owned,
                    controlled, used or occupied by the Company and all the
                    rights or interests vested in the Company relating to any
                    land and premises at the date hereof and the particulars set
                    out in schedule 4 are true and accurate in all material
                    respects and not misleading.

          8.1.2     The Company is not the original lessee of any land or
                    premises other than the Properties and has not given a
                    guarantee or entered into any direct covenant with a
                    landlord or assignor of any land or premises other than the
                    Properties.

          8.1.3     The Company has legal and beneficial title to each of the
                    Properties.

          8.1.4     The Company has in its possession or unconditionally held to
                    its order all the documents of title and other documents and
                    papers relating to each of the Properties.

                                       40



          8.1.5     The Properties, title deeds and documentation relating
                    thereto, and all tenant's fixtures and fittings and plant,
                    equipment and other chattels on the Properties, are not
                    subject to any Encumbrance nor, so far as the Warrantors are
                    aware, any overriding interest (as defined in section 70,
                    Land Registration Act 1925) nor is there any person in
                    possession or occupation of or who has or claims any right
                    of any kind in respect of any of the Properties adversely to
                    the estate, interest, right or title therein of the Company;

          8.1.6     So far as the Warrantors are aware, there are no rights,
                    interests, covenants, restrictions, reservations, licences
                    or easements or any disputes or outstanding notices (whether
                    given by a landlord, a local authority or any other person)
                    which adversely affect the Properties or the proper use and
                    enjoyment of any of the Properties for the purpose of the
                    business now being carried on at the Properties by the
                    Company.

          8.1.7     There has been no dealing with any of the Properties
                    otherwise than at arm's length and in particular no dealing
                    at an undervalue which may give rise to a claim for improper
                    stamping or setting aside.

          8.1.8     None of the Properties is subject to the payment of any
                    outgoings other than the usual rates and taxes and the
                    payments referred to in the lease or licence under which the
                    Properties are held and all sums due to date in respect
                    thereof have been paid.

          8.1.9     Each of the Properties:

                    (c)  enjoys access and egress over roads and footpaths
                         which, so far as the Warrantors are aware, have been
                         adopted by the appropriate highway authority and are
                         maintainable at the public expense;

                    (d)  drains foul sewage and surface water to public sewers,
                         is served by water, electricity, gas and telephone
                         utilities and either the pipes, sewers, wires, cables,
                         conduits and other conducting media serving the
                         Properties connect directly to the mains without
                         passing through land in the occupation or ownership of
                         any third party or, if they do not, so far as the
                         Warrantors are aware, each of the Properties has the
                         benefit of all necessary easements and rights for the
                         maintenance and use thereof and such rights are held on
                         terms which do not entitle any person to terminate or
                         curtail the same; and

                    (e)  so far as the Warrantors are aware, has the benefit of
                         all other easements and rights necessary for its proper
                         use and enjoyment for the purposes of the business now
                         being carried on at the Properties by the Company and
                         such easements and rights are held on terms which do
                         not entitle any person to terminate or curtail the
                         same.

          8.1.10    The Company has not entered into any commitment (whether
                    legally binding or not) and the Company is not party to any
                    subsisting agreement with any person or company whereby a
                    fee (including but not limited to an abort fee) will be paid
                    to such person or company in respect of the management, use,
                    development, letting or sale of any of the Properties.

          8.1.11    So far as the Warrantors are aware, there are no unpaid
                    charges for the construction or adoption of any road or
                    sewer or other service serving the Property.

8.2       Planning

                                       41



          8.2.1     In relation to each of the Properties, its existing use is
                    set out in Part 1 of schedule 4 ("Existing Use").

          8.2.2     So far as the Warrantors are aware, there are no lawfully
                    enforceable restrictions or prohibitions contained in any
                    planning permission for the Existing Use which restrict or
                    prohibit the Existing Use of any of the Properties.

          8.2.3     So far as the Warrantors are aware, the Existing Use of each
                    of the Properties is the permitted use under the Town and
                    Country Planning legislation (which term includes the Town &
                    Country Planning Act 1990, the Planning (Listed Buildings
                    and Conservation Areas) Act 1990, the Planning (Hazardous
                    Substances) Act 1990 and the Planning (Consequential
                    Provisions) Act 1990) and is not a temporary or personal
                    use.

          8.2.4     So far as the Warrantors are aware, all development carried
                    out in relation to each of the Properties has been lawful
                    and all necessary consents and permissions have been
                    obtained for such development.

          8.2.5     So far as the Warrantors are aware, the consents and
                    permissions referred to in paragraph 8.2.4 are valid,
                    subsisting and unimpeachable and are also either
                    unconditional or subject only to conditions which have been
                    satisfied so that nothing further remains to be done
                    thereunder.

          8.2.6     The Company has not received notice of any resolution,
                    proposal or order made or contemplated for the compulsory
                    acquisition of any of the Properties by the local or any
                    other authority nor any outstanding order, notice or other
                    requirement of any such authority that affects the Existing
                    Use of any of the Properties or involves expenditure in
                    compliance with it.

          8.2.7     No compensation has been received consequent upon a refusal
                    of any planning permission affecting any of the Properties
                    or the imposition of any restrictions in any such planning
                    permission and no such planning permission is suspended.

8.3       Leasehold Properties

          8.3.1     Where any of the Properties is leasehold, particulars of
                    each lease vested in the Company are set out in Part 3 of
                    schedule 4 and in relation to each such lease:

                    (a)  any consent necessary for the grant of the lease has
                         been obtained and a copy of the consent is with the
                         title deeds to the Property to which the lease relates;

                    (b)  no rent reviews are or should be currently under
                         negotiation or the subject of a reference to an expert
                         or arbitrator or the courts;

                    (c)  the receipt for the payment of rent which fell due
                         immediately prior to the date hereof is unqualified;

                    (d)  no notices of breaches of any covenants or conditions
                         contained in the lease have been given or received on
                         the part of either the landlord or the Company and the
                         landlord has not refused to accept rent or made any
                         complaint of breach of covenant;

                    (e)  no alterations, improvements or additions have been
                         made to the Property to which the lease relates since
                         the grant of the lease or in respect of all such

                                       42



                         alterations, improvements or additions made all
                         necessary consents and approvals have first been
                         obtained; and

                    (f)  VAT is not chargeable on the rent or any other payment
                         to be made under the lease and no election has been
                         made by the landlord to waive exemption from VAT in
                         respect of the lease.

8.4       Inferior leases

          The Company is in actual occupation of each of the Properties and no
          other person is or will be entitled to occupy or use any part or any
          of the Property.

8.5       Statutory compliance/environmental issues

          The Company has not received notice of any breach or allegation of any
          breach of the requirements of:

                    the Shops Act 1950 and 1965
                    the Clean Air Act 1993
                    the Construction (Design and Management) Regulations 1995
                    the Factories Act 1961
                    the Offices, Shops and Railway Premises Act 1963
                    the Fire Precautions Act 1971
                    the Health and Safety at Work etc. Act 1974
                    the Control of Pollution Act 1974
                    the Food and Environmental Protection Act 1985
                    the Planning (Hazardous Substances) Act 1990
                    the Environmental Protection Act 1990
                    the Water Resources Act 1991 the Water Industry Act 1991
                    the Radioactive Substances Act 1993
                    or the Public Health Acts or other legislation concerning
                    health, safety or environmental matters or any regulations,
                    orders, notices or directions made under any of such
                    legislation which in any such case affect any of the
                    Properties.

          8.5.1     Where required, a fire certificate has been issued in
                    respect of each of the Properties and so far as the
                    Warrantors are aware, each of the Properties complies in all
                    respects with current fire regulations.

9.        Environmental

9.1       Compliance with Environmental Law

          So far as the Warrantors are aware, at all times during the period of
          occupation by the Company the Property (other than the premises at 19
          Greenfield Avenue, Stourbridge) has been used, and at all times the
          Business has been conducted thereon, in all material respects in
          compliance with Environmental Law.

9.2       Environmental Liability

          There are no events, states of affairs, conditions, circumstances,
          activities, practices, incidents, or actions (including the
          generation, use, treatment, storage, transport, deposit, disposal,
          discharge or management of Hazardous Matter) which, so far as the
          Warrantors are aware, have occurred or are occurring or have been or
          are in existence at, in, under or about the Property (other than the
          premises at 19 Greenfield Avenue, Stourbridge) at all times

                                       43



          during the period of occupation of the Property by the Company or in
          or about the conduct of the Business by the Company which will give
          rise to Environmental Liability.

9.3       Notice of claims

          At no time has the Company received any notice, claim or other
          communication alleging any actual or potential Environmental
          Liability.

10.       Other assets

10.1      Title

          10.1.1    The Company has Legal and Beneficial Title to all assets of
                    the Company which are included in the Accounts or have
                    otherwise been represented as being the property of the
                    Company or which were at the Balance Sheet Date used or held
                    for the purposes of its business and (except for assets
                    disposed of or realised by the Company in the ordinary
                    course of business) the Company retains such title to all
                    such assets free from any Encumbrance, hire or hire purchase
                    agreement or leasing agreement or agreement for payment on
                    deferred terms and all such assets are in the possession and
                    control of the Company and are sited within the United
                    Kingdom.

          10.1.2    The Company has not acquired or agreed to acquire any
                    material asset on terms that title to such asset does not
                    pass to the Company until full payment is made.

10.2      Encumbrances

          The Company has Legal and Beneficial Title to all assets which have
          been acquired by the Company since the Balance Sheet Date and (except
          for assets disposed of or realised by the Company in the ordinary
          course of business) the same are in the possession and control of the
          Company and none is the subject of any Encumbrance nor has the Company
          created or agreed to create any Encumbrance or entered into any
          factoring arrangement, hire-purchase, conditional sale or credit sale
          agreement which has not been Disclosed and in respect of any such
          Encumbrance, arrangement or agreement so Disclosed there has been no
          default by the Company in the performance or observance of any of the
          provisions thereof.

10.3      Condition of assets

          The plant and machinery (including fixed plant and machinery) and all
          vehicles and office and other equipment shown in the Accounts or
          acquired since the Balance Sheet Date or otherwise used in connection
          with the Business which have not been disposed of in the ordinary
          course of business:

          10.3.1    are in reasonable repair and condition having regard to
                    their age (and subject to fair wear and tear) and are
                    regularly maintained and in satisfactory working order;

          10.3.2    are each capable of doing the work for which they were
                    designed and/or purchased and so far as the Warrantors are
                    aware will each be so capable (subject to fair wear and
                    tear) during the period of time over which the value of such
                    assets will be written down to nil in the accounts of the
                    Company;

          and the vehicles owned by the Company are roadworthy and duly licensed
          for the purposes for which they are used.

10.4      Condition of stock

                                       44



          The Company's stock-in-trade is in good condition and is capable of
          being sold by the Company in the ordinary course of business in
          accordance with its current price list without rebate or allowance to
          a purchaser.

10.5      Rental payments

          Rentals payable by the Company under any leasing, hire-purchase or
          other similar agreement to which it is a party are set out in the
          Disclosure Documents and have not been and as far as the Warrantors
          are aware are not likely to be increased.

11.       Insurance

11.1      Extent of insurance

          The Company is and has at all material times been, in the reasonable
          opinion of the Warrantors, adequately covered against all legal
          liability and risks normally insured against by such companies
          (including liability to employees or third parties for personal injury
          or loss or damage to property, product liability and loss of profit).

11.2      Premiums and claims

          Particulars of all policies of insurance of the Company now in force
          have been Disclosed and such particulars are true and correct and all
          premiums due on such policies have been duly paid and all such
          policies are valid and in force. So far as the Warrantors are aware
          there are no circumstances which might lead to any liability under
          such insurance being avoided by the insurers or the premiums being
          increased. There is no claim outstanding under any such policies and
          so far as the Warrantors are aware there are no circumstances likely
          to give rise to a claim.

12.       Litigation

12.1      Litigation and arbitration proceedings

          12.1.1    Save as plaintiff in the collection of debts (not exceeding
                    (pound)5,000 in the aggregate) arising in the ordinary
                    course of business, the Company is not now engaged in any
                    litigation, arbitration or criminal proceedings and, so far
                    as the Warrantors are aware, there are no lawsuits or
                    arbitration proceedings pending or threatened by or against
                    the Company or any person for whose acts or defaults the
                    Company may be vicariously liable.

          12.1.2    The Company has not, in the last three years preceding the
                    date of this Agreement, been involved in any litigation,
                    arbitration, criminal proceedings or material dispute with
                    any person who is or was a supplier or customer of
                    importance to the Company or the Business, or where such
                    litigation, arbitration, proceedings or dispute resulted in
                    adverse publicity or loss of goodwill.

          12.1.3    So far as the Warrantors are aware, there is no matter or
                    fact in existence which might give rise to any legal
                    proceedings or arbitration involving the Company including
                    any which might form the basis of any criminal prosecution
                    against the Company.

12.2      Injunctions, etc.

          No injunction or order for specific performance has been granted
          against the Company.

                                       45



12.3      Orders and judgments

          The Company is not subject to any order or judgment given by any court
          or governmental agency which is still in force and has not given any
          undertaking to any court or to any third party arising out of any
          legal proceedings.

13.       Licences

13.1      General

          The Company has all necessary licences (including statutory licences),
          permits, consents and authorities (public and private) for the proper
          and effective carrying on of the Business and in the manner in which
          the Business is now carried on and all such licences, permits,
          consents and authorities are valid and subsisting and the Warrantors
          know of no reason why any of them should be suspended, cancelled or
          revoked whether in connection with the sale to the Purchaser or
          otherwise and, so far as the Warrantors aware, there are no factors
          that might in any way prejudice the continuance or renewal of any of
          those licences, permits, consents or authorities and the Company is
          not restricted by contract from carrying on any activity in any part
          of the world.

13.2      Data Protection Act 1998

          13.2.1    Those members of the Group which are required to register
                    under the Data Protection Act 1998 have registered or
                    applied to register themselves under the Data Protection Act
                    1998 in respect of all registrable personal data held by
                    them, and all due and requisite fees in respect of such
                    registrations have been paid.

          13.2.2    The details contained in such registrations or applications
                    are correct, proper and suitable for the purpose(s) for
                    which the Company holds or uses the personal data which are
                    the subject of them.

          13.2.3    So far as the Warrantors are aware, all personal data held
                    by each member of the Group has been held in accordance with
                    the data protection principles and there has been no
                    unauthorised disclosure of such personal data.

14.       Trading

14.1      Tenders, etc.

          No offer, tender or the like is outstanding (the value of which to the
          Company could exceed (pound)50,000 in any year) which is capable of
          being converted into an obligation of the Company by an acceptance or
          other act of some other person.

14.2      Delegation of powers

          There are in force no powers of attorney given by the Company other
          than to the holder of an encumbrance solely to facilitate its
          enforcement nor any other authority (express, implied or ostensible)
          given by the Company to any person to enter into any contract or
          commitment or do anything on its behalf other than any authority of
          employees to enter into routine trading contracts in the normal course
          of their duties.

14.3      Consequence of acquisition of Shares by Purchaser

          The acquisition of the Shares by the Purchaser or compliance with the
          terms of this Agreement will not:

                                       46



          14.3.1    so far as the Warrantors are aware, cause the Company to
                    lose the benefit of any right or privilege it presently
                    enjoys or cause any person who normally does business with
                    the Company not to continue to do so on the same basis as
                    previously;

          14.3.2    relieve any person of any obligation to the Company (whether
                    contractual or otherwise) or legally entitle any person to
                    determine any such obligation or any right or benefit
                    enjoyed by the Company or to exercise any right whether
                    under an agreement with or otherwise in respect of the
                    Company;

          14.3.3    conflict with or result in the breach of or constitute a
                    default under any of the terms, conditions or provisions of
                    any agreement or instrument to which the Company is now a
                    party or any loan to or mortgage created by the Company or
                    of its memorandum or articles of association;

          14.3.4    result in any present or future indebtedness of the Company
                    becoming due and payable or capable of being declared due
                    and payable prior to its stated maturity; or

          14.3.5    entitle any person to receive from the Company any finder's
                    fee, brokerage or other commission.

14.4      Guarantees and warranties

          The Company has not given any guarantee or warranty or made any
          representation in respect of articles or trading stock, sold or
          contracted to be sold by it, save for any warranty or guarantee
          implied by law and (save as aforesaid) has not accepted any liability
          or obligation to service, maintain, repair, take back or otherwise do
          or not do anything in respect of any articles or stock that would
          apply after any such article or stock has been delivered by it.

14.5      Fair trading, etc.

          So far as the Warrantors are aware, the Company is not and has not
          been party to or directly or indirectly concerned in any agreement,
          arrangement, understanding or practice (whether or not legally
          binding) or in the pursuit of any course of conduct which is:

          14.5.1    registrable under the RTPA or notifiable under the
                    Competition Act 1998 or capable of giving rise to an
                    investigation by the Director General of Fair Trading or a
                    reference to the Monopolies and Mergers Commission;

          14.5.2    in contravention or breach of the EC Treaty, the Fair
                    Trading Act 1973, the Consumer Credit Act 1974, the Resale
                    Prices Act 1976, the Trade Descriptions Act 1968, the RTPA,
                    the Competition Act 1980, the Consumer Protection Act 1987,
                    the Competition Act 1998 or any regulations, orders, notices
                    or directions made thereunder; or

          14.5.3    is otherwise registrable, unenforceable or void or renders
                    the Company or any of its officers liable to administrative,
                    civil or criminal proceedings under any anti-trust, trade
                    regulation or similar legislation in any jurisdiction where
                    the Company carries on business.

14.6      Restrictions on trading

          The Company is not and has not been a party to any agreement,
          arrangement, understanding or practice restricting the freedom of the
          Company to provide and take goods and services by such means and from
          and to such persons and into or from such place as it may from time to
          time think fit.

                                       47



14.7      Possession of records

          14.7.1    The Company does not have any of its records, systems,
                    controls, data or information recorded, stored, maintained,
                    operated or otherwise wholly or partly dependent on or held
                    by any means (including any electronic, mechanical or
                    photographic process whether computerised or not) which
                    (including all means of access thereto and therefrom) are
                    not under the exclusive ownership and direct control of the
                    Company.

14.8      Business names

          The Company does not use on its letterhead, books or vehicles or
          otherwise carry on the Business under any name other than its
          corporate name.

15.       Contracts

15.1      Onerous contracts

          There are no long term contracts (that is, contracts not terminable by
          the Company without penalty on six months' notice or less) or onerous
          or unusual or abnormal contracts (that is, contracts for material
          capital commitments or contracts differing from those in the ordinary
          course of business) binding upon the Company and no expenses or
          liabilities of a material amount have been incurred before the date of
          this Agreement by the Company otherwise than for the purpose of the
          Company's business.

15.2      Material contracts

          All contracts to which the Company is a party as are material have
          been Disclosed and the Company is not a party to or subject to any
          agreement, transaction, obligation, commitment, understanding,
          arrangement or liability which:

          15.2.1    other than in the case of ongoing sales and/or distribution
                    agreements, is incapable of complete performance in
                    accordance with its terms within six months after the date
                    on which it was entered into or undertaken;

          15.2.2    was, at the time of entering into, known by the Warrantors
                    or by the Company to be likely to result in a loss to the
                    Company on completion of performance;

          15.2.3    cannot readily be fulfilled or performed by the Company on
                    time and without undue or unusual expenditure of money and
                    effort;

          15.2.4    involves obligations, restrictions, expenditure or receipts
                    of an unusual, onerous or exceptional nature and not in the
                    ordinary course of business;

          15.2.5    involves or is likely to involve the supply of goods by or
                    to the Company (other than supplies from Atlantech to
                    Atlantech UK) the aggregate sales value of which will
                    represent in excess of five % of the turnover of the Company
                    for the year ended on the Balance Sheet Date;

          15.2.6    requires the Company to pay any commission, finder's fee,
                    royalty or the like; or

          15.2.7    is in any way otherwise than in the ordinary course of the
                    Company's business.

15.3      Performance of contracts

                                       48



          15.3.1    The terms of all contracts of the Company have been complied
                    with by the Company in all material respects and, so far as
                    the Warrantors are aware, by the other parties to the
                    contracts in all material respects and there are no
                    circumstances likely to give rise to a default by the
                    Company or, so far as the Warrantors are aware, by the other
                    parties under any such contract.

          15.3.2    There are no outstanding claims, separately or in the
                    aggregate, of material amounts, against the Company on the
                    part of customers or other parties in respect of defects in
                    quality or delays in delivery or completion of contracts or
                    deficiencies of design or performance or otherwise relating
                    to liability for goods or services sold or supplied by the
                    Company and no such claims are threatened or anticipated
                    and, as far as the Warrantors are aware, there is no matter
                    or fact in existence in relation to goods or services
                    currently sold or supplied by the Company which might give
                    rise to the same.

          15.3.3    The Company has no knowledge of the invalidity of or grounds
                    for rescission, avoidance or repudiation of any agreement or
                    other transaction to which the Company is a party and has
                    received no notice of any intention to terminate, repudiate
                    or disclaim any such agreement or other transaction.

16.       Employees

16.1      Particulars of employees

          The particulars shown in the schedule of employees comprised in the
          Disclosure Documents are true and complete in all material respects
          and show in respect of each Director, officer and employee of the
          Company his date of birth, the date on which he commenced continuous
          employment with the Company for the purposes of ERA and all
          remuneration payable and other benefits provided or which the Company
          is bound to provide (whether now or in the future) to each such person
          and include full particulars of all remuneration arrangements
          (particularly profit sharing, incentive and bonus arrangements to
          which the Company is a party whether binding or not) and each
          Director, officer and employee of the Company is listed therein.

16.2      Service contracts

          There is no contract of service in force between the Company and any
          of its Directors, officers or employees which is not terminable by the
          Company without compensation (other than any compensation payable
          under Parts X and XI, ERA) on 12 weeks' notice given at any time or
          otherwise in accordance with section 86, ERA other than as Disclosed.
          There are no consultancy or management services agreements in
          existence between the Company and any other person, firm or company,
          and there are no agreements or other arrangements (binding or
          otherwise) between the Company or any employers' or trade association
          of which the Company is a member and any Trade Union. There are no
          outstanding pay negotiations with any employees or Trade Unions.

16.3      Benefits

          There are no amounts owing to present or former directors, officers or
          employees of the Company other than not more than one month's arrears
          of remuneration accrued or due or for reimbursement of business
          expenses incurred within a period of three months preceding the date
          of this Agreement and no moneys or benefits other than in respect of
          remuneration or emoluments of employment are payable to or for the
          benefit of any present or former director, officer or employee of the
          Company, nor any dependant of any present or former director, officer
          or employee of the Company.

                                       49



16.4      Liabilities and payments

          Save to the extent (if any) to which provision or allowance has been
          made in the Accounts:

          16.4.1    no liability is currently outstanding or, so far as the
                    Warrantors are aware is anticipated, by the Company for
                    breach of any contract of employment or for services or for
                    severance payments or for redundancy payments or protective
                    awards or for compensation for unfair dismissal or for
                    failure to comply with any order for the reinstatement or
                    re-engagement of any employee or for sex or race
                    discrimination or for any other liability accruing from the
                    termination or variation of any contract of employment or
                    for services;

          16.4.2    no gratuitous payment is currently outstanding from the
                    Company in connection with the actual or proposed
                    termination, suspension or variation of any contract of
                    employment or for services of any present or former
                    director, officer or any dependant of any present or former
                    director, officer or employee of the Company; and

          16.4.3    the Company has not agreed to make any payment to or
                    provided or agreed to provide any benefit for any present or
                    former director, officer or employee of the Company, which
                    is currently outstanding.

16.5      Relevant legislation

          16.5.1    The Company has in relation to each of its employees (and so
                    far as relevant to each of its former employees) complied
                    with:

                    (g)  all obligations imposed on it by all relevant statutes,
                         regulations and codes of conduct and practice
                         (including, without limitation, Health and Safety at
                         Work etc. Act 1974 and the Working Time Regulations
                         1998) affecting its employment of any persons and all
                         relevant orders and awards made thereunder and has
                         maintained all necessary records regarding the service,
                         terms and conditions of employment of each of its
                         employees; and

                    (h)  all collective agreements, recognition agreements and
                         customs and practices for the time being affecting its
                         employees or their conditions of service.

          16.5.2    There is no liability or claim against the Company
                    outstanding or anticipated under the Equal Pay Act 1970, the
                    Sex Discrimination Acts 1975 and 1986, the Race Relations
                    Act 1976, the ERA, TUPE, TULRCA or the Trade Union Reform
                    and Employment Rights Act 1993.

16.6      Termination of employment

          No present director, officer or employee of the Company has given or
          received notice terminating his employment and Completion of this
          Agreement will not entitle any employee to terminate his employment or
          trigger any entitlement to a severance payment or liquidated damages.

16.7      Share and other schemes

          The Company does not have in existence nor is it proposing to
          introduce, and none of its directors, officers or employees
          participate in (whether or not established by the Company) any
          employee share trust, share incentive scheme, share option scheme or
          profit sharing scheme for the benefit of all or any of its present or
          former directors, officers or employees or

                                       50



          the dependants of any of such persons or any scheme whereunder any
          present or former director, officer or employee of the Company is
          entitled to a commission or remuneration of any other sort calculated
          by reference to the whole or part of the turnover, profits or sales of
          the Company or any other person, firm or company including any
          profit-related pay scheme established under Chapter III, Part V, ICTA
          1988.

16.8      Disputes and claims

          16.8.1    No dispute exists (nor are the Warrantors aware of any
                    circumstances which may lead to any dispute) between the
                    Company and a material number or category of its employees
                    or any Trade Union(s) or Works Council and so far as the
                    Warrantors are aware there are no wage or other claims
                    outstanding against the Company by any person who is now or
                    has been a director, officer or employee of the Company.

          16.8.2    The Company has not had during the last three years any
                    strike, work stoppages, slowdown or work-to-rule by its
                    employees or lock-out, nor, so far as the Warrantors are
                    aware, is any anticipated, which has caused, or is likely to
                    cause, the Company to be materially incapable of carrying on
                    its business in the normal and ordinary course.

16.9      Transfer of undertakings

          The Company has not been a party to any relevant transfer as defined
          in TUPE nor has the Company failed to comply with any duty to inform
          and consult any Trade Union under the said regulations within the
          period of one year preceding the date of this Agreement.

16.10     Agreements with Trade Unions

          The Company is not a party to any agreement or arrangement with or
          commitment to any trade unions or staff association nor are any of its
          employees members of any trades union or staff association.

17.       Pension Schemes

17.1      Save for the Atlantech Medical Devices Limited Retirement Benefits
          Scheme ("the SSAS") and the Clerical Medical Group Stakeholder Pension
          Plan ("the Stakeholder"), there is not in operation any arrangement
          for the provision of, and the Companies are not paying or contributing
          towards, nor are they under any moral or legal liability or contingent
          liability to pay or secure, any pension or other benefit on
          retirement, resignation, dismissal, death, sickness or disability or
          on the attainment of a specified age or the completion of a specified
          number of years of service for the benefit of any of the Employees or
          any dependant of an Employee; and the Companies have not undertaken to
          make any ex gratia payment to or in respect of any of the Employees.

17.2      As regards the SSAS:

          17.2.1    complete and accurate details of the SSAS (including all
                    documentation, benefit structures, augmentations and funding
                    details) have been Disclosed;

          17.2.2    all benefits under the SSAS (other than those which are
                    fully insured) are provided on a money purchase basis and
                    there is no obligation (other than in the case of those
                    benefits which are fully insured) to provide any specified
                    level of benefits;

                                       51



          17.2.3    the identities of those of the Employees who are members of
                    the SSAS or of persons who have any rights under the SSAS in
                    respect of any of the Employees have been Disclosed;

          17.2.4    as at Completion, all contributions due to be paid in
                    respect of the SSAS by the Companies have been duly paid;

          17.2.5    all premiums by way of insurance which are payable in
                    respect of the SSAS by the Companies or by the trustees or
                    other administrators of the SSAS have been duly paid and
                    full details of the insurance policies or contracts
                    concerned have been Disclosed;

          17.2.6    all benefits (other than refunds of contributions) payable
                    under the SSAS on the death of any person or during periods
                    of sickness or disability are as at Completion fully insured
                    under a policy effected with an insurance company of good
                    repute and there is no reason why the relevant policies
                    cannot be continued on the same terms following Completion;

          17.2.7    all consultancy, legal and other fees, charges or expenses
                    in relation to the SSAS have been paid and no services have
                    been rendered in respect of which an account or other
                    invoice has not been rendered;

          17.2.8    no legal proceedings in connection with the SSAS are
                    pending, threatened or expected (including any complaint to
                    the Pensions Ombudsman) and there is no fact or circumstance
                    likely to give rise to any such proceedings;

          17.2.9    the SSAS has been administered in accordance with the
                    provisions of the SSAS and has been administered in
                    accordance with and comply with all applicable legislation,
                    regulatory requirements and the general requirements of
                    trust law, and (without limitation to the foregoing) -

                    (a)  the SSAS does not and has not directly or indirectly
                         discriminated between male and female employees as
                         regards eligibility, the rate of contributions or the
                         benefits to be provided in any way which is contrary to
                         Article 141 of the Treaty of Rome or any UK Statute;
                         and

                    (b)  neither the trustees of the SSAS nor the Companies have
                         engaged or currently engage in any activity in relation
                         to the SSAS which would require any of them to be
                         authorised for the purposes of the Financial Services
                         and Markets Act 2000;

          17.2.10   the SSAS is an exempt approved scheme within the meaning of
                    Chapter IV Part I of the Income and Corporation Taxes Act
                    1988 and there is no reason why such approval may be
                    withdrawn; and

          17.2.11   a contracting out certificate under the Pension Schemes Act
                    1993 is in force covering the employments of all Employees
                    who are members of the SSAS and there is no reason why such
                    a certificate may be cancelled.

17.3      As regards the Stakeholder:

          17.3.1    all benefits under the Stakeholder (other than those which
                    are fully insured) are provided on a money purchase basis
                    and there is no obligation (other than in the case of those
                    benefits which are fully insured) to provide any specified
                    level of benefits. Contributions made by the Companies in
                    respect of the Stakeholder do not

                                       52



                    exceed the permitted maximum as defined in section 638 of
                    the Income and Corporation Taxes Act;

          17.3.2    the Companies have at all times complied with all the
                    provisions of the Stakeholder which apply to it and section
                    3 of the Welfare Reform and Pensions Act 1999 (the "1999
                    Act"). The Stakeholder complies with the 1999 Act, the
                    Stakeholder Pension Schemes Regulations 2000 and any other
                    applicable legislation and regulations;

          17.3.3    the identities of those of the Employees who are members of
                    the Stakeholder have been Disclosed and the level of both
                    employee and employer contributions payable in respect of
                    each member has been Disclosed and the Companies shall not
                    before Completion take any steps affecting the level of
                    employer contributions;

          17.3.4    as at Completion, all contributions, premiums and expenses
                    due to be paid in respect of the Stakeholder by the
                    Companies have been duly paid;

          17.3.5    no legal proceedings in connection with the Stakeholder are
                    pending, threatened or expected (including any complaint to
                    the Pensions Ombudsman) and there is no fact or circumstance
                    likely to give rise to any such proceedings;

          17.3.6    the Stakeholder does not and has not directly or indirectly
                    discriminated between male and female employees as regards
                    eligibility, the rate of contributions or the benefits to be
                    provided in any way which is contrary to Article 141 of the
                    Treaty of Rome or any UK Statute;

          17.3.7    the Companies have not engaged and do not currently engage
                    in any activity in relation to the Stakeholder which would
                    require them to be authorised for the purposes of the
                    Financial Services and Markets Act 2000; and

          17.3.8    the Stakeholder is an exempt approved scheme within the
                    meaning of Chapter IV Part XIV of the Income and Corporation
                    Taxes Act 1988 and there is no reason why such approval may
                    be withdrawn.

18.       Intellectual Property

18.1      Ownership and rights

          18.1.1    Parts 1 and 2 of schedule 7 respectively contain particulars
                    of all Registered Proprietary Intellectual Property and
                    material Unregistered Proprietary Intellectual Property.

          18.1.2    The Company is either the sole beneficial owner of or is
                    licensed to use all Intellectual Property required for the
                    Company to carry on its business as of the date of
                    Completion.

18.2      Enforcement

          18.2.1    So far as the Warrantors are aware, the Proprietary
                    Intellectual Property is valid and subsisting and none of
                    the Proprietary Intellectual Property is the subject of
                    outstanding or threatened disputes, claims or proceedings
                    for cancellation, revocation, opposition, interference,
                    rectification or contested ownership.

          18.2.2    Details of Patents owned by the Company are set out in
                    schedule 7.

                                       53



          18.2.3    All Registered Proprietary Intellectual Property has been
                    maintained and all renewal fees have been paid on time.

          18.2.4    All Know-How owned, used or exploited by the Company has
                    been kept secret and confidential and has, as far as the
                    Warrantors are aware, not been disclosed to third parties
                    other than as required in the normal course of business
                    subject to confidentiality undertakings being obtained by
                    the Company.

          18.2.5    Nothing has been done to diminish or otherwise affect the
                    reputation of unregistered Trade Marks, owned, used or
                    otherwise exploited by the Company.

18.3      Intellectual Property Agreements

          18.3.1    Parts 3 and 4 of schedule 7 respectively contain particulars
                    of all Intellectual Property Agreements whereby:

                    (a)  the Company uses or exploits any Third Party
                         Intellectual Property ("Licences-In"); or

                    (b)  the Company has authorised or otherwise permitted,
                         expressly or by implication, any use whatsoever of any
                         Proprietary Intellectual Property, or granted to any
                         third party any right or interest in respect of any
                         Proprietary Intellectual Property ("Licences-Out").

          18.3.2    Save as set out in schedule 7, none of the Proprietary
                    Intellectual Property has been charged, mortgaged, licensed
                    or otherwise encumbered.

          18.3.3    So far as the Warrantors are aware, all Intellectual
                    Property Agreements are valid and binding and none has been
                    the subject of any breach or default by any party or of any
                    event which with notice or lapse of time or both would
                    constitute a default.

          18.3.4    No member of the Group has received notice of any dispute,
                    claim or proceeding arising out of or relating to the
                    Intellectual Property Agreements and the Warrantors are not
                    aware of any circumstances which are reasonably likely to
                    lead to any such dispute, claim or proceeding arising.

          18.3.5    No Intellectual Property Agreement will terminate or become
                    capable of termination or otherwise be adversely affected by
                    the execution and completion of this Agreement.

18.4      Infringement

          18.4.1    The Company has not infringed and, as far as the Warrantors
                    are aware, does not infringe any Intellectual Property of a
                    third party as a result of the Company's use or exploitation
                    of the Intellectual Property in the conduct of the Business
                    involving the use and exploitation of the Proprietary
                    Intellectual Property or the Third Party Intellectual
                    Property, nor, as far as the Warrantors are aware, will such
                    use or exploitation give rise to any infringement dispute,
                    claims or proceedings against the Company.

          18.4.2    So far as the Warrantors are aware, there are not and have
                    not been any disputes, claims or proceedings threatened or
                    in existence in any court or tribunal in respect of any
                    Intellectual Property used or exploited by the Company in
                    the conduct of the Business.

                                       54



          18.4.3    So far as the Warrantors are aware, there has been and is no
                    current or anticipated infringement by any third party of
                    any Proprietary Intellectual Property or Third Party
                    Intellectual Property.

19.       Information technology and telecommunications

19.1      Ownership

          19.1.1    All IT Systems are owned by the Company or leased under
                    written lease agreements, and are not wholly or partly
                    dependent on any facilities or services not under the
                    exclusive ownership and/or control of the Company.

          19.1.2    So far as the Warrantors are aware, all the IT Contracts are
                    valid and binding and none of the IT Contracts has been the
                    subject of any breach or default, or of any event which
                    (with notice or lapse of time or both) would constitute a
                    default, or is liable to be terminated or otherwise
                    adversely affected by the transaction contemplated by this
                    Agreement.

19.2      Computer operation and maintenance

          19.2.1    All IT Systems are in satisfactory working order and have
                    been and are being properly and regularly maintained and
                    replaced. No part of the IT Systems has materially failed to
                    function at any time during the twelve months prior to the
                    date hereof.

          19.2.2    All IT Services are being and have been provided materially
                    in accordance with the relevant IT Contract.

          19.2.3    The Company has full and unrestricted access to and use of
                    the IT Systems, and no third party agreements or consents
                    are required to enable the Company to continue such access
                    and use following completion of the transaction contemplated
                    by this Agreement.

          19.2.4    So far as the Warrantors are aware it is not necessary for
                    the Company to incur as at the date of Completion any
                    further material expenditure on the modification,
                    development, expansion or (save in the normal course of
                    business) replacement of the IT Systems in order to carry on
                    its Business as at the date of Completion; and

          19.2.5    The Company has not suffered material loss as a result of
                    any virus or other extraneously-induced malfunction, and so
                    far as the Warrantors are aware, no person has had
                    unauthorised access to the IT Systems or any data stored
                    thereon. The Company operates a documented procedure to
                    minimise the risk of such infections and unauthorised
                    access.

          19.2.6    All data processed using the IT Systems and/or the IT
                    Services has been regularly archived in hard copy form. Such
                    hard copies have been properly stored and catalogued.

          19.2.7    The Company has taken all steps reasonably necessary to
                    ensure that its business can continue in the event of a
                    failure of the IT Systems (whether due to natural disaster,
                    power failure or otherwise).

19.3      Euro compliance

          The IT Systems accept payment, process payments and produce invoices
          in Euros.

                                       55



20.       Legislation

          The Company has not received notice of and is not aware of any
          allegation of breach of the requirements of any legislation which is
          applicable to it.

                                       56



                                     PART 2

                               TAXATION WARRANTIES

21.       Taxation

21.1      General

          21.1.1    Notices and returns

                    All notices, returns, computations and registrations of the
                    Company for the purposes of Taxation have been made
                    punctually on a proper basis and are correct and none of
                    them is, or so far as the Warrantors are aware is likely to
                    be, the subject of any dispute with any Taxation Authority.

          21.1.2    All information supplied by the Company to a Tax Authority
                    for the purposes of Taxation was when supplied and remains
                    complete and accurate in all material respects.

          21.1.3    Payment of Tax due

                    All Taxation which the Company is liable to pay prior to
                    Completion has been or will be so paid prior to Completion.

          21.1.4    Penalties or interest on Tax

                    The Company is not liable to pay any penalty, fine,
                    surcharge or interest charged by virtue of the provisions of
                    the TMA or any other Taxation Statute.

          21.1.5    Compliance with PAYE, national insurance contribution and
                    Tax collection obligations

                    (c)  All income tax deductible and payable under the PAYE
                         system has, so far as is required to be deducted, been
                         deducted from all payments made or treated as made by
                         the Company and all amounts due to be paid to the
                         Inland Revenue prior to the date of this Agreement have
                         been so paid, including all Tax chargeable on benefits
                         provided for directors, employees or former employees
                         of the Company or any persons required to be treated as
                         such.

                    (d)  All deductions and payments required to be made under
                         any Taxation Statute in respect of national insurance
                         and social security contributions (including employer's
                         contributions) have been so made.

                    (e)  All payments by the Company to any person which ought
                         to have been made under deduction of Tax have been so
                         made and the Company (if required by law to do so) has
                         accounted to the Inland Revenue for the Tax so
                         deducted.

                    (f)  Proper records have been maintained in respect of all
                         such deductions and payments and all applicable
                         regulations have been complied with.

                    (g)  The Disclosure Documents contain details so far as they
                         affect the Company of all current dispensations agreed
                         with the Inland Revenue in relation to PAYE and all
                         notifications given by the Inland Revenue under section
                         166, ICTA 1988.

                                       57



          21.1.6    Investigations

                    The Company has not been subject to any visit, audit,
                    investigation, discovery or access order by any Taxation
                    Authority (other than those that are routinely carried out
                    by a Taxation Authority) and so far as the Warrantors are
                    aware there are no circumstances existing which make it
                    likely that a visit, audit, investigation, discovery or
                    access order will be made.

          21.1.7    Residence

                    The Company is and always has been resident for Taxation
                    purposes only in the jurisdiction in which it is
                    incorporated and does not and has not undertaken any
                    business or owned any assets in any other jurisdiction.

          21.1.8    Tax provision

                    Full provision or reserve has been made in the Accounts
                    prepared in accordance with the standard accounting practice
                    applicable to the Company for all Taxation assessed or
                    liable to be assessed on the Company or for which it is
                    accountable in respect of income, profits or gains earned,
                    accrued or received or deemed to be earned, accrued or
                    received on or before the Balance Sheet Date, including
                    distributions made down to such date or provided for in the
                    Accounts and proper provision has been made in the Accounts
                    for deferred Taxation in accordance with generally accepted
                    accounting principles.

          21.1.9    Concessions and arrangements

                    The amount of Taxation chargeable on the Company during any
                    accounting period ending on or within the six years before
                    the Balance Sheet Date has not depended on any concessions,
                    agreements or other formal or informal arrangements with any
                    Taxation Authority.

          21.1.10   Section 765, ICTA 1988

                    The Company has not without the prior consent of the
                    Treasury carried out or agreed to carry out any transaction
                    under section 765, ICTA 1988 which would be unlawful in the
                    absence of such consent and has, where relevant, complied
                    with the requirements of section 765A(2), ICTA 1988 (supply
                    of information on movement of capital within the EU) and any
                    regulations made or notice given thereunder.

          21.1.11   Transactions requiring clearance or consent

                    All particulars furnished to any Taxation Authority in
                    connection with an application for clearance or consent by
                    the Company or on its behalf or affecting the Company has
                    been made and obtained on the basis of full and accurate
                    disclosure to the relevant Taxation Authority of all
                    relevant material facts and considerations; and any
                    transaction for which clearance or consent was obtained has
                    been carried into effect only in accordance with the terms
                    of the relevant clearance or consent.

          21.1.12   Calculation of Taxation liability

                    The Company has sufficient records relating to past events
                    to permit accurate calculation of the Taxation liability or
                    relief which would arise upon a disposal or realisation or
                    supply on completion of each asset owned by the Company at
                    the

                                       58



                    Balance Sheet Date or acquired by the Company since that
                    date but before Completion.

          21.1.13   Claims and disclaimers

                    The Company has duly submitted all claims and disclaimers
                    the making of which has been assumed for the purposes of the
                    Accounts.

21.2      Corporation tax, including corporation tax on chargeable gains

          21.2.1    Base values and acquisition costs

                    If each of the capital assets of the Company were disposed
                    of on the date hereof for a consideration equal to the book
                    value of that asset in, or adopted for the purposes of, the
                    Accounts or, in the case of assets acquired since the
                    Balance Sheet Date, equal to the consideration given upon
                    its acquisition, no liability to corporation tax on
                    chargeable gains or balancing charges under the CAA would
                    arise and for the purpose of determining the liability to
                    corporation tax on chargeable gains there shall be
                    disregarded any relief and allowances available to the
                    Company other than amounts falling to be deducted under
                    section 38, TCGA.

          21.2.2    Short life assets

                    The Company has not made any election under section 37, CAA
                    nor is it taken to have made such an election under section
                    37(8)(c), CAA.

          21.2.3    Long life assets

                    The Company does not own and has not owned a long life asset
                    (within the meaning of section 38A, CAA) in respect of which
                    any claim for capital allowances would be subject to the
                    provisions of section 38E-38G, CAA.

          21.2.4    Industrial buildings

                    None of the assets of the Company expenditure on which has
                    qualified for a capital allowance under Part I, CAA has at
                    any time been used otherwise than as an industrial building
                    or structure.

          21.2.5    Distributions

                    No distribution within the meaning of sections 209, 210 and
                    211, ICTA 1988 has been made (or will be deemed to have been
                    made) by the Company after 5th April, 1965 except dividends
                    shown in its audited accounts and the Company is not bound
                    to make any such distribution.

          21.2.6    Demergers

                    The Company has not been engaged in nor been a party to any
                    of the transactions set out in sections 213 to 218
                    inclusive, ICTA 1988 nor has it made or received a
                    chargeable payment as defined in section 218(1), ICTA 1988.

          21.2.7    Issues of securities

                    No securities (within the meaning of section 254(1), ICTA
                    1988) issued by the Company and remaining in issue at the
                    date of this Agreement were issued in such circumstances
                    that the interest payable thereon falls to be treated as a
                    distribution

                                       59



                    under either sections 209(2)(d), 209(2)(da) or 209(2)(e),
                    ICTA 1988, nor has the Company agreed to issue such
                    securities in such circumstances.

          21.2.8    Capital distributions

                    The Company has not received any capital distribution to
                    which the provisions of section 189, TCGA could apply.

          21.2.9    Land sold and leased back

                    The Company has not entered into any transaction to which
                    the provisions of section 779 or 780, ICTA 1988 have been or
                    could be applied.

          21.2.10   Non-deductible payments

                    No rents, interest, annual payments or other sums of an
                    income nature paid or payable by the Company or which the
                    Company is under an existing obligation to pay in the future
                    under current law and practice are or may be wholly or
                    partially disallowable as deductions in computing trading
                    profits, management expenses or charges in computing profits
                    for the purposes of corporation tax.

          21.2.11   No unremittable income or gains

                    No claim has been made by the Company under sections 584,
                    585 or 723 ICTA 1988 or under section 279, TCGA.

          21.2.12   Payments to directors, officers or employees

                    The Company has not agreed to make any payment to or agreed
                    to provide any benefit for any Director or former director,
                    officer or employee of the Company, whether as compensation
                    for loss of office, termination of employment or otherwise,
                    which is not allowable as a deduction in calculating the
                    profits of the Company for Taxation purposes whether up to
                    or after the Balance Sheet Date.

          21.2.13   Transfer pricing

                    The Company is not a party to any transaction or arrangement
                    under which it will be required to pay for any asset or any
                    services or facilities of any kind an amount which is in
                    excess of the market value of that asset or those services
                    or facilities, neither is or was the Company a party to any
                    transaction or arrangements to which the provisions of
                    section 770A and schedule 28 AA, ICTA 1988 will apply and
                    nor will the Company receive any payment for an asset or any
                    services or facilities of any kind that it has supplied or
                    provided or is liable to supply or provide which is less
                    than the market value of that asset or those services or
                    facilities.

          21.2.14   Transactions not at arm's length

                    The Company has not disposed of or acquired any asset in
                    circumstances falling within section 17 or 19, TCGA nor
                    given or agreed to give any consideration to which section
                    128(1)(2), TCGA will apply.

          21.2.15   Transactions between connected persons

                    No allowable loss has accrued to the Company to which
                    section 18(3), TCGA will apply.

                                       60



          21.2.16   Depreciatory transactions

                    (h)  No allowable loss which might accrue on the disposal by
                         the Company of any share in or security of any company
                         is so far as the Warrantors are aware likely to be
                         reduced by virtue of the provisions of sections 176 and
                         177, TCGA.

                    (i)  The Company has not been a party to any scheme or
                         arrangement whereby the value of an asset has been
                         materially reduced as set out in sections 30-34, TCGA.

          21.2.17   Other claims made by the Company

                    The Company has made no claim under section 280, TCGA (tax
                    on chargeable gains payable by instalments).

          21.2.18   Gifts

                    The Company has not received any assets by way of gift as
                    mentioned in section 282, TCGA and the Company has not held,
                    and does not hold, shares in a company to which section 125,
                    TCGA could apply.

          21.2.19   Non-resident companies

                    (j)  There has not accrued or arisen any income, profit or
                         gain in respect of which the Company may be liable to
                         corporation tax by virtue of the provisions of section
                         13, TCGA or Chapter IV of Part XVII, ICTA 1988.

                    (k)  The Company has not been served with a notice in
                         respect of the unpaid corporation tax liability of any
                         company pursuant to section 191, TCGA.

          21.2.20   Controlled foreign companies

                    No notice of the making of a direction under section 747,
                    ICTA 1988 has been received by the Company and so far as the
                    Warrantors are aware no circumstances exist which would
                    entitle the Inland Revenue to make such a direction or to
                    apportion any profits of a controlled foreign company to the
                    Company pursuant to section 752, ICTA 1988.

          21.2.21   Agent for non-residents

                    The Company has not been a party to any transaction or
                    arrangement whereby it is or may hereafter become liable for
                    Taxation under or by virtue of section 42A, ICTA 1988 or
                    regulations made thereunder or section 126, FA 1995.

          21.2.22   Loan relationships

                    (l)  All interests, discounts and premiums payable by the
                         Company in respect of its loan relationships (within
                         the meaning of section 81, FA 1996) are eligible to be
                         brought into account by the Company as a debit for the
                         purposes of Chapter II of Part IV, FA 1996 at the time
                         and to the extent that such debits are recognised in
                         the statutory accounts of the Company.

                    (m)  The Disclosure Documents contain full particulars of
                         any debtor relationship (within the meaning of section
                         103, FA 1996) of the Company which relates to a
                         relevant discounted security (within the meaning of
                         paragraph 3 of

                                       61



                         schedule 13, FA 1996) to which paragraph 17 or 18 of
                         schedule 9, FA 1996 applies.

                    (n)  The Company has not been a party to a loan relationship
                         which had an unallowable purpose (within the meaning of
                         paragraph 13 of schedule 9, FA 1996).

                    (o)  The Disclosure Documents contain full particulars of:

                         (i)     any loan relationships to which the Company is
                                 a party to which paragraph 8 of schedule 15, FA
                                 1996 has applied or will apply on the
                                 occurrence of a relevant event (within the
                                 meaning of paragraph 8(2) of schedule 15, FA
                                 1996);

                         (ii)    2the amount of any deemed chargeable gain or
                                 deemed allowable loss that has arisen or will
                                 arise on the occurrence of such relevant event;
                                 and

                         (iii)   any election made pursuant to paragraph 9 of
                                 schedule 15, FA 1996.

                    (p)  The Company has not entered into any transaction to
                         which paragraph 11 of schedule 9, FA 1996 applies.

21.3      Close companies

          21.3.1    Close company status

                    The Company has at all times been a close company within the
                    meaning of sections 414 and 415, ICTA 1988.

          21.3.2    Close investment-holding company status

                    The Company has not in any accounting period beginning after
                    31st March, 1989 been a close investment-holding company as
                    defined in section 13A, ICTA 1988.

          21.3.3    Distributions

                    No distribution within section 418, ICTA 1988 has ever been
                    made by the Company.

          21.3.4    Loans to participators

                    Any loans or advances made or agreed to be made by the
                    Company within sections 419 and 420 or 422, ICTA 1988 have
                    not been released or written off or agreed to release or
                    write off the whole or any part of any such loans or
                    advances.

21.4      Inheritance tax

          21.4.1    No transfers of value and associated operations

                    The Company has made no transfers of value within sections
                    94 and 202, ITA nor has the Company received a transfer of
                    value such that liability might arise under section 199, ITA
                    nor has the Company been party to associated operations in
                    relation to a transfer of value as defined by section 268,
                    ITA.

          21.4.2    Inland Revenue charge

                                       62



                    There is no unsatisfied liability to inheritance tax
                    attached to or attributable to the Shares or any asset of
                    the Company and none of them are subject to an Inland
                    Revenue charge as mentioned in section 237 and 238, ITA.

          21.4.3    Power of sale, mortgage or charge

                    No asset owned by the Company nor the Shares are liable to
                    be subject to any sale, mortgage or charge by virtue of
                    section 212, ITA.

21.5      VAT

          21.5.1    Returns and payments

                    The Company is a taxable person duly registered for the
                    purposes of VAT.

          21.5.2    VAT groups

                    The Company is not and has not been a member of a group for
                    VAT purposes.

          21.5.3    Transactions between connected persons

                    The Company has not been or agreed to be party to any
                    transaction or arrangement in relation to which a direction
                    has been or could be made under paragraph 1 of schedule 6,
                    VATA or to which paragraph 2(3A) of schedule 10, VATA
                    applied.

          21.5.4    Charge to VAT as agent or representative

                    The Company is not and has not agreed to become liable for
                    VAT by virtue of sections 47 and 48, VATA.

          21.5.5    VAT and Properties

                    The Company or its relevant associate for the purposes of
                    paragraph 3(7) of schedule 10, VATA has exercised the
                    election to waive exemption from VAT (pursuant to paragraph
                    2 of schedule 10, VATA) only in respect of those Properties
                    listed (as having been the subject of such an election) in
                    the Disclosure Documents and:

                    (q)  neither the Company nor its relevant associate has any
                         obligation to exercise such an election in respect of
                         any other of the Properties;

                    (r)  any notification of the election and information
                         required by paragraph 3(6) of schedule 10, VATA has
                         been given and any permission required by paragraph
                         3(9) of schedule 10, VATA has been properly obtained;

                    (s)  so far as the Warrantors are aware no election has or
                         will be disapplied or rendered ineffective by virtue of
                         the application of the provisions of paragraph 2 (3AA)
                         of schedule 10, VATA;

                    (t)  the Company has not agreed to refrain from making an
                         election in relation to any of the Properties.

          21.5.6    Capital goods scheme

                                       63



                    The Company does not own and has not at any time within the
                    period of ten years preceding the date hereof owned any
                    assets which are capital items subject to the Capital Goods
                    Scheme under Part XV of the VAT Regulations 1995.

21.6      Stamp duty

          21.6.1    Stamp duty

                    All stampable documents wheresoever executed (other than
                    those which have ceased to have any legal effect) to which
                    the Company is a party as a purchaser, transferee, assignee,
                    lessee or mortgagee and which are required to prove the
                    Company's right, title or interest in an asset beneficially
                    owned by the Company on Completion have been duly stamped or
                    stamped with a particular stamp denoting that no stamp duty
                    is chargeable.

                                       64



                                   SCHEDULE 4

                                     PART 1

                                  UK PROPERTIES



          (1)                 (2)                   (3)                (4)                   (5)
    DESCRIPTION OF          TENURE             REGISTERED OR     TITLE NUMBER AND         EXISTING USE
       PROPERTY                                UNREGISTERED     GRADE OF TITLE (IF
                                                                    REGISTERED)
                                                                           
Unit 38 Harrogate        Leasehold             Unregistered     N/A                    Offices and storage
Business Park,
Wetherby Road,
Harrogate

Unit 2 Back Gladstone    Licence               Unregistered     N/A                    Storage
Street,
Harrogate

Premises at 19           Verbal agreement      Unregistered     N/A                    Offices and storage
Greenfield Avenue,
Stourbridge


                                     PART 2

                                  US PROPERTIES



          (1)                 (2)                   (3)                (4)                   (5)
    DESCRIPTION OF          TENURE             REGISTERED OR     TITLE NUMBER AND         EXISTING USE
       PROPERTY                                UNREGISTERED     GRADE OF TITLE (IF
                                                                    REGISTERED)
                                                                           
Premises at              Leasehold              N/A              N/A                   Offices and storage
Lakeview Office
Park, South
Semoran
Boulevard, Winter
Park, Florida


                                       65



                                     PART 3

                                 LEASES/LICENCES



         (1)                  (2)                    (3)                    (4)                    (5)
    DESCRIPTION OF            DATE                   TERM                 PARTIES          CURRENT YEARLY RENT
       PROPERTY
                                                                                   
Unit 38 Harrogate        14/07/2000             5 year from and       D S Estates Limited      ***
Business Park,                                  including 03/04/2000  (1)
Wetherby Road,
Harrogate
                                                                      Atlantech Medical
                                                                      Devices Limited (2)

Unit 2 Back              05/06/2001             Until determined by   Pelican Marketing        ***
Gladstone Street,                               one month's written   Limited (1)
Harrogate                                       notice

                                                                      Atlantech Medical
                                                                      Devices Limited (2)

19 Greenfield            May 2000               Until determined by   Ronald Mifsud (1)        ***
Avenue                                          reasonable notice
Stourbridge                                                           Atlantech UK (2)


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the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       66



                                   SCHEDULE 5

                                     PART I

                BASIS FOR PREPARATION OF THE COMPLETION ACCOUNTS

The Completion Accounts shall consist of the following as at the close of
business on the date of Completion:

(i)       ***

(ii)      ***

The Completion Accounts shall be prepared in accordance with the accounting
policies and principles adopted by each Company to the extent consistent with US
GAAP and otherwise accordance with the applicable standards under US GAAP.

***

(i)       ***

(ii)      ***

For the avoidance of doubt, at Completion Atlantech will repay outstanding loans
from directors, which in aggregate total ***. A corresponding equivalent amount
will appear in the Completion Accounts as an inter-company loan from the
Purchaser.

The Completion Accounts shall include a schedule listing the full and accurate
details of all claims, elections, surrenders, disclaimers, notices or consents,
the adjustment to or revision of making, giving or doing of which in each case
was taken into account in computing the provision or reserve for Tax in the
Completion Accounts.

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       67



                                   SCHEDULE 6

                                   COMPLETION

                                     PART 1

1.        Warrantors' obligations

          On Completion, the Warrantors shall deliver to the Purchaser:

1.1       statements from each of the banks at which each Company and each of
          the Subsidiaries maintains an account of the amount standing to the
          credit or debit of all such bank accounts as at the close of business
          no earlier than three Business Days prior to Completion;

1.2       the cash book balances of the Company and each of the Subsidiaries as
          at Completion with statements reconciling such cash book balances and
          the relevant cheque books with the balances on the bank accounts of
          the Company and each of the Subsidiaries as shown by the statements
          referred to in paragraph 1.1;

1.3       the cheque books relating to all the bank accounts of the Company and
          each of the Subsidiaries together with confirmation that no cheques
          have been written by the Company or any of the Subsidiaries since
          preparation of the statements referred to in paragraph 1.2;

1.4       the (i) Tax Deed duly executed by each of the Warrantors, and (ii)
          Service Agreements in the agreed terms duly executed by each of
          Nicholas Woods, Clive Reay-Young, Jennifer Garman and Simon Mifsud;

1.5       transfers of the Shares duly executed by the registered holders
          thereof in favour of the Purchaser or its nominee(s) together with the
          relevant original share certificates in the names of such registered
          holders or appropriate deeds of indemnity;

1.6       such waivers, consents or other documents (including any power of
          attorney under which any document required to be delivered under Part
          1 of this schedule has been executed) in the agreed terms to enable
          the Purchaser and its nominee(s) to be registered as the holders of
          the Shares;

1.7       original certificates in respect of all issued shares in the capital
          of each of the Subsidiaries;

1.8       the statutory registers and minute books (properly written up to the
          time immediately prior to Completion), the common seal (if any), the
          certificate of incorporation and (if applicable) any certificate of
          incorporation on change of name of the Company and each of the
          Subsidiaries;

1.9       the documents of title to the Properties;

1.10      the written resignations in the agreed terms of all the Directors
          (except Nick Woods and Clive Reay-Young) from their respective
          offices, such resignations to take effect from Completion;

1.11      the written resignation of the auditors of the Company and of each of
          the Subsidiaries in the agreed terms to take effect from Completion
          containing the statements referred to in section 394(1), CA 85 that
          they consider there are no such circumstances as are mentioned in that
          section and confirming that they have deposited or shall deposit that
          statement in accordance with section 394(2), CA 85 at the respective
          registered offices of the Company and each of the Subsidiaries; and

                                       68



2.        Purchaser's obligations

          On completion, the Purchaser shall deliver to each Warrantor:

2.1       a counterpart of the Tax Deed duly executed by the Purchaser;

2.2       a counterpart of each Service Agreement duly executed by the relevant
          Company; and

2.3       a counterpart of a *** agreement for each Warrantor in the agreed
          terms duly executed by the Guarantor.

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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       69



                                     PART 2

          On Completion, the Warrantors shall cause a board meeting of the
          Company and of each of the Subsidiaries to be held at which:

1.        in the case of each Company only, the said transfers of the Shares
          shall be passed for registration and registered (subject to the same
          being duly stamped, which shall be at the cost of the Purchaser);

2.        the resignations referred to in paragraphs 1.10 and 1.11 of Part 1
          shall be tendered and accepted so as to take effect at the close of
          the meeting;

3.        persons nominated by the Purchaser (in the case of directors subject
          to any maximum number imposed by the relevant articles of association)
          shall be appointed additional directors;

4.        Messrs. PricewaterhouseCoopers LLP shall be appointed auditors.

                                       70



                                   SCHEDULE 7

                              INTELLECTUAL PROPERTY

A    -    PART 1 REGISTERED PROPRIETARY INTELLECTUAL PROPERTY

***

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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the portions.

                                       71



B    -    TRADE MARK PORTFOLIO



                         COUNTRY OF
NAME OF TRADE MARK       REGISTRATION        CLASSES REGISTERED     TRADE MARK NUMBER
- -------------------------------------------------------------------------------------
                                                           
***                      ***                ***                     ***
- -------------------------------------------------------------------------------------
***                      ***                                        ***
- -------------------------------------------------------------------------------------
***                      ***
- -------------------------------------------------------------------------------------
***                      ***
- -------------------------------------------------------------------------------------


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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       72



PART 2    UNREGISTERED PROPRIETARY INTELLECTUAL PROPERTY

UNREGISTERED RIGHT                               DETAILS
- --------------------------------------------------------------------
***                                              ***
- --------------------------------------------------------------------
***                                              ***
- --------------------------------------------------------------------
Unregistered trade names                         PED

                                                 Endoflip

                                                 Cobra

                                                 Revolution

                                                 Arthroclear

                                                 Pathfinder

                                                 Barracuda

                                                 Marlin

                                                 Manta 1

                                                 Swordfish

                                                 Beluga

                                                 Piranha

                                                 Jaws

                                                 Tiger Shark

                                                 Hammerhead
- --------------------------------------------------------------------

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*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       73



PART 3    LICENCES IN

***

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       74



PART 4    LICENCES OUT

***

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       75



                                   SCHEDULE 8

                       LIMITATION OF WARRANTORS' LIABILITY

                                     PART 1

                               GENERAL LIMITATIONS

1.        Notwithstanding the provisions of Clause 6, the Vendors shall not be
          liable in respect of a breach of any of the Warranties if and to the
          extent that the loss occasioned thereby has been recovered under the
          Indemnities or the Tax Deed.

2.        The Warrantors shall not be liable under the Warranties:

2.1       to the extent that the facts which might result in a Claim or possible
          Claim were Disclosed;

2.2       to the extent that the subject of the Claim is allowed or provided for
          or reserved in the Accounts, the Management Accounts or the Completion
          Accounts or was specifically referred to in the notes to any such
          accounts in respect thereof; or

2.3       to the extent that a Claim arises or is increased:

          2.3.1     wholly or partly from an act or omission compelled by law;

          2.3.2     as a result of any increase in rates of Taxation since the
                    date of this Agreement; or

          2.3.3     wholly or partly as a result of the passing or coming into
                    force of or any change in any enactment, law, regulation,
                    directive, requirement or any practice of any government,
                    government department or agency or regulatory body
                    (including but not limited to extra-statutory concessions of
                    the Inland Revenue) after the date of this Agreement whether
                    or not having retrospective effect; or

2.4       if and to the extent that a Claim is increased due to the Purchaser or
          the Guarantor failing to act in all material respects in accordance
          with the provisions of paragraph 5 of this schedule; or

2.5       to the extent that such liability occurs or arises as a result of or
          is otherwise attributable to any voluntary act, transaction or
          omission of either Company or the Subsidiary or the Purchaser or the
          Guarantor or any member of the Purchaser's Group on or after
          Completion; or

2.6       to the extent that such liability occurs or arises wholly as a result
          of any act or omission carried out by the Warrantors at the specific
          request of the Purchaser or the Guarantor after Completion; or

2.7       to the extent that the income, profits or gains in respect of which
          the liability arises were actually earned, accrued or received by
          either Company or the Subsidiary but were not reflected in the
          Accounts or the Management Accounts or Completion Accounts; or

2.8       to the extent that any Claim by the Purchaser or the subject matter
          thereof has been or is made good or is otherwise compensated for
          (otherwise than by the Purchaser or any member of the Purchaser's
          Group); or

2.9       to the extent that the matter to which it relates

                                       76



          2.9.1     is or, but for this Agreement, is recoverable by either
                    Company or the Subsidiaries from insurers and the amount is
                    so recovered; or

          2.9.2     is in respect of lost goodwill or possible business
                    following Completion where such loss is unrelated to a
                    Claim.

3.        The Purchaser agrees for itself and on behalf of every member of the
          Purchaser's Group with the Warrantors that in respect of any matter
          which may give rise to a Claim which relates to both Companies:

3.1       no loss, damage, cost, expense or other liability shall be met more
          than once;

3.2       such Claim shall for the purposes of paragraph 6 of this schedule
          shall be separate identifiable and quantifiable in respect of each
          Company.

4.

4.1       Where the Purchaser and/or either Company and/or the Subsidiary is/are
          at any time entitled to recover from some other person (including any
          Tax Authority) any sum in respect of any matter giving rise to a Claim
          the Purchaser shall and shall procure that the relevant Company or the
          Subsidiary shall take all reasonable steps to enforce such recovery
          prior to issuing proceedings against the Warrantors (but, for the
          avoidance of doubt, without prejudice to its right to take action
          against the Warrantors including the right to serve a notice of claim
          on the Warrantors in accordance with paragraph 6.6 of Part 2 and/or
          Part 3 of this Schedule), and in the event that the Purchaser or the
          Company or the Subsidiary shall recover any amount from such other
          person the amount of the Claim against the Warrantors shall be reduced
          by the amount recovered less all costs, charges and expenses
          reasonably incurred by the Purchaser or the Company or the Subsidiary
          in recovering that sum from such other person.

4.2       If the Warrantors pay at any time to the Purchaser or to either
          Company or to a Subsidiary an amount pursuant to a Claim and the
          Purchaser or the Company or a Subsidiary subsequently becomes entitled
          to recover from some other person any sum in respect of any matter
          giving rise to such Claims the Purchaser shall and shall procure that
          the relevant Company or the Subsidiary shall take all reasonable steps
          to enforce such recovery and shall, if successful in such recovery,
          forthwith repay to the Warrantors so much of the amount paid by them
          to the Purchaser or the relevant Company or the Subsidiary as does not
          exceed the sum recovered from such other person less all costs,
          charges and expenses reasonably incurred by the Purchaser or the
          relevant Company or the Subsidiary in recovering that sum from such
          other person.

4.3       If any amount is repaid to the Warrantors by the Purchaser or either
          Company or the Subsidiary pursuant to paragraph 4.2 above an amount
          equal to the amount so repaid shall be deemed never to have been paid
          by the Warrantors for the purposes of Part 2 of this schedule and
          accordingly shall not be treated as an amount in respect of which any
          liability has been incurred.

5.

5.1       If the Purchaser or either Company or a Subsidiary become aware of a
          matter which is reasonably likely to give rise to a Claim:

          5.1.1     the Purchaser shall (or shall procure that the relevant
                    Company or the Subsidiary concerned shall) as soon as
                    reasonably practicable give written notice to each Warrantor
                    of the matter and shall consult with each Warrantor with
                    respect to such

                                       77



                    matter but such notice shall not be a condition precedent to
                    the liability of the Warrantors;

          5.1.2     the Purchaser shall (and shall procure that the Company or
                    Subsidiary concerned shall) provide to each Warrantor and
                    his advisers reasonable access to premises and personnel and
                    to relevant assets, documents and records within the
                    Purchaser's Group for the purposes of investigating the
                    matter and enabling the Warrantors to take the action
                    referred to in paragraph 5.1.4;

          5.1.3     each Warrantor (at his cost) may take copies of the
                    documents or records, and photograph the premises or assets,
                    referred to in paragraph 5.1.2;

          5.1.4     subject to paragraph 5.1.5 below and the Warrantors
                    accepting unconditionally in writing to the Purchaser
                    liability for a relevant Claim the Purchaser shall (i) (and
                    shall procure that the Company or Subsidiary concerned
                    shall) take such action as the Warrantors may reasonably
                    request in writing to negotiate, avoid, dispute, resist,
                    mitigate, compromise, defend or appeal against any such
                    Claim and any adjudication with respect thereto which shall
                    include (without limitation) the Company or Subsidiary
                    applying to postpone (so far as legally possible) the
                    payment of any taxation and (ii) shall not, and shall ensure
                    that no member of the Purchaser's Group will admit liability
                    in respect of, or compromise, or settle, the matter without
                    the prior written consent of the Warrantors (such consent
                    not to be unreasonably withheld or delayed);

          5.1.5     the Warrantors shall indemnify and secure the Purchaser and
                    the relevant Company and Subsidiary to their reasonable
                    satisfaction against all losses, damages and expenses
                    including interest on overdue tax and reimburse to the
                    Purchaser and the relevant Company and Subsidiary all
                    out-of-pocket expenses reasonably incurred by them in
                    complying with their obligations under this paragraph 5;

                                     PART 2

                    LIMITATIONS UNDER THE WARRANTIES/TAX DEED

6.        The liability of the Warrantors in respect of any claim under the
          Warranties or claim under the Tax Deed (and any claim pursuant to
          clause 9 of this Agreement with respect to paragraphs 6.3 and 6.5
          below):

6.1       shall not arise unless and until the amount of such claim when
          aggregated with other claims based on essentially the same or similar
          facts exceeds *** in respect of any single item;

6.2       shall not arise unless and until the amount of such claim when
          aggregated with the amount of any other such claim made against the
          Warrantors under this Agreement or the Tax Deed or which would have
          been made but for the operation of this paragraph 6.2 exceeds *** in
          which event all of such claim or claims shall be recoverable hereunder
          (and not just the excess);

6.3       in respect of such claims in connection with Atlantech shall not (when
          aggregated with the amount of all other such claims together with any
          claim pursuant to clause 9 of this Agreement) exceed *** and

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the Securities and Exchange Commission. Confidential treatment has been
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                                       78



6.4       in respect of such claims in connection with Atlantech UK shall not
          (when aggregated with the amount of all other such claims) exceed ***
          and

6.5       shall not (when aggregated with the amount of all other such claims
          together with any claim pursuant to clause 9 of this Agreement) exceed
          *** and

6.6       shall cease on the date falling eighteen (18) months after the date of
          this Agreement with respect to claims under the Warranties (other than
          Tax Warranties), except in respect of matters which have been the
          subject of a bona fide written claim which is made before the relevant
          date by or on behalf of the Purchaser to the Vendors giving reasonable
          details of all material aspects of the Claim including the Purchaser's
          bona fide estimate of the amount thereof. Any such claim shall (if it
          has not previously been satisfied, settled or withdrawn) be deemed to
          have been withdrawn unless legal proceedings in respect of it have
          been commenced by both being issued and served within six months of
          such notification to the Warrantors,

provided always that in the case of each Warrantor his /her liability in
aggregate shall never exceed an amount equal to the amount of Provisional
Consideration received by him at Completion as set out opposite his name in
Column (E) of Schedule 1 (or, in the case of Simon Mifsud ***.

                                     PART 3

           TIME LIMITATIONS UNDER THE TAX WARRANTIES AND THE TAX DEED

          The liability of the Warrantors in respect of any Claim or any claim
          under the Tax Deed shall cease on the date falling seven (7) years
          after the date of this Agreement except in respect of matters which
          have been the subject of a bona fide written claim which is made
          before the relevant date by or on behalf of the Purchaser to the
          Warrantors giving reasonable details of all material aspects of the
          claim including the Purchaser's bona fide estimate of the amount
          thereof. Any such claim shall (if it has not previously been
          satisfied, settled or withdrawn) be deemed to have been withdrawn
          unless legal proceedings in respect of it have been commenced by both
          being issued and served within six months of such notification to the
          Warrantors.

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       79



                                   SCHEDULE 9

                              SUBSIDIARY WARRANTIES

                                     PART A

                      ATLANTECH MEDICAL DEVICES (USA) INC.

          In this Part A the following words shall have the following meanings:

          "Accounts" means the unaudited monthly management accounts of the
          Subsidiary for the sixteen month period ended on the Accounts Date
          comprising the unaudited balance sheet and profit and loss account as
          at and for the period ended on the Accounts Date;

          "Accounts Date" means 31 August 2002.

1.        The facts set out under the heading "The Subsidiary" in Schedule 2 are
          accurate in all material respects and not misleading.

2.        Atlantech is the legal and beneficial owner of the shares in the
          Subsidiary set out under the heading "The Subsidiary" opposite
          Atlantech's name in Schedule 2. Such shares constitute the whole of
          the allotted and issued share capital of the Subsidiary, have been
          properly allotted and issued and there is no agreement, arrangement or
          obligation requiring the creation, allotment, issue, transfer,
          redemption or repayment of, or the grant to any person of the right
          (whether conditional or not) to require the allotment, issue,
          transfer, redemption or repayment of, any shares in the capital of the
          Subsidiary (including, without limitation, an option or right or
          pre-emption or conversion).

3.        There is no litigation, arbitration, prosecution, administrative or
          other legal proceedings or dispute in existence or threatened against
          Atlantech Medical Devices Limited in respect of the shares in the
          Subsidiary and there are no facts known to the Warrantors or any of
          them which might give rise to any such proceedings or any such
          dispute.

4.        There is no encumbrance on, over or affecting any of the issued or
          unissued shares in the capital of the Subsidiary and there is no
          agreement or commitment to give or create any encumbrance or
          negotiations which may lead to such an agreement or commitment and no
          claim has been made by any person to be entitled to an encumbrance in
          relation thereto.

5.

5.1       The Accounts disclose all the material assets and liabilities of the
          Subsidiary as at the Accounts Date.

5.2       The Accounts have been prepared in accordance with accounting policies
          consistent with US GAAP with all due care. The cumulative profits,
          assets and liabilities of Atlantech Medical Devices (USA) Inc stated
          in the US Accounts have not been knowingly or wilfully misstated.

6.        Since the Accounts Date the Subsidiary has not (other than as
          disclosed in the Accounts):

6.1       acquired any material assets (namely, any asset of a value in excess
          (in aggregate) of US$10,000);

6.2       incurred any material liability (namely, any liability of a value in
          excess (in aggregate) of US$10,000); or

                                       80



6.3       entered into any material contract (written or otherwise) outside the
          ordinary course of business.

7.        All the property and assets which are described and included in the
          Accounts or which are used in connection with the business of the
          Subsidiary are:

7.1       legally and beneficially owned by the Subsidiary or used by the
          Subsidiary with the consent of the legal and beneficial owner;

7.2       in the possession or under the control of the Subsidiary;

7.3       free from all encumbrances and there is not any agreement or
          commitment to give or create, and no claim has been made by any person
          entitled to; any encumbrance; and

7.4       are situated in the United States of America.

8.        So far as the Warrantors are aware, at all times during the period of
          occupation by the Company the U.S. Property has been used, and at all
          times the Business has been conducted thereon, in all material
          respects in compliance with Environmental Law.

9.        Details of all insurance policies effected by the Subsidiary or by any
          other person in relation to any of the Subsidiary's assets are annexed
          to the Disclosure Letter and all such details are accurate in all
          material respects and all such insurance policies are currently in
          force.

10.       All the accounts, books, registers, ledgers and financial and other
          material records of whatsoever kind of the Subsidiary (including all
          invoices and other records required for customs and excise purposes)
          are materially up to date, in its possession or under its control and
          have been properly and accurately kept and compiled in all material
          respects.

11.       The Subsidiary does not own any material Intellectual Property and so
          far as the Warrantors are aware has not disclosed any Confidential
          Information to any third party (other than the Companies).

12.       Copies of the employment agreements for all employees of the
          Subsidiary are annexed to the Disclosure Letter and these contain all
          material terms of employment with respect to such individuals.

13.       There is not outstanding any claim against, nor are there (or have
          there been) any litigation, arbitration or administrative proceedings
          involving, the Subsidiary and no dispute exists between the Subsidiary
          and any customer or supplier thereof nor are there any circumstances
          of which the Warrantors are aware and which are believed by the
          Warrantors to be likely to give rise to any such dispute or claim.

14.       Save as disclosed in the Accounts, the Subsidiary does not have
          outstanding any borrowing nor any encumbrance or any obligation to
          create an encumbrance.

15.       So far as the Warrantors are aware, neither the Subsidiary nor any of
          its officers (during the course of their duties in relation to the
          business of the Subsidiary) has committed or omitted to do any act or
          thing the commission or omission of which is in contravention of any
          statutory obligation or any other federal law of the United States of
          America or law of the state of Florida.

16.       The Subsidiary has not since its incorporation had any subsidiary or
          subsidiary undertaking.

                                       81



17.       The copy of the articles of incorporation of the Subsidiary annexed to
          the Disclosure Letter is accurate and complete.

18.       The lease with respect to the premises at South Semoran Boulevard,
          Winter Park, Florida annexed to the Disclosure Letter is accurate in
          all material respects and the Subsidiary does not own or have any
          other interest in any real estate.

19.       The Subsidiary does not operate any pension scheme for its employees
          nor is liable or under any obligation to contribute to any pension
          scheme.

                                     PART B

                              ATLANTECH ITALIA SRL

1.        Atlantech is the legal and beneficial owner of 80% shares in Atlantech
          Italia Srl. So far as the Warrantors are aware, such shares constitute
          80% of the allotted and issued share capital of Atlantech Italia Srl,
          have been properly allotted and issued and there is no agreement,
          arrangement or obligation requiring the creation, allotment, issue,
          transfer, redemption or repayment of, or the grant to any person of
          the right (whether conditional or not) to require the allotment,
          issue, transfer, redemption or repayment of, any shares in the capital
          of Atlantech Italia Srl (including, without limitation, an option or
          right or pre-emption or conversion).

2.        There is no litigation, arbitration, prosecution, administrative or
          other legal proceedings or dispute in existence or threatened against
          Atlantech Medical Devices Limited in respect of the shares in
          Atlantech Italia Srl and there are no facts known to the Warrantors or
          any of them which might give rise to any such proceedings or any such
          dispute.

3.        So far as the Warrantors are aware, there is not outstanding any claim
          against, nor are there (or have there been) any litigation,
          arbitration or administrative proceedings involving, Atlantech Italia
          Srl *** and no dispute exists between Atlantech Italia Srl and any
          customer or supplier thereof nor are there any circumstances of which
          the Warrantors are aware and which are believed by the Warrantors to
          be likely to give rise to any such dispute or claim.

*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       82



         SIGNED AS A DEED by                      )      _______________________
                                                                 Director

         for and on behalf of                     )

         ARTHROCARE CORPORATION                   )      _______________________
                                                         Director/Secretary

         SIGNED AS A DEED by                      )      _______________________
                                                                 Director

         for and on behalf of                     )

         ARTHROCARE CAYMAN LIMITED                )      _______________________
                                                         Director/Secretary

         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         NICHOLAS WOODS

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         CLIVE REAY-YOUNG

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation

                                       83



         SIGNED AS A DEED by
         JENNIFER GARMAN

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       84



         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:
__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       85



         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for***

         in the presence of:

         ________________________________
         Name
         ________________________________
         Address
         ________________________________

         ________________________________

         ________________________________
         Occupation


         SIGNED AS A DEED by JENNIFER GARMAN
         acting as Attorney for
         ***

         in the presence of:

__________
*** Certain information on this page has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.

                                       86

EX-21.1

Exhibit 21.1

ARTHROCARE CORPORATION

SUBSIDIARIES OF THE REGISTRANT

ArthroCare International, Inc.

ArthroCare Foreign Sales Corporation

ArthroCare Corporation Cayman Islands

ArthroCare Deutschland GmbH

ArthroCare U.K. LTD

ArthroCare Europe AB

ArthroCare Italy SPA

ArthroCare France SRL

AngioCare Corporation

ArthroCare Costa Rica SRL

ArthroCare Atlantech Medical Devices

ArthroCare Atlantech-GmbH

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File Nos: 333-56284, 333-06297, 333-59379, 333-43296 and 333-62130) of ArthroCare Corporation of our report dated February 5, 2003, relating to the financial statements and financial statement schedule, which appears in this Form 10-K.

/s/    PricewaterhouseCoopers LLP

San Jose, California

March 25, 2003