Use these links to rapidly review the documentTABLE OF CONTENTS ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2010

Commission File Number: 0-27422

ARTHROCARE CORPORATION(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction of
Incorporation or organization)

94-3180312(I.R.S. employer
Identification number)7500 Rialto Blvd., Building Two, Suite 100, Austin, TX 78735(Address of principal executive offices and zip code)(512) 391-3900(Registrant's telephone number, including area code)


Securities
registered pursuant to Section 12 (b) of the Act:Common Stock, $0.001 Par Value

Securities registered pursuant to Section 12 (g) of the Act:None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o    No ý

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 ý    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)
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.    ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ý

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o    No ý

As of June 30, 2010, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant
was approximately $827,736,628 (based upon the closing sales price of such stock as reported by NASDAQ on such date). Shares of Common Stock held by each officer, director and holder of
5 percent 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 February 3, 2011, the number of outstanding shares of the Registrant's Common Stock was 27,228,270.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act of 1934, as amended, in connection with our annual
meeting of stockholders, scheduled to be held May 12, 2011, that we expect to file with the commission within 120 days after December 31, 2010, are incorporated by reference into
Part III of this Annual Report.



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ARTHROCARE CORPORATION  FORM 10-K ANNUAL REPORT  TABLE OF CONTENTS



PART I

3ITEM 1. BUSINESS

3ITEM 1A. RISK FACTORS

13ITEM 1B. UNRESOLVED STAFF COMMENTS

29ITEM 2. PROPERTIES

29ITEM 3. LEGAL PROCEEDINGS

29PART II

32ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES

32ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

35ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

36ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

52ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

54CONSOLIDATED BALANCE SHEETS

56CONSOLIDATED STATEMENTS OF OPERATIONS

57CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

58CONSOLIDATED STATEMENTS OF CASH FLOWS

59NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

60ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

91ITEM 9A. CONTROLS AND PROCEDURES

91ITEM 9B. OTHER INFORMATION

93PART III

94ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

94ITEM 11. EXECUTIVE COMPENSATION

94ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS

94ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

95ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

95PART IV

96ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

96Schedule II

101VALUATION AND QUALIFYING ACCOUNTS

101SIGNATURES

102INDEX TO EXHIBITS*

103


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ADDITIONAL INFORMATION

"ArthroCare," "we," "us," "our," and "Company" refer to ArthroCare® Corporation, unless the context otherwise requires.

In
this Annual Report on Form 10-K, references to and statements regarding North America refer to the United States, or U.S., Canada and Mexico, references to U.S.
dollars or USD or $ are to United States Dollars, and references to the euro or € are to the legal currency of the European Union, or EU.

Throughout
this Annual Report on Form 10-K we incorporate by reference certain information from other documents filed with the Securities and Exchange Commission, or
the SEC. Please refer to such information at www.sec.gov.

This
Annual Report on Form 10-K contains forward-looking statements. In "Part IItem 1ARisk Factors," we discuss some of the
risk factors that
could cause our actual results to differ materially from those provided in the forward-looking statements.

PART I

ITEM 1.    BUSINESS

Overview

We are a medical device company that develops, manufactures and markets surgical products, many of which are based on our minimally
invasive patented Coblation® technology. We have grown beyond our roots in arthroscopy to capitalize on market opportunities across several medical specialties, improving many existing
soft-tissue surgical procedures and enabling new minimally invasive procedures. Our innovative technologies improve the lives of individuals as diverse as world class athletes suffering
from torn rotator cuffs or anterior cruciate ligaments to senior citizens suffering from herniated discs and children suffering from tonsillitis. We incorporated in California in 1993 and
reincorporated in Delaware in 1995.

Our
objective is to expand on our position as a leading global provider of minimally invasive surgical products. We seek to differentiate ourselves in this competitive market by
providing our patients and user-physicians with improved treatment options. To accomplish this objective, we are focused on a business strategy featuring the following key
elements:



Business Overview

Our business consists of two core product areas: Sports Medicine and Ear Nose and Throat, or ENT. We also manufacture and sell products
based on our technology for other procedures, such as certain spine procedures. Our Sports Medicine, ENT and Other products are marketed and sold

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through
two principal geographic distribution channels: Americas (North and South America) and International (all other geographies).

Many
of our key products are based on our patented Coblation technology, which uses bipolar radiofrequency energy to generate a precisely focused plasma field to remove and shape soft
tissues such as cartilage and tendons. This use of bipolar energy is the primary factor that distinguishes our Coblation technology from traditional monopolar and bipolar radiofrequency surgical
tools. Monopolar devices drive electrical energy into the treatment site and requires electrical energy to travel through the patient's body and exit via a grounding pad usually placed underneath the
patient. Conversely,
traditional bipolar devices include both an active electrode and a return at the tip of the device so a separate grounding pad is not required. To effect treatment by a bipolar device, electrical
energy is applied at the surgical site, where it is concentrated at the targeted tissue and exits via the return electrode. These traditional monopolar and bipolar electrosurgical or laser surgery
tools use the heat from the electrical current to burn away targeted tissue, often causing thermal damage to tissue surrounding the targeted surgical area.

Our
bipolar Coblation devices also include both an active and return electrode at the tip but, in contrast to other bipolar devices, apply electrical energy in a conductive medium at the
surgical site. The electrical energy along with electrically conductive fluid, which is found in normal saline solutions, form a highly ionized vapor layer, or plasma field, around the active
electrode of the Coblation device. This plasma field enables our Coblation-based products to operate at lower ambient temperatures than traditional devices, minimizing tissue necrosis and damage when
compared to traditional bipolar or monopolar instruments.

The
use of Coblation allows surgeons to operate with a high level of precision and accuracy to minimize collateral tissue damage. Our Coblation-based systems consist of a controller unit
with accessories and an assortment of sterile, single-use disposable devices that are engineered to address specific types of procedures. A single multi-purpose surgical system using
Coblation technology can replace the multiple surgical tools traditionally used in soft-tissue surgery procedures.

We
have applied Coblation technology to soft-tissue surgery throughout the body, primarily in the areas of arthroscopic sports medicine, ENT and spine applications. We also
are exploring the use of Coblation technology in other markets.

Sports Medicine



Our Sports Medicine product area focuses on the development, production and marketing of surgical products used in the treatment of
soft tissue injuries, mostly in the shoulder, knees and hips. Each year, we estimate that more than 600,000 people in the U.S. suffer from instabilities or tendon tears of the shoulder and
1.2 million more people are treated for cartilage, meniscus or tendon injuries in the knee. Sports Medicine is currently our largest product area and
accounted for 68.5 percent, 67.9 percent and 67.6 percent of our total product sales during 2010, 2009 and 2008, respectively. We have experienced significant growth in Sports
Medicine that we believe has been driven by several factors, including:



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Sports
activities often affect joints that are susceptible to damage from blows, falls or sudden changes in direction, as well as from natural degeneration associated with repeated use
and aging. Arthroscopic surgeries are most commonly performed on the knees and shoulders but are also used in the treatment of injuries affecting other joints, such as elbows, wrists, ankles and hips.
Prior to the widespread availability of arthroscopic surgery, joint injuries were treated through surgery involving large incisions, and through cutting or dislocating muscles to reach targeted
tissues. These open procedures often required a hospital stay and prolonged rehabilitation and recovery. In contrast, arthroscopic surgery is performed through several small incisions, or portals,
resulting in lower overall costs, reduced surgical trauma, pain and scarring, and fewer complications. Arthroscopic surgery generally is performed on an outpatient basis with no overnight stay. We
believe that the products that we develop, produce, market and sell through Sports Medicine represent a substantial advancement in arthroscopic surgery because our technologies minimize collateral
tissue damage to reduce patient pain and speed recovery times.



The ArthroWand® Product Line.Our ArthroWand product line is the principal product line in Sports Medicine. This line features a
series
of Coblation based specialized disposable radio frequency surgical wands designed for single patient use to treat a number of orthopedic conditions, including injuries of the shoulder, knee, hip,
foot, ankle, elbow and wrist. ArthroWands are used with a controller, a software based radio frequency generator that provides electromagnetic energy used to create the localized plasma for tissue
removal in arthroscopic surgeries for ablation, resection and coagulation of soft tissue and to seal bleeding vessels.

The Opus® Collection.In 2004, we acquired Opus Medical, Inc., a manufacturer of a proprietary family of specialized implants
and
instruments, which facilitates a "knotless" arthroscopic repair for shoulder injuries, such as rotator cuff tears. Before Opus, variation in physician skills and training were limitations to wide
adoption of completely arthroscopic surgical repairs. Opus technology enabled many surgeons to complete repairs arthroscopically that previously were only possible with open surgical methods. These
products may reduce overall procedural costs and surgical time, and expand the number of patients eligible for arthroscopic treatment.

The Atlantech® Collection.In 2002, we acquired two of our European distributors, which allowed us to accelerate the implementation
of
our direct sales strategy in two key European markets and access to a broad line of hand-held surgical instruments, procedural kits and trays and reusable accessories to facilitate
arthroscopic surgery.

ENT



In ENT, we focus on the development, production and marketing of surgical products used in the treatment of conditions typically
treated by ENT healthcare professionals. Our ENT product area accounted for 27.8 percent, 27.8 percent, and 27.3 percent of our total product sales during 2010, 2009 and 2008,
respectively. One of the most common ENT procedures which utilize our products is the removal of tonsils and adenoids, and we estimate that there are more than 600,000 tonsillectomies performed in the
U.S. each year. The majority of tonsillectomies are performed on pediatric patients. Other commonly performed ENT procedures include endoscopic sinus surgery, turbinate reduction and procedures to
remove or stiffen tissue to treat snoring. These procedures are performed by ENT surgeons in hospitals and ambulatory surgery centers. Historically, monopolar electrocautery devices, or bovies, were
the standard for removal, or ablation, of soft tissue and cauterization during ENT procedures. Coblation continues to gain widespread market acceptance, particularly for tonsil and adenoid procedures.

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The ENT Wands Product Line.ENT has developed a variety of products for use by ENT surgeons for general head, neck and oral surgical
procedures,
including sinus surgery, the treatment of snoring, reduction of nasal turbinates, and adenoid and tonsil removal. ENT markets three categories of disposable devices, or wands, to address the ENT
Marketsuction wands, channeling wands and excision wands, each of which use Coblation technology to provide significant benefits over bovies and similar devices. During a tonsillectomy,
suction wands simultaneously ablate and remove tissue providing the surgeon enhanced visibility and shortening anesthesia time. Channeling wands provide controlled ablation with effective hemostasis
control to minimize bleeding during turbinate reduction procedures, which relieve nasal obstructions and stiffen the soft palate for the treatment of snoring. Excision wands provide precise dissection
of soft tissue with minimal damage to surrounding tissue.

The Rapid Rhino® Product Line.In 2005, we completed the purchase of substantially all of the assets of Applied
Therapeutics, Inc., or ATI, a maker of sinus surgery treatment products, that are complementary to our ENT devices. ATI's carboxymethyl-cellulose based packing and tamponade products are used
in situations of significant nosebleed, or epistaxis, treatments which are treated in an emergency room setting or surgicenter. Our Rapid Rhino product line includes the dissolvable Stammberger Sinus
Dressing and Sinu Knit, which are used after endoscopic sinus surgery to control minor bleeding, facilitate epithelial healing and preserve the spatial integrity of the sinus area. Our Rapid Rhino
product line also includes epistaxis balloon tamponade products, which are used primarily in the hospital emergency room environment to control chronic nosebleeds.

Other



We develop, produce and market surgical products used in the treatment of spine related and other conditions. Other product sales
accounted for 3.7 percent, 4.3 percent and 5.1 percent of our product sales during 2010, 2009 and 2008, respectively.



SpineWand® Product Line.The SpineWand devices use Coblation-based technology to treat soft tissue (intervertebral disc) conditions
in
the spine. Disc decompression, a common soft tissue minimally-invasive treatment for herniated discs, involves the removal of disc material either through a narrow tube, or cannula, using
x-ray technology for guidance or through a minimal surgical incision. Ongoing clinical studies are evaluating minimally invasive disc decompression as an alternative to current forms of
standard care for certain indications associated with this condition. Our Plasma Disc Decompression, or PDD, SpineWands are products for the treatment of contained herniated discs. The PDD SpineWands
remove portions of these herniated discs to relieve pressure on
major spinal nerves and are designed for use in both large and small disc spaces, as well as for treatments requiring the removal of soft tissue in the spine through a much smaller incision rather
than through a cannula. Our Cavity SpineWand®is used to reduce the size of malignant lesions within the vertebrae in patients suffering
from spinal compression fractures resulting from benign and malignant tumors.

WoundWand® Debridement Device.The WoundWand was Conformité Européenne, or CE, marked in 2010 making it
available for distribution in Europe. The WoundWand is intended for wound debridement in acute and chronic wounds and wound cleansing by removal of necrotic tissue in a precise and controlled manner.
In 2011, we intend to conduct studies to evaluate the clinical effectiveness of the WoundWand.

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Reimbursement Assistance Services

Beginning in the fourth quarter of 2005, DiscoCare, Inc., or DiscoCare, an independently owned medical device distributor and
reimbursement service provider, purchased SpineWand products from us and sought reimbursement for the wands on a "carve-out" or "stand-alone" basis. DiscoCare provided the products to its
customers generally at no charge in exchange for either (i) an assignment of the right to bill private third-party insurance companies and other payors for the product or (ii) a letter
of protection or attorney's lien in a personal injury case for separate reimbursement of the product. DiscoCare originally distributed our SpineWand products on a limited geographical basis. DiscoCare
approached us about distributing the SpineWands pursuant to this "carve-out" or "stand-alone" model and providing reimbursement services to customers on a national basis, and in the fourth
quarter of 2006, our agreement was amended to provide DiscoCare with national distribution and reimbursement services rights and to require us to pay a service fee to DiscoCare. On December 31,
2007, we acquired all of the common stock of DiscoCare from its sole shareholder.

In
June 2007, we established a new, wholly-owned subsidiary, Device Reimbursement Services, or DRS, which in the fourth quarter of 2007 began to sell our Sports Medicine products,
generally at discounted prices, in exchange for an assignment of the right to bill private third-party insurance companies and other payors for our products upon completion of a procedure using our
products.

After
the acquisition of DiscoCare, we continued to sell products and provide reimbursement services through our DiscoCare and DRS subsidiaries until the fourth quarter of 2008, when
DiscoCare ceased accepting letters of protection in personal injury cases and making any further claims to healthcare carriers. All other claims submission by DiscoCare and DRS ceased in the first
quarter of 2009 and the subsidiaries have continued to engage in an orderly wind down of their business operations.

Our Customers and Competition

Our primary customers across all of our product areas are surgeons and other specialized medical professionals who utilize our products
to treat their patients. Our primary competitors include Medtronic, Inc., Smith & Nephew, Stryker Corporation, Johnson & Johnson, Olympus (through its subsidiary Gyrus) and
Arthrex, Inc. These competitors tend to be large, well-financed companies with diverse product lines.

In
the Sports Medicine market, we also compete directly with competitors to whom we have licensed our technology for limited fields of use.

For
additional discussion of the risks and considerations concerning our competition, see "Part IItem 1ARisk Factors."

Our Distribution Network



We sell our Sports Medicine products in the Americas through a network of employee sales representatives, independent sales agents and
independent distributors. We sell our ENT products in the U.S. exclusively through employee sales representatives and outside of the U.S. we sell to independent distributors. As of December 31,
2010, for these two core business areas our sales organization approximated 480 persons, including sales management. We also sell our other products in the Americas through independent sales agents
and distributors. Sales in the Americas accounted for 72.0 percent, 72.9 percent and 73.5 percent of our total product sales during 2010, 2009 and 2008, respectively. We
continually evaluate the balance between direct sales representatives, independent agents and distributors in an effort to maximize the coverage and efficiency of our product sales platform. For the
year ended December 31, 2010, approximately 52 percent of Americas product sales

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were
from direct sales representatives and the remainder was from independent sales agents or distributors.



Markets outside of the Americas accounted for 28.0 percent, 27.1 percent and 26.5 percent of our total product
sales during 2010, 2009 and 2008, respectively. Our international sales efforts are focused on current key markets where we sell direct to end users of our products, including several countries in
Western Europe and Australia, as well as strategic growth markets, including India, China and Russia where we work through independent distributors. If we are successful, we expect that our strategic
growth markets will develop into key markets for our products in the future.

For
the year ending December 31, 2010, approximately 65 to 70 percent of international sales were derived from direct markets where we manage the relationship with our end
customers and the remainder is through distributors.

Geographic Information

For financial reporting purposes, net sales and long-lived assets attributable to significant geographic areas are
presented in Note 18, "Segment Information" in the notes to the consolidated financial statements.

Research and Development

We conduct our research and development activities in the U.S. on three campuses in Irvine and Sunnyvale, California and Austin, Texas.
Research and development expenses as reported includes experimental research, new product development, process engineering, regulatory affairs and clinical studies and were in aggregate
10.1 percent, 10.9 percent and 10.4 percent of our total net revenues during 2010, 2009 and 2008, respectively. Our efforts are focused on:



We
continue to explore and develop the plasma physics underlying our Coblation technology and evaluate the use of our technology in new fields of treatment. We are engaged with a number
of doctors, scientists and research institutions to further understand the technology and expand its applications base and technical capability.

To
facilitate our research and development efforts, we routinely receive feedback from the physicians who use our products and consult with our Scientific Advisory Boards, which are
comprised of respected and experienced physicians and surgeons who advise us on our products, current and prospective, and other areas relating to our medical devices. These medical professionals are
valued contributors and advisors to our research and development process and allow us to achieve significant and innovative strides in our product development.

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Manufacturing and Supply

Our products are primarily manufactured at our facility located in San Jose, Costa Rica. We believe our existing operations will
provide adequate capacity for our manufacturing needs at least through 2011.

We
have established manufacturing process and quality assurance systems in conformance with the International Organization for Standardization's ISO 13485:2003 standard, the FDA's
Quality System Regulation, 21 CFR Part 820 and we are certified under the Canadian Medical Devices Conformity Assessment System. Our facilities are in conformance with domestic and
international regulatory requirements that apply to medical device manufacturers and routinely are subject to audits by U.S. Food and Drug Administration, or FDA, Technischer
Überwachungs-Verein, or TUV, a Notified Body per the Medical Device Directive for the European Union, and other regulatory agencies representing countries in which our products are
sold.

Our
products are manufactured from several components, most of which are supplied to us from third parties. Most of the components 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 establishment of additional or replacement suppliers may not be
accomplished quickly. In isolated cases, we rely upon single source suppliers. In such cases, a disruption of our single supply source could materially affect and disrupt our ability to manufacture
and distribute certain of our products. Due to regulatory and other requirements regarding the manufacture of our products, we
may not be able to quickly establish additional or replacement sources for these certain components or materials. Generally, we have been able to obtain and maintain adequate supplies of such raw
materials and components. We also primarily use a single subcontractor located in Costa Rica to sterilize our disposable devices to which we loaned the majority of the funds necessary to construct
their Costa Rican sterilization facility. As a part of this agreement we receive guaranteed processing times on their sterilization services. While we have alternate product sterilization service
providers, a significant disruption to the primary sterilization provider could temporarily impact our ability to supply products in a timely manner. Disruption of these supply sources and our
inability to develop alternative sources for such supply, would result in a material disruption of our ability to sell this line of products for an extended time period and could adversely affect our
operations.

DHL
Solutions, Inc. is a significant provider of logistic services, including warehousing of finished goods and a variety of transportation services. The company primarily
utilizes FedEx Corporation as the provider of transportation services associated with the shipment of finished products to customers and field returns in North America. Shipment of finished products
outside of North America and the transportation of raw materials and other production related shipments are handled by a variety of third party common carriers based on a competitive sourcing process.
The providers of these services change from time to time and there are alternate sources of these services should any single provider prove unable to supply contracted services. The complex nature of
the underlying support technologies utilized to exchange critical product information with these third party transportation providers, such as "Electronic Data Interchange", has, at times, caused
disruptions in our ability to deliver products to customers on a timely basis. Failure of these supporting systems could impair our business for the duration of the failure.

Patents and Proprietary Rights

We own over 210 issued U.S. patents and over 170 issued international patents. In addition, we have over 135 U.S. and international
pending patent applications. We believe our issued patents are directed at, among other things, 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 many different surgical procedures. In addition, our issued patents are directed

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at
many of the core features of our acquired technologies from Opus, Atlantech, Parallax and ATI. Our earliest Coblation-related patents will begin to expire in 2012. The majority of our royalty
income is associated with licenses that include core Coblation patent rights which extend through the end of 2014.

In
addition to patents, we hold intellectual property that we believe has significant value and provides us with competitive advantages in the form of copyrights, know-how,
trademarks and customer relationships.

See
"Part IItem 1ARisk Factors" and Intangible Asset information outlined in Note 8, "Goodwill and Intangible Assets" in the notes to the
consolidated financial statements for additional information.

Government Regulation



Our products are considered medical devices and are subject to extensive regulation in the U.S. We must comply with FDA regulations to
market our products or obtain pre-market 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. Non-compliance 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 or a new use for a medical device into the U.S. market, we must obtain FDA clearance of a 510(k)
premarket notification or obtain premarket approval. If we can establish that our device is "substantially equivalent" to an existing device for which the FDA has not called for premarket approvals,
we may seek clearance from the FDA to market the device by submitting a 510(k) premarket notification. The 510(k) premarket notification requires the support of appropriate data, including, in some
cases, clinical data establishing the claim of substantial equivalence to the satisfaction of the FDA. Where a product is not deemed as substantially equivalent to an existing device, a more rigorous
premarket approval process, or a PMA process, is required. This PMA process requires us to independently demonstrate that the new medical device is safe and effective by collecting data regarding
design, materials, bench and animal testing, and human clinical data for the medical device. Only if the FDA determines there is reasonable assurance that the medical device is safe and effective,
will the FDA authorize the
device's commercial release. The premarket approval process is much more detailed, time-consuming and expensive than the 510(k) process.

We
have received 510(k) clearance to the extent we believe it is required for all of our products for a variety of indications.

We
strive to ensure that our products not requiring clearance meet our manufacturing and quality guidelines and standards to the same extent as if clearance were required.

Our
products and the facilities manufacturing our products are subject to continued review and periodic inspections by the FDA. Each U.S. device-manufacturing establishment must be
registered with the FDA. Domestic manufacturing establishments are subject to biannual inspections by the FDA, and must comply with the FDA's quality system regulations. Further, we must report
adverse events involving our devices to the FDA under regulations issued by the FDA. Failure to maintain compliance with the regulatory requirements of the FDA may result in administrative or judicial
actions, such as

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fines,
warning letters, holds on clinical studies, product recalls or seizures, product detention or refusal to permit the import or export of products, refusal to approve pending applications or
supplements, restrictions on marketing or manufacturing, injunctions, or civil or criminal penalties.

Federal
healthcare laws apply when we or our customers submit claims for items or services that are reimbursed under Medicare, Medicaid or other federally funded healthcare programs. The
principal federal laws include: (1) the False Claims Act which prohibits the submission of false or otherwise improper claims for payment to a federally funded healthcare program;
(2) the Anti-Kickback Statute which prohibits offers to pay or receive remuneration of any kind for the purpose of inducing or rewarding referrals of items or services reimbursable
by a Federal healthcare program; (3) the Stark law which prohibits physicians from referring Medicare or Medicaid patients to a provider that bills these programs for the provision of certain
designated health services if the physician (or a member of the physician's immediate family) has a financial relationship with that provider; and (4) healthcare fraud statutes that prohibit
false statements and improper claims with any third party payor. Often similar state laws also apply to claims submitted under state Medicaid or state funded healthcare programs. Some states, such as
California, Massachusetts and Vermont, mandate implementation of corporate compliance programs to ensure compliance with these laws. In addition, the U.S. Foreign Corrupt Practices Act can be used to
prosecute companies in the U.S. for arrangements with physicians, or other parties outside the U.S. if the physician or party is a government official of another country and the arrangement violates
the law of that country.

The
laws applicable to us are subject to change and to evolving interpretations. To help build more consistent business practices, we have implemented a corporate-wide
compliance
program that intends to conform business practices throughout our business areas to applicable laws and regulations.

For
additional discussion of the risks and considerations surrounding our business in the context of our regulatory environment, see
"Part IItem 1ARisk Factors."



International sales of our products are subject to strict regulatory requirements. The regulatory review process varies from country to
country. The member countries of the European Union, or EU, have adopted the European Medical Device Directives, which create a single set of medical device regulations for all EU member countries.
These regulations require companies that wish to manufacture and distribute medical devices in EU member countries to obtain the CE Mark, for their products. We have authorization to apply the CE Mark
to substantially all of our products. Additionally, we have obtained regulatory clearance to market our key products throughout other countries. In addition, the U.S. Foreign Corrupt Practices Act can
be used to prosecute companies in the U.S. for arrangements with physicians, or other parties outside the U.S. if the physician or party is a government official of another country and the arrangement
violates the law of that country. Other international laws such as the U.K. Anti-Bribery Act provide further restrictions on interactions with physicians and other potential customers.



The demand for our products is highly dependent on the policies of third-party payors such as Medicare, Medicaid, and private insurance
and managed care organizations that reimburse our customers when they use our products. If coverage or payment policies of these third-party payors are revised in light of increased efforts to control
healthcare spending or otherwise, the amount we may charge or the demand for our products may decrease. Government programs, including Medicare and Medicaid, private healthcare insurance and
managed-care plans have attempted and continue to attempt to control costs by limiting the amount of reimbursement they will pay for particular procedures or treatments. This practice has
increased price sensitivity among certain customers for our

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products.
Additionally, some third-party payors require approval of coverage for new or innovative devices or therapies before they will reimburse healthcare providers who use the medical devices or
therapies. Even though a new medical device may have been approved for commercial distribution, we
may find limited demand for the device until reimbursement approval has been obtained from governmental and private third-party payors. In the U.S., we believe that healthcare reform legislation
proposals will most likely remain focused on reducing the cost of healthcare and that efforts by private payors to contain costs through managed care and other methods will continue in the future as
efforts to reform the healthcare system continue. We believe we can effectively respond to reasonable changes resulting from the worldwide trend toward cost containment due to our manufacturing
efficiencies and cost controls. However, it is difficult for us to predict the potential impact of cost containment trends on future operating results due to uncertainty that remains regarding future
legislation.

Impact of Business Outside of the U.S.

Our operations in countries outside the U.S. are accompanied by certain financial and other risks. Relationships with customers and
effective terms of sale vary by country, often with longer payment terms on receivables than are typical in the U.S. Currency exchange rate fluctuations can affect net sales from, and profitability
of, our operations outside the U.S. See "Part IIItem 7AQuantitative and Qualitative Disclosures About Market Risk" and Note 18, "Segment Information" in
the notes to the consolidated financial statements. In addition, the repatriation of certain earnings of our foreign operations may result in U.S. tax cost of approximately $11.4 million.

Product Liability Risk and Insurance Coverage

The development, manufacture and sale of medical products entail significant risk of product liability claims. We cannot assure you
that our current product liability insurance 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 our ability to attract and retain customers for our products.

Employees

At December 31, 2010 we had 1,407 employees. In North America, we had 459 employees, of which 21 were engaged in supply and
logistics activities, 110 in research and
development, process engineering, and clinical affairs activities, 182 in sales, customer service and marketing activities, 60 in regulatory affairs and quality assurance, and 86 in administration,
finance and corporate support functions. In Europe and Asia Pacific, we had 204 employees responsible for our international markets. In Costa Rica, we had 744 employees engaged in manufacturing and
plant management. We have no employees covered by collective bargaining agreements, and we believe we maintain good relations with our employees.

Where You Can Find Additional Information

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 SEC: 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, as amended, or the
Exchange Act. You may also read and copy any materials that we file with the SEC at the SEC's Public Reference Room at 100 F

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Street,
NE, 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 www.sec.gov.

Forward Looking Statements

This Annual Report may include "forward-looking" statements. Forward-looking statements broadly involve our current expectations or
forecasts of future results. Our forward-looking statements generally relate to our growth and growth strategies, financial results, product development, regulatory approvals, competitive strengths,
intellectual property rights, litigation and tax matters, mergers and acquisitions, market acceptance of our products, accounting estimates, financing activities, ongoing contractual obligations and
sales efforts. Such statements can be identified by the use of terminology such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "intend," "may," "plan," "possible," "project,"
"should," "will" and similar words or expressions.

For
more information about the nature of forward-looking statements and risks that could affect our future results and the disclosure provided in this Annual Report, please see
"Part IItem 1ARisk Factors" and
Exhibit 99.1Forward-Looking Statements, which is incorporated herein by reference.

ITEM 1A.    RISK FACTORS

This section identifies specific risks that should be considered carefully in evaluating our business. Any of these risks could
adversely affect our business, results of operations or financial condition. Although we believe that these risks represent the material risks relevant to us, our business and our industry, new
material risks may emerge that we are currently unable to predict. As a result, this description of the risks that affect our business and our industry is not exhaustive. The risks discussed below
could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in Exhibit 99.1, "Forward-Looking
Statements".

The restatement of our previous financial statements, the Audit Committee's review of certain accounting, financial reporting and insurance billing and healthcare compliance
practices and the DOJ and other investigations, legal and administrative proceedings have increased our costs and could result in fines, injunctions, orders, and penalties which could materially
adversely affect our business, financial condition, results of operations, and liquidity.

As previously reported, during 2009 and 2008, we experienced substantial delays in filing our periodic reports as a result of issues
identified during a review of certain accounting and financial reporting matters as well as certain insurance billing and healthcare compliance practices conducted under the direction of our Audit
Committee (the "Review"), which began in July 2008. The Review was completed in August 2009 and the results were reported to the Audit Committee and to the Board. In July 2008, we also commenced a
separate comprehensive review of our accounting policies and procedures, financial reporting, internal controls and corporate governance. We completed this comprehensive review in November 2009, and
as a result of our comprehensive review and the Review, we made extensive organizational and operational changes and improved our internal controls. As a result of errors and possible irregularities
identified by the Review and management's review and analysis of certain accounting matters, we restated our financial statements for: the years ended December 31, 2007, 2006, 2005, and 2004;
the quarter ended March 31, 2008 and each of the quarters for the years ended December 31, 2007 and 2006 in our Form 10-K for the year ended December 31, 2008
filed on November 18, 2009, or the 2008 Form 10-K.

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We are involved in ongoing material legal proceedings and the actions currently pending result primarily from matters relating to our restatement and Review. See
Note 11, "Litigation and Contingencies," in the notes to the consolidated financial statements. These proceedings and other legal actions may harm our business or liquidity in the future.

We
have incurred substantial cost and expenses for legal and accounting services due to the Review and resulting Department of Justice, or DOJ, investigations. These matters will likely
continue to divert our management's time and attention periodically and cause us to continue to incur substantial costs and expenses. Such investigations can also lead to fines or injunctions or
orders with respect to future activities. We could incur substantial additional costs to defend and resolve litigation, investigations or proceedings arising out of or related to these matters. In
addition, we could be exposed to enforcement or other actions with respect to these matters by the DOJ or other federal or state agencies. At this point, we are unable to predict the duration, scope
or result of these investigations or whether any of these agencies will commence any legal action. Any such investigations may result in us being subject to criminal and civil penalties and other
remedial measures, which could have an adverse impact on our business, results of operations, financial condition and liquidity.

On
October 18, 2010, we, our directors' and officers' insurance carriers, and the plaintiffs in the Federal Court and State Court derivative actions agreed in principal to a
settlement. Under the terms of the proposed settlement, the director and officer insurers will collectively pay us $8.0 million, on behalf of the individuals named as defendants in the Federal
Court and State Court derivative actions, to settle the State and Federal Derivative actions. The lawyers for the plaintiffs will be entitled to seek an award
of legal fees and costs from the Federal Court in an amount not to exceed $2.25 million. The agreement also provides that the directors' and officers' insurers will pay the Company an
additional $2.0 million for a broad mutual release by us and the insurers of any further rights or obligations under the directors' and officers' liability insurance policies. The settlement
calls for certain mutually acceptable governance changes and is subject to approval of the former officers and directors who are parties to the derivative actions, an agreement by those former
officers and directors to release our directors' and officers' liability insurance carriers of any further rights or obligations under the applicable directors' and officers' liability insurance
policies, the execution of a full and final settlement agreement, and the approval of the settlement of the derivative actions by the U.S. District Court, Western District of Texas. Upon approval of
this settlement agreement, any further litigation cost or damages we incur that is based on the restatement or related events, including the ongoing DOJ investigation, the consolidated securities
Class Action case described in Note 11, "Litigation and Contingencies" in the notes to the consolidated financial statements, and any ongoing indemnity obligations related to these matters will
be funded without the benefit of further insurance coverage.

Many
of our pending legal proceedings are in the early stages and we cannot predict their outcomes. However, irrespective of the outcomes, we may incur substantial costs, including
defense and indemnity costs, and these matters may divert the attention of our technical and management personnel, which could materially harm our business. We may continue to incur ongoing indemnity
obligations with respect to certain former officers of ours who are still subject to potential legal action against them. Moreover, if we do not prevail in any of the actions still pending against us,
we could be required to pay substantial damages or settlement costs. Adverse outcomes or other developments during the course of litigation or other proceedings may harm our business, financial
condition, results of operations or liquidity as well as investors' perception of our business, any of which could harm our stock price.

Our failure to comply with extensive government regulations could subject us to penalties and materially adversely affect our business, results of operations and financial
condition.

Our medical device products and operations are subject to extensive regulation by the FDA and various other federal, state and foreign
governmental authorities. Government regulations and foreign

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requirements
specific to medical devices are wide ranging and govern, among other things: design, development and manufacturing; testing, labeling and storage; clinical trials; product safety;
marketing, sales and distribution; pre-market clearance and approval; record keeping procedures; advertising and promotions; recalls and field corrective actions; post-market
surveillance, including reporting of deaths or serious injuries and malfunctions that, if they were to recur, could lead to death or serious injury; and product import and export.

We
must also comply with the U.S. anti-kickback statute and the foreign corrupt practices act and similar foreign anti-bribery statutes in the sales and
distribution of our products.

The
FDA, DOJ and other governmental authorities have broad enforcement powers, and our failure to comply with these regulatory requirements could result in governmental agencies or a
court taking action, including any of the following, which would adversely affect our business: issuing public warning letters to us; imposing fines and penalties on us; obtaining an injunction
preventing us from manufacturing or selling our products; bringing civil or criminal charges against us; delaying the introduction of our products into the market; delaying pending requests for
clearance or approval of new uses or modifications to our existing products; recalling, detaining or seizing our products; or withdrawing or denying approvals or clearances for our products.

If we fail to comply with complex and rapidly evolving laws and regulations, we could suffer civil and criminal penalties, be required to pay substantial damages and make
significant changes to our products and operations.

During the past several years, the U.S. health care industry has been subject to an increase in governmental regulation at both the
federal and state levels. We are subject to numerous federal and state regulations. As part of our internal compliance program, we review our sales and marketing materials, contracts and programs with
counsel, and require employees and marketing representatives to participate in regular training. We also have adopted and train our personnel on the code of conduct for Interactions with Health Care
Professionals promulgated by the Advanced Medical Technology Association, or AdvaMed, a leading trade association representing medical device manufacturers. Most recently, we amended our Code of
Business Conduct and Ethics, the "Code of Ethics," in August 2009. Originally adopted in 2004 to qualify as a "code of ethics" within the meaning of Section 406 of the Sarbanes-Oxley Act of
2002, the Code of Ethics was amended to qualify as well as a "code of conduct" under the current Federal Sentencing Guidelines and "Compliance Program Guidance for Pharmaceutical Manufacturers" 68 FR
23731 (May 5, 2003) applicable to medical device companies as published by the Office of Inspector General for the Department of Human Services. The Code of Ethics applies to all of our
directors, officers, employees and agents. It also serves as an essential element of our Corporate Compliance Program, as announced in August 2009. However, we can give no assurances that our
compliance program will ensure that the Company is in compliance with existing or future applicable laws and regulations. If our compliance program fails to meet its objectives, or if we otherwise
fail to comply with existing or future applicable laws and regulations, we could suffer civil or criminal penalties. We devote significant operational and managerial resources to comply with these
laws and regulations. Different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality or could require
us to make significant changes to our products and operations. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure you that we will be able
to obtain or maintain the regulatory approvals required to operate our business.

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Our accounting policies and methods require management to make judgments and estimates about matters that are inherently uncertain, which may result in our actual results
differing significantly from those generated by our judgments and estimates.

We are required to exercise judgment in the application of our accounting policies and methods to comply with generally accepted
accounting principles in the U.S., or GAAP, and to reflect management's judgment of the most appropriate manner to report our financial condition and results of operations. See Note 3, "Summary
of Significant Accounting Policies" in the notes to the consolidated financial statements for a description of our significant accounting policies.

The
accounting policies we have identified as critical to the presentation of our financial condition and results of operations are described in
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates". We
believe these policies are critical because they require management to make particularly subjective or complex judgments about matters that are inherently uncertain at the end of a period and because
of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. Due to the complexity of these critical accounting policies, our
accounting methods relating to these policies involve substantial use of estimates. Estimates are inherently imperfect predictors of actual results because they are based on assumptions, including
assumptions about future events. Our estimates may not include assumptions that reflect very positive or very negative market conditions and, accordingly, our actual results could differ significantly
from those generated by our estimates. As a result, the estimates that we use to prepare our financial statements, as well as our estimates of our future results of operations, may be significantly
inaccurate.

We may be the subject of federal, state and/or foreign government civil and criminal enforcement efforts against health care companies, which could result in civil and/or
criminal penalties which could have a material negative impact on our operations and financial condition.

In addition to uncertainties surrounding coverage policies, both federal and state government agencies have heightened civil and
criminal enforcement efforts against health care companies, as well as their executives and managers. These efforts generally relate to a wide variety of matters, including referral and billing
practices, and implicate a variety of state and federal laws, including state insurance fraud provisions, common law fraud theories, as well as both state and federal
fraud-and-abuse, anti-kickback, false claims statutes, and the foreign corrupt practices act and similar international anti-bribery laws and
regulations. Although we no longer directly bill any payor, some of our prior activities could become the subject of additional governmental investigations or inquiries. In addition, even though we no
longer directly bill any payor, we are still subject to health care fraud and abuse regulation and enforcement by both the federal government and the states in which we conduct our business.

The
risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their
provisions are open to a variety of interpretations. Moreover, recent health care reform legislation has strengthened these laws. For example, the Patient Protection and Affordable Care Act (PPACA)
which was signed into law in March 2010, among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes; a person or entity no
longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, PPACA provides that the government may assert that a claim including items or services resulting
from a violation of the federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Moreover, we expect there will continue to be
federal and state laws and/or regulations, proposed and implemented, that could impact our operations and business. The extent to which future legislation or regulations if any relating to health care
fraud abuse laws and/or enforcement may be enacted or what effect such legislation or regulation would have on our business remains uncertain. If our operations

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are
found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages,
fines, exclusion from governmental health care programs, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our
financial results.

We may in the future be subject to intellectual property claims, which are costly to defend, could require us to pay damages and could limit our ability to use certain
technologies in the future.

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 additional patent infringement claims or other litigation, including interference proceedings declared by the U.S. Patent and
Trademark Office, or USPTO, to determine the priority of inventions. The defense and prosecution of intellectual property lawsuits, USPTO reexamination and interference proceedings and related legal
and administrative proceedings, generally are costly and time-consuming. If other parties violate our proprietary rights, further litigation may be necessary to enforce our patents, to
protect trade secrets or know-how we own or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or reexamination or interference
proceedings will be costly and cause significant diversion of effort by our technical and management personnel.

An
adverse determination in existing claims, additional litigation or reexamination 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 certain technology. Furthermore, we cannot assure you that we could obtain necessary 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.

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, business, financial condition, results of operations
and future growth prospects.

Our ability to compete effectively depends in part on developing and maintaining the proprietary aspects of our Coblation technology
and our acquired technologies. 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. In addition, we believe that our issued patents are directed at many of
the core features of our acquired technologies from Opus, Parallax, Atlantech and Applied Therapeutics, Inc. ("ATI"). Our earliest Coblation-related patents will begin to expire in 2012. The
majority of our royalty income is associated with licenses that include core Coblation patent rights which extend through the end of 2014.

There
is no assurance 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 investors that those patents will not be successfully challenged, invalidated or circumvented prior to their expiration. In addition, we cannot
provide assurance 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 U.S. or in international markets. In Sports Medicine, many of
our competitors have licensed our technology for limited fields of use. Patent applications are maintained in secrecy for a

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

We may not be able to keep pace with technological change or successfully develop new products with wide market acceptance, which could cause us to lose business to
competitors.

We compete in a market characterized by rapidly changing technology. We may not be able to keep pace with technology or to develop
viable new products. Our future financial performance will depend in part on our ability to develop and manufacture new products in a cost-effective manner, to introduce these products to
the market on a timely basis, and to achieve market acceptance of these products. Factors which may result in delays of new product introductions or cancellation of our plans to manufacture and market
new products include capital constraints, research and development delays, and delays in acquiring regulatory approvals. Our new products and new product introductions may fail to achieve expected
levels of market acceptance. Factors impacting the level of market acceptance include our ability to successfully implement new technologies, the timeliness of our product introductions, our product
pricing strategies, our available financial and technological resources for product promotion and development, our ability to show clinical benefit from our products, and the availability of coverage
and reimbursement for our products as discussed in the risk factor titled "Changes in coverage and reimbursement for procedures using our products could affect physicians" below.

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The markets for our products are intensely competitive, which may result in our competitors developing technologies and products that are more effective than ours or that
make our technologies and products obsolete. Many of our competitors have significantly greater resources and market power than we do.

The markets for our current products in our core businesses are intensely competitive. 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 technologies or products obsolete or uncompetitive in these markets.

Our
primary competitors across all of our operating units consist of Medtronic, Inc., Smith & Nephew, Stryker Corporation, Johnson & Johnson, Olympus (through their
subsidiary Gyrus), and Arthrex, Inc.. These competitors tend to be large, well-financed companies with diverse product lines who may 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
price discounts as a competitive tactic. 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 U.S. have purchasing contracts with our competitors. Accordingly, customers may be dissuaded from purchasing our products instead of our competitors'
products to the extent the purchase would cause them to lose discounts on our competitors' products. In addition, we are aware of several small companies offering alternative treatments for back pain
and other ailments or indications that may indirectly compete with our products.

If
we were to be unable to continue to compete for any of the above reasons, it could have a material adverse effect on our business, financial condition, results of operations and
future growth prospects.

Until we resolve our contingencies, we may not have access to a cost effective credit facility and we will be required to fund a significant amount of cash to fund our
working capital needs and planned expenditure with cash on hands. Our ability to generate cash depends on many factors beyond our control.

In the absence of a credit facility as a possible source of liquidity, our ability to meet our working capital needs and to fund
capital expenditures will depend on our ability to generate cash from operations and effectively manage our cash balances. This is subject to general economic, financial, competitive and other factors
that may be beyond our control. We are unable to predict the outcome of ongoing litigation and investigations to which we are a party and these matters could have a material adverse effect on our
liquidity and cash flows. See Note 11, "Litigation and Contingencies," in the notes to the condensed consolidated financial statements for further discussion on legal proceedings. We expect
that our cash flows from operations together with cash on hand will be sufficient to satisfy our short-term and, excluding the uncertainty related to the ongoing litigation and
investigations to which we are a party, long-term normal operating
liquidity requirements; however, we cannot assure you that our business will generate sufficient cash flow from operations in an amount sufficient to enable us to fund our other liquidity needs.

As
a result, from time to time, we may be required to seek financing from alternative sources. We cannot assure you that such alternative funding will be available to us on terms and
conditions acceptable to us, or at all.

In
addition, we maintain deposit accounts with numerous financial institutions around the world in amounts that exceed applicable governmental deposit insurance levels. While we actively
monitor our deposit relationships, the unanticipated failure of a financial institution in which we maintain deposits could cause us to suffer losses that could materially harm our results of
operations and financial condition.

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Any control deficiencies relating to our internal control over financial reporting could result in errors in our reported results and could have a material adverse effect on
our operations, investor confidence in our business and the trading prices of our securities.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its
inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human
failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will
not be prevented or detected on a timely basis by internal control over financial reporting.

A failure to remain current in our filings may have material impacts on our business and liquidity.

If we are not able to remain current in our filings with the SEC, we will face several adverse consequences and restrictions. We will
not be able to have a registration statement under the Securities Act of 1933, as amended (the "Securities Act"), covering a public offering of securities, declared effective by the SEC, or make
offerings pursuant to existing registration statements; we will not be able to make an offering to any purchasers not qualifying as "accredited investors" under certain "private placement" rules of
the SEC under Regulation D; we will not be eligible to use a "short form" registration statement on Form S-3 for a period of at least 12 months after
the time we become current in our periodic and current reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); we will not be able to deliver the requisite annual report
and proxy statement to our stockholders to hold our annual stockholders meeting; our employees cannot be granted stock options, nor will they be able to exercise stock options registered on
Form S-8, because Form S-8 would not be available to us; and our Common Stock may be delisted from the NASDAQ Stock Market. These restrictions may impair our
ability to raise funds in the public markets, should we desire to do so, and to attract and retain employees.

In
addition, pursuant to the Registration Rights Agreement between us and the holders of our Series A Preferred Stock, if our registration statement ceases to be available to the
holders of our Series A Preferred Stock, a Registration Default occurs. If we are not able to cure this Registration Default in a timely manner we are obligated to pay the holders of the
Series A Preferred Stock 2.00 percent per annum of the original liquidation preference of the Series A Preferred Stock, accruing from the date of the Registration Default until
the Registration Default is cured.

Medical device reprocessors that reprocess our single-use devices and then provide them to customers at a lower cost than a new device may adversely affect our
business.

Certain medical device reprocessors routinely collect used or opened but unused single-use devices from customers and
reprocess and repackage these products to customers at a price lower than the price of a new device. These reprocessed devices may be confused with our authorized products, reduce our product sales
and harm our reputation with key physicians who may not have knowledge that the devices have been reprocessed. In addition, this may increase time and expense spent investigating and addressing
performance issues, including product liability issues, related to reprocessed devices. We may be required to incur additional expense to protect ourselves against performance claims associated with
reprocessed devices and to enforce infringements by reprocessors of our proprietary and contractual rights.

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Failure to obtain FDA clearance or approval for our products could materially adversely affect our business, results of operations, financial condition, and future growth
prospects.

In the U.S., before we can market a new medical device, or a new use of, or claim for, or significant modification to, an existing
product, we must first receive either premarket clearance under Section 510(k) of the U.S. Federal Food, Drug, and Cosmetic Act, or FDCA, or approval of a PMA submission from the FDA, unless an
exemption applies. In the 510(k) clearance
process, the FDA must determine that a proposed device is "substantially equivalent" to a device legally on the market, known as a "predicate" device, with respect to intended use, technology and
safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. However, as was the case in our recent submission
for 510(k) clearance of Coblator IQ ENT Plasma Wands, the FDA has a high degree of latitude when evaluating submissions and may determine that a proposed device submitted for 510(k) clearance is not
substantially equivalent, or NSE, to a predicate device.

Recent
trends in FDA's review of 501(k) submissions suggest that FDA is often requiring manufacturers to provide new, more expansive or different information regarding a particular
device than what the manufacturer anticipated. This has resulted in increasing uncertainty and delay in the premarket notification review process. In January 2011, the FDA announced
twenty-five specific action items it intends to take with respect to the 510(k) process to add greater transparency and certainty to the review process. These reforms, when fully
implemented, could impose additional regulatory requirements upon us which could delay our ability to obtain new clearances, increase the costs of compliance, or restrict our ability to maintain
current clearances.

An
FDA NSE determination means that the device is automatically reclassified into Class III and we cannot market the device unless it is either approved through the PMA process or
reclassified into Class I or Class II based on further submissions with supporting data. A new submission may require clinical data. The PMA approval pathway requires an applicant to
demonstrate the safety and effectiveness of the device based, in part, on data obtained in clinical trials. Both of these processes can be expensive and lengthy and entail significant user fees,
unless exempt. The FDA's 510(k) clearance process usually takes from three to twelve months, but it can last longer. The process of obtaining PMA approval is much more costly and uncertain than the
510(k) clearance process. It generally takes from one to three years, or even longer, from the time the PMA application is submitted to the FDA until an approval is obtained. There is no assurance
that we will be able to obtain FDA clearance or approval for any of our new products on a timely basis, or at all. Failure to obtain FDA clearance or approval for our new products could materially
adversely affect our business, results of operations, financial condition, and future growth prospects.

Modifications to our currently FDA-cleared products may require new regulatory clearance or approvals or require us to recall or cease marketing our current
products until clearances or approvals are obtained.

After a device receives 510(k) premarket notification clearance from the FDA, 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 processes may require a new 510(k)
clearance or Premarket Approval, or PMA. The FDA requires every manufacturer to make the determination regarding the need for a new 510(k) clearance or PMA approval in the first instance, but the FDA
may review any manufacturer's decision and may retroactively require the manufacturer to submit a premarket notification requesting 510(k) clearance or an application for PMA approval. The FDA also
can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or approval is obtained. FDA guidance documents define when to submit premarket notifications
for new or modified devices. These guidance documents also define modifications for which a new 510(k) is not required. We have modified some of our marketed devices, and have determined that in
certain instances new 510(k) clearances or PMA

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approvals
are not required. No assurance can be made that the FDA would agree with any of our decisions not to seek 510(k) clearance or PMA approval. If the FDA requires us to cease marketing and/or
recall the modified device until we obtain a new 510(k) clearance or PMA approval, our business, financial condition, results of operations and future growth prospects could be materially adversely
affected.

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or "off-label" uses, which would
adversely affect our financial condition.

Our promotional materials and training methods must comply with FDA regulations and other applicable laws and regulations, including
the prohibition of the promotion of a medical device for a use that has not been cleared or approved by the FDA. Use of a device outside its cleared or approved indications is known as
"off-label" use. Physicians may use our products off-label, as the FDA does not restrict or regulate a physician's choice of treatment within the practice of medicine. However,
if the FDA determines that our promotional materials or training constitutes the promotion of an off-label use, it could subject us to certain sanctions ranging from a request that we
modify our training or promotional materials to further regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and/or
criminal penalties against us or our officers or employees. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or
training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for
reimbursement. In that event, our reputation could be damaged and adoption of the products
would be impaired. Although our policy is to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and
conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of injury to patients, and, in turn, the risk of
product liability claims. Product liability claims are expensive to defend and could divert our management's attention and result in substantial damage awards against us.

Our products may in the future be subject to product recalls that could harm our reputation, business operations and financial results, and if our products cause or
contribute to a death or serious injury, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or FDA enforcement actions.

The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event
of material deficiencies or defects in design or manufacture or in the event that a product poses an unacceptable risk to health. Manufacturers may, under their own initiative, recall a product if any
material deficiency in a device is found. A government mandated or voluntary recall by us or one of our distributors could occur as a result of an unacceptable risk to health, component failures,
manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our
financial condition and results of operations. Any of these sanctions could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers'
demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.

Further,
under the FDA medical device reporting regulations, or MDR, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or
serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Any adverse event involving our products could
result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection, mandatory recall or other enforcement action. Any corrective action,
whether voluntary or

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involuntary,
as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and
financial results.

If we or our third-party suppliers fail to comply with the FDA's Quality System Regulations, our manufacturing operations could be interrupted and our sales and our ability
to generate profits could suffer.

We and certain of our third-party suppliers are required to comply with the FDA's Quality System Regulation, or QSR, which covers the
methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. We and our suppliers are also
subject to the regulations of foreign jurisdictions regarding the manufacturing process if we market our products in these jurisdictions. The FDA enforces the QSR through periodic and unannounced
inspections of manufacturing facilities. If our facilities or those of our suppliers fail to take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take
enforcement action, including any of the following sanctions: untitled letters; warning letters, fines, injunctions, consent decrees and civil penalties; customer notifications or repair, replacement,
refunds, recall, detention or seizure of our products; operating restrictions or partial suspension or total shutdown of production; refusing or delaying our requests for 510(k) clearance or premarket
approval of new products or modified products; withdrawing 510(k) clearances on PMA approvals that have already been granted; refusal to grant export approval for our products; or criminal
prosecution.

Any
of these sanctions could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers' demands. We may also be required
to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.

We require foreign regulatory approvals to market and sell our products in other countries. Failure to obtain and maintain these regulatory approvals could harm our ability
to generate revenue.

To be able to market and sell our products in other countries, we must obtain regulatory approvals and comply with the regulations of
those countries. These regulations, including the requirements for approvals and the time required for regulatory review, vary from country to country. Obtaining and maintaining foreign regulatory
approvals is expensive, and we cannot be certain that we will receive regulatory approvals in any foreign country in which we plan to market our products. If we fail to obtain or maintain regulatory
approval in any foreign country in which we plan to market our products, our ability to generate revenue could be harmed.

Changes in coverage and reimbursement for procedures using our products could affect use of our devices and our future revenue.

The demand for our products is highly dependent on the policies of third-party payors such as Medicare, Medicaid, private insurance,
and managed care organizations that reimburse our customers when they use our products. Failure by physicians, hospitals and other users of our products to obtain sufficient coverage and reimbursement
from healthcare payors for procedures in which our products are used, or adverse changes in environmental and private third-party payors' policies toward coverage and reimbursement for such procedures
would have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

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In the U.S., third-party payors continue to implement initiatives that restrict the use of certain technologies to those that meet certain clinical evidentiary
requirements. We are aware of several third-party payors in the U.S., including governmental payors such as Medicare and Medicaid and private health insurance companies, who consider Coblation
technology used in certain procedures to treat certain clinical conditions to be experimental or investigational. These payors have developed policies that deny coverage and therefore make no
reimbursement for such procedures using our devices. Procedures using our devices that are not covered by some payors include such procedures as plasma disc decompression, or Coblation nucleoplasty,
as well as Coblation or radiofrequency volumetric tissue reduction for (1) removing soft tissue during arthroscopic surgery, (2) hypertrophied nasal turbinates for the treatment of
chronic nasal obstruction or obstructive sleep apnea and (3) soft palate and tongue for the treatment of obstructive sleep apnea. However, some payors in the U.S. provide coverage and
reimbursement for Coblation tonsillectomy for certain clinical indications and percutaneous vertebroplasty for patients that meet specified criteria. In addition, some payors are moving toward a
managed care system and control their health care costs by limiting authorizations for surgical procedures, including elective procedures using our devices. Failure to obtain favorable payor policies
could have a material adverse effect on our business and operations.

In
addition to uncertainties surrounding coverage policies, third-party payors from time to time update reimbursement amounts and also revise the methodologies used to determine
reimbursement amounts. This includes annual updates to payments to ambulatory surgical centers and physicians for procedures using our products. Since reimbursement for our products generally is
included as part of the payments for procedures, these updates directly impact the amounts recognized for the costs of our products. An example of payment updates is the Medicare program updates to
physician payments, which is done on an annual basis using a prescribed statutory formula. In the past, when the application of the formula
resulted in lower payment, Congress has passed interim legislation to prevent the reductions. For 2010, CMS projected a rate reduction of 21.2% under the statutory formula and a number of legislative
measures were passed to prevent this reduction. For the second half of 2010, the update factor was increased by 2.2 percent. For 2011, the Medicare and Medicaid Extenders Act of 2010 which was
signed into law on December 15, 2010, froze the 2010 update through 2011. Because CMS was required to make its other changes to the Medicare Physician Fee Schedule (including adjustments made
to certain codes identified to be misvalued) budget neutral, CMS made a downward adjustment to what is known as the "conversion factor," which translates values into dollar amounts. Whereas the
conversion factor for the end of 2010 was $36.8729, it is $33.9764 for 2011. At this time, is it uncertain how the change would affect our business. If Congress fails to intervene to prevent the
negative update factor in the future, the resulting decrease in payment may adversely affect our revenues and results of operations.

New
laws, regulations and judicial decisions, or new interpretations of existing laws, regulations and decisions that relate to healthcare availability, methods of delivery or payment
for products and services, or sales, marketing or pricing may cause our revenue to decline. In addition, we may need to revise our research and development plans if a program or programs no longer are
commercially viable. Such changes could cause our stock price to decline or experience periods of volatility.

The
PPACA legislation, among other things, imposes significant new taxes on medical device makers which will result in a significant increase in the tax burden on our industry, and could
have a material, negative impact on our results of operations and our cash flows. Other elements of this legislation such as comparative effectiveness research, an independent payment advisory board,
payment system reforms including shared savings pilots and other provisions could significantly change the way healthcare is developed and delivered, and may materially impact many aspects of our
business.

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 coverage
and

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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 investors that any such approvals will be obtained in a timely manner, if at all.
We are also unable to predict at this time the impact on our business of any future changes, if any, that are made to coverage and reimbursement policies by government action in key international
markets.

Product liability claims could adversely impact our financial condition and impair our reputation.

Our business exposes us to potential product liability risks which are inherent in the design, manufacture and marketing of medical
devices. In addition, many of our products are designed to be implanted in the human body for long periods of time. Component failures, manufacturing flaws, design defects or inadequate disclosure of
product related risks or product related information with respect to these or other products we manufacture or sell could result in an unsafe condition or injury to a patient. The occurrence of such a
problem could result in product liability claims or a recall of one or more of our products, which could ultimately result in the removal from the body of such products and claims regarding associated
costs and damages, which could materially adversely impact our business, financial condition, results of operations, our ability to attract and retain customers for our products, and future growth
prospects.

We
cannot assure you that our current product liability insurance 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, our ability to attract and retain customers for our products, and future growth
prospects.

We are dependent on key suppliers, and supply disruptions could materially adversely affect our business, financial condition, results of operations and future growth
prospects.

Some of the key components of our products are purchased from single vendors. If the supply of materials from a single source supplier
were interrupted, replacement or alternative sources might not be readily obtainable due to the regulatory and other requirements applicable to our manufacturing operations or the availability of
certain product drawings and/or specifications. A new or supplemental filing with applicable regulatory authorities may require us to obtain clearance prior to our marketing a product containing new
material. This clearance process may take a substantial period of time and we cannot assure investors that we would be able to obtain the necessary regulatory approval for a 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 primarily use a subcontractor located in Costa Rica to sterilize our disposable devices. We have the ability to use alternative sterilization service providers for most
of our products. If our Costa Rica sterilization service were to be disrupted for any reason, we would be required to use alternative sources with longer processing and logistics cycles, which could
lead to a disruption in our ability to supply products for a period of time.

We
are dependent on warehouses in the U.S. and Belgium owned and operated by Deutsche Post DHL, Inc. If our ability to use these warehouses is disrupted, we may be unable to
supply products to our customers on a timely basis, which could materially adversely affect our business.

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The
complex nature of the underlying support technologies utilized to exchange critical product information with third party transportation and logistics providers, such as Electronic
Data Interchange, has, at times, caused disruptions in our ability to deliver products to customers on a timely basis. Failure of these supporting systems could impair our business for the duration of
the failure.

Our business is susceptible to risks associated with international operations.

International operations are generally subject to a number of risks, including: protectionist laws, business practices, licenses,
tariffs and other trade barriers that favor local competition; multiple, conflicting and changing governmental laws and regulations, such as tax laws regulating intercompany transactions; difficulties
in managing foreign operations, including staffing, seasonality of operations, dependence on local vendors, and collecting accounts receivable; loss of proprietary information due to piracy,
misappropriation or weaker laws regarding intellectual property protection; foreign currency exchange rate fluctuations; and political and economic instability.

We
derived 28.0 percent, 27.1 percent and 26.5 percent of our total product sales for the year ended December 31, 2010, 2009 and 2008, respectively, from
customers located outside of the Americas. We expect international revenue to remain a significant percentage of total revenue and we believe that we must continue to expand our international sales
activities to be successful. Historically, a majority of our international revenues and costs have been denominated in foreign currencies and we expect future international revenues and costs will be
denominated in foreign currencies. Our international sales growth will be limited if we are unable to establish appropriate foreign operations, expand international sales channel management and
support organizations, hire additional personnel, develop relationships with international sales representatives, and establish relationships with additional distributors. In that case, our business,
operating results and financial condition could be materially adversely affected. Even if we are able to successfully expand international operations, we cannot be certain that we will be able to
maintain or increase international market demand for our products.

Disruptions or other adverse developments at our Costa Rica facility could materially adversely affect our business.

Our high-volume disposable devices and controllers are manufactured at our Company owned facility in an industrial park in
San Jose, Costa Rica. If our Costa Rica facility is not able to produce sufficient quantities of our controllers and products with adequate quality, or if our Costa Rica operations are disrupted for
any reason, then we may be forced to locate alternative manufacturing facilities, including facilities operated by third parties. Disruptions may include, but are not limited to: changes in the legal
and regulatory environment in Costa Rica; slowdowns or work stoppages within the Costa Rican customs authorities; acts of God (including but not limited to potential disruptive effects from an active
volcano near the facility or earthquakes, hurricanes and other natural disasters); and other issues associated with significant operations that are remote from our headquarters and operations centers.
Additionally, continued growth in product sales could outpace the ability of our Costa Rican operation to supply ordered products on a timely basis or cause us to take actions within our supply and
manufacturing operations which increase costs, complexity and timing. Locating alternative facilities would be time-consuming, would disrupt our production and cause shipment delays and
could result in damage to our reputation and profitability. Additionally, we cannot assure you that alternative manufacturing facilities would offer the same cost structure as our Costa Rica facility.

Future changes in technology or market conditions could result in adjustments to our recorded asset balance for intangible assets, including goodwill, resulting in
additional non-cash charges that could significantly impact our operating results.

Our balance sheet includes significant intangible assets, including goodwill and other acquired intangible assets. The determination of
related estimated useful lives and whether these assets are

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impaired
involves significant judgments. Our ability to accurately predict future cash flows related to these intangible assets may be adversely affected by unforeseen and uncontrollable events. In
the highly competitive medical device industry, new technologies could impair the value of our intangible assets if they create market conditions that adversely affect the competitiveness of our
products. We test our goodwill for impairment in the fourth quarter of each year, but we also test goodwill and other intangible assets for impairment at any time when there is a change in
circumstances that indicates that the carrying value of these assets may be impaired. Any future determination that these assets are carried at greater than their fair value could result in
substantial non-cash impairment charges, which could significantly impact our reported operating results.

Delaware law and provisions in our charter could make the acquisition of our company by another company more difficult, which could adversely affect our stock price.

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. Certain 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 advance notice and other 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. Certain 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. 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 the company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our Common Stock. These provisions of
Delaware law, our certificate of incorporation, and our bylaws may have the effect of delaying or preventing changes in control or management of the Company, which could have an adverse effect on the
market price of our stock.

One Equity Partners, a private equity firm, may have influence on our major corporate decisions.

As previously reported, on September 1, 2009, an affiliate of One Equity Partners, or OEP, a private equity firm, acquired our
Series A Preferred Stock. See "Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity
and Capital Resources" in our 2009 Form 10-K for a description of this transaction. As a result of this transaction, OEP became the largest beneficial owner of our stock. At this
time, assuming conversion of the Series A Preferred Stock to our Common Stock, including make-whole amounts as defined in the Certificate of Designation for the Series A
Preferred Stock but excluding outstanding options and warrants held by other parties, OEP would represent an ownership interest of approximately 17.6 percent of our voting stock. In connection
with this transaction, we expanded the Board of Directors to eight members and granted OEP the right to nominate two directors. Effective September 1, 2009, Messrs. Gregory Belinfanti
and Christian Ahrens, both partners of OEP, were appointed to our Board of Directors.

Consequently,
OEP may have the ability to influence our Board of Directors and matters requiring stockholder approval, subject to the restrictions placed on OEP by the Securities
Purchase Agreement, including without limitation OEP's agreement to vote for any director nominated by the Board and to comply with the terms of the standstill.

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Since
September 1, 2010, OEP is free to convert the Series A Preferred Stock into our Common Stock and, subject to the registration requirements of the federal securities
laws, dispose of such stock, which could result in a decrease of the market price of our Common Stock, particularly if such dispositions are made in the open market and are substantial.

We are dependent upon key management, technical personnel and advisors, and loss of our key personnel and advisors could have a material adverse effect on our business and
results of operations.

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. Loss of key personnel would materially impact our ability to meet our financial and
operational objectives and could have a material adverse effect on our business and our results of operations.

Circumstances associated with our integration of acquisitions may adversely affect our operating results.

An element of our growth strategy in the future may be the pursuit of acquisitions of other businesses that expand or complement our
existing products and distribution channels. Integrating businesses, however, involves a number of special risks, including: the possibility that management attention may be diverted from regular
business concerns by the need to integrate operations; unforeseen costs, difficulties and liabilities in integrating our and the acquired company's employees, operations and systems; accounting,
regulatory, or compliance issues that could arise in connection with, or as a result of, the acquisition of the acquired company; challenges in retaining our customers or the customers of the acquired
company following the acquisition; the difficulty of incorporating acquired technology and rights into our products and services; and impairment charges if our acquisitions are not successful due to
these risks.

In
addition, we may finance future acquisitions by issuing equity securities, which may dilute the holdings of our current stockholders. If we are unable to successfully complete and
integrate strategic
acquisitions in a timely manner, our business, financial condition or operating results may be adversely affected.

Our operating results may fluctuate.

In our experience, our results of operations may fluctuate significantly from period to period. Adverse fluctuations due to these
factors may adversely affect our level of revenues and profitability, results of operations, financial condition, and future growth prospects in the short and long term: the introduction of new
product lines and increased penetration in existing applications; achievement of research and development milestones; the amount and timing of expenditures and the receipt and recognition of license
fees; and timing of the receipt of orders and product shipments, absence of a backlog of orders, and the rate of product returns.

Factors may make the market price of our stock highly volatile.

The market price of our Common Stock could fluctuate substantially in the future. Investors may be unable to resell our Common Stock at
or above their purchase price. This volatility may subject our stock price to material fluctuations due to the factors discussed in this "Risk Factors" section, and other factors including market
reaction to acquisitions and trends in sales, marketing, and research and development; rumors or dissemination of false information; changes in coverage or earnings estimates by analysts; our ability
to meet analysts' or market expectations; and sales of Common Stock by existing stockholders.

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As
previously reported, as of September 1, 2009, OEP owns all of our outstanding Series A Preferred Stock. Since September 1, 2010, OEP may convert the
Series A Preferred Stock into our Common Stock and, subject to the registration requirements of the federal securities laws, dispose of such stock, which could result in a decrease of the
market price of our Common Stock, particularly if such dispositions are made in the open market and are substantial.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.    PROPERTIES

We lease a facility in Austin, Texas, which serves as our corporate headquarters. The Austin, Texas facility is used for general and
administrative purposes as well as for research and development activities. Our lease for this building will expire in June 2016. We lease a facility in Irvine, California, which is used for product
and prototype development. This lease expires in March 2016. In Sunnyvale, California we lease a facility for research and development, general and administrative purposes and prototype manufacturing.
Our lease for this building will expire in February 2014. We also lease, on a month-to-month basis, a warehouse in a neighboring building in Sunnyvale, California for
warehousing and distribution. Internationally, we lease a facility in Stockholm, Sweden, which serves as our coordination center for international sales and marketing activities, which expires in
2014. We have access to a facility in Opglabbeek, Belgium that is used for our European repair center. In Costa Rica, we own a building located in a tax-advantaged business park. This
facility serves as our principal manufacturing location for disposable devices and implants.

We
believe these facilities, in addition to multiple less significant facilities leased in various countries around the world for sales, marketing and administrative purposes are in good
condition, well maintained, and are suitable and adequate to carry on our business.

ITEM 3.    LEGAL PROCEEDINGS

In addition to the matters specifically described below, we are involved in other legal and regulatory proceedings that arise in the
ordinary course of business that do not have a material impact on our business. Litigation claims and proceedings of all types are subject to many factors that generally cannot be predicted
accurately.

We
record reserves for claims and lawsuits when they are probable and reasonably estimable. Except as otherwise specifically noted, we currently cannot determine the ultimate resolution
of the matters described below. For matters where the likelihood or extent of a loss is not probable or cannot be reasonably estimated, we have not recognized in our consolidated financial statements
the potential liability that may result from these matters. If one or more of these matters is determined against us, it could have a material adverse effect on our earnings, liquidity and financial
condition.

We
continue to gather additional facts and information related to insurance billing and healthcare compliance issues and marketing and promotional practices in connection with these
legal and administrative proceedings with the assistance of legal counsel.

SEC Investigation

The Fort Worth Regional Office of the Securities and Exchange Commission's ("SEC") Division of Enforcement conducted a formal
investigation into accounting matters related to the restatement of financial results as announced by us on July 21, 2008 and completed on November 18, 2009, when we filed our Annual
Report on Form 10-K for the fiscal year ended December 31, 2008, in which we provided a detailed description of these matters with respect to the Review and the restatement.
We

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have
entered a settlement with the SEC that fully resolves the SEC investigation against the Company. Under the settlement, we have consented to the entry by the SEC of an administrative order (the
"Order"), on February 9, 2011, directing us to cease and desist from committing or causing violations of the reporting, books and records and internal control provisions of the federal
securities laws in Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and under Rules 12b-20, 13a-1 and 13a-13
promulgated under the Exchange Act. We consented to the entry of the Order without admitting or denying the Order's assertions of factual findings. No monetary penalty or fine was imposed on us, and
none of our current officers or employees were charged.

DOJ Investigation

The DOJ is investigating certain activities including past sales, accounting, and billing procedures primarily in relation to the
operation of our Spine product sales. The DOJ is also reviewing our relationship with our DiscoCare subsidiary. We are cooperating with this
investigation. At this stage of the investigation, we cannot predict the ultimate outcome and we are unable to estimate any potential liability we may incur.

Private Securities Class Action and Shareholder Derivative Lawsuits



On April 4, 2008, a putative securities class action was filed in Federal court in the Southern District of Florida against us
and certain of our former executive officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. Plaintiffs allege
that the defendants violated federal securities laws by issuing false and misleading financial statements and making material misrepresentations regarding our internal controls, business, and
financial results. On October 28, 2008, the court granted our motion to transfer this case to the U.S. District Court, Western District of Texas. (McIlvaine v.
ArthroCare, et al).

On
July 25, 2008, a putative securities class action was filed in Federal court in the Western District of Texas against us and certain of our current and former executive
officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. Plaintiffs allege that the defendants violated federal
securities laws by issuing false and misleading financial statements and making material misrepresentations regarding our internal controls, business, and financial results.
(Strong v. ArthroCare, et al).

On
August 7, 2008, a derivative action was filed in Federal court in the Southern District of Florida against us and our then-current directors alleging breach of
fiduciary duty based on our alleged improper revenue recognition, improper reporting of such revenue in SEC filings and press releases, failure to maintain adequate internal controls, and failure to
supervise management. On October 14, 2008, the court granted our motion to transfer this case to the U.S. District Court, Western District of Texas. (Weil v. Baker, et
al).

On
March 4, 2009, a derivative action was filed in Federal court in the Western District of Texas against our then current directors, a former director, certain of our current and
former executive officers and other employees and PricewaterhouseCoopers LLP alleging (i) disgorgement under Section 304 of the Sarbanes-Oxley Act; (ii) violations of
Section 10(b) of the Exchange Act and Rule 10b-5; (iii) breach of fiduciary duty; (iv) abuse of control; (v) gross mismanagement of the Company;
(vi) waste of corporate assets; (vii) insider trading; and (viii) unjust enrichment. (King v. Baker, et al).

On
April 29, 2009, a derivative action was filed in Federal court in the Western District of Texas against our then current directors and a former director alleging breach of
fiduciary duty based on improper revenue recognition, improper reporting of such revenue in SEC filings and press releases,

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failure
to maintain adequate internal controls, and failure to supervise management. (Barron v. Baker, et al).

On
October 28, 2008, and thereafter, the two putative securities class actions and the shareholder derivative actions were consolidated and designated:In
Re ArthroCare Corporation Securities Litigation, Case No. 1:08-cv-00574-SS (consolidated) in the U.S. District Court, Western
District of Texas. On December 10, 2008, Lead Plaintiffs and Lead Plaintiffs' counsel were appointed in the putative consolidated securities class action. The Lead Plaintiff filed an Amended
Consolidated Class Action Complaint on December 18, 2009, seeking unspecified monetary damages and interest. ArthroCare filed a Motion to Dismiss the Amended Consolidated Class Action Complaint
on February 16, 2010. On July 20, 2010, the federal court issued a ruling granting in part and denying in part ArthroCare's Motion to Dismiss, permitting certain claims related to
statements after December 11, 2007 to continue.



On September 23, 2008, a derivative action was filed in Texas State District Court against us, and our then current directors
and certain of our current and former officers. (Wieser v. Baker). In this action, one of our shareholders alleged derivative claims on behalf of us,
that our directors and officers breached their fiduciary duties to shareholders by allowing improper financial reporting, failing to maintain adequate financial controls over revenue recognition,
disseminating false financial statements, abuse of control, gross mismanagement, waste of corporate assets, and engaging in insider trading.

On
October 20, 2008, a derivative action was filed in Texas State District Court against us, our then directors and certain of our current and former executive officers.
(Bocklet v. Baker). In this action, one of the Company's shareholders alleged derivative claims on behalf of us, that our directors and officers
breached their fiduciary duties to shareholders by failing to maintain adequate financial controls over revenue recognition, allowing improper financial reporting, disseminating false financial
statements, and engaging in insider trading.

On
October 27, 2008, a derivative action was filed in Texas State District Court against us, our then directors and certain of our current and former executive officers.
(Guthrie v. Baker). In this action, one of our shareholders alleged derivative claims on behalf of us that our directors and officers breached their
fiduciary duties to shareholders by failing to maintain adequate financial controls over revenue recognition, allowing improper financial reporting, disseminating false financial statements, and
engaging in insider trading.

On
March 18, 2009, these three shareholder derivative actions were consolidated and designated:In Re ArthroCare Corporation Derivative
Litigation, Case No. D-1-GN-08-3484 (consolidated), Travis County District Court. The consolidated action seeks financial
compensation, certain governance changes and removal of certain directors. On our motion, the state shareholder derivative actions were stayed pending resolution of all motions to dismiss the federal
Amended Consolidated Class Action Complaint and class certification, if any, of a class in the federal Amended Consolidated Class Action Complaint.



On October 18, 2010, we, our directors' and officers' insurance carriers, and the plaintiffs in the Federal Court and State
Court derivative actions agreed in principal to a settlement. Under the terms of the proposed settlement, the director and officer insurers will collectively pay $8 million to us, on behalf of
the individuals named as defendants in the Federal Court and State Court derivative actions, to settle the State and Federal Derivative actions. The lawyers for the plaintiffs will be entitled to seek
an award of legal fees and costs from the Federal Court in an amount not to exceed $2.25 million. The agreement also provides that the directors' and officers' insurers will pay us an
additional $2.0 million

31

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Table of Contents

for
a broad mutual release by us and the insurers of any further rights or obligations under the directors' and officers' liability insurance policies. The settlement calls for certain mutually
acceptable governance changes and is subject to approval of the former officers and directors who are parties to the derivative actions, an agreement by those former officers and directors to release
our directors' and officers' liability insurance carriers of any further rights or obligations under the applicable directors' and officers' liability insurance policies, the execution of a full and
final settlement agreement, and the approval of the settlement of the derivative actions by the U.S. District Court, Western District of Texas. Upon approval of this settlement agreement, we will
incur any further litigation cost or damages allegedly resulting from or based on the restatement or related events, including the ongoing DOJ investigation, the consolidated securities Class Action
case described in Note 11, "Litigation and Contingencies" and any ongoing indemnity obligations without the benefit of further insurance coverage.

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

On January 19, 2010, Nasdaq accepted our application for listing on the Nasdaq Global Select Market and our shares began trading
on the Nasdaq Global Select Market on January 22, 2010, under the symbol "ARTC". From January 16, 2009 until January 22, 2010 our securities were traded on an electronic quotation
service maintained by Pink OTC Markets, Inc., or Pink Sheets, under the symbol "ARTC.PK". Prior to January 16, 2009 our common stock was publicly traded on The Nasdaq Stock
Market LLC, or Nasdaq, under the symbol "ARTC." The following table sets forth, for the periods indicated, the quarterly high and low closing sales prices of our Common stock.

December 31, 2010Quarter 1

Quarter 2

Quarter 3

Quarter 4High

$
30.92

$
32.18

$
29.94

$
31.77Low


23.30


26.31


25.21


26.79




December 31, 2009Quarter 1

Quarter 2

Quarter 3

Quarter 4High

$
8.42

$
11.50

$
20.55

$
23.70Low


2.95


4.90


10.99


18.00


As
of February 3, 2011, there were 27,228,270 shares of our common stock outstanding, and the closing price of our common stock was $28.83 per share.

As
of December 31, 2010, there were 75,000 outstanding shares of preferred stock and 198 holders of record of 27,104,984 shares of outstanding common stock. We have not paid any
cash dividends since our inception and do not anticipate paying cash dividends on our common stock or preferred stock in the foreseeable future.

On
September 1, 2009, we sold 75,000 shares of Series A Preferred Stock to OEP AC Holdings LLC, an affiliate of OEP, for gross proceeds of $75.0 million. The
sale of the Series A Preferred Stock was to an accredited investor and is exempt from registration under Rule 506 Regulation D of the Securities Act of 1933.

The
holders of the Series A Preferred Stock may convert their shares at any time, in whole or in part, at a rate of 66.667 shares of the Company's Common Stock per $1,000 of
Liquidation Preference of the Series A Preferred Stock, subject to customary anti-dilution adjustments (the "Conversion Rate"), representing an initial conversion price of $15.00
per share of Common Stock. If a conversion occurs prior to the expiration of the Dividend Duration Period, the number of shares of Common

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Table of Contents

Stock
received shall be increased for a make-whole adjustment equal to the number of additional shares of Series A Preferred Stock the holder would have otherwise been paid during
the Dividend Duration Period, multiplied by the Conversion Rate (the "Make-Whole Adjustment").

The
Company may, at any time, cause an automatic conversion of all outstanding shares of Series A Preferred Stock upon no less than 10 days prior notice if the closing
sales price of the Common Stock equals or exceeds $35.00 per share (subject to adjustment in the event of a stock split, stock dividend, combination or other similar recapitalization) for the prior 20
consecutive trading days, the Company is current on its reporting requirements with the SEC, the Company has an effective resale registration statement and related prospectus that permits the Common
Stock issued upon such automatic conversion to be immediately resold thereunder, and the current investigation of the Company by the DOJ has been terminated, settled or finally adjudicated.

No
conversion of Series A Preferred Stock will be permitted to the extent that any holder of Series A Preferred Stock would individually hold in excess of
19.99 percent of the Company's voting power after the proposed conversion, or to the extent that the holders of Series A Preferred Stock would hold in excess of 17.8 percent of
the Company's voting power in the aggregate, in each case solely attributable to their holdings of Series A Preferred Stock and any Common Stock received upon conversion thereof (such
limitations collectively, the "Conversion Cap"). Shares of Series A Preferred Stock not convertible as a result of the Conversion Cap shall remain outstanding and shall become convertible to
the extent the Conversion Cap no longer applies.

We
describe our equity compensation plans in our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of
stockholders scheduled to be held May 12, 2011, which is hereby incorporated herein by reference.

33

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Table of Contents

PERFORMANCE GRAPH

This performance graph shall not be deemed "filed" for purposes of Section 18 of the Exchange Act, or
incorporated by reference into any filing of ArthroCare under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such
filing.

The
following graph shows a comparison of total stockholder return for holders of our common stock for the five years ended December 31, 2010 compared with the Nasdaq Stock
Exchange, U.S. Index and the Nasdaq Health Services Index. This graph is presented pursuant to SEC rules. The information below is based on $100 invested on December 31, 2005, including
reinvestment of dividends with fiscal years ending December 31. The stock prices of medical device companies like ours are subject to a number of factors, such as those discussed in
"Part IItem 1ARisk Factors," above.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*Among ArthroCare Corporation, the NASDAQ Composite Index  and the NASDAQ Health Services Index

GRAPHIC



Cumulative Total Return12/2005

12/2006

12/2007

12/2008

12/2009

12/2010ArthroCare Corporation


100.00


94.73


114.02


11.32


56.24


73.71NASDAQ Composite


100.00


111.74


124.67


73.77


107.12


125.93NASDAQ Health Services


100.00


109.80


117.78


87.97


99.96


100.19


34

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Table of Contents

ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA

The following selected financial data (in thousands, except per share data) should be read in conjunction with
"Part IIItem 7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, 2010, 2009 and 2008 and the balance sheet data as of
December 31, 2010 and 2009 have been derived from audited consolidated financial statements included elsewhere 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,(1)2010

2009

2008

2007

2006Statements of Operations Data:Product sales(2)

$
338,757

$
308,493

$
295,118

$
261,632

$
226,026Royalties, fees and other


16,622


15,624


12,165


11,099


10,015Total revenues


355,379


324,117


307,283


272,731


236,041Gross profit


244,628


233,177


214,638


188,234


168,055Operating expenses(3)


190,358


233,124


238,509


192,957


134,115Net income (loss) from continuing operations


37,518


(5,296
)

(24,582
)

455


19,342Net income (loss)


37,084


(5,777
)

(35,025
)

491


27,673Net income (loss) applicable to common stockholders(4)


33,820


(33,822
)

(35,025
)

491


27,673Net earnings (loss) per share from continuing operations applicable to common stockholdersBasic

$
1.04

$
(1.24
)
$
(0.92
)
$
0.02

$
0.74Diluted

$
1.03

$
(1.24
)
$
(0.92
)
$
0.02

$
0.69Net earnings (loss) per share applicable to common stockholdersBasic

$
1.03

$
(1.26
)
$
(1.32
)
$
0.02

$
1.06Diluted

$
1.02

$
(1.26
)
$
(1.32
)
$
0.02

$
0.99




December 31,2010

2009

2008

2007

2006Balance Sheet Data:Cash, cash equivalents, restricted cash equivalents and investments

$
132,536

$
57,386

$
37,980

$
43,176

$
30,756Working capital


191,939


106,267


43,406


121,991


97,395Total assets


439,195


391,128


389,485


397,947


365,791Long-term liabilities


13,979


5,147


10,058


66,919


4,196Series A 3% Redeemable Convertible Preferred Stock(5)


73,768


70,504








Total stockholders' equity


295,728


250,395


246,491


281,053


309,923


---

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Table of Contents

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 report. Readers should also review carefully "Part IItem 1ARisk Factors" and
Exhibit 99.1"Forward-Looking Statements," which provides information about the forward-looking statements in this report and a
discussion of the factors that might cause our actual results to differ, perhaps materially, from these forward-looking statements.

Overview

We are a medical device company that develops, manufactures and markets surgical products, many of which are based on our minimally
invasive patented Coblation technology. Our products are used across several medical specialties, improving many existing soft-tissue surgical procedures and enabling new minimally
invasive surgical procedures. Our business is divided into two core product areas: Sports Medicine and ENT. We also manufacture and sell products based on our technology for other procedures, such as
certain spine procedures. Each of the Sports Medicine, ENT and Other product areas market and sell their products in two principal geographic markets: Americas (North and South America) and
International (all other geographies).

As
previously reported, in 2009 and 2008, we experienced substantial delays in filing our periodic reports as a result of issues identified during the Review, which was completed in
August 2009, and the restatement of prior financial statements, which was completed in November 2009 with the filing of our delinquent periodic reports. During the year ended December 31, 2009,
our results of operations, financial position and cash flows were adversely affected by the effect that the Review and the restatement had on our management and employees and the significant costs of
the Review and restatement.

First Quarter 2010 Accounting Corrections

Our results for the year ended December 31, 2010 include reductions of stock compensation expense to correct forfeiture
calculation errors in prior periods. The impact of the error was an overstatement of operating expenses of $0.7 million in the year ended December 31, 2009 and $0.4 million in the
year ended December 31, 2008. To correct this error, we recorded reductions of $0.8 million to general and administrative expense and $0.3 million to sales and marketing expense
in the quarter ended March 31, 2010. We have determined that the impact of this uncorrected error is immaterial to all prior periods and the year ended December 31, 2010.

Key Financial Items, Trends and Uncertainties Affecting Our Business

Our management reviews and analyzes several metrics and ratios in order to manage our business and assess the quality of and potential
variability of our operating performance. The most important of these financial metrics and ratios include:

Product Sales Growth

Our principal source of revenue is from sales of our products, which primarily include disposable surgical devices and implants.
Product sales growth in 2010, 2009, and 2008 was 9.8 percent, 4.5 percent and 12.8 percent, respectively. We also contract manufacture disposable surgical devices for use in
Sports Medicine procedures for another medical devices company which is included in product sales. During the year ended December 31, 2010, product sales from contract manufacturing was

36

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Table of Contents

$25.6 million
compared to $12.4 million in 2009. Contract manufactured products sold in 2010 may not be indicative of contract manufactured products in the future. Product sales growth
in 2010, 2009, and 2008 related to our proprietary products which are sold through our direct sales employees, independent sales agents and independent distributors was 5.1 percent,
2.8 percent and 13.1 percent, respectively.

We
anticipate that our proprietary disposable device sales and implants will remain the key component of our product sales for the foreseeable future. We also generate revenue from
royalties and fees from licensing of our products and technology to other companies and earn other revenues from shipping and handling costs billed to customers.

Gross Product Margin

Gross product margin as a percentage of product sales in 2010, 2009, and 2008 was 67.3 percent, 70.5 percent and
68.6 percent, respectively. Cost of product sales consists of all product manufacturing costs (including material costs, labor costs, manufacturing overhead, warranty and other direct product
costs), adjustments to the carrying value of inventory for excess or obsolete items, certain stock based compensation costs associated with manufacturing and operations personnel and costs of product
shipped to our customers. Cost of product sales also includes the amortization of controller units that have been placed at customer locations to enable the use of our disposable surgical products. We
maintain ownership of all placed controllers and the cost of controller units are capitalized and amortized into cost of product sales over the estimated useful life of the controller unit. Most of
our manufactured products are produced at our Costa Rica facility which has experienced stable operations. Raw materials used to produce our products are generally not subject to substantial commodity
price volatility.

The
comparability of gross product margin between periods will be impacted by several items, including the mix between proprietary and contract manufactured product sales; the stability
of our average sales price on proprietary products; changes in the estimated amount of research and engineering activities related to manufacturing process design or improvement; and, changes in our
product emphasis which could result in obsolescence charges being included in the cost of product sales in a particular period.

Operating Margin

Operating margin is our income (loss) from operations as a percentage of total revenues. Our key operating expenses include expenses
incurred in connection with research and development, sales and marketing, general and administrative and amortization of intangible assets. During 2009 and 2008 our operating expenses were
significantly impacted by the substantial expense incurred in connection with the Review and the restatement of our financial statements and goodwill impairment. Operating margin in 2010, 2009, and
2008 was positive 15.3 percent, 0.0 percent, and negative 7.8 percent, respectively.

We
expect to continue to spend approximately $9 to $10 million each quarter in 2011 in research, engineering, new product development, regulatory affairs, and clinical studies. We
anticipate that sales
and marketing spending could temporarily increase as a percentage of total revenue if we undertake initiatives to expand our direct sales and distribution capabilities. Over the long-term,
we expect sales and marketing expense as a percentage of total revenue to remain approximately the same as our current experience.

Net Earnings

Net earnings represent the net income or loss in the period. Net earnings will be affected by the same trends that impact our revenues,
gross product margin and operating margin. In addition, net earnings will also be affected by other income and expenses, such as interest expense, foreign currency

37

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Table of Contents

gains
and losses and income taxes. Interest expense and bank fees were lower in the year ended December 31, 2010 as we repaid all outstanding bank borrowings on September 1, 2009 and we
anticipate this trend to continue until we enter into credit facilities in the future. We expect that we will report foreign currency gains or losses each period due primarily to changes in the value
of the euro, British pound and Australian dollar versus the U.S. dollar.

Our
effective income tax rate is less than the U.S. statutory rate as many of the jurisdictions in which we operate have lower corporate statutory tax rates, including Costa Rica, where
we have a tax holiday that extends through December 2015. In years of loss, our effective tax rate may exceed the U.S. statutory rate depending on the apportionment of income or loss between
jurisdictions in which we operate. We expect to be able to fully utilize our deferred tax assets.

38

---



Table of Contents

Results of Operations

Overview of our Results of Operations

Results of operations for the three years ending December 31, 2010, 2009 and 2008 (in thousands, except percentages and
per-share data) were as follows:

Year Ended December 31,(1)2010

2009

2008Dollars

% Total
Revenue

Dollars

% Total
Revenue

Dollars

% Total
RevenueRevenues:Product sales

$
338,757


95.3
%
$
308,493


95.2
%
$
295,118


96.0
%Royalties, fees and other


16,622


4.7
%

15,624


4.8
%

12,165


4.0
%Total revenues


355,379


100.0
%

324,117


100.0
%

307,283


100.0
%Cost of product sales


110,751


31.2
%

90,940


28.1
%

92,645


30.1
%Gross profit


244,628


68.8
%

233,177


71.9
%

214,638


69.9
%Operating expenses:Research and development


35,846


10.1
%

35,203


10.9
%

31,930


10.4
%Sales and marketing


107,852


30.3
%

114,539


35.4
%

125,502


40.9
%General and administrative


38,491


10.8
%

46,034


14.2
%

50,359


16.4
%Amortization of intangible assets


5,237


1.5
%

5,309


1.6
%

5,479


1.8
%Reimbursement services


92


0.0
%

353


0.1
%

1,966


0.6
%Impairment of goodwill





0.0
%




0.0
%

6,252


2.0
%Investigation and restatementrelated costs


2,840


0.9
%

31,686


9.7
%

17,021


5.5
%Total operating expenses


190,358


53.6
%

233,124


71.9
%

238,509


77.6
%Income (loss) from operations


54,270


15.3
%

53


0.0
%

(23,871
)

(7.8
)%Interest and other expense, net


(3,864
)




(2,212
)




(8,886
)Income (loss) from continuing operations before income taxes


50,406





(2,159
)




(32,757
)Income tax provision (benefit)


12,888





3,137





(8,175
)Net income (loss) from continuing operations


37,518





(5,296
)




(24,582
)Loss from discontinued operations, net of taxes


(434
)




(481
)




(10,443
)Net income (loss)


37,084





(5,777
)




(35,025
)Accrued dividend, beneficial conversion feature and accretion charges on Series A 3% Convertible Preferred Stock


(3,264
)




(28,045
)




Net income (loss) applicable to common stockholders

$
33,820




$
(33,822
)



$
(35,025
)Weighted-average shares outstanding:Basic


27,006





26,803





26,610Diluted


27,348





26,803





26,610Earnings (loss) per share from continuing operations applicable to common stockholders:Basic

$
1.04




$
(1.24
)



$
(0.92
)Diluted

$
1.03




$
(1.24
)



$
(0.92
)Earnings (loss) per share applicable to common stockholders: stockholders:Basic

$
1.03




$
(1.26
)



$
(1.32
)Diluted

$
1.02




$
(1.26
)



$
(1.32
)


---

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---



Table of Contents

2010 Comparison with 2009

Product Sales

Product sales consist principally of sales of disposable surgical devices and implants. Product sales by each of our product groups and
geographic markets for the years ended December 31, 2010 and 2009 are as follows (in thousands, except percentages):

Year Ended December 31, 2010

Year Ended December 31, 2009Americas

International

Total Product
Sales

% Net
Product Sales

Americas

International

Total Product
Sales

% Net
Product SalesSports Medicine

$
160,859

$
71,120

$
231,979


68.5
%
$
147,169

$
62,533

$
209,702


67.9
%ENT


79,019


15,270


94,289


27.8
%

72,375


13,299


85,674


27.8
%Other


4,122


8,367


12,489


3.7
%

5,231


7,886


13,117


4.3
%Total Product Sales

$
244,000

$
94,757

$
338,757


100.0
%
$
224,775

$
83,718

$
308,493


100.0
%% Net Product Sales


72.0
%

28.0
%

100.0
%




72.9
%

27.1
%

100.0
%


Sports Medicine product sales increased 10.6 percent, or $22.3 million, in 2010 compared to 2009. Product sales in the Americas
increased by $13.7 million, due largely to a $13.2 million increase in contract manufacturing volume pursuant to an existing supply and distribution agreement with Smith & Nephew
and included $6.6 million for the recognition of product sales from prior periods that were deferred pending resolution of certain contract issues with customers which occurred during the first
quarter of 2010. Excluding the recognition of deferred revenue, proprietary product sales in the Americas decreased $6.1 million, or 4.2 percent, in 2010. Approximately half of this
decline we believe is attributable to lower sales volume due to an overall slowdown in the underlying Sports Medicine procedure utilization in the United States and half of the decline is related to
lower average sales prices. International product sales increased $8.6 million, due primarily to volume increases in our direct markets.

ENT
product sales increased 10.1 percent, or $8.6 million, in 2010 compared to 2009. Product sales increased in the Americas as a result of increased Coblation product
sales volumes, increased Rapid Rhino product sales volumes and higher average sales price. International product sales increased primarily due to higher sales to distributors, particularly in the Asia
Pacific region.

Other
product sales decreased $0.6 million, or 4.8 percent, in 2010 compared to 2009. In the Americas, PDD SpineWand sales continue to be negatively affected by the Centers
for Medicare & Medicaid Services, or CMS, negative reimbursement determination in September 2008. International product sales increased primarily as a result of increased sales volumes in our
direct international markets.

In
total, International product sales across all product groups increased $11.0 million or 13.2 percent during 2010 when compared to 2009. Product sales increased by
approximately $8.7 million in 2010 in our direct International markets, while sales to distributors increased by approximately $2.3 million. For the year ended December 31, 2010,
changes in foreign currency rates had a negligible effect on product sales when compared to 2009.

Royalties, Fees and Other Revenues

Royalties, fees, and other revenues consist mainly of revenue from the licensing of our products and technology along with shipping and
handling costs billed to customers. Such revenues increased $1.0 million in 2010 compared to 2009. The increase was primarily a result of increased royalties from third parties that use our
radio frequency, or RF, technology pursuant to a license.

40

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Table of Contents

Cost of Product Sales

Cost of product sales for the years ended December 31, 2010 and 2009 were as follows (in thousands, except percentages):

Year Ended December 31,2010

2009Dollars

% Net
Product
Sales

Dollars

% Net
Product
SalesProduct cost

$
91,931


27.1
%
$
74,046


24.0
%Controller amortization


10,019


3.0
%

9,108


3.0
%Other


8,801


2.6
%

7,786


2.5
%Total Cost of Product Sales

$
110,751


32.7
%
$
90,940


29.5
%


Gross
product margin as a percentage of product sales for 2010 was 67.3 percent in 2010 compared to 70.5 percent in 2009. Gross product margin was lower in 2010 due to
increased revenue from contract manufactured product which is sold at a lower average sales price, but for which we do not incur sales commission or marketing expense. Additionally, charges for excess
and obsolete inventory increased
$5.8 million in 2010 compared to 2009 as we chose to de-emphasize certain handhelds and instrumentation sets associated with our Sports Medicine Atlantech product line.

Operating Expenses

Operating expenses for the periods shown were as follows (in thousands, except percentages):

Year Ended December 31,2010

2009Dollars

% Total
Revenue

Dollars

% Total
RevenueResearch and development

$
35,846


10.1
%
$
35,203


10.9
%Sales and marketing


107,852


30.3
%

114,539


35.3
%General and administrative


38,491


10.8
%

46,034


14.2
%Amortization of intangible assets


5,237


1.5
%

5,309


1.6
%Reimbursement services


92


0.0
%

353


0.1
%Investigation and restatement-related costs


2,840


0.9
%

31,686


9.8
%Total operating expenses

$
190,358


53.6
%
$
233,124


71.9
%


Sales and marketing expensedecreased $6.7 million, to 30.3 percent of total revenues in 2010 compared to
35.3 percent of total revenues in 2009. Sales and marketing expense as a percentage of total revenues decreased as a result of deferred revenue that was recognized in the first quarter of 2010
and an increase in contract manufacturing product revenues, neither of which incurred selling expenses such as commissions. Sales and marketing expenses decreased in 2010 as well due to a result of
lower product demonstration costs and a decrease in bad debt allowance requirements due to improved cash collection of accounts receivable. Additionally, sales and marketing expense in the Americas
decreased in 2010 compared to 2009 as we restructured our distribution channel for our spine products from primarily a direct sales organization to a network of independent agents.

General and administrative expensedecreased $7.5 million, to 10.8 percent of total revenues in 2010 compared to
14.2 percent of total revenues in 2009. The decrease in expenses was primarily a result of a decrease in legal fees related to certain patent matters that were settled in December 2009,
partially offset by an increase in accounting and compliance personnel.

41

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Investigation and restatement expensewas $2.8 million in 2010 compared to $31.7 million in 2009.
The decrease is a result of completing the Review and restatement in November of 2009. We expect to continue to incur legal defense costs in connection with the DOJ and shareholder class action and
shareholder derivative matters arising from the Review and restatement and the defense costs will continue to be classified as investigation and restatement-related expense in future periods as
incurred.

Interest and Other Expense, Net

Interest and other expense for the periods shown were as follows (in thousands, except percentages):

Year Ended December 31,2010

2009Interest and other income, net

$
216

$
312Interest expense


(769
)

(3,757
)Foreign exchange gain (loss), net


(3,311
)

1,233Interest and other expense, net

$
(3,864
)
$
(2,212
)


Interest
expense decreased $3.0 million in 2010 from $3.8 million in 2009, primarily as a result of repaying outstanding borrowings under our credit agreement in September
2009. We expect that we will report foreign currency gains or losses each period due primarily to changes in the value of the euro, British pound and Australian dollar versus the U.S. dollar.

Discontinued Operations

In the fourth quarter of 2010, we determined that our non-Coblation spine products met the criteria under generally
accepted accounting principles to be reported as discontinued operations. Our non-Coblation spine products consist of our Parallax and Contour product lines. As a result of this
determination, reported product sales for the years ended December 31, 2010, 2009, and 2008 have been reduced by $5.9 million, $7.5 million, and $10.5 million, respectively
and the impact from these discontinued product lines on our current and previously reported net income (loss) in all periods is separately reported as "Loss from discontinued operations, net of taxes"
in our Consolidated Statements of Operations. Net assets of $3.1 million identifiable with these discontinued product lines is reported in our December 31, 2010 Consolidated Balance
Sheet as "Assets held for sale".

Income Tax Provision (Benefit)

Our effective tax rate in 2010 was 25.6 percent. Lower foreign tax rates reduced income tax expense in 2010 by
$6.6 million when compared to the U.S. corporate tax rate, and R&D credits reduced income tax expense by $1.3 million. In January 2009, the U.S. Treasury issued temporary
cost-sharing regulations and as a result, we decided to adjust our intercompany payments for all open tax years. As a result of these adjustments to our intercompany payments, we utilized
approximately $1.9 million of our reserves for uncertain tax positions and recorded additional income tax expense of approximately $3.6 million in 2009. Adjusted for the effect of this
change in regulations, our effective tax rate for 2009 was 21.5 percent.

Accrued Dividends, Beneficial Conversion Feature and Accretion Charges on Series A 3% Preferred Stock

Accrued dividends, beneficial conversion feature and accretion charges on Series A 3% Convertible Preferred Stock decreased to
$3.3 million in 2010 compared to $28.0 million in 2009. We accrued $3.3 million of dividends and accretion charges for the full year in 2010 compared to $1.0 million in
2009 for the period from September 1, 2009 (the date of issuance) to the end of the year. In 2009 we

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also
recognized a beneficial conversion feature of $27.0 million on the sale of the Series A Preferred Stock that was immediately charged against net loss applicable to common
stockholders.

2009 Comparison with 2008

Product Sales

Product sales consist principally of sales of disposable surgical devices and implants. Product sales by each of our product groups and
geographic markets for the years ended December 31, 2009 and 2008 are as follows (in thousands, except percentages):

Year Ended December 31, 2009

Year Ended December 31, 2008Americas

International

Total Product
Sales

% Net
Product Sales

Americas

International

Total Product
Sales

% Net
Product SalesSports Medicine

$
147,169

$
62,533

$
209,702


67.9
%
$
142,856

$
56,676

$
199,532


67.6
%ENT


72,375


13,299


85,674


27.8
%

68,412


12,072


80,484


27.3
%Other


5,231


7,886


13,117


4.3
%

5,772


9,330


15,102


5.1
%Total Product Sales

$
224,775

$
83,718

$
308,493


100.0
%
$
217,040

$
78,078

$
295,118


100.0
%% Net Product Sales


72.9
%

27.1
%

100.0
%




73.5
%

26.5
%

100.0
%


Sports Medicine product sales increased 5.1 percent primarily as a result of International market sales growth of 10.3 percent and
higher contract manufacturing volume. Sports Medicine product sales increased 3.0 percent in the Americas market. Approximately half of the increase was from higher contract manufacturing
volume pursuant to a supply and distribution agreement with Smith & Nephew. In the U.S., which is the largest component of our Americas market, Sports Medicine product sales were also
influenced by slowed procedure volume growth in the first half of 2009 caused by weaker general economic conditions.

ENT
product sales increased by 6.4 percent as a result of higher Coblation sales both in the Americas and International markets. The increase in Coblation sales is attributed to
greater market share in tonsillectomy and adenoidectomy procedures.

Other
product sales decreased $2.0 million in 2009 compared to 2008. In the Americas, PDD SpineWand sales were negatively affected by a Centers for Medicare & Medicaid
Services, or CMS, negative reimbursement determination in September 2008 as well as management's decision in the fourth quarter of 2008 to cease our reimbursement assistance service activities which
had previously been a significant distribution focus for Spine in the Americas. International Spine sales were negatively affected by reduced private insurance reimbursement and weaker general
economic conditions in Europe.

Across
all product areas, the U.S. dollar reported value of International product sales increased 7.2 percent in 2009. The translation effect of changes in foreign currency rates
reduced the 2009 U.S. dollar reported value of local currency product sales by $5.4 million. In 2009, product sales increased in existing direct International markets, we expanded our direct
market presence in certain European countries including Switzerland and Scandinavian countries, and product sales increased to distributors in the Asia Pacific region.

Royalties, Fees and Other Revenues

Royalties, fees, and other revenues consist mainly of revenue from the licensing of our products and technology, plus shipping and
handling costs billed to customers. Royalties, fees, and other

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revenues
increased to $15.6 million in 2009 compared to $12.2 million in 2008. 2009 includes a lump sum royalty settlement received in the fourth quarter of $2.5 million. Adjusted
for this lump sum settlement, royalties, fees, and other revenues increased 7.4 percent primarily as a result of increased sales by third parties of products that use our RF technology pursuant
to a license.

Cost of Product Sales

Cost of product sales for the periods shown were as follows (in thousands, except percentages):

Year Ended December 31,2009

2008Dollars

% Net
Product
Sales

Dollars

% Net
Product
SalesProduct cost

$
74,046


24.0
%
$
76,183


25.8
%Controller amortization


9,108


3.0
%

8,856


3.0
%Other


7,786


2.5
%

7,606


2.6
%Total Cost of Product Sales

$
90,940


29.5
%
$
92,645


31.4
%


Product
margin as a percentage of net product sales increased to 70.5 percent in 2009 from 68.6 percent in 2008. The increase in 2009 product margin is a result of higher
excess and obsolescence reserves recorded in 2008 that reduced the carrying value of inventory in 2008, partially offset by higher royalties costs incurred in 2009 due to the arbitration matter
involving Gyrus and Ethicon.

Operating Expenses

Operating expenses for the periods shown were as follows (in thousands, except percentages):

Year Ended December 31,2009

2008Dollars

% Total
Revenue

Dollars

% Total
RevenueResearch and development

$
35,203


10.9
%
$
31,930


10.4
%Sales and marketing


114,539


35.3
%

125,502


40.9
%General and administrative


46,034


14.2
%

50,359


16.4
%Amortization of intangible assets


5,309


1.6
%

5,479


1.8
%Reimbursement services


353


0.1
%

1,966


0.6
%Impairment of goodwill





0.0
%

6,252


2.0
%Investigation and restatement-related costs


31,686


9.8
%

17,021


5.5
%Total operating expenses

$
233,124


71.9
%
$
238,509


77.6
%


Research and development expenseincreased $3.3 million to 10.9 percent of total revenues in 2009 from 10.4 percent
in 2008. The increase in research and development expenses in 2009 compared to 2008 is primarily attributable to an increase in personnel cost as a result of incentive compensation in 2009 and
increased headcount in quality control personnel.

Sales and marketing expensedecreased $11.0 million, to 35.3 percent of total revenues in 2009 compared to
40.9 percent of total revenues in 2008 primarily as a result of sales and marketing cost reduction efforts in the Americas. ENT sales and marketing expenses for the Americas were reduced by
approximately 20 percent in 2009 as a result of terminating various marketing initiatives from 2008. Other product area sales and marketing expenses were reduced by approximately
one-third as we restructured the Spine distribution channel from a fixed cost direct sales force to an independent agent structure.

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General and administrative expensedecreased $4.3 million in 2009 and was 14.2 percent of total revenues compared to
16.4 percent of total revenues in 2008. In 2008, we accrued $15.1 million for the arbitration panel's award decision announced in June 2009 in the arbitration matter involving Gyrus and
Ethicon originally brought against us in May 2008. We also incurred legal costs in 2008 associated with our strategic options process that was terminated in July 2008 and support costs related to our
March 2008 NASDAQ hearing. These additional costs in 2008 were partially offset by $8.3 million of increased legal defense costs related to the arbitration matter involving Gyrus and Ethicon
and the Delaware
proceedings against Gyrus and increased accounting and compliance personnel in response to internal control remediation needs in 2009.

Reimbursement servicesexpense declined in 2009 as we continued the orderly wind-down of our reimbursement assistance services
subsidiaries during 2009.

Investigation and restatementexpenses are costs incurred in 2009 and 2008 as a result of the Review and associated restatement of
previously reported financial statements contained in our 2008 Form 10-K. These expenses include legal fees, forensic accounting fees and incremental audit fees.

Interest and Other Expense, Net

Interest and other expense for the periods shown were as follows (in thousands, except percentages):

Year Ended December 31,2009

2008Interest and other income, net

$
312

$
563Interest expense


(3,757
)

(3,792
)Foreign exchange gain (loss), net


1,233


(5,657
)Interest and other expense, net

$
(2,212
)
$
(8,886
)


The
$6.7 million decrease in net interest and other expense in 2009 is primarily attributable to the U.S. dollar weakening against the material foreign currencies in which we
operate, partially offset by a decrease in interest earned on investments as a result of declining investment balances.

Income Tax Provision (Benefit)

In January 2009, the U.S. Treasury Department issued temporary cost-sharing regulations and as a result, we decided to
adjust our intercompany payments for all open tax years. As a result of these adjustments to our intercompany payments, we utilized approximately $1.9 million of our reserves for uncertain tax
positions and recorded additional income tax expense of approximately $3.6 million in 2009. Adjusted for the effect of this change in regulations, our effective tax rate for 2009 was
21.5 percent. Our effective tax rate in 2008 was 25.0 percent.

Accrued Dividends, Beneficial Conversion Feature and Accretion Charges on Series A 3% Preferred Stock

We recognized a beneficial conversion feature of $27.0 million on the sale of the Series A Preferred Stock that was
immediately charged against net loss applicable to common stockholders. We also accrued $1.0 million for additional dividend and accretion charges on the Series A Preferred Stock in
2009. For additional information relating to our Series A Preferred Stock, see Note 12, "Mezzanine Equity" in the notes to the consolidated financial statements.

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Liquidity and Capital Resources

Historically, our liquidity needs have been to finance the costs of operations, to acquire complementary businesses or assets and to
make repurchases of our common stock. Our operating cash flow has historically been affected by the overall profitability of the sales of our products, our ability to invoice and collect from
customers in a timely manner, and our ability to efficiently implement our acquisition strategy and manage costs. We expect that our cash flows from operations together with cash on hand will be
sufficient to satisfy our short-term requirements and, excluding the uncertainty related to the ongoing litigation and investigations to which we are a party, long-term normal
operating liquidity requirements. As a result of repaying and terminating our Credit Agreement on September 1, 2009, we do not currently have access to a credit facility as a possible source of
liquidity.

Cash Flows and Working Capital for the Year Ended December 31, 2010 compared to the year ended December 31, 2009

As of December 31, 2010, we had $191.9 million in working capital compared to $106.3 million at
December 31, 2009. The change in working capital is primarily a result of cash received from operating activities.

Cash
provided by operating activities in 2010 was $82.6 million, compared to $19.5 million in 2009, and differed from our net income of $37.1 million as a result of
non-cash expenses such as depreciation and amortization expense of $24.1 million, deferred taxes of $2.9 million, stock-based compensation of $8.0 million, changes in
inventory and warranty reserves of $8.1 million, and changes in operating assets and liabilities of $1.2 million. Cash provided by operating activities included cash provided by
discontinued operations of $0.5 million and $0.7 million for the years ended December 31, 2010 and 2009, respectively.

Cash
used in investing activities was $12.2 million in 2010 consisting primarily of property and equipment additions. Cash used in investing activities was $12.4 million in
2009 and consisted primarily of property and equipment purchases offset by the removal of cash restrictions due to the termination of the Credit Agreement.

Cash
provided by financing activities was $3.6 million in 2010 and consisted primarily of proceeds from the exercise of stock options and tax benefit resulting from the exercise
of employee stock options. Cash provided by financing activities was $15.9 million in 2009 as we sold our Series A Preferred Stock for an aggregate purchase price of $75.0 million
less direct issuance cost of $5.6 million and we repaid our outstanding principal balance under our Credit Agreement of $55.0 million.

Cash Flows and Working Capital for the Year Ended December 31, 2009 compared to the year ended December 31, 2008

As of December 31, 2009, we had $106.3 million in working capital compared to $43.4 million at December 31,
2008. At December 31, 2008 we had $55 million of borrowings outstanding under our Credit Agreement that was classified as short-term debt and which reduced our working
capital. The change in working capital is primarily a result of the sale of our Series A Preferred Stock for $75.0 million as discussed above which was used to repay the outstanding
borrowings under our Credit Agreement. As of December 31, 2009, our principal sources of liquidity consisted of $57.4 million in cash and cash equivalents.

Cash
provided by operating activities in 2009 was $19.5 million, compared to $32.0 million in 2008, and differed from our net loss of $5.8 million as a result of
non-cash expenses such as depreciation and amortization expense of $23.9 million and stock-based compensation of $6.6 million. Accrued liabilities were reduced by
$17.4 million, primarily as a result of final settlement and payment of the Gyrus arbitration matter. Cash provided by operating activities included cash provided by discontinued

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operations
of $0.7 million and $3.3 million for the years ended December 31, 2009 and 2008, respectively.

Cash
used in investing activities was $12.4 million in 2009 consisting primarily of property and equipment additions offset by the removal of cash restrictions due to the
termination of the Credit Agreement. Cash used in investing activities was $24.7 million in 2008 consisting primarily of property and equipment additions.

Cash
provided by financing activities was $15.9 million in 2009 as we sold our Series A Preferred Stock for an aggregate purchase price of $75.0 million less direct
issuance cost of $5.6 million and we repaid our outstanding principal balance under our Credit Agreement of $55.0 million. Cash used in financing activities was $11.5 million in
2008 as we made common stock repurchases of $11.8 million.

Contractual Obligations and Commercial Commitments

The following table aggregates all material contractual obligations and commercial commitments that affected our financial condition
and liquidity as of December 31, 2010 (in thousands):

Payments Due by Period
(in thousands)Total(1)

Less than
1 Year

1-3
Years

3-5
Years

More than
5 YearsOperating lease obligations

$
13,125

$
3,297

$
5,327

$
2,980

$
1,521Educational grants(2)


150


50


100





Purchase commitments with suppliers(3)


9,769


7,111


2,658





Total

$
23,044

$
10,458

$
8,085

$
2,980

$
1,521


---

The
Company has not included liabilities for uncertain tax positions in the above table of contractual obligations and commercial commitments because the Company is unable to estimate
the anticipated timing of payment.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the
U.S., or GAAP, requires our management to make judgments, assumptions and estimates that affect the amounts of revenue, expenses, income, assets and liabilities, reported in our consolidated financial
statements and accompanying notes. Understanding our accounting policies and the extent to which our management uses judgment, assumptions and estimates in applying these policies is integral to
understanding our financial statements. We describe our most significant accounting policies in Note 3, "Summary of Significant Accounting Policies" in the notes to the consolidated financial
statements. We have identified the following accounting policies as those that require significant judgments, assumptions and estimates and that have a significant impact on our

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financial
condition and results of operations. These policies are considered critical because they may result in fluctuations in our reported results from period to period due to the significant
judgments, estimates and assumptions about highly complex and inherently uncertain matters and because the use of different judgments, assumptions or estimates could have a material impact on our
financial condition or results of operations. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as appropriate based on changing
conditions.



Our principal sources of revenue are from sales of our products through our direct sales professionals, independent sales agents and
independent distributors. We recognize these revenues when there is persuasive evidence of an arrangement providing for the sale of a product, delivery of the product has occurred, the sale price of
the product is fixed or determinable and collectability is reasonably assured.

For
product sales made by our direct sales professionals or independent agents, our criteria for revenue recognition is complete when our product is delivered to end customers, such as
surgical centers and hospitals. These sales occur either through a purchase order submitted by the customer or through trunk sales. For purchase orders, we ship product to and invoice the end customer
directly. For trunk sales, product is hand-delivered at the end customer's premises from trunk stock maintained by the direct sales representative or independent agent and a
bill-only order is received notifying us of the product's delivery at which time we invoice the end customer.

Sales
to distributors occur either as stocking and replenishment orders or as drop shipments to end customers. In the majority of cases involving sales to distributors, our requirements
for revenue recognition are met when we deliver product to a particular distributor. In the case of certain distributors, prior to March 2010, we had agreed to pricing reductions based on the
distributors' ultimate reselling price and in those cases we recognized revenue on a "sell-through" basis only after the distributor had sold our products to an end user. In order to
determine the amount of sell-through revenue that should be recognized during a given reporting period, we relied on reports from the distributors that provided us with information about
sales to end customers during the reporting period as well as the amount and types of our products in the distributor's inventory at the end of a reporting period. Our management was required to
exercise a significant level of judgment to determine the accuracy and reliability of the reported information. We used a first-in-first-out accounting method to
account for products sold by these distributors where we applied the sell-through method.

Our
customers generally have the right to return or exchange products purchased from us for up to 60 days from the date of product shipment. At each period end, we determine the
extent to which our revenues need to be reduced to account for returns and exchanges and we record a reserve against revenue recognized during that period for product returns and exchanges that our
management estimates are likely to occur after the end of that period. We base these estimates on our historical experience with our customers and on direct customer feedback. We had an agreement with
one customer that provided for an extended right of exchange. Our management concluded that the duration of the exchange agreement with this customer was inconsistent with our revenue recognition
criteria and as a result revenue related to product sales to this customer was deferred until the related right of exchange period expired during the first quarter of 2010. This customer no longer has
this extended right of return.

Our
revenue recognition is also impacted by management's estimate of our customers' ability to pay us pursuant to the terms of our customer agreements. If after we have recognized
revenue, collectability of an account receivable becomes doubtful, we will establish an allowance for doubtful accounts with respect to the previously recognized revenue that remains uncollected.
Where our

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management
forms a judgment that a particular customer has not established a sufficient credit history but decides to deliver products to the customer, we will defer recognizing revenues on
product sales to that customer until collectability is reasonably assured, which typically coincides with the collection of cash. Once the customer establishes a reliable payment history we generally
return to normal revenue recognition based on our criteria. We regularly review the creditworthiness of our customers considering such factors as historical collection experience, a customer's current
credit standing, the age of accounts receivable balances, and general economic conditions that may affect a customer's ability to pay (both individually and in the aggregate).

Prior
to ceasing activities in our DiscoCare and DRS subsidiaries in early 2009, products were billed to and cash collected from third-party payors for which we have determined that we
are unable to conclude as to whether the exchange represented persuasive evidence of an arrangement providing for
the sale of product or whether amounts billed, including those collected, would be subject to future disputes with the payor due to insurance reimbursement practices. Accordingly, product sales
revenues have been reversed until the Company is able to conclude on the above, including revenue for product sales where the Company has collected cash. Cash received from third-party payors related
to DiscoCare and DRS has been recorded on the consolidated balance sheet as an accrued liability pending the resolution of any possible dispute. With the cessation of the DiscoCare and DRS businesses,
we are no longer engaged in product sales activities where we bill third-party payors.

Although
the terms of our agreements with many of our customers provide that risk of loss passes to the customer upon shipment, we have historically accepted the risk of loss until
product delivery. Accordingly, we only recognize revenues on a product sale if, in management's judgment, it has been delivered during the relevant reporting period. The application of this policy
requires our management to make estimates as to the timing of deliveries. We base these estimates on our historical experience with product shipments to particular markets that we serve. We regularly
compare these estimates to actual results based on delivery confirmations to determine whether a change of estimate is required.

We
generally recognize license fees and other revenue over the term of the associated agreement. Royalties represent the largest component of non-product sales revenue and
are recognized as earned, based on our estimates using current and historical trends adjusted for market factors, and are classified as royalties, fees and other revenues in the accompanying
statements of operations.

When
we make payments to our customers, we recognize those payments as a reduction of revenue unless we can determine that we received products or services that have a fair value equal
to the amount of the payment to the customer. In order to determine the fair value of the products or services received and whether alternative sources of supply exist, management is required to use
judgment and make estimates to determine the amount that should be classified as a reduction of revenue and the amount to be classified as an expense.



We value our inventory based on cost. We adjust the value of our inventory to the extent our management determines that our cost cannot
be recovered due to obsolescence or other factors. In order to make these determinations, our management uses estimates of future demand and sales prices for each product to determine appropriate
inventory reserves and to make corresponding reductions in inventory values to reflect the lower of cost or market value. In the event of a sudden significant decrease in demand for our products, or a
higher incidence of inventory obsolescence, we could be required to increase our inventory reserve, which would increase our cost of product sales and decrease our gross profit.

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Our goodwill balance is not amortized to expense; instead it is tested for impairment at least annually. During 2010, we changed our
annual goodwill impairment test date from December 31 to October 31, which represents a change in accounting principle. Management concluded that this change was preferable as it
facilitates the timely reporting of our financial results If events or indicators of impairment occur between annual impairment analyses, we perform an impairment analysis of goodwill at that date.
These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant asset.
In testing for a potential impairment of goodwill, we: (1) verify there are no changes to our reporting units with goodwill balances; (2) allocate goodwill to our various reporting units
to which the acquired goodwill relates; (3) determine the carrying value, or book value, of our reporting units, as some of the assets and liabilities related to each reporting unit are held by
a corporate function; (4) estimate the fair value of each reporting unit using a discounted cash flow model; (5) reconcile the fair value of our reporting units in total to our market
capitalization adjusted for a subjectively estimated control premium and other identifiable factors; (6) compare the fair value of each reporting unit to its carrying value; and (7) if
the estimated fair value of a reporting unit is less than the carrying value, we must estimate the fair value of all identifiable assets and liabilities of that reporting unit, in a manner similar to
a purchase price allocation for an acquired business to calculate the implied fair value of the reporting unit's goodwill and recognize an impairment charge if the implied fair value of the reporting
unit's goodwill is less than the carrying value.

The
process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis, including the identification of our
reporting units, identification and allocation of the assets and liabilities to each of our reporting units and determination of fair value. In estimating the fair value of a reporting unit for the
purposes of our annual or periodic impairment analyses, we make estimates and significant judgments about the future cash flows of that reporting unit. Our cash flow forecasts are based on assumptions
that represent the highest and best use for our reporting units. Changes in judgment on these assumptions and estimates could result in further goodwill impairment charges. We believe that the
assumptions and estimates utilized are appropriate based on the information available to management.

On
October 31, 2010, we performed our required annual goodwill impairment test. Our goodwill has been allocated to our Sports MedicineAmericas,
ENTAmericas and International reporting units. The test requires us to compare the fair value of each reporting unit to its carrying value. If the fair value is less than the carrying
value, we are required to compare the carrying value of the reporting unit's goodwill to its implied fair value. The fair values of our Sports MedicineAmericas, ENTAmericas
and International reporting units,
with goodwill balances of $80.7 million, $11.1 million and $27.2 million, respectively, were determined to be in excess of the carrying values of the reporting units and therefore
no impairment charges were recognized related to these reporting units. The discounted cash flow analyses utilized a discount rate of 13.3 percent for each of the reporting units. The average
growth rates utilized in our discounted cash flow models for the Sports MedicineAmericas, ENTAmericas and International reporting units approximated the average growth rate
between 2008 and 2010. We believe these growth rates are reasonable estimates of future performance. We noted that a 25 percent reduction in the growth rates or a 25 percent increase in
the discount rate for the Sports MedicineAmericas, ENTAmericas and International reporting units would not result in an impairment charge. The enterprise fair values implied
by the discounted cash flow analysis were below our total market capitalization, which reflects the conservative nature of our forecasts. As the fair value of the reporting units was significantly
above the carrying value using these conservative estimates, we concluded that the second step of the goodwill impairment test was not necessary.

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Intangible assets with finite lives and property, plant and equipment are amortized or depreciated over their estimated useful life on a straight line basis. We
monitor conditions related to these assets to determine whether events and circumstances warrant a revision to the remaining amortization or depreciation period. We test these assets for potential
impairment whenever our management concludes events or changes in circumstances indicate that the carrying amount may not be recoverable. The original estimate of an asset's useful life and the impact
of an event or circumstance on either an asset's useful life or carrying value involve significant judgment regarding estimates of the future cash flows associated with each asset.

In
addition to testing goodwill impairment, we tested our $2.1 million of intangible assets associated with our Other products and discontinued operations for impairment. We
determined that the future net cash flows associated with each asset were in excess of the carrying value of each asset and therefore, no impairment charge was recorded.



The outcomes of legal proceedings and claims brought against us and other loss contingencies are subject to significant uncertainty. We
accrue a charge against income when
our management determines that it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. In addition, we accrue for the
authoritative judgments or assertions made against us by government agencies at the time of their rendering regardless of our intent to appeal. In determining the appropriate accounting for loss
contingencies, 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. We regularly evaluate
current information available to us to determine whether an accrual should be established or adjusted. Estimating the probability that a loss will occur and estimating the amount of a loss or a range
of loss involves significant judgment.



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 when we expect the amount of tax benefit to be realized is less than the carrying value of the
deferred tax asset.

We
make an evaluation at the end of each reporting period as to whether or not some or all of the undistributed earnings of our foreign subsidiaries are permanently reinvested. While we
may have concluded in the past that some of such undistributed earnings are permanently reinvested, facts and circumstances may change in the future. Changes in facts and circumstances may include a
change in the estimated capital needs of our foreign subsidiaries, or a change in our corporate liquidity requirements. Such changes could result in our management determining that some or all of such
undistributed earnings are no longer permanently reinvested. In that event, we would be required to recognize income tax liabilities on the assumption that our foreign undistributed earnings will be
distributed to the U.S.

Accounting
for income taxes involves uncertainty and judgment on how to interpret and apply tax laws and regulations within our annual tax filings. Such uncertainties from time to time
may result in a tax position that may be challenged and overturned by a tax authority in the future which could result in additional tax liability, interest charges and possibly penalties. An income
tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities, based on the
technical merits of the position. The liability for uncertain tax positions, including related interest and penalties, is recorded as

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other
non-current liabilities or offsetting deferred tax asset, as applicable. Interest on unpaid taxes and penalties when incurred are classified as a component of income tax expense.



Our Series A Preferred Stock is classified as mezzanine equity and is shown on our balance sheet net of issuance costs. The
difference between the carrying value of the Series A Preferred Stock and its redemption value is accreted over 5 years using the effective interest method. As the Series A
Preferred Stock is convertible at the option of the holder, we immediately amortized the entire amount of the beneficial conversion feature, as determined on the date of issuance, as a dividend.
Additional dividends are accrued at the stated rate each period so that the mezzanine equity carrying value will equal its redemption value on the fifth anniversary of the issuance when any remaining
unconverted Series A Preferred Stock could be redeemable at the option of the holder. Dividends declared on the Series A Preferred Stock shares, the accretion of issuance costs and
amortization of the beneficial conversion feature reduce the amount of net earnings that are available to common stockholders and are presented together as a separate amount on the consolidated
statements of operations.



We account for stock-based compensation by measuring and recognizing as compensation expense the fair value of all share-based payment
awards made to employees, including employee stock options and restricted stock awards. The determination of fair value involves a number of significant estimates. We use the Black-Scholes option
pricing model to estimate the value of employee stock options which requires a number of assumptions to determine the model inputs. These include the expected volatility of our stock and employee
exercise behavior which are based on historical data as well as expectations of future developments over the term of the option. As stock-based compensation expense is based on awards ultimately
expected to vest it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates. Management's estimate of forfeitures is based on historical experience but actual forfeitures could differ materially as a result of voluntary employee actions and involuntary actions which
would result in a significant change in our stock-based compensation expense amounts in the future.

Recently Issued Accounting Pronouncements

New accounting pronouncements or changes in existing accounting pronouncements may have a significant effect on our results of
operations, our financial condition, our net worth or our business operations.

In
October 2009, the Financial Accounting Standards Board ("FASB") issued amended revenue recognition guidance for arrangements with multiple deliverables. This guidance is effective for
all new or materially modified arrangements entered into on or after January 1, 2011 with earlier application permitted as of the beginning of a fiscal year. We do not expect the implementation
of this guidance to have a material impact on the consolidated financial statements.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks as part of our ongoing business operations, primarily risks from changing interest rates and
foreign currency exchange rates that may impact, adversely or otherwise, our financial condition, results of operations, or cash flows.

Our
interest income is dependent on changes in the general level of U.S. interest rates. Our cash and cash equivalents consist of money market funds and various deposit accounts.

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The
table below presents principal amounts and related weighted average interest rates as of December 31, 2010 for our cash and cash equivalents (in thousands, except
percentages):

Cash and cash equivalents

$
132,536Average interest rate earned on cash and cash equivalents


0.24
%


Foreign Currency Risk

A significant portion of our international sales and operating expenses are denominated in currencies other than the U.S. dollar. To
the extent that the exchange rates for these currencies fluctuate against the U.S. dollar, we will experience variations in our results of operations and financial condition.

Our
cash and cash equivalents at December 31, 2010 are denominated primarily in U.S. dollars; however, we also maintain balances in Euros, British pounds, Swedish kroner, Swiss
francs, Australian dollars and Costa Rican colones in support of local subsidiary operations. A 10 percent change in the December 31, 2010 exchange rates for these currencies would have
an impact on pre-tax income of approximately $1.2 million.

We
have not used derivative financial instruments to hedge against foreign currency exchange risk and do not anticipate doing so in the future. Our objective to minimize foreign currency
gains and losses has been managed by maintaining only enough cash necessary for immediate working capital requirements in accounts denominated in currencies other than the U.S. dollar and holding the
majority of our cash and cash equivalents in U.S. dollar accounts.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

The following financial statements of the Company and the Report of Independent Registered Public Accounting Firm are included in this
Report on the pages indicated.



Description

PageFinancial Statements:Report of Independent Registered Public Accounting Firm

55Consolidated Balance Sheets as of December 31, 2010 and December 31, 2009

56Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008

57Consolidated Statements of Stockholders' Equity for the years ended December 31, 2010, 2009 and 2008

58Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008

59Notes to the Consolidated Financial Statements

60Financial Statement Schedule:Schedule II: Valuation and Qualifying Accounts for the years ended December 31, 2010, 2009, and
2008

101


All
other schedules are omitted because they are not applicable.

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Report of Independent Registered Public Accounting Firm

To
Board of Directors and Stockholders of ArthroCare Corporation:

In
our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of ArthroCare Corporation and its
subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 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 accompanying index presents fairly, in all
material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2010, based on criteria established inInternal ControlIntegrated
Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and
financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting,
included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial
statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/
PricewaterhouseCoopers LLP
Austin, Texas
February 14, 2011

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ARTHROCARE CORPORATION        CONSOLIDATED BALANCE SHEETS        (in thousands, except par value data)

December 31,2010

2009ASSETSCurrent assets:Cash and cash equivalents

$
132,536

$
57,386Accounts receivable, net of allowances of $2,445 and $4,069 at 2010 and 2009, respectively


48,870


45,789Inventories, net


34,087


48,628Deferred tax assets


24,661


12,983Prepaid expenses and other current assets


4,424


6,563Assets held for sale


3,081


Total current assets


247,659


171,349Property and equipment, net


41,582


47,386Intangible assets, net


10,733


17,975Goodwill


119,020


119,076Deferred tax assets


16,019


30,526Other assets


4,182


4,816Total assets

$
439,195

$
391,128LIABILITIES, REEDEMABLE CONVERTIBLE PREFERRED AND STOCKHOLDERS' EQUITYCurrent liabilities:Accounts payable

$
13,819

$
14,299Accrued liabilities


40,197


46,077Deferred tax liabilities


149


3Deferred revenue





4,508Income tax payable


1,555


195Total current liabilities


55,720


65,082Deferred tax liabilities


213


303Other non-current liabilities


13,766


4,844Total liabilities


69,699


70,229Commitments and contingencies (Notes 10 and 11)Series A 3% Redeemable Convertible Preferred Stock, par value $0.001; Authorized: 100 shares; Issued and outstanding:
75 shares at 2010 and 2009


73,768


70,504Stockholders' equity:Preferred stock, par value $0.001; Authorized: 4,900 shares; Issued and outstanding: none





Common stock, par value, $0.001: Authorized: 75,000 shares; Issued: 31,102 and 30,905 shares; Outstanding: 27,112 and 26,886 shares, at December 31,
2010 and 2009, respectively


27


27Treasury stock: 3,990 and 4,019 shares at December 31, 2010 and 2009, respectively


(107,899
)

(108,724
)Additional paid-in capital


386,395


379,921Accumulated other comprehensive income


4,246


1,645Retained earnings (accumulated deficit)


12,959


(22,474
)Total stockholders' equity


295,728


250,395Total liabilities, redeemable convertible preferred stock and stockholders' equity

$
439,195

$
391,128


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

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ARTHROCARE CORPORATION        CONSOLIDATED STATEMENTS OF OPERATIONS        (in thousands, except per-share data)

Years Ended December 31,2010

2009

2008Revenues:Product sales

$
338,757

$
308,493

$
295,118Royalties, fees and other


16,622


15,624


12,165Total revenues


355,379


324,117


307,283Cost of product sales


110,751


90,940


92,645Gross profit


244,628


233,177


214,638Operating expenses:Research and development


35,846


35,203


31,930Sales and marketing


107,852


114,539


125,502General and administrative


38,491


46,034


50,359Amortization of intangible assets


5,237


5,309


5,479Impairment of goodwill








6,252Reimbursement services


92


353


1,966Investigation and restatement-related costs


2,840


31,686


17,021Total operating expenses


190,358


233,124


238,509Income (loss) from operations


54,270


53


(23,871
)Other income, net


216


312


563Interest expense and bank fees


(769
)

(3,757
)

(3,792
)Foreign exchange gain (loss), net


(3,311
)

1,233


(5,657
)Interest and other expense, net


(3,864
)

(2,212
)

(8,886
)Income (loss) from continuing operations before income taxes


50,406


(2,159
)

(32,757
)Income tax provision (benefit)


12,888


3,137


(8,175
)Net income (loss) from continuing operations


37,518


(5,296
)

(24,582
)Loss from discontinued operations, net of taxes


(434
)

(481
)

(10,443
)Net income (loss)


37,084


(5,777
)

(35,025
)Accrued dividend, beneficial conversion feature and accretion charges on Series A 3% Convertible Preferred Stock


(3,264
)

(28,045
)

Net income (loss) applicable to common stockholders

$
33,820

$
(33,822
)
$
(35,025
)Weighted-average shares outstanding:Basic


27,006


26,803


26,610Diluted


27,348


26,803


26,610Earnings (loss) per share from continuing operations applicable to common stockholders:Basic

$
1.04

$
(1.24
)
$
(0.92
)Diluted

$
1.03

$
(1.24
)
$
(0.92
)Earnings (loss) per share applicable to common stockholders:Basic

$
1.03

$
(1.26
)
$
(1.32
)Diluted

$
1.02

$
(1.26
)
$
(1.32
)


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

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ARTHROCARE CORPORATION        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY        (in thousands)

Common
Stock
Shares

Common
Stock
Amount

Treasury
Stock

Additional
Paid-In
Capital

Accumulated
Other
Comprehensive
Income

Retained
Earnings
(Accumulated
Deficit)

Total
Stockholders'
Equity

Comprehensive
Income (Loss)Balance, December 31, 2007


26,808

$
27

$
(101,321
)
$
358,065

$
3,970

$
20,312

$
281,053Issuance of common stock through:Exercise of options and restricted stock


97








1,221








1,221Employee stock purchase plan


15








391








391Contribution to employee benefit plan


79





2,154


(639
)




(655
)

860Stock compensation











9,797








9,797Income tax effect of exercise of stock options











3,816








3,816Purchase of common stock


(244
)




(11,778
)










(11,778
)Currency translation adjustment














(3,844
)




(3,844
)
$
(3,844
)Net loss

















(35,025
)

(35,025
)

(35,025
)Balance, December 31, 2008


26,755


27


(110,945
)

372,651


126


(15,368
)

246,491


(38,869
)Issuance of common stock through:Exercise of options and restricted stock


50








359








359Contribution to employee benefit plan


81





2,221








(1,329
)

892Stock compensation











6,557








6,557Income tax effect of exercise of stock options











1,412








1,412Accrued dividends and accretion charges on Series A 3% Convertible Preferred Stock











(1,058
)







(1,058
)Currency translation adjustment














1,519





1,519


1,519Net loss

















(5,777
)

(5,777
)

(5,777
)Balance, December 31, 2009


26,886


27


(108,724
)

379,921


1,645


(22,474
)

250,395


(4,258
)Issuance of common stock through: Exercise of options and restricted stock


190








1,868








1,868Employee stock purchase plan


5








128








128Contribution to employee benefit plan


31





825


80








905Stock compensation











8,001








8,001Income tax effect of exercise of stock options











(1,990
)







(1,990
)Accrued dividends and accretion charges on Series A 3% Redeemable Convertible Preferred Stock











(1,613
)




(1,651
)

(3,264
)Currency translation adjustment














2,601





2,601


2,601Net income

















37,084


37,084


37,084Balance, December 31, 2010


27,112

$
27

$
(107,899
)
$
386,395

$
4,246

$
12,959

$
295,728

$
39,685


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

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ARTHROCARE CORPORATION        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

Year Ended December 31,2010

2009

2008Cash flows from operating activities:Net income (loss)

$
37,084

$
(5,777
)
$
(35,025
)Adjustments to reconcile net income (loss) to net cash provided by by operating activities:Depreciation and amortization


24,130


23,904


22,994Impairment of goodwill and intangible assets








18,945Provision for doubtful accounts receivable and product returns


(336
)

3,147


7,258Provision for inventory and warranty reserves


8,149


2,778


7,987Non-cash stock compensation expense


8,001


6,557


9,878Deferred taxes


2,885


1,339


(10,516
)Income tax benefits relating to employee stock options


(1,608
)

(1,099
)

(3,746
)Unrealized foreign exchange (gain) loss


4,594


(1,939
)

(1,505
)Other


1,027


1,224


1,990Changes in operating assets and liabilitiesAccounts receivable


(2,057
)

(2,800
)

(9,227
)Inventories


5,990


6,936


(7,792
)Prepaid expenses and other current assets


2,615


3,136


(2,558
)Accounts payable


(698
)

(3,375
)

2,405Accrued liabilities


(2,001
)

(17,391
)

29,548Deferred revenue


(4,508
)

1,298


1,445Income taxes payable


(631
)

1,530


(48
)Net cash provided by operating activities


82,636


19,468


32,033Cash flows from investing activities:Purchases of property and equipment


(12,231
)

(16,140
)

(20,890
)Earnout payment for purchase of ATI, net








(483
)Payments for business combinations, including earnouts, and purchases of intangible assets


(149
)

(439
)

(1,375
)Proceeds from principle payments of loan receivable


168





Disbursement of loan receivable





(180
)

(2,320
)Net change in restricted cash equivalents and investments





4,362


396Proceeds from maturities of available-for-sale securities


38


33


Net cash used in investing activities


(12,174
)

(12,364
)

(24,672
)Cash flows from financing activities:Proceeds from issuance of preferred stock, net of issuance cost





69,446


Payments for purchases of treasury stock








(11,778
)Repayments on revolving credit agreement





(55,000
)

(5,000
)Payment for deferred debt cost








(114
)Proceeds from issuance of common stock, net of issuance costs


128





391Proceeds from exercise of options to purchase common stock, net of issuance costs


1,868


359


1,221Income tax benefit relating to employee stock options


1,608


1,099


3,746Net cash provided by (used in) financing activities


3,604


15,904


(11,534
)Effect of exchange rate changes on cash and cash equivalents


1,084


872


(570
)Net increase (decrease) in cash and cash equivalents


75,150


23,880


(4,743
)Cash and cash equivalents, beginning of the period


57,386


33,506


38,249Cash and cash equivalents, end of the period

$
132,536

$
57,386

$
33,506


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

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ARTHROCARE CORPORATION        NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1FORMATION AND BUSINESS OF THE COMPANY

ArthroCare Corporation ("ArthroCare" or the "Company") is a medical device company incorporated on April 29, 1993, that develops, manufactures and markets surgical products, many
of which are based on the Company's minimally invasive patented Coblation® technology. The Company's products are used across several medical specialties, improving many existing
soft-tissue surgical procedures and enabling new minimally invasive surgical procedures. The Company's business consists of two core product areas: Sports Medicine and ENT. The Company's
products are sold through two geographic distribution channels: Americas (North and South America) and International (all other geographies).

NOTE 2FIRST QUARTER 2010 ACCOUNTING CORRECTIONS

Our results for the period ended December 31, 2010 include reductions of stock compensation expense to correct forfeiture calculation errors in prior periods. The impact of the
error was an overstatement of operating expenses of $0.4 million in the year ended December 31, 2008 and $0.7 million in the year ended December 31, 2009. To correct this
error, we recorded reductions of $0.8 million to general and administrative expense and $0.3 million to sales and marketing expense in the quarter ended March 31, 2010. We have
determined that the impact of this uncorrected error is immaterial to all prior periods, and the correction is immaterial to the year ended December 31, 2010.

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation.The consolidated financial statements include the accounts of the Company and all of its wholly owned
subsidiaries. All
significant intercompany transactions and accounts have been eliminated. The Company uses the calendar year as its fiscal year.

Use of Estimates.The preparation of financial statements in conformity with accounting principles generally accepted in the U.S.
requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent 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.

Cash and Cash Equivalents.The Company considers 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.

Inventories and Inventory Allowances.The Company's inventories are stated at standard cost, which include material, labor and overhead
costs and
approximates actual cost determined on a first-in, first-out basis. The Company adjusts the value of its inventory to the extent management determines that the cost cannot be
recovered due to obsolescence or other factors. In order to make these determinations, management uses estimates of future demand and sales prices for each product to determine appropriate inventory
reserves and to make corresponding reductions in the carrying value of inventory to reflect the lower of cost or market value. In the event of a sudden significant decrease in demand for the Company's
products, or a higher incidence of inventory obsolescence, the Company could be required to increase its inventory reserve, which would increase cost of product sales and decrease gross profit.

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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Property and Equipment.Property and equipment is stated at cost and is depreciated on a straight-line basis over the asset's estimated
useful life. The Company places the majority of its manufactured controller units with customers in order to facilitate the sale of disposable devices. Controller units placed with customers are
capitalized at cost and amortized to cost of product sales over a four-year period. Leasehold improvements are amortized over the shorter of five years or the lease term. Furniture,
fixtures, machinery and equipment are amortized over a five year period, while computer equipment and software are amortized over three to five years. Buildings are depreciated over a thirty year
life. Maintenance and repair costs are charged to operations as incurred. Upon retirement or sale, the cost of disposed assets and their accumulated depreciation are removed from the balance sheet and
any gain or loss is recognized in current operations. The Company tests its property, plant and equipment for potential impairment whenever management concludes
events or changes in circumstances indicate that the carrying amount may not be recoverable. The original estimate of an asset's useful life and the impact of an event or circumstance on either an
asset's useful life or carrying value involve significant judgment.

Revenue Recognition.The Company's principal sources of revenue are from sales of its products through direct sales professionals,
independent sales
agents and independent distributors. These revenues are recognized when there is persuasive evidence of an arrangement providing for the sale of a product, delivery of the product has occurred, the
sale price of the product is fixed or determinable and collectability is reasonably assured. Revenues include shipping and handling costs billed to customers. Shipping and handling costs are presented
as a part of cost of product sales, when related to revenue producing activities.

For
product sales made by direct sales professionals or independent agents, the Company's criteria for revenue recognition is generally complete when the product is delivered to end
customers, such as surgical centers and hospitals. These sales occur either through a purchase order submitted by the customer or through trunk sales. For purchase orders, the Company ships product to
and invoices the end customer directly. For trunk sales, product is hand-delivered at the end customer's premises from trunk stock maintained by the direct sales representative or
independent agent and a bill-only order is received notifying the Company of the product's delivery at which time the end customer is invoiced.

Sales
to distributors occur either as stocking and replenishment orders or as drop shipments to end customers. In the majority of cases involving sales to distributors, the requirements
for revenue recognition are met when the product is delivered to a particular distributor. Prior to March of 2010, the Company agreed to pricing concessions for certain distributors based on the
distributors' ultimate reselling price and in these cases revenue was recognized on a "sell-through" basis only after the distributor sold the products to an end user. In order to
determine the amount of sell-through revenue that should be recognized during a given reporting period, the Company relied on reports from the distributors that provided information about
sales to end customers during the reporting period as well as the amount and types of products in the distributor's inventory at the end of a reporting period. The Company's management was required to
make estimates and exercise a significant level of judgment to determine the accuracy and reliability of the reported information. A first-in-first-out accounting
method was used to account for products sold by these distributors where the sell-through method had been applied.

Customers
generally have the right to return or exchange products purchased from the Company for up to 60 days from the date of product shipment. At each period end, the Company
determines the

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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

extent
to which its revenues need to be reduced to account for expected returns and exchanges and a reserve is recorded against revenue recognized. These estimates are based on historical experience
with customers and on direct customer feedback. The Company had an agreement with one customer that provided for an extended right of exchange. Management determined that for this customer, it was not
possible to reasonably estimate future return levels and as a result, revenue related to product sales to this customer was deferred until the related right of exchange period expired in the first
quarter of 2010. This customer no longer has this extended right of return.

Revenue
recognition is also impacted by management's estimate of customers' ability to pay pursuant to the terms of customer agreements. If after the Company has recognized revenue,
collectability of an account receivable becomes doubtful, an allowance for doubtful accounts will be established with respect to the previously recognized revenue that remains uncollected. When
management forms a judgment that a particular customer has not established a sufficient credit history but decides to deliver products to the customer, revenue recognition will be deferred.
Once the customer establishes a reliable payment history the Company generally returns to normal revenue recognition based on the Company's criteria. The creditworthiness of customers is periodically
reviewed considering such factors as historical collection experience, a customer's current credit standing, the age of accounts receivable balances, and general economic conditions that may affect a
customer's ability to pay.

Prior
to early 2009, certain products were billed to and cash collected from third-party payors that the Company may judge to be subject to possible disputes or re-pricing by
the payors. Because of the Company's limited history with such disputes and re-pricings, management has concluded that the criteria for revenue recognition are not satisfied with respect
to these product sales and revenue recognition was deferred for these sales until the risk of disputes or claims was judged by management to be remote. Since early 2009 the Company is no longer
engaged in product sales activities where it bills third-party payors.

Although
the terms of the agreements with many of the Company's customers provide that title and risk of loss passes to the customer upon shipment, the Company has historically accepted
the risk of loss until product delivery. Accordingly, revenue is recognized on a product sale if in management's judgment it has been delivered during the relevant reporting period. The application of
this policy requires management to make estimates as to the timing of deliveries. These estimates are based on historical experience with product shipments to particular markets that are served. These
estimates are regularly compared to actual results based on delivery confirmations to determine whether a change of estimate is required.

The
Company generally recognizes license fees and other revenues over the term of the associated agreement. Royalties represent the largest component of non-product sales
revenue and are recognized as earned, based on management's estimates using current and historical trends adjusted
for market factors, and are classified as royalties, fees and other revenues in the accompanying consolidated statements of operations.

When
payments are made to customers, the Company recognizes those payments as a reduction of revenue unless it can be determined that the Company received products or services that are
separable from the customer purchasing its product that have a fair value equal to the amount of the payment to the customer. When the fair value of the products or services received is less than the
consideration

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

paid,
only the portion that meets the above criteria is recognized as an expense and the excess is recorded as a reduction in revenue.

Discontinued Operation.In the fourth quarter of 2010, management determined that the Company's non-Coblation spine products met the
criteria under generally accepted accounting principles to be reported as discontinued operations. The Company's non-Coblation spine products consist of its Parallax and Contour product
lines. As a result of this determination, the reported impact from these discontinued product lines on current and previously reported net income (loss) in all periods is separately reported as "Loss
from discontinued operations, net of taxes" in the Consolidated Statements of Operations. Assets identifiable with these discontinued product lines is reported in the December 31, 2010
Consolidated Balance Sheet as "Assets held for sale".

Business Combinations.Assets acquired and liabilities assumed as part of a business acquisition are generally recorded at their fair
value at the
date of acquisition. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining fair value of identifiable assets, particularly
intangibles, and liabilities acquired also requires management to make estimates, which are based on all available information and in some cases assumptions with respect to the timing and amount of
future revenues and expenses associated with an asset. Accounting for business acquisitions requires management to make judgments as to whether a purchase transaction is a multiple element contract,
meaning that it includes other transaction components such as a settlement of a preexisting relationship. This judgment and determination affects the amount of consideration paid that is allocable to
assets and liabilities acquired in the business purchase transaction.

Goodwill.The Company's goodwill balance is not amortized to expense; instead it is tested for impairment at least annually. The
Company performs its
annual goodwill impairment analysis in the fourth quarter. During 2010, the Company changed its annual goodwill impairment test date from December 31 to October 31, which represents a
change in accounting principle. Management concluded that this change was preferable in order to facilitate the timely reporting of our financial results. This
change did not have an impact on the consolidated balance sheet or the consolidated statement of operations. If events or indicators of impairment occur between annual impairment analyses, the Company
performs an impairment analysis of goodwill at that date. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators,
competition, or sale or disposition of a significant asset. In testing for a potential impairment of goodwill, the Company: (1) verifies there are no changes to its reporting units with
goodwill balances; (2) allocates goodwill to its various reporting units to which the acquired goodwill relates; (3) determines the carrying value, or book value, of its reporting units,
as some of the assets and liabilities related to each reporting unit are held by a corporate function; (4) estimates the fair value of each reporting unit using a discounted cash flow model;
(5) reconciles the fair value of its reporting units in total to the Company's market capitalization adjusted for a subjectively estimated control premium and other identifiable factors;
(6) compares the fair value of each reporting unit to its carrying value; and (7) if the estimated fair value of a reporting unit is less than the carrying value, the Company must
estimate the fair value of all identifiable assets and liabilities of that reporting unit, in a manner similar to a purchase price allocation for an acquired business to calculate the implied fair
value of the reporting unit's goodwill and recognize an impairment charge if the implied fair value of the reporting unit's goodwill is less than the carrying value.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The
process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis, including the identification of the
Company's reporting units, identification and allocation of the assets and liabilities to each of its reporting units and determination of fair value. In estimating the fair value of a reporting unit
for the purposes of the annual or periodic impairment analyses, the Company makes estimates and significant judgments about the future cash flows of that reporting unit. The cash flow forecasts are
based on assumptions that represent the highest and best use for the Company's reporting units. Changes in judgment on these assumptions and estimates could result in further goodwill impairment
charges. The Company believes that the assumptions and estimates utilized are appropriate based on the information available to management.

Intangible
assets with finite lives are amortized over their estimated useful life. The Company monitors conditions related to these assets to determine whether events and circumstances
warrant a revision to the remaining amortization period. The Company tests its intangible assets with finite lives for potential impairment whenever management concludes events or changes in
circumstances indicate that the carrying amount may not be recoverable. The original estimate of an asset's useful life and the impact of an event or circumstance on either an asset's useful life or
carrying value involve significant judgment.

Series A 3% Redeemable Convertible Preferred Stock.The Company's Series A Preferred Stock is classified as mezzanine equity
and is
shown net of issuance costs. The difference in carrying value and
redemption value resulting from offering costs and return of capital to the investor is accreted over the redemption period using the effective interest method. As the preferred stock is convertible
at the option of the holder, the Company elected to immediately amortize the entire amount of the beneficial conversion feature as a dividend on the date of issuance. As the Company had an accumulated
deficit, the election to immediately amortize the beneficial conversion feature had no impact on the accompanying consolidated balance sheets. Additional dividends are accrued at the stated rate each
period so that the mezzanine equity carrying value will equal its redemption value at the date the equity is redeemable and are recorded on the declaration date at fair market value. Dividends on the
preferred stock shares, including declared dividends, accrued cumulative dividends, deemed dividends on the accretion of issuance costs and amortization of the beneficial conversion feature, reduce
the net income available to common stockholders and are presented as a separate amount on the accompanying consolidated statements of operations.

Earnings Per Share.The Company calculates earnings per share ("EPS") using the two class method for all periods ending after
September 1,
2009, the date of issuance of the Series A Preferred Stock. Under the two-class method, distributed and undistributed earnings are allocated to common stockholders based on their
participation rights in those earnings.

Treasury Stock.Treasury stock is accounted for under the cost method and is included as a component of stockholders' equity. When
treasury stock is
sold, the treasury stock balance is relieved using the weighted average cost.

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

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Advertising Expense.Advertising expenses are charged to operations as sales and marketing expenses as incurred. Advertising expense
was
$1.1 million, $1.5 million and $3.0 million in 2010, 2009 and 2008, respectively.

Reimbursement Services.Reimbursement services represent the costs the Company incurred related to DiscoCare and DRS activities and to
affect their
subsequent cessation of activities.

Stock-Based Compensation.The Company accounts for stock-based compensation by measuring and recognizing as compensation expense the
grant date fair
value of all share-based payment awards made to employees, including employee stock options and restricted stock awards. The determination of fair value involves a number of significant estimates. The
Company uses the Black-Scholes option pricing model to estimate the value of employee stock options which requires a number of assumptions to determine the model inputs. These include the expected
volatility of stock and employee exercise behavior which are based on historical data as well as expectations of future developments over the term of the option. As stock-based compensation expense is
based on awards ultimately expected to vest it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Management's estimate of forfeitures is based on historical experience but actual forfeitures could differ materially as a result of voluntary employee actions
and involuntary actions which would result in a significant change in future stock-based compensation expense.

The
Company presents excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.

Legal and Other Contingencies.The outcomes of legal proceedings and claims brought against the Company and other loss contingencies are
subject to
significant uncertainty. The Company accrues a charge against income when management determines that it is probable that an asset has been impaired or a liability has been incurred and the amount of
loss can be reasonably estimated. In determining the appropriate accounting for loss contingencies, the Company will consider the likelihood of loss or impairment of an asset or the incurrence of a
liability, as well as management's ability to reasonably estimate the amount of loss. Current information available to the Company is regularly evaluated to determine whether an accrual should be
established or adjusted. Estimating the probability that a loss will occur and estimating the amount of a loss or a range of loss involves significant judgment.

Foreign Currency Translation.Assets and liabilities of foreign subsidiaries that operate primarily in a currency other than the U.S.
dollar 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 these subsidiaries' financial statements are recorded directly as a separate component of stockholders' equity and represent essentially all
of the balance under the caption "accumulated other comprehensive income."

For
the Company's foreign subsidiaries that operate primarily in the U.S. dollar, all foreign currency denominated monetary assets and liabilities are remeasured into U.S. dollars at
exchange rates in effect at the balance sheet date, and non-monetary assets and related elements of expense are remeasured using historical rates of exchange. Income and expense elements
are remeasured into U.S.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

dollars
using average exchange rates in effect during the period. Remeasurement gains and losses are recorded each period in the statement of operations.

Concentration of Risks and Uncertainties.A majority of the Company's cash and cash equivalents are maintained at financial institutions
in the U.S.
Deposits at these institutions may exceed federally insured limits on such deposits. The Company has not experienced any losses on deposits of cash and cash equivalents.

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. No individual customer represented more than 10 percent of product sales during the years ended December 31, 2010, 2009 and 2008 or the
accounts receivable balance as of December 31, 2010 and 2009.

Income Taxes.The Company accounts 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 when the amount of expected tax benefit to be realized is less than the carrying
value of the deferred tax asset.

An
evaluation is made at the end of each reporting period as to whether or not some or all of the undistributed earnings of foreign subsidiaries are permanently reinvested. While the
Company may have concluded in the past that earnings of its foreign subsidiaries are permanently reinvested, facts and circumstances may change in the future based on the estimated capital needs of
foreign subsidiaries, or a change in corporate liquidity requirements. Such changes could result in management determining that some or all of such undistributed earnings are no longer permanently
reinvested. In that event, the Company would be required to recognize income tax liabilities on the assumption that foreign undistributed earnings will be distributed to the U.S.

Accounting
for income taxes involves uncertainty and judgment on how to interpret and apply tax laws and regulations within the Company's annual tax filings. Such uncertainties from time
to time may result in a tax position that may be challenged and overturned by a tax authority in the future which could result in additional tax liability, interest charges and possibly penalties. An
income tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities, based on
the technical merits of the position. The liability for unrecognized tax benefits, including related interest and penalties, is recorded as other non-current liabilities or offsetting
deferred tax asset, as applicable. Interest and penalties are classified as a component of income tax expense.

Investigation and Restatement Related Costs.Investigation and restatement related costs are expenses incurred as a result of the SEC
and DOJ
investigations described in Note 11 "Litigation and Contingencies" and costs associated with the Review and restatement of previously reported financial statements contained in the 2008
Form 10-K filed on November 18, 2009. These costs include legal expenses, forensic accountant fees and incremental external audit costs.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recently Issued Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board ("FASB") issued amended revenue recognition guidance for arrangements with
multiple deliverables. For the Company, this guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011. We do not expect it to have a
material impact on the consolidated financial statements.

NOTE 4DISCONTINUED OPERATIONS

In the fourth quarter of 2010, we determined that our non-Coblation spine products met the criteria under generally accepted accounting principles to be reported as
discontinued operations. Our non-Coblation spine products consist of our Parallax and Contour product lines. As a result of this determination, reported product sales for the years ended
December 31, 2010, 2009, and 2008 have been reduced by $5.9 million, $7.5 million and $10.5 million, respectively and the impact from these discontinued product lines on
our current and previously reported net income (loss) in all periods is separately reported as "Loss from discontinued operations, net of taxes" in our Consolidated Statements of Operations. Net
assets of $3.1 million identifiable with these discontinued product lines is reported in our December 31, 2010 Consolidated Balance Sheet as "Assets held for sale".

The
following table presents the assets held for sale by major class (in thousands):

December 31,
2010Inventory

$
1,719Equipment, net of acumulated depreciation of $349


63Intangible assets, net of accumulated amortization of $6,800


1,299Assets held for sale

$
3,081


The
results of non-Coblation spine products, net of tax, are reported as discontinued operations for the years ended December 31, 2010, 2009 and 2008. Revenues and
income from discontinued operations and income taxes related to discontinued operations for the years ended December 31, 2010, 2009 and 2008 were as follows (in thousands):

Year Ended December 31,2010

2009

2008Revenue

$
5,851

$
7,491

$
10,454Loss from discontinued operations before income taxes(1)


(616
)

(739
)

(10,123
)Income tax benefit


(182
)

(258
)

320Loss from discontinued operations

$
(434
)
$
(481
)
$
(10,443
)


(1)The
2008 loss from discontinued operations before income taxes includes an allocated goodwill impairment charge of $12.7 million.


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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)




NOTE 5COMPUTATION OF EARNINGS (LOSS) PER SHARE

The Company's Series A Preferred Stock has participation rights in dividends issued to common stockholders. As a result, the Company calculates earnings per share using the two
class method for periods ending after September 1, 2009, the date on which the Company issued the Series A Preferred Stock. The following is a reconciliation of net income (loss)
applicable to common stockholders and the number of shares used in the calculation of basic and diluted earnings (loss) per share applicable to common stockholders (in thousands, except
per-share data):

Year Ended December 31,2010

2009

2008Income (loss) from continuing operations allocated to common stockholders (net of $6,061 attributable to Series A Preferred Stock for 2010)

$
28,193

$
(33,341
)
$
(24,582
)Loss from discontinued operations (net of $77 attributable to Series A Preferred Stock for 2010)


(357
)

(481
)

(10,443
)Net income (loss) allocated to common stockholders (net of $5,984 attributable to Series A Preferred Stock for 2010)


27,836


(33,822
)

(35,025
)Basic:Weighted-average common shares outstanding


27,006


26,803


26,610Earnings (loss) from continuing operations per share allocated to common stockholders

$
1.04

$
(1.24
)
$
(0.92
)Loss from discontinued operations per share allocated to common stockholders


(0.01
)

(0.02
)

(0.40
)Earnings (loss) per share allocated to common stockholders

$
1.03

$
(1.26
)
$
(1.32
)Diluted:Weighted-average shares outstanding used inbasic calculation


27,006


26,803


26,610Dilutive effect of options


266





Dilutive effect of unvested restricted stock


76





Weighted-average common stock and common stock equivalents


27,348


26,803


26,610Earnings (loss) from continuing operations per share allocated to common stockholders

$
1.03

$
(1.24
)
$
(0.92
)Loss from discontinued operations per share allocated to common stockholders


(0.01
)

(0.02
)

(0.40
)Earnings (loss) per share allocated to common stockholders

$
1.02

$
(1.26
)
$
(1.32
)Stock issuable upon conversion of the Series A Preferred Stock


5,806


5,806


Stock awards excluded from calculation as their effect would be anti-dilutive


1,977


3,221


3,137


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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6INVENTORY

The following summarizes the Company's inventories (in thousands):

December 31,2010

2009Raw materials

$
9,387

$
8,937Work-in-process


7,687


6,990Finished goods


27,372


39,08144,446


55,008Inventory valuation reserves


(10,359
)

(6,380
)Inventories, net

$
34,087

$
48,628


NOTE 7PROPERTY AND EQUIPMENT

The following summarizes the Company's property and equipment (in thousands):

December 31,2010

2009Controller placements

$
40,438

$
40,117Computer equipment and software


28,938


28,652Machinery and equipment


20,271


19,288Furniture, fixtures and leasehold improvements


12,074


11,656Building and improvements


7,178


6,668Land


745


745Construction in process


208


1,639109,852


108,765Less: accumulated depreciation


(68,270
)

(61,379
)Total property and equipment, net

$
41,582

$
47,386


Depreciation
expense related to the Company's property and equipment was $18.1 million, $17.3 million and $16.5 million for the years ended December 31, 2010,
2009 and 2008, respectively.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8GOODWILL AND INTANGIBLE ASSETS

Goodwill

The changes in the carrying amount of goodwill are as follows (in thousands):

December 31,2010

2009Goodwill as of January 1, 2010 and 2009 net of accumulated impairment losses of $18,945

$
119,076

$
118,054Acquisitions, earnouts, and purchase accounting adjustments


83


(328
)Translation adjustments


(139
)

1,350Goodwill as of December 31, 2010 and 2009 net of accumulated impairment losses of $18,945

$
119,020

$
119,076


Changes
to goodwill in 2010 and 2009 were related to purchase accounting adjustments, which were immaterial both individually and in the aggregate, and foreign translation adjustments
related to goodwill.

Intangible assets with finite lives

Intangible assets are originally recorded at historical cost, in the case of separately purchased intangible assets, or at estimated
fair value, in the case of assets acquired in the purchase of a business, and all of the Company's intangible assets are subject to amortization ratably over their estimated useful lives. Intangible
assets consist of the following (in thousands, except weighted average useful life):

December 31,Weighted-
Average
Useful Life2010

2009Intellectual property rights

$
21,399

$
26,901

8.0 yearsPatents


9,766


11,700

8.0 yearsDistribution/customer relationships


5,797


6,459

6.5 yearsTrade name/trademarks


4,228


4,828

7.8 yearsLicensing, employment and non-competition agreements


426


1,118

3.0 years41,616


51,006

7.7 yearsLess: accumulated amortization


(30,883
)

(33,031
)Total intangible assets, net

$
10,733

$
17,975


Total
amortization expense for the years ended December 31, 2010, 2009 and 2008 was approximately $5.3 million, $5.3 million and $5.5 million, respectively.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8GOODWILL AND INTANGIBLE ASSETS (Continued)

Estimated future amortization expense is as follows (in thousands):

2011

$
5,3322012


4,6922013


6262014


422015


6Thereafter


35$
10,733


NOTE 9ACCRUED LIABILITIES

The following summarizes the Company's accrued liabilities (in thousands):

December 31,2010

2009Compensation

$
19,236

$
14,865Insurance dispute reserve


9,830


15,268Legal fees and arbitration accrual


2,041


2,862Agent commissions


1,837


2,107Royalties and discounts


1,660


2,946Accounting and reporting costs


863


2,750Other


4,730


5,279$
40,197

$
46,077


The
Company entered into settlement and release agreements in the year ended December 31, 2010 with certain private insurers related to cases in which letters of protection were
held by its DiscoCare subsidiary. The Company agreed to pay these insurers an aggregate of $6.0 million, which reduced the Company's insurance dispute reserve when paid in 2010.

NOTE 10COMMITMENTS

The Company leases certain facilities and equipment under operating leases. The Company recognizes rent expense on a straight-line basis over the lease term. Rent expense for
2010, 2009 and 2008 was $6.4 million, $6.1 million and $6.0 million, respectively.

The
Company provides contributions to foundations that promote and support education and research initiatives.

In
the ordinary course of business, the Company enters into agreements to purchase materials in the future that are enforceable, legally binding and specify terms with fixed or minimum
quantities to be purchased and the approximate timing of payments.

The
Company advances legal fees as required pursuant to indemnification agreements that were entered into with certain former executives and employees while they were employed with the
Company. During the year ended December 31, 2010, the Company advanced $3.8 million and has

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10COMMITMENTS (Continued)

recorded
additional liabilities for $1.1 million at December 31, 2010 under these indemnity agreements. We expect to continue to advance payments pursuant to these agreements in future
periods; however, management is unable to estimate the amount or timing of future payments under such agreements.

At
December 31, 2010, total future minimum commitments were as follows (in thousands):

Minimum Lease
Payments

Educational
Grants

Purchase
Commitments

Total2011

$
3,297

$
50

$
7,111

$
10,4582012


2,796


50


2,658


5,5042013


2,531


50





2,5812014


1,705








1,7052015


1,275








1,275Thereafter


1,521








1,521$
13,125

$
150

$
9,769

$
23,044


Warranties

Disposable medical devices are guaranteed for materials, function and workmanship for a single usage. The Company's warranty obligation
is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. The Company periodically evaluates and adjusts the warranty reserve to the
extent actual warranty expense varies from the original estimates.

NOTE 11LITIGATION AND CONTINGENCIES

In addition to the matters specifically described below, the Company is involved in other legal and regulatory proceedings that arise in the ordinary course of business that do not have
a material impact on the Company's business. Litigation claims and proceedings of all types are subject to many factors that generally cannot be predicted accurately.

The
Company records reserves for claims and lawsuits when they are probable and reasonably estimable. Except as otherwise specifically noted, the Company currently cannot determine the
ultimate resolution of or the amount of monetary damages sought as relief in the matters described below. For matters where the likelihood or extent of a loss is not probable or cannot be reasonably
estimated, the Company has not recognized in its consolidated financial statements the potential liability that may result from these matters. If one or more of these matters is determined against the
Company, it could have a material adverse effect on the Company's earnings, liquidity and financial condition.

The
Company continues to gather additional facts and information related to insurance billing and healthcare compliance issues and marketing and promotional practices in connection with
these legal and administrative proceedings with the assistance of legal counsel.

SEC Investigation

The Fort Worth Regional Office of the Securities and Exchange Commission's ("SEC") Division of Enforcementconducted a formal
investigation into accounting matters related to the restatement of financial results as announced by the Company on July 21, 2008 and completed on November 18, 2009,

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 11LITIGATION AND CONTINGENCIES (Continued)

when
the Company filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2008, in which it provided a detailed description of these matters with respect
to the Review and the restatement. The Company has entered a settlement with the SEC that fully resolves the SEC investigation against the Company. Under the settlement, the Company has consented to
the entry by the SEC of an administrative order (the "Order"), on February 9, 2011, directing the Company to cease and desist from committing or causing violations of the reporting, books and
records and internal control provisions of the federal securities laws in Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and under
Rules 12b-20, 13a-1 and 13a-13 promulgated under the Exchange Act. The Company consented to the entry of the Order without admitting or denying the Order's
assertions of factual findings. No monetary penalty or fine was imposed on the Company, and none of the Company's current officers or employees were charged.

DOJ Investigation

The Department of Justice ("DOJ") is investigating certain of the Company's activities including past sales, accounting, and billing
procedures primarily in relation to the
operation of the Company's Spine product sales. The DOJ is also reviewing the Company's relationship with its DiscoCare subsidiary. The Company is cooperating with this investigation. At this stage of
the investigation, the Company cannot predict the ultimate outcome and is unable to estimate any potential liability the Company may incur.

Private Securities Class Action and Shareholder Derivative Lawsuits



On April 4, 2008, a putative securities class action was filed in Federal court in the Southern District of Florida against the
Company and certain of its former executive officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. Plaintiffs
allege that the defendants violated federal securities laws by issuing false and misleading financial statements and making material misrepresentations regarding the Company's internal controls,
business, and financial results. On October 28, 2008, the court granted the Company's motion to transfer this case to the U.S. District Court, Western District of Texas.
(McIlvaine v. ArthroCare, et al).

On
July 25, 2008, a putative securities class action was filed in Federal court in the Western District of Texas against the Company, and certain of its current and former
executive officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. Plaintiffs allege that the defendants violated
federal securities laws by issuing false and misleading financial statements and making material misrepresentations regarding the Company's internal controls, business, and financial results.
(Strong v. ArthroCare, et al).

On
August 7, 2008, a derivative action was filed in Federal court in the Southern District of Florida against the Company and its then-current directors alleging
breach of fiduciary duty based on the Company's alleged improper revenue recognition, improper reporting of such revenue in SEC filings and press releases, failure to maintain adequate internal
controls, and failure to supervise management. On October 14, 2008, the court granted the Company's motion to transfer this case to the U.S. District Court, Western District of Texas.
(Weil v. Baker, et al).

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NOTE 11LITIGATION AND CONTINGENCIES (Continued)

On
March 4, 2009, a derivative action was filed in Federal court in the Western District of Texas against the Company's current directors, a former director, certain of its
current and former executive officers and other employees and PricewaterhouseCoopers LLP alleging (i) disgorgement under Section 304 of the Sarbanes-Oxley Act;
(ii) violations of Section 10(b) of the Exchange Act and Rule 10b-5; (iii) breach of fiduciary duty; (iv) abuse of control; (v) gross
mismanagement of the Company; (vi) waste of corporate assets; (vii) insider trading; and (viii) unjust enrichment. (King v. Baker, et
al).

On
April 29, 2009, a derivative action was filed in Federal court in the Western District of Texas against the Company's current directors and a former director alleging breach of
fiduciary duty based on the Company's improper revenue recognition, improper reporting of such revenue in SEC filings and press releases, failure to maintain adequate internal controls, and failure to
supervise management. (Barron v. Baker, et al).

On
October 28, 2008, and thereafter, the two putative securities class actions and the shareholder derivative actions were consolidated and designated:In
Re ArthroCare Corporation Securities Litigation, Case No. 1:08-cv-00574-SS (consolidated) in the U.S. District Court, Western
District of Texas. On December 10, 2008, Lead Plaintiffs and Lead Plaintiffs' counsel were appointed in the putative consolidated securities class action. The Lead Plaintiff filed an Amended
Consolidated Class Action Complaint on December 18, 2009, seeking unspecified monetary damages and interest. ArthroCare filed a Motion to Dismiss the Amended Consolidated Class Action Complaint
on February 16, 2010. On July 20, 2010, the federal court issued a ruling granting in part and denying in part ArthroCare's Motion to Dismiss, permitting certain claims related to
statements after December 11, 2007 to continue.



On September 23, 2008, a derivative action was filed in Texas State District Court against the Company, and its then current
directors and certain of its current and former officers. (Wieser v. Baker). In this action, one of the Company's shareholders alleged derivative claims
on behalf of the Company that its directors and officers breached their fiduciary duties to shareholders by allowing improper financial reporting, failing to maintain adequate financial controls over
revenue recognition, disseminating false financial statements, abuse of control, gross mismanagement, waste of corporate assets, and engaging in insider trading.

On
October 20, 2008, a derivative action was filed in Texas State District Court against the Company, its then directors and certain of its current and former executive officers.
(Bocklet v. Baker). In this action, one of the Company's shareholders alleged derivative claims on behalf of the Company that its directors and officers
breached their fiduciary duties to shareholders by failing to maintain adequate financial controls over revenue recognition, allowing improper financial reporting, disseminating false financial
statements, and engaging in insider trading.

On
October 27, 2008, a derivative action was filed in Texas State District Court against the Company, its then directors and certain of its current and former executive officers.
(Guthrie v. Baker). In this action, one of the Company's shareholders alleged derivative claims on behalf of the Company that its directors and officers
breached their fiduciary duties to shareholders by failing to maintain adequate financial controls over revenue recognition, allowing improper financial reporting, disseminating false financial
statements, and engaging in insider trading.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 11LITIGATION AND CONTINGENCIES (Continued)

On
March 18, 2009, these three shareholder derivative actions were consolidated and designated:In Re ArthroCare Corporation Derivative
Litigation, Case No. D-1-GN-08-3484 (consolidated), Travis County District Court. The consolidated action seeks financial
compensation, certain governance changes and removal of certain directors. On the Company's motion, the state shareholder derivative actions were stayed pending resolution of all motions to dismiss
the federal Amended Consolidated Class Action Complaint and class certification, if any, of a class in the federal Amended Consolidated Class Action Complaint.



On October 18, 2010, the Company, its directors' and officers' insurance carriers, and the plaintiffs in the Federal Court and
State Court derivative actions agreed in principal to a settlement. Under the terms of the proposed settlement, the director and officer insurers will collectively pay $8 million to the
Company, on behalf of the individuals named as defendants in the Federal Court and State Court derivative actions, to settle the State and Federal Derivative actions. The lawyers for the plaintiffs
will be entitled to seek an award of legal fees and costs from the Federal Court in an amount not to exceed $2.25 million. The agreement also provides that the directors' and officers' insurers
will pay the Company an additional $2 million for a broad mutual release by the Company and the insurers of any further rights or obligations under the directors' and officers' liability
insurance policies. The settlement calls for certain mutually acceptable governance changes and is subject to approval of the former officers and directors who are parties to the derivative actions,
an
agreement by those former officers and directors to release the Company's directors' and officers' liability insurance carriers of any further rights or obligations under the applicable directors' and
officers' liability insurance policies, the execution of a full and final settlement agreement, and the approval of the settlement of the derivative actions by the U.S. District Court, Western
District of Texas. Upon approval of this settlement agreement, we will incur any further litigation cost or damages allegedly resulting from or based on the restatement or related events, including
the ongoing DOJ investigation, the consolidated securities Class Action case and any ongoing indemnification obligations without the benefit of further insurance coverage.

NOTE 12MEZZANINE EQUITY

Series A 3.00% Redeemable Convertible Preferred Stock

On September 1, 2009, the Company issued and sold 75,000 shares of the Company's Series A 3 Percent Redeemable
Convertible Preferred Stock, par value $0.001 per share (the "Series A Preferred Stock"), for an aggregate purchase price of $75.0 million (the "Equity Financing") pursuant to the
Securities Purchase Agreement dated August 14, 2009, by and between the Company and OEP AC Holdings, LLC ("OEP").

The
Company used approximately $39 million of the proceeds to repay all outstanding indebtedness under a 5-year revolving credit agreement dated January 13,
2006 (the "Credit Agreement") and to cash collateralize a letter of credit. After the repayment of the Credit Agreement and the payment of fees and expenses related thereto and to the issuance of the
Preferred Stock to OEP, the Company had approximately $35 million of net proceeds, which the Company has used together with cash from operations to fund its general business requirements.

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NOTE 12MEZZANINE EQUITY (Continued)

Cumulative
dividends on the Series A Preferred Stock are payable-in-kind on a quarterly basis at the rate per annum of 3 percent of the liquidation
preference of $1,000 per share (the "Liquidation Preference") until October 1, 2014, (the "Dividend Duration Period"). As of December 31, 2010 and 2009, dividends of $3.1 million
and $0.8 million were accrued, respectively.

The
holders of the Series A Preferred Stock may convert their shares at any time, in whole or in part, at a rate of 66.667 shares of the Company's Common Stock per $1,000 of
Liquidation Preference of the Series A Preferred Stock, subject to customary anti-dilution adjustments (the "Conversion Rate"), representing an initial conversion price of $15.00
per share of Common Stock. If a conversion occurs prior to the expiration of the Dividend Duration Period, the number of shares of Common Stock received shall be increased for a make-whole
adjustment equal to the number of additional shares of Series A Preferred Stock the holder would have otherwise been paid during the Dividend Duration Period, multiplied by the Conversion Rate
(the "Make-Whole Adjustment"). As of December 31, 2010, none of the shares of Series A Preferred Stock have been converted into Common Stock.

The
Company may, at any time after September 1, 2010, cause an automatic conversion of all outstanding shares of Series A Preferred Stock upon no less than 10 days
prior notice if the closing sales price of the Common Stock equals or exceeds $35.00 per share (subject to adjustment in the event of a stock split, stock dividend, combination or other similar
recapitalization) for the prior 20 consecutive trading days, the Company is current on its reporting requirements with the SEC, the Company has an effective resale registration statement and related
prospectus that permits the Common Stock issued upon such automatic conversion to be immediately resold thereunder, and the current DOJ investigations of the Company by the U.S. Attorney's offices in
Florida and North Carolina have been terminated, settled or finally adjudicated.

No
conversion of Series A Preferred Stock will be permitted to the extent that any holder of Series A Preferred Stock would individually hold in excess of
19.99 percent of the Company's voting power after the proposed conversion, or to the extent that the holders of Series A Preferred Stock would hold in excess of 17.8 percent of
the Company's voting power in the aggregate, in each case solely attributable to their holdings of Series A Preferred Stock and any Common Stock received upon conversion thereof (such
limitations collectively, the "Conversion Cap"). Shares of Series A Preferred Stock not convertible as a result of the Conversion Cap shall remain outstanding and shall become convertible to
the extent the Conversion Cap no longer applies.

At
any time after September 1, 2014, or in connection with a change in control of the Company, holders of the Series A Preferred Stock may require the Company to redeem any
or all outstanding shares of Series A Preferred Stock at the Liquidation Preference amount plus any applicable
Make-Whole Adjustment. The Series A Preferred Stock has a maximum redemption value of $87.1 million.

The
Series A Preferred Stock will rank subordinate and junior in right of payments to all indebtedness of the Company. Holders of the Series A Preferred Stock will vote
with the Common Stock on an as-converted basis, including any applicable Make-Whole Adjustment. However, no holder of the Series A Preferred Stock shall be permitted to
vote more than an equivalent of 19.99 percent of the Company's outstanding voting securities solely attributable to its ownership of the Series A Preferred Stock and any Common Stock
received upon conversion thereof. Holders of a majority of the Series A Preferred Stock then outstanding, voting as a separate class, must approve any amendment to

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NOTE 12MEZZANINE EQUITY (Continued)

the
Company's articles of incorporation or bylaws that would adversely affect the rights of the holders of the Series A Preferred Stock.

The
Series A Preferred Stock can be converted into a maximum of 5,805,921 shares of the Company's common stock (the "Conversion Shares") representing a conversion price after the
Make-Whole Adjustment of $12.92 (the "Conversion Price"). The closing value of the Company's common stock on the date of issuance was $17.45 (the "Closing Price") resulting in an intrinsic
value of $4.65 per Conversion Share calculated as the Closing Price of $17.45 less the Conversion Price of $12.92 less approximately $0.7 million in proceeds which were used to pay expenses of
the investor. This resulted in a beneficial conversion feature of $27.0 million on the sale of the Series A Preferred Stock based on the intrinsic value of each Conversion Share
multiplied by the number of Conversion Shares. The beneficial conversion feature was immediately charged against net loss applicable to common stockholders as the Series A Preferred stock can
be converted into common stock at the option of the holder.

Gross
proceeds from the sale of the Series A Preferred Stock were reduced by direct issuance cost of $5.6 million, including the amount used to pay the expenses of the
investor, and will be accreted over a five year period using the effective interest rate method. Total accretion charges for the periods ended December 31, 2010 and 2009 were
$1.0 million and $0.3 million and were recorded as a dividend.

Pursuant
to the Registration Rights Agreement between us and the holders of our Series A Preferred Stock, the Company was required to file a registration statement on
Form S-1 prior to September 1, 2010, to register the resale of the Common Stock underlying the Series A Preferred Stock. If the registration statement was not filed or
became effective September 1, 2010, then the Company would be required to pay the holders of the Series A Preferred Stock an amount equal to 2.00 percent per annum of the
liquidation preference of the Series A Preferred Stock until the registration default was cured. The Company filed a registration statement on Form S-1 on May 13,
2010, a notice of effectiveness on August 8, 2010, and a Post Effective Amendment on December 6, 2010, to convert the registration statement on Form S-1 to a
registration statement on
Form S-3. Accordingly, as of December 31, 2010, the Company was in compliance with its registration statement obligations contained in the Registration Rights Agreement.

NOTE 13STOCKHOLDERS EQUITY

Treasury Stock

In 2010, 2009 and 2008, the Company issued 30,500 shares from treasury valued at $0.9 million, 81,524 shares valued at
$0.9 million, 78,669 shares valued at $0.9 million, respectively, in order to fulfill the Company's obligations to match employees' 401(k) contributions with shares of Company stock.

Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan, or ESPP. Under the ESPP plan, regular full-time employees (subject to
certain exceptions) may contribute up to 10 percent of base compensation to the semi-annual purchase of shares of the Company's common stock at 95 percent of the fair market
value at certain plan-defined dates. The Company reserved a total of 450,000 shares of

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NOTE 13STOCKHOLDERS EQUITY (Continued)

common
stock for issuance under the ESPP and as of December 31, 2010, 52,239 shares remained available for future purchases under the ESPP.

Stock Option Plans

In August 1999, the Company adopted the Non-statutory Option Plan ("1999 Plan") which expired in 2009. Awards that were
granted prior to the expiration of the 1999 Plan will continue to operate in accordance with the terms of the 1999 Plan.

In
May 2003, the Company adopted the 2003 Incentive Stock Plan ("2003 Plan") under which the Board of Directors is authorized to grant incentive and non-statutory stock
option awards and restricted stock awards to employees and consultants. The 2003 Plan has been amended with approval of the Company's stockholders to increase the number of shares available for
issuance to a total of 5,900,000 shares. As of December 31, 2010, the Company had 3,247,439 shares available for future grant under the 2003 Plan.

Options
granted under the 1999 Plan and the 2003 Plan generally become exercisable over a 36-month period for the current CEO, 48-month period for all other employees and
restricted stock awards generally become exercisable over a three Board of Directors and five year period for all other employees. All options and awards granted under each of the Company's plans have
a legal life of seven years, effective February 2005. Prior to that, options granted had a legal life of 10 years from the grant date. The Company has historically issued new shares upon
exercises of stock options and vesting of restricted stock.

The
1999 Plan and the 2003 Plan authorize the Company to issue Stock Appreciation Rights ("SARs") to directors, employees and consultants of the Company. SARs granted under the plans
have an
expiration term of seven years and generally become exercisable over a 48-month period.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13STOCKHOLDERS EQUITY (Continued)

Activity
for all stock based compensation plans for the years ended December 31, 2010, 2009 and 2008 is as follows:

Stock Options Outstanding

Restricted Stock Awards OutstandingNumber of
Shares

Weighted-
Average Exercise
Price

Number of
Shares

Weighted-
Average Grant
Date Fair ValueBalance as of December 31, 2007


2,995,245

$
28.78


358,870

$
35.41Granted


81,686

$
42.85


128,507

$
43.21Exercised/vested


(74,590
)
$
21.89


(133,979
)
$
20.71Canceled/forfeited


(164,656
)
$
36.76


(54,006
)
$
42.28Balance as of December 31, 2008


2,837,685

$
28.90


299,392

$
44.10Granted


1,153,462

$
23.50


177,619

$
23.50Exercised/vested


(22,234
)
$
20.38


(52,677
)
$
39.88Canceled/forfeited


(1,110,135
)
$
28.04


(62,301
)
$
44.43Balance as of December 31, 2009


2,858,778

$
27.12


362,033

$
34.55Granted


102,100

$
27.38


79,708

$
28.24Exercised/vested


(115,254
)
$
17.96


(87,670
)
$
32.35Canceled/forfeited


(245,192
)
$
30.30


(27,596
)
$
44.78Balance as of December 31, 2010


2,600,432

$
27.24


326,475

$
32.74


Net
cash proceeds from the exercise of stock option awards were $1.9 million, $0.4 million, and $1.2 million for the years ended December 31, 2010, 2009 and
2008, respectively.

As
of December 31, 2010, there was $8.4 million of unrecognized compensation expense related to unvested stock option awards granted under the Company's stock plans. That
unrecognized cost is expected to be recognized over a weighted average period of 2.6 years. At December 31, 2010, the aggregate intrinsic value associated with these options was
$16.2 million.

During
the year ended December 31, 2010, the Company issued 79,708 shares of restricted common stock, which were valued at $2.1 million when reduced by estimated
forfeitures. At December 31, 2010, there was total unrecognized compensation expense of $5.8 million, net of estimated forfeitures, related to unvested restricted stock awards and units.
That unrecognized cost is expected to be recognized over a weighted average period of 2.7 years. At December 31, 2010, the aggregate intrinsic value associated with the unvested
restricted stock awards was $10.1 million.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13STOCKHOLDERS EQUITY (Continued)

Stock
option awards outstanding and currently exercisable by exercise price for all plans at December 31, 2010 were as follows:

Options Outstanding

Options ExercisableRange of Exercise Prices

Shares
Outstanding

Weighted-Average
Remaining
Contractual Life

Weighted-
Average
Exercise Price

Options
Exercisable

Weighted-
Average
Exercise Price$  9.84 - $16.10


301,898


1.85

$
13.49


301,898

$
13.49$17.30 - $22.77


205,851


0.93

$
21.94


205,851

$
21.94$23.50 - $23.50


1,026,218


5.85

$
23.50


379,262

$
23.50$24.38 - $28.42


292,378


3.49

$
26.20


210,465

$
26.05$28.70 - $36.08


324,544


2.18

$
33.90


297,267

$
33.99$37.24 - $44.04


287,633


3.30

$
41.23


263,757

$
41.19$44.50 - $48.05


142,038


2.05

$
46.41


138,140

$
46.46$50.62 - $54.15


19,872


3.59

$
51.09


16,137

$
51.09Total


2,600,432


3.77

$
27.24


1,812,777

$
28.24


Valuation and Expense Information

The following table summarizes the reporting of total stock based compensation expense resulting from employee stock options, including
stock appreciation rights, and restricted stock awards for the years ended December 31, 2010, 2009 and 2008 (in thousands):

Year Ended December 31,2010

2009

2008Cost of product sales

$
1,401

$
1,079

$
1,309Research and development


849


671


1,208Sales and marketing


2,282


2,403


3,170General and administrative


3,469


2,404


4,191Stock based compensation expense before income taxes


8,001


6,557


9,878Income tax benefit


2,360


2,227


3,431Total stock-based compensation expense, net of income taxes

$
5,641

$
4,330

$
6,447


The
weighted average fair value of each option granted to employees during the years ended December 31, 2010, 2009 and 2008 were estimated at $12.76, $10.73 and $20.63,
respectively. The fair value of each stock option was estimated on the grant date using the Black Scholes option pricing

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13STOCKHOLDERS EQUITY (Continued)

model
with the following weighted average assumptions for the years ended December 31, 2010, 2009 and 2008:

2010

2009

2008Expected term (in years)


4.4


4.2


3.8Expected volatility


56
%

56
%

66
%Risk-free interest rate


1.7
%

1.9
%

2.6
%Expected dividends











Stock-based
compensation expense recognized has been reduced for estimated forfeitures at a rate of 5.7 percent based on the Company's historical experience. Forfeitures are
estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

NOTE 14LOAN RECEIVABLE

The Company loaned $2.5 million to a sterilization subcontractor with proceeds used to construct the subcontractor's Costa Rican sterilization facility. The loan, which is
recorded in other assets in the accompanying consolidated balance sheet, bears interest at a fixed rate of 7.0 percent and calls for repayment during the period of 2010 through 2015. The loan
is secured by all of the subcontractor's assets in Costa Rica. The balance of the loan receivable, including accrued interest, at December 31, 2010 and 2009 is $2.5 million and
$2.7 million respectively. The Company has not recorded an allowance for collectability on the loan, and there are no amounts past due.

NOTE 15INCOME TAXES

The components of income (loss) before income taxes were as follows (in thousands):

Year Ended December 31,2010

2009

2008Domestic

$
29,433

$
(2,949
)
$
(30,961
)Foreign


20,973


790


(1,796
)Total

$
50,406

$
(2,159
)
$
(32,757
)


The
amounts identified above exclude loss from discontinued operations before income taxes of $0.6 million, $0.7 million and $10.1 million for 2010, 2009 and 2008,
respectively.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 15INCOME TAXES (Continued)

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

Year Ended December 31,2010

2009

2008Current:Federal

$
7,801

$
845

$
579State


1,221


205


903Foreign


981


748


859Total current


10,003


1,798


2,341Deferred:Federal


3,088


2,033


(8,133
)State


(8
)

(485
)

(2,196
)Foreign


(195
)

(209
)

(187
)Total deferred


2,885


1,339


(10,516
)Total income tax provision (benefit)

$
12,888

$
3,137

$
(8,175
)


The
amounts identified above exclude the provision (benefit) for income tax from discontinued operations. These amounts are ($0.2 million), ($0.3 million), and
$0.3 million for 2010, 2009 and 2008, respectively.

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

Year Ended December 31,2010

2009

2008Tax at federal statutory rate

$
17,642

$
(756
)
$
(11,465
)State income taxes


890


(70
)

(306
)Differences in foreign tax rates


(6,555
)

289


1,060Research and development credits


(1,276
)

(940
)

(1,282
)Stock-based compensation


693


330


419Nondeductible expenses


324


391


470Goodwill impairment








2,188Accruals for intercompany payments


1,814


3,867


312Other


(644
)

26


429Total income tax provision (benefit)

$
12,888

$
3,137

$
(8,175
)


The
Company's tax expense for the period 2008 through 2010 was significantly reduced due to a tax holiday for its Costa Rica manufacturing operations. Under its holiday, the Company will
not be subject to Costa Rican income tax until January 2016. At that time, the Company will become subject to the normal Costa Rican corporate taxes, which are currently 30 percent. Without the
Costa Rican tax holiday, the increase in income tax and the impact on earnings (loss) per share would have been

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NOTE 15INCOME TAXES (Continued)

$2.7 million
and $0.10, $2.7 million and $0.10 and $2.4 million and $0.09, respectively, for 2010, 2009 and 2008, respectively.

December 31,2010

2009Federal loss carryover

$
10,284

$
18,914Portion related to unrecognized stock-based compensation deductions





401State loss carryover





6,550Portion related to unrecognized stock-based compensation deductions





401Federal research and development credit carryover


7,111


6,988State research and development credit carryover


8,972


8,505


The
Company's federal net operating loss carryforwards will expire during the period 2020 through 2024 if not utilized. The Company's federal research and development credit
carryforwards will expire during the period 2012 through 2030. The state research and development credits are not subject to expiration.

Under
U.S. tax law, certain changes in the Company's ownership could result in an annual limitation on the amount of net operating loss carryforwards and income tax credits that could be
utilized to offset future tax liabilities. At December 31, 2010, all of the Company's federal net operating loss carryforwards of approximately $10.3 million are subject to an annual
utilization limit of approximately $0.9 million pursuant to IRC Section 382.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 15INCOME TAXES (Continued)

The
Company's deferred tax assets and liabilities consist of the following (in thousands):

December 31,2010

2009Deferred tax assets:Net operating loss carryovers, net of reserves

$
3,600

$
7,555R&D and other tax credits, net of reserves


12,943


12,610Allowances and reserves


8,794


7,183Deferred revenue


14,130


17,116Alternative Minimum Tax credit


822


371Stock-based compensation


6,022


7,303Other


454


10Gross deferred tax assets


46,765


52,148Valuation allowance





(292
)Subtotal


46,765


51,856Deferred tax liabilities:Property and equipment


(3,107
)

(3,692
)Non-goodwill intangibles


(3,191
)

(4,948
)Other


(149
)

(13
)Gross deferred tax liabilities


(6,447
)

(8,653
)Net deferred tax assets

$
40,318

$
43,203


During
2010, the Company utilized $0.3 million of deferred tax assets which had a full valuation allowance as of the beginning of the year.

Income
tax benefits resulting from employee stock compensation of $1.2 million, $1.4 million, and $3.8 million, were credited to additional paid-in
capital for the years ended December 31, 2010, 2009 and 2008, respectively. Additionally, in 2010, the Company made an adjustment to reduce additional paid-in capital by
$3.2 million to reflect the impact of the amendment and filing of prior year returns for 2006 through 2009.

Deferred
U.S. income taxes and foreign withholding taxes are not provided on the undistributed cumulative earnings of foreign subsidiaries because those earnings are considered to be
permanently reinvested in those operations. The permanently reinvested undistributed earnings were approximately $30.1 million as of December 31, 2010. The tax impact resulting from a
distribution of these earnings would be approximately $11.4 million.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 15INCOME TAXES (Continued)

The
Company's change in uncertain tax benefit reserves during 2010, 2009 and 2008 were as follows (in thousands):

2010

2009

2008Balance at January 1

$
7,078

$
8,490

$
8,451Additions for tax positions of current period


2,252


652


632Additions for tax positions of prior years


7,384





Decreases for tax positions of prior years


(236
)

(2,064
)

(593
)Balance at December 31

$
16,478

$
7,078

$
8,490


As
of December 31, 2010, total uncertain tax positions amounted to $16.5 million. Should the tax positions prove successful, the Company's tax expense would be reduced by
$15.2 million (net of federal benefit). $11.6 million of the uncertain tax position reserves is included in noncurrent liabilities, while the remaining $3.6 million of uncertain
tax positions reduce the research and development carry-forward deferred tax assets. No interest or penalty provisions have been recorded as of December 31, 2010 as the Company had net
operating loss carryovers available.

In
February 2008, the Company submitted an application with the Internal Revenue Service (the "IRS") for an Advanced Pricing Agreement, ("APA"), relating to the transfer pricing policies
between the Company and its foreign subsidiaries. The Company has subsequently withdrawn from the process.

In
2010, the Company was notified by the IRS of its intention to examine the 2006 federal income tax return. No adjustments have yet been proposed; however, it is expected that the
examination will not be completed until 2012.

The
Company is subject to audit by the IRS and California Franchise Tax Board for the years 1994 through 2010 as a result of its net operating loss and credit carryover positions, and by
the Texas State Comptroller for the years 2006 through 2010. As the Company has operations in most other U.S. states, other state tax authorities may assess deficiencies related to prior year
activities; however, the years open to assessment vary with each state. The Company also files income tax returns for non-U.S. jurisdictions; the most significant of which are the UK,
Sweden, and Germany. The years open to adjustment for the UK and Germany are 2006 through 2010. The years open to adjustment for Sweden are 2008 and 2010.

In
2009, the Company had adjusted its accrued inter-company payments for all open years as a result of the issuance of new U.S. cost sharing regulations. As a result of the realization
of changes to the payment amounts, approximately $1.9 million of the income tax reserve was reversed in 2009. The impact of this change resulted in approximately $3.5 million of the
additional income tax expense during first quarter of 2009.

In
2010, the Company amended or filed its U.S. income tax returns for its 2006, 2007, 2008 and 2009 tax years. The Company's tax filings were based on its historical intercompany cost
sharing and transfer pricing policies whereas the tax liability accrued in prior years was based on certain possible modifications to these policies. The excess income tax payable over the amount
reported in the Company's income tax returns of approximately $7.4 million has been recorded as an addition to uncertain tax positions of prior years during 2010.

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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 16EMPLOYEE BENEFIT PLAN

The Company maintains a Retirement Savings and Investment Plan ("401(k) Plan"), which covers all U.S.-based employees. Eligible employees may defer salary (before tax) up to a federally
specified maximum. Management, at its discretion, may make matching contributions in stock on behalf of the participants in the 401(k) Plan. The Company matched up to $2,500 in Company stock annually
in 2010, 2009 and 2008. The Company matched approximately $0.9 million of employee contributions to the 401(k) Plan in each of the years ended December 31, 2010, 2009 and 2008.

NOTE 17FAIR VALUE MEASUREMENTS

At December 31, 2010, the assets measured at fair value on a recurring basis consisted of short-term investments of $0.1 million, which were fair valued based
on quoted prices from active markets for identical assets. The Company's short-term investments consist primarily of corporate bonds. The Company had no assets or liabilities that were
measured at fair value on a non-recurring basis. The estimated fair value of the Company's notes payable and loan receivable approximate the carrying value presented in its consolidated
balance sheet based on discounting the expected future cash flows using current market rates as of December 31, 2010.

NOTE 18SEGMENT INFORMATION

The Company has organized its marketing and sales efforts based on four operating segments which are aggregated into one reportable segmentthe development, manufacture and
marketing of disposable devices for less invasive surgical procedures and implants. Each of the Company's operating segments has similar economic characteristics, technology, manufacturing processes,
customers, distribution and marketing strategies, regulatory environments, and shared infrastructures. These operating segments are Sports MedicineAmericas, ENTAmericas,
Other-Americas and International.

Product
sales by operating segments and product area for the periods shown were as follows (in thousands):

Year Ended December 31, 2010

Year Ended December 31, 2009

Year Ended December 31, 2008Americas

International

Total
Product
Sales

Americas

International

Total
Product
Sales

Americas

International

Total
Product
SalesSports Medicine

$
160,859

$
71,120

$
231,979

$
147,169

$
62,533

$
209,702

$
142,856

$
56,676

$
199,532ENT


79,019


15,270


94,289


72,375


13,299


85,674


68,412


12,072


80,484Other


4,122


8,367


12,489


5,231


7,886


13,117


5,772


9,330


15,102Total Product Sales

$
244,000

$
94,757

$
338,757

$
224,775

$
83,718

$
308,493

$
217,040

$
78,078

$
295,118


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 or regional

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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 18SEGMENT INFORMATION (Continued)

area
where the Company's customer is domiciled. Product sales by geography for the periods shown were as follows (in thousands):

Year Ended December 31,2010

2009

2008United States

$
226,383

$
212,766

$
208,554Non-United States(1)


112,374


95,727


86,564Total product sales

$
338,757

$
308,493

$
295,118


(1)No
additional locations are individually significant.


Long-lived
assets by geography at the balance sheet dates shown were as follows (in thousands):

December 31,2010

2009United States

$
27,285

$
31,791Costa Rica


12,750


13,693Other


5,729


6,719Total long-lived assets

$
45,764

$
52,203


NOTE 19QUARTERLY FINANCIAL INFORMATION (unaudited)

The following tables present certain unaudited condensed consolidated quarterly financial information for each quarter in the years ended December 31, 2010 and 2009. In the
Company's opinion, this unaudited quarterly information has been prepared on the same basis as the consolidated

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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 19QUARTERLY FINANCIAL INFORMATION (unaudited) (Continued)

financial
statements and includes all adjustments necessary to state fairly the information for the periods presented (in thousands, except per share data).

Year Ended December 31, 2010First Quarter

Second Quarter

Third Quarter

Fourth QuarterRevenues:Product sales

$
85,165

$
83,066

$
82,917

$
87,609Royalties, fees and other


3,949


4,113


3,536


5,024Total revenues


89,114


87,179


86,453


92,633Cost of product sales


26,579


28,358


28,632


27,182Gross profit


62,535


58,821


57,821


65,451Operating expenses:Research and development


8,879


8,414


9,244


9,309Sales and marketing


26,855


26,887


26,156


27,954General and administrative


8,970


9,083


9,283


11,155Amortization of intangible assets


1,315


1,302


1,315


1,305Reimbursement services


21


24


25


22Investigation and restatement-related costs


1,043


528


317


952Total operating expenses


47,083


46,238


46,340


50,697Income from operations


15,452


12,583


11,481


14,754Interest and other income (expense), net


(3,061
)

(1,164
)

1,227


(866
)Income from continuing operationsbefore income taxes


12,391


11,419


12,708


13,888Income tax provision


3,314


3,134


3,536


2,904Net income from continuing operations


9,077


8,285


9,172


10,984Income (loss) from discontinued operations, net of taxes


(250
)

(203
)

85


(66
)Net income


8,827


8,082


9,257


10,918Accrued dividend, beneficial conversionfeature and accretion charges on Series A3% Redeemable Convertible Preferred Stock


(802
)

(812
)

(820
)

(830
)Net income attributable to common stockholders

$
8,025

$
7,270

$
8,437

$
10,088Weighted-average shares outstanding:Basic


26,922


26,976


27,017


27,059Diluted


27,221


27,352


27,323


27,446Earnings per share from continuing operations applicable to common stockholders:Basic

$
0.25

$
0.23

$
0.25

$
0.31Diluted

$
0.25

$
0.22

$
0.25

$
0.30Earnings per share applicable to common stockholders:Basic

$
0.25

$
0.22

$
0.26

$
0.31Diluted

$
0.24

$
0.22

$
0.25

$
0.30


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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 19QUARTERLY FINANCIAL INFORMATION (unaudited) (Continued)

Year Ended December 31, 2009First Quarter

Second Quarter

Third Quarter

Fourth QuarterRevenues:Product sales

$
73,575

$
75,443

$
74,716

$
84,759Royalties, fees and other


3,159


3,230


3,066


6,169Total revenues


76,734


78,673


77,782


90,928Cost of product sales


21,288


21,555


23,684


24,413Gross profit


55,446


57,118


54,098


66,515Operating expenses:Research and development


8,136


9,262


9,019


8,786Sales and marketing


28,475


29,224


27,517


29,323General and administrative


11,932


12,157


11,967


9,978Amortization of intangible assets


1,334


1,337


1,330


1,308Reimbursement services


168


98


46


41Investigation and restatement-related costs


8,724


7,306


9,293


6,363Total operating expenses


58,769


59,384


59,172


55,799Income (loss) from operations


(3,323
)

(2,266
)

(5,074
)

10,716Interest and other income (expense), net


(1,338
)

(1,929
)

(1,653
)

2,708Income (loss) from continuing operations before income taxes before income taxes


(4,661
)

(4,195
)

(6,727
)

13,424Income tax provision (benefit)


1,757


(1,597
)

(2,573
)

5,550Net income (loss) from continuing operations


(6,418
)

(2,598
)

(4,154
)

7,874Loss from discontinued operations, net of taxes


(89
)

(91
)

(273
)

(28
)Net income (loss)


(6,507
)

(2,689
)

(4,427
)

7,846Accrued dividend, beneficial conversion feature and accretion charges on Series A 3% Redeemable Convertible Preferred Stock








(27,252
)

(793
)Net income (loss) attributable to common stockholders

$
(6,507
)
$
(2,689
)
$
(31,679
)
$
7,053Weighted-average shares outstanding:Basic


26,746


26,810


26,838


26,857Diluted


26,746


26,810


26,838


27,024Earnings (loss) per share from continuing operations applicable to common stockholders:Basic

$
(0.24
)
$
(0.10
)
$
(1.17
)
$
0.22Diluted

$
(0.24
)
$
(0.10
)
$
(1.17
)
$
0.22Earnings (loss) per share applicable to common stockholders:Basic

$
(0.24
)
$
(0.10
)
$
(1.18
)
$
0.22Diluted

$
(0.24
)
$
(0.10
)
$
(1.18
)
$
0.21


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ARTHROCARE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 20SUPPLEMENTAL CASH FLOW INFORMATION

Information below is in thousands:

Year Ended December 31,2010

2009

2008Cash paid for interest

$


$
2,312

$
2,991Cash paid for income taxes


1,802





4,553Non cash Series A Preferred Stock beneficial conversion feature and accretion charges


3,264


28,045





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Table of Contents

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

None.

ITEM 9A.    CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Securities Exchange Act of 1934, management has evaluated, with the
participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Disclosure
controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed
to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our CEO and CFO, as
appropriate, to allow timely decisions regarding our required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes 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 was required to apply its judgment in evaluating and
implementing possible controls and procedures.

Pursuant
to this evaluation, our CEO and CFO concluded that, as of December 31, 2010, the end of the period covered by this report, our disclosure controls and procedures were
effective at the reasonable assurance level.

MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management, under the supervision of the CEO and CFO, is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting, as defined in Rules 13a-15(f) under the Exchange Act, refers to a process designed by, or under the supervision of,
our CEO and CFO, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external reporting purposes in accordance with GAAP and includes those policies and procedures that:



Internal
control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial
reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a

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risk
that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the
financial reporting process, and it is possible to design into the process safeguards to reduce, though not eliminate, the risk.

Management
assessed the effectiveness of our internal control over financial reporting as of December 31, 2010, using the framework set forth in the report of the Treadway
Commission's Committee of Sponsoring Organizations (COSO), "Internal ControlIntegrated Framework." As a result of that assessment, management has concluded that our internal control over
financial reporting was effective as of December 31, 2010.

PricewaterhouseCoopers LLP,
the independent registered public accounting firm that audited the consolidated financial statements included in this Report on
Form 10-K for the year ended December 31, 2010, issued an audit report on the effectiveness of our internal control over financial reporting as of December 31, 2010,
which report is set forth on page 45 of this annual report.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

Management has evaluated, with the participation of our CEO and CFO, whether any changes in our internal control over financial
reporting that occurred during the quarter ended December 31, 2010 have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based
on that evaluation, management concluded that there have been no changes in ArthroCare's internal control over financial reporting during the quarter ended December 31, 2010 that has materially
affected, or is reasonably likely to materially affect, ArthroCare's internal control over financial reporting.

REMEDIATION OF PREVIOUSLY EXISTING MATERIAL WEAKNESSES

Management previously concluded that we did not maintain an effective control environment with the sufficient complement of personnel,
procedures for gathering and disseminating information pertinent to our financial reporting or activities (information and communication) that effectively monitor the performance of controls.
Management previously concluded that we did not maintain effective controls related to our period-end financial reporting process to provide reasonable assurance that (a) account
reconciliations were performed properly and that reconciliations and journal entries were consistently reviewed for completeness and accuracy; (b) foreign currency transactions and balances
were valued accurately; (c) stock-based compensation was accurately recorded; and (d) operating expenses were recognized in the proper period which also affected the accuracy and
valuation of certain intangible assets, prepaid expenses, and accrued liabilities. Management also previously concluded that we did not maintain effective controls related to our accounting for
business acquisitions.

Remediation
measures have been implemented to address the above-described material weaknesses throughout the year. These measures included adding personnel to the accounting function
with knowledge, experience and training suitable to our financial reporting requirements and changing the accounting organization to better align personnel to specific accounting activities and
responsibilities; strengthening the communication flow between business and accounting personnel to provide a sufficient level of assurance that essential data required to properly apply GAAP to our
transactions is completely and accurately communicated to our accounting personnel in a timely manner; enhancing our financial reporting policies, procedures and processes involving account
reconciliations, journal entries and corresponding supporting documentation; and changing monitoring practices concerning the review of key accounting controls and processes to ensure consistent
compliance to established procedures and policies. Throughout 2010, management has continued to monitor, evaluate and improve upon these measures as previously reported under "Remediation Activities"
in Item 4 in our

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Form 10-Q
for each of the quarters ended September 30, 2010, June 30, 2010, and March 31, 2010. As of the date of this filing, management concluded that the
previously disclosed remediation activities have been effectively functioning in place for a sufficient period of time, including the fourth quarter, to demonstrate reliance in their design and
implementation. Accordingly, management believes that the aforementioned material weaknesses relating to the control environment, information and communication, monitoring the performance of controls,
the period-end financial reporting process, and acquisition accounting have been remediated as of December 31, 2010.

ITEM 9B.    OTHER INFORMATION

None.

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PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Effective August 14, 2009, our Board of Directors adopted amendments to our Code of Business Conduct and Ethics, or the Code.
These amendments provide that our employees may not provide non-employee health care professionals with gifts, entertainment or recreational items, regardless of value. Limited exceptions
to this general rule are made for modest meals incidental to a scientific presentation and educational items of modest value that serve a genuine educational function and benefit patients. The
amendments also set forth the roles of our new General Counsel and new Compliance Officer in certain governance matters.

Originally
adopted in 2004 to qualify as a "code of ethics" within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder, the Code was
amended to qualify as well as a "code of conduct" under the current Federal Sentencing Guidelines and "Compliance Program Guidance for Pharmaceutical Manufacturers" 68 FR 23731
(May 5, 2003) (applicable to medical device companies according to end note 5) published by the Office of Inspector General for the Department of Human Services. The Code applies to all
of our directors, officers, employees and agents. It also serves as an essential element of our Corporate Compliance Program, as announced in August 2009. A copy of the Code is available on our
website at www.ArthroCare.com. We intend to post any amendments to, or waivers from, if any, our Code on our website.

All
additional information required by this item is included in our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our
annual meeting of stockholders scheduled to be held May 12, 2011 and is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

All information required by this item is included in our definitive Proxy Statement to be filed pursuant to Regulation 14A under
the Exchange Act of 1934 in connection with our annual meeting of stockholders scheduled to be held May 12, 2011 and is incorporated herein by reference.

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

Except as set forth below regarding securities authorized for issuance under equity compensation plans, the information required by
this item is included in our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders scheduled to be held
May 12, 2011 and is incorporated herein by reference.

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EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of December 31, 2010 regarding the common stock that may be issued upon the exercise
of options, warrants and rights under our existing equity compensation plans.

Plan category

Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights

Weighted average
exercise price of
outstanding options,
warrants and rights

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected
in the first column)Equity compensation plans approved by security holders(1)


2,979,146


28.74


3,247,439Equity compensation plans not approved by security holders(2)


601,001


27.34


Total


3,580,147


28.50


3,247,439


(1)Includes
52,239 shares remaining available for future issuance under the Company's Employee Stock Purchase Plan.(2)Consists
of shares issuable under our Amended and Restated Non-statutory Option Plan, which does not require the approval of, and has not been
approved by, our stockholders.


ITEM 13.    CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Under its charter, the Audit Committee is responsible for reviewing and approving all related party transactions, regardless of the
dollar amount involved, that, if entered into, would be required to be disclosed under the rules and regulations of the SEC. No member of the Audit Committee having an interest in a related party
transaction may participate in any decision regarding that transaction.

All
additional information required by this item is included in our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our
annual meeting of stockholders scheduled to be held May 12, 2011 and is incorporated herein by reference.

DIRECTOR INDEPENDENCE

Our Board of Directors, with the assistance of the Nominating and Corporate Governance Committee, has reviewed the independence of all
current Board members under the NASDAQ listing standards and our Corporate Governance Guidelines. The Board of Directors has determined that all current Board members, other than David Fitzgerald,
meet the general requirements to be independent directors under the NASDAQ listing standards and our Corporate Governance Guidelines. Based on its review, the Board of Directors has also determined
that Terrence E. Geremski, James G. Foster and Tord B. Lendau meet the specific independence requirements to serve on the Audit Committee under the Nasdaq listing standards and the
Securities Exchange Act.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

All information required by this item is included in our definitive Proxy Statement to be filed pursuant to Regulation 14A under
the Exchange Act, in connection with our annual meeting of stockholders scheduled to be held May 12, 2011 and is incorporated herein by reference.

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PART IV

ITEM 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1).  Documents filed as part of this annual report.



(a)(2).  Financial statement schedule



(a)(3).  Exhibits

2.1

Agreement and Plan of Merger, dated as of September 3, 2004, by and among ArthroCare Corporation, Opus Medical, Inc., OC Merger Sub Corporation, OC Acquisition Sub LLC, and James W. Hart and
Steven L. Gex, as the Shareholders' Agents (Incorporated herein by reference to Exhibit 2.1 to the registrant's Current Report on Form 8-K filed on November 18, 2004).2.2

Amendment No. 1, dated as of October 6, 2004, to the Agreement and Plan of Merger, dated as of September 3, 2004, by and among ArthroCare Corporation, Opus Medical, Inc., OC Merger Sub Corporation,
OC Acquisition Sub LLC, and James W. Hart and Steven L. Gex, as the Shareholders' Agents (Incorporated herein by reference to Exhibit 2.2 to the registrant's Current Report on Form 8-K filed on November 18,
2004).2.3

Asset Purchase Agreement, dated as of August 16, 2005, by and among ArthroCare Corporation, a Delaware corporation, ArthroCare (Deutschland) GmbH, a corporation organized under the laws of Germany and a
wholly-owned subsidiary of ArthroCare, ArthroCare UK, Ltd., a corporation registered in England & Wales and a wholly-owned subsidiary of ArthroCare, Applied Therapeutics, Inc., a Florida corporation, Applied Therapeutics, Ltd.,
 a corporation registered in England & Wales, Applied Therapeutics GmbH, a corporation organized under the laws of Germany and BHK Holding, a corporation organized under the laws of the Cayman Islands. (Incorporated herein by reference
to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on August 22, 2005).3.1

Restated Certificate of Incorporation of the Company. (Incorporated herein by reference to Exhibit 3.1 filed previously with the Company's Annual Report on Form 10-K for the period ended December 30,
2000).


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3.2

Amended and Restated Bylaws of the Company. (Incorporated herein by reference to Exhibit 3.1 filed previously with the Company's Current Report on Form 8-K filed on August 17, 2009).4.1

Specimen Common Stock Certificate. (Incorporated herein by reference to Exhibit 4.1 filed previously with the Company's Registration Statement on Form 8-A (Registration No. 000-27422)).4.2

Certificate of Designations of Series A 3.00 percent Convertible Preferred Stock (Par Value $0.001) (Incorporated herein by reference to Exhibit 99.2 filed previously with the Company's Current Report
on Form 8-K filed on August 17, 2009).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 Company's Registration Statement on
Form S-1 (Registration No. 33-80453)).10.2*

Incentive Stock Plan and form of Stock Option Agreement there under. (Incorporated herein by reference to Exhibit 10.2 filed previously with the Company's Registration Statement on Form S-1 (Registration
No. 33-80453)).10.3*

Director Option Plan and form of Director Stock Option Agreement there under. (Incorporated herein by reference to Exhibit 10.3 filed previously with the Company's Registration Statement on Form S-1
(Registration No. 33-80453)).10.4*

Employee Stock Purchase Plan and forms of agreements there under. (Incorporated herein by reference to Exhibit 10.4 filed previously with the Company'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 Company's Registration Statement on Form S-1 (Registration No. 33-80453)).10.6

Litigation Settlement Agreement, between the Company and ETHICON Inc. dated June 24, 1999 (Incorporated herein by reference to Exhibit 10.33 previously filed with the Company's Quarterly Report on
Form 10-Q for the period ended July 3, 1999).10.7

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 Company's Quarterly Report on
Form 10-Q for the period ended July 1, 2000).10.8*

Amendment to the 1995 Director Option Plan (Incorporated herein by reference to Exhibit 4.3 to the Company's Statement on Form S-8 filed on August 8, 2000).10.9*

Amended and Restated 2003 Incentive Stock Plan (Incorporated herein by reference to the Company's Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on March 23,
2010.10.10*

Second Amendment to the 1995 Director Option Plan (Incorporated herein by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on
May 8, 2003).10.11

Agreement and Plan of Merger, dated as of October 23, 2003, as amended by Amendment No. 1 to Agreement and Plan of Merger, dated as of January 5, 2004, by and among ArthroCare Corporation, Alpha Merger
Sub Corporation and Medical Device Alliance Inc. (Incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on February 11, 2004).


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10.12

Contingent Value Rights Agreement, dated as of January 28, 2004, by and among ArthroCare Corporation, Alpha Merger Sub Corporation, Medical Device Alliance Inc., Wells Fargo Bank, N.A. and Frank Bumstead
(Incorporated herein by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on February 11, 2004).10.13

Form of Stockholder Waiver Agreement, dated as of October 23, 2003, by each of Vegas Ventures, LLC, Jeffrey Barber and Howard Preissman (Incorporated herein by reference to Exhibit 99.3 to the Company's
Current Report on Form 8-K filed on October 31, 2003).10.14

Form of Option Agreement under the Amended and Restated 2003 Incentive Plan (Incorporated herein by reference to Exhibit 10.48 to the Company's Current Report on Form 8-K filed on February 22,
2005).10.15

Form of Restricted Stock Bonus Agreement under the Amended and Restated Director Option Plan (Incorporated herein by reference to Exhibit 10.49 to the Company's Current Report on Form 8-K filed on
February 22, 2005).10.16

Form of Restricted Stock Bonus Agreement under the Amended and Restated 2003 Incentive Stock Plan (Incorporated herein by reference to Exhibit 10.50 to the Company's Current Report on Form 8-K filed on
February 22, 2005).10.17

Settlement and License Agreement between the Company, ArthroCare Corporation Cayman Islands, a corporation organized under the laws of the Cayman Islands and a wholly-owned subsidiary of the Company and
Smith & Nephew, Inc., dated September 2, 2005 (Incorporated herein by reference to Exhibit 10.52 to the Company's Quarterly Report on Form 10-Q filed November 3, 2005).10.18

Supply and Distribution Agreement between the Company, ArthroCare Corporation Cayman Islands, a corporation organized under the laws of the Cayman Islands and a wholly-owned subsidiary of the Company and
Smith & Nephew, Inc., dated September 2, 2005 (Incorporated herein by reference to Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q filed November 3, 2005).10.19

Lease Agreement between Lantana Office Properties I, L.P. and the Company (Incorporated herein by reference to Exhibit 10.57 to the Company's Quarterly Report on 10-Q filed on June 30,
2006).10.20

Settlement and License Agreement between the Company, ArthroCare Corporation Cayman Islands and MarcTec, LLC effective January 3, 2007 (Incorporated herein by reference to the Company's Annual Report on
Form 10-K filed February 27, 2007).10.21*

Form of "Amended VP Continuity Agreement" between ArthroCare Corporation and its Vice Presidents (Incorporated herein by reference to Exhibit 10.61 to the Company's Current Report on Form 8-K filed on
April 5, 2007).10.22*

Form of "Amended Senior VP Continuity Agreement" between ArthroCare Corporation and its Senior Vice Presidents (Incorporated herein by reference to Exhibit 10.62 to the Company's Current Report on Form 8-K
filed on April 5, 2007).10.23

Amendment dated September 20, 2007 to Supply and Distribution Agreement between the Company ArthroCare Corporation Cayman Islands and Smith & Nephew, Inc. (Incorporated herein by reference to
Exhibit 10.31 to the Company's Annual Report on Form 10-K filed on November 18, 2009).10.24

Stock Purchase Agreement, dated as of December 31, 2007, by and between ArthroCare Corporation and DiscoCare, Inc. (Incorporated herein by reference to Exhibit 10.65 to the Company's Annual Report on
Form 10-K filed on February 29, 2008).


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10.25

2008 Executive Officer Bonus Plan (Incorporated herein by reference to Exhibit 10.66 to the Company's Current Report on Form 8-K filed on February 28, 2008).10.26

Pricing and Delivery Amendment dated June 16, 2008 to Supply and Distribution Agreement between the Company, ArthroCare Corporation Cayman Islands and Smith & Nephew, Inc. (Incorporated herein by
reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2008 filed on November 18, 2009).10.27

Amendment dated June 16, 2008 for Development and Supply of S&N Branded Probes and Controllers to Supply and Distribution Agreement between the Company, ArthroCare Corporation Cayman Islands and
Smith & Nephew, Inc. (Incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2008 filed on November 18, 2009).10.28

Resignation Letter of Michael A. Baker dated February 18, 2009 (Incorporated herein by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K filed on February 19.
2009).10.29

General Release and Separation Agreement between John Raffle and the Company, dated February 21, 2009 (Incorporated herein by reference to Exhibit 10.71 to the Company's Current Report on Form 8-K filed
on February 26, 2009).10.30*

Employment Agreement between ArthroCare Corporation and David Fitzgerald, effective March 30, 2009 (Incorporated herein by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed on
April 3, 2009).10.31*

Employment Agreement between ArthroCare Corporation and Todd Newton, effective April 2, 2009 (Incorporated herein by reference to Exhibit 10.75 to the Company's Current Report on Form 8-K filed on
April 3, 2009).10.32*

Restatement Bonus Plan adopted March 30, 2009 (Incorporated herein by reference to Exhibit 10.76 to the Company's Current Report on Form 8-K filed on April 3, 2009).10.33*

Indemnification Agreement dated April 2, 2009 between ArthroCare Corporation and Todd Newton (Incorporated herein by reference to Exhibit 10.77 to the Company's Current Report on Form 8-K filed on
April 3, 2009).10.34

Securities Purchase Agreement, dated as of August 14, 2009, by and between ArthroCare Corporation and OEP AC Holdings, LLC. (Incorporated herein by reference to Exhibit 10.50 to the Company's Annual
Report on 10-K filed on November 18, 2009).10.35

Disclosure Letter to Securities Purchase Agreement, dated as of August 14, 2009, by and between ArthroCare Corporation and OEP AC Holdings, LLC. (Incorporated herein by reference to Exhibit 10.51 to the
Company's Annual Report on 10-K filed on November 18, 2009).10.36

Registration Rights Agreement, dated as of August 14, 2009, by and between ArthroCare Corporation and OEP AC Holdings, LLC. (Incorporated herein by reference to Exhibit 10.52 to the Company's Annual
Report on 10-K filed on November 18, 2009).10.37

Letter Agreement dated September 1, 2009 between ArthroCare Corporation and OEP AC Holdings, LLC with regard to director seats for OEP representatives. (Incorporated herein by reference to Exhibit 10.53
to the Company's Annual Report on 10-K filed on November 18, 2009).


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10.38

Third Amendment to Credit Agreement and Forbearance Agreement with respect to Credit Agreement between the Company, Bank of America, N.A., Wells Fargo Bank National Association, and certain other lenders dated
January 13, 2006. (Incorporated herein by reference to Exhibit 10.54 to the Company's Annual Report on 10-K filed on November 18, 2009).10.39*

2009 Executive Officer Bonus Plan dated December 9, 2009 (Incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on 8-K filed on December 14, 2009).10.40*

2010 Executive Officer Bonus Plan dated January 7, 2010 (Incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on 8-K filed on January 11, 2010).10.41*

Correction to Certificate of Designations of Series A 3.00% Convertible Preferred Stock (Incorporated herein by reference to Exhibit 99.2 to the Company's current report on 8-K filed on August 2,
2010.)10.42**

General Release and Separation Agreement between Rich Christensen and the Company dated December 31, 2010.18.1**

Preferability letter from Independent Registered Public Accounting firm indicating change to preferable method of accounting.21.1**

Subsidiaries of the Company.23.1**

Consent of Independent Registered Public Accounting Firm31.1**

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2**

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1**

Certification of the Chief Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2**

Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1**

Forward-Looking Statements.


Confidential
treatment has been granted as to portions of this exhibit.*Management
contract or compensatory plan or arrangement.**Filed
herewith.


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Financial Statement Schedule

The following financial statement schedule is filed as a part of this report under Schedule II immediately preceding the
signature page: Schedule IIValuation and Qualifying Accounts for the three fiscal years ended December 31, 2010, 2009 and 2008. All other schedules called for by
Form 10-K are omitted because they are not applicable or the required information is shown in the consolidated financial statements, or notes thereto, included herein.



Schedule II        ARTHROCARE CORPORATION        VALUATION AND QUALIFYING ACCOUNTS  (in thousands)

Balance at
Beginning
of Period

Additional
Charges to
Costs and
Expenses

Deductions

Balance at
End of
PeriodYear ended December 31, 2010Deducted from asset accounts:Allowance for doubtful accounts

$
3,637

$
(508
)
$
(956
)
$
2,173Product returns


432


172


(332
)

272Inventory reserves


6,380


6,894


(2,915
)

10,359Warranty reserves


477


1,255


(1,203
)

529Year ended December 31, 2009Deducted from asset accounts:Allowance for doubtful accounts

$
2,973

$
924

$
(260
)
$
3,637Product returns


1,028


2,223


(2,819
)

432Inventory reserves


7,769


888


(2,277
)

6,380Warranty reserves


429


1,890


(1,842
)

477Year ended December 31, 2008Deducted from asset accounts:Allowance for doubtful accounts

$
2,508

$
2,069

$
(1,604
)
$
2,973Product returns


1,801


5,189


(5,962
)

1,028Inventory reserves


3,401


6,569


(2,201
)

7,769Warranty reserves


441


1,418


(1,430
)

429


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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 CorporationBy:

/s/ DAVID FITZGERALD David Fitzgerald President and Chief Executive Officer


Date:
February 14, 2011

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

Signature

Title

Date/s/ DAVID FITZGERALD David Fitzgerald

President, Chief Executive Officer and
Director (Principal Executive Officer)

February 14, 2011/s/ TODD NEWTON Todd Newton

Senior Vice President Finance and
Chief Financial Officer (Principal
Financial and Accounting Officer)

February 14, 2011/s/ JAMES G. FOSTER James G. Foster

Director

February 14, 2011/s/ PETER L. WILSON Peter L. Wilson

Director

February 14, 2011/s/ TORD B. LENDAU Tord B. Lendau

Director

February 14, 2011/s/ BARBARA D. BOYAN Barbara D. Boyan

Director

February 14, 2011/s/ TERRENCE E. GEREMSKI Terrence E. Geremski

Director

February 14, 2011/s/ GREGORY A. BELINFANTI Gregory A. Belinfanti

Director

February 14, 2011/s/ CHRISTIAN P. AHRENS Christian P. Ahrens

Director

February 14, 2011


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ARTHROCARE CORPORATION

INDEX TO EXHIBITS*

Exhibit
Number

Exhibit Name10.42

General Release and Separation between Rich Christensen and the Company dated December 31, 2010.18.1

Preferability letter from Independent Registered Public Accounting firm indicating change to preferable method of accounting.21.1

Subsidiaries of the Registrant.23.1

Consent of Independent Registered Public Accounting Firm.31.1

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1

Forward-Looking Statements.


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103

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