SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

                                  ANNUAL REPORT
                         PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended                                 Commission File Number
     January 3, 1998                                              0-27422

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


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

             595 North Pastoria Avenue, Sunnyvale, California 94086
              (Address of principal executive offices and zip code)

                                 (408) 736-0224
              (Registrant's telephone number, including area code)

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

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

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

As of March 4, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $133,445,790 (based upon the closing sales
price of such stock as reported by The Nasdaq Stock Market on such date).
Shares of Common Stock held by each officer, director, and holder of 5% or more
of the outstanding Common Stock on that date have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination

As of March 4, 1998, the number of outstanding shares of the Registrants'
Common Stock was 8,896,386.

                       DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference from the Registrant's proxy statement for the 1998
Annual Stockholders Meeting (the Proxy Statement) which will be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year ended January 3, 1998.



<PAGE>
                                     PART I

ITEM 1.        BUSINESS.

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

OVERVIEW

ArthroCare develops, manufactures and markets surgical instruments based on 
its novel Coblation (TM) technology. ArthroCare's tools enable surgeons to
ablate  (remove) or shrink soft tissue and achieve hemostasis (sealing small
bleeding  vessels). ArthroCare's Coblation-based tools are designed to allow
surgeons to  operate on soft tissue with a high degree of precision and
accuracy, and with  minimal damage to surrounding tissues. The ArthroCare
Arthroscopic System  replaces the multiple surgical tools traditionally used in
arthroscopic  procedures with one multi-purpose, surgical system that consists
of a controller  unit and a series of disposable ArthroWand surgical tools
specialized for  particular types of surgery. In March 1995, the company
received clearance of its  510(k) premarket notification to market the
ArthroCare Arthroscopic System for  use in arthroscopic surgery of the knee,
shoulder, ankle and elbow. The company  began shipping products for use in
arthroscopic surgery of the shoulder and knee  in December 1995. In July 1996,
it received clearance of its 510(k) premarket  notification to market its
Arthroscopic System for use in arthroscopic surgery of  the wrist and hip. 

To date, the company's operations have consisted primarily of research and 
development, product engineering, seeking patent approvals on novel technology,
obtaining FDA clearance of its Arthroscopic System, developing a network of 
distributors in the United States and abroad to market the Arthroscopic System,
marketing and sales efforts and more than two years of product sales. The
company  has realized increasing revenues from the sale of its products, but
continues to  generate operating losses and anticipates generating losses in
the future.  Whether the company can successfully manage the transition to a
larger-scale  commercial enterprise will depend upon increasing sales of
disposable ArthroWands  from its domestic and international distribution
network, obtaining additional  international regulatory approvals for the
Arthroscopic System, obtaining  domestic and international regulatory approvals
for potential future products and  maintaining its financial and management
systems, procedures and controls.

COBLATION TECHNOLOGY

Coblation technology is ArthroCare's patented soft-tissue surgical technology 
upon which all the company's products are based. Coblation technology is a
novel  use of radio frequency energy characterized by precision, accuracy, ease
of use  and the capability of performing at a temperature lower than current
traditional  surgical tools.

Traditional electrosurgical tools have relied upon heat to essentially burn 
away targeted tissue, which often results in collateral thermal damage to
tissue  surrounding the surgical area. Even excimer lasers, which are cooler
than other  types of soft-tissue surgical tools, lack tactile feedback and
therefore make it  difficult for surgeons to control the depth of tissue
penetration and also can  lead to collateral tissue damage. Coblation
technology employs a lower  temperature process that minimizes the risk of
thermal burn while increasing a  surgeon's control and precision.

Coblation works through a cool process similar to that of excimer lasers. It 
uses the electrically conductive fluid employed in arthroscopic surgeries in
the  gap between the electrode and tissue. When electrical current is applied
to this  fluid, it turns into a charged layer of particles, called a plasma
layer. Charged  particles accelerate through the plasma and gain sufficient
energy to break the  molecular bonds within cells. This literally causes the
cells to disintegrate  molecule by molecule, so that tissue is volumetrically
removed. But, because this  effect is confined to the surface layer of the
target tissue, there is minimal  damage to surrounding tissue. An additional
advantage is that, unlike excimer  lasers, Coblation can be performed in a
continuous mode. This results in much  more efficient tissue removal.

In addition to achieving more precise tissue removal (or shrinkage) and less 
damage to collateral tissue, surgical tools based on Coblation technology can 
achieve hemostasis (sealing small bleeding vessels) near the surgical site,
which  reduces bleeding at the site.

Coblation technology is applicable to soft tissue surgery thoughout the body 
and the company is exploring its use in other non-arthroscopic indications.

The company commercially introduced the Arthroscopic System in December 1995 
and by the year ended January 2, 1998, had reported 25 months of sales.  The 
Arthroscopic System is the company's only commercial product and will account
for  substantially all of the company's revenue for the foreseeable future.  As
such,  the company is highly dependent on its Arthroscopic System. 
Additionally, the  company's potential products for non-arthroscopic
indications are in various  stages of development, and the company may be
required to undertake time- consuming and costly development activities and
seek regulatory approval of these  devices.  There can be no assurance that
product development will ever be  successfully completed, that regulatory
approval, if applied for, will be granted  by the United States Food and Drug
Administration ("FDA") on a timely basis, if  at all, or that the potential
products will ever achieve commercial acceptance.

THE ARTHROSCOPY MARKET

Historically, severe joint injuries have been treated using open surgery 
involving large incisions, a hospital stay and a prolonged recovery period. In 
contrast, arthroscopic surgery, which was introduced in the early 1980s, is 
performed through several small incisions called portals and can be performed
on  an outpatient basis. The company believes that arthroscopic surgery has
gained  wide market acceptance because it promises shorter hospital stays and
reduced  recovery time.

In 1996, approximately 2.2 million arthroscopic procedures were performed in 
the United States. According to industry sources, the number of arthroscopic 
procedures is growing due to patient demand for less invasive procedures as
well  as the increasing incidence of joint injuries caused by a greater
emphasis on  physical fitness and an aging population. Joints are susceptible
to injuries from  blows, falls or twisting, as well as from natural
deterioration and stiffening  associated with aging.

To perform arthroscopic surgery, a surgeon must use a tool to visualize the 
site and a tool to perform the surgery. The tool used to visualize the site, 
called an arthroscope, is a small fiber-optic viewing instrument made up of a 
small lens, a light source and a video camera, which allows the surgeon to view
the surgical procedure on a video monitor. During the arthroscopic procedure,
an  irrigant, such as saline or sterile water, is flushed through the joint to
permit  clear visualization through the arthroscope and to create the space
within the  joint for the surgical procedure. The surgeon inserts the
arthroscope into the  joint through a portal measuring approximately six
millimeters (1/4 of an inch)  in length. Other portals are used for the
insertion of surgical instruments to  perform the surgery and to facilitate the
flow of irrigants. With small incision  sites and direct access to most areas
of the joint, a surgeon can diagnose and  correct an array of joint problems
such as cartilage tears, ligament tears and  removal of loose and degenerative
tissue.

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

Knee

The knee is the most commonly injured joint. In 1996, it accounted for 
approximately 1.5 million arthroscopic procedures in the United States. Damage
to  a meniscus - a pad of cartilage that helps cushion the knee joint - is a
common  form of knee injury. A meniscus can be torn by a twist of the leg when
the knee  is flexed, displaced either inward toward the center of the tibia
(central shin  bone) or outward beyond the surface of the femur (central
thighbone), or worn  down by normal aging. The knee is also susceptible to
partial or complete tears  of the ligaments and degeneration of the cartilage
on the underside of the  patella (knee cap). In addition, the cartilage
covering the bony surfaces of the  knee wears down with age and can become
rough or tear loose from the bone,  causing pain and interfering with smooth
joint movement.

Shoulder 

The shoulder joint, because of its range of motion, is susceptible to a number 
of injuries. In 1996, approximately 440,000 arthroscopic procedures in the 
shoulder were performed in the United States. The company believes that
shoulder  arthroscopy is the fastest-growing portion of the arthroscopy market.
With  repetitive motion and lifting of the arm, such as that which occurs
during a  tennis serve, the acromion (the "roof" of bone formed where the
scapula, or  shoulder blade, extends over the humerus, the bone of the upper
arm) may pinch  one of the shoulder muscles and cause persistent pain, known as
a rotator cuff  injury. This condition can be treated by strengthening
exercises and  physiotherapy; however, many rotator cuff injuries require
surgical intervention.  The company believes that a significant percentage of
the population is born with  an acromion that hooks over the humerus, making
such individuals more susceptible  to rotator cuff injuries.

Elbow, Ankle, Wrist and Hip 

The elbow, ankle, wrist and hip joints are also susceptible to certain stress-
related injuries and deterioration due to aging. In 1996, approximately 220,000 
arthroscopic procedures were performed in the elbow, ankle and wrist, in the 
United States. The company believes that the current number of surgical 
procedures in the elbow, ankle, wrist and hip is relatively small due to the 
limitations on conventional arthroscopic surgical equipment.

CONVENTIONAL TREATMENT METHODOLOGIES: THE PROBLEM

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

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

Power instruments are generally used to smooth tissue and cartilage defects on 
the surface of the bones of the joint. The damaged tissue is removed from the 
joint using suction through a cannula surrounding the shaft of the tool, which 
can become obstructed by bits of tissue and bone. Power shavers have rotating 
cutters inside a tube and are not currently available in a wide variety of tip 
angles or sizes for the precise shaving of tissue. This prevents power shavers 
from being used in many areas of the joint.

Mechanical instruments are used primarily in meniscus removal by snipping away 
the unwanted tissue. Because mechanical tools must open and shut to operate,
they  cannot be used in small areas such as the back of the knee. In addition, 
mechanical tools must be resharpened at regular intervals and sterilized after 
each procedure.

Electrosurgery systems are primarily used to achieve hemostasis, which is 
necessary to minimize bleeding and maximize the arthroscopic surgeon's
visibility  of the procedure through the arthroscope. Bleeding occurs most
commonly in  shoulder arthroscopies. Electrosurgical systems contain two
electrodes: the  electrode tip held by the surgeon and a dispersive pad that
rests under the  patient's body. The metal electrode tip of the instrument,
which resembles a  pencil point, is placed on or near the bleeding vessel to be
sealed. A generator  connected to the electrode delivers high-frequency voltage
that arcs between the  electrode and the target tissue, sealing blood vessels
in its vicinity. After  arcing, the current travels through the remaining
tissue of the patient, through  the skin to the dispersive electrode pad,
before being directed back to the  generator. A non-conductive media such as
sterile water is used in the surgical  space so that the electricity is forced
into the tissue instead of into the  surrounding fluid. As a result of its
conductivity, saline - the preferred  irrigant - cannot be used during the
procedure.

Laser systems are used to ablate tissue while achieving simultaneous 
hemostasis. Laser systems are not tactile tools, meaning that the surgeon
cannot  feel how much tissue is being ablated. The surgeon must be extensively
trained to  precisely position the laser to control the depth of tissue
penetration to  minimize unintended tissue damage. The company believes that
laser tools have not  received wide acceptance because of high cost, lack of
tactile feedback for the  surgeon and the required training and certification.

THE ARTHROCARE ARTHROSCOPIC SYSTEM

The company's Arthroscopic System is a high-frequency, surgical device 
intended to perform tissue ablation and simultaneous hemostasis. The company 
sells its Arthroscopic System for use in all six major joints: knee, shoulder, 
elbow, ankle, wrist and hip. Tissues such as meniscus, synovium, cartilage and 
ligaments can be ablated using the Arthroscopic System. In addition, the 
company's capsular shrinkage (CAPS) wand is used to shrink collagen in shoulder
procedures.

The company's Arthroscopic System comprises an array of disposable bipolar 
multielectrode tools (ArthroWands), a connecting cable, foot pedal (or switch) 
and a radio frequency power controller. The System 2000 controller,
approximately  14 inches by 11 inches by five inches, is used to deliver
high-frequency power to  the ArthroWands. To ablate different tissues or
achieve hemostasis, the surgeon  can control the voltage level using the foot
pedal or keys on the front panel of  the controller. The cable, which is
approximately 10 feet in length, connects the  System 2000 controller to the
ArthroWand. Power is transmitted through the cable  to the ArthroWand by
depressing a foot pedal, thereby enabling surgeons to use  the ArthroWand as a
conventional probe as well as an instrument that ablates and  achieves
hemostasis (cauterize).

Accordingly, the surgeon using the Arthroscopic System need not remove and 
insert a variety of instruments to perform different tasks as is required when 
using conventional arthroscopic instruments. The ArthroWand is approved for
sale  in tip sizes 1.5 mm to 4.5 mm, and in tip angles ranging from 0 to 90
degrees.  The company currently sells 14 models in various tip sizes, angles
and shapes  which enable the surgeon to ablate different volumes of tissue and
to reach  treatment sites not readily accessible by existing mechanical
instruments and  motorized cutting tools.

The company commercially introduced the Arthroscopic System in December 1995 
and by the year ended January 3, 1998, had reported 25 months of sales. By the 
end of fiscal 1997, the company had shipped  over 1,500 controller units. In 
addition, the company has sold more than 140,000 ArthroWands. The company has 
ramped up its manufacturing capabilities and from 1996 to 1997 it doubled 
ArthroWand volumes while maintaining high yields. During fiscal 1997, the
company  also began manufacturing the System 2000 controllers in-house, to
maintain  process control, manage availability and leverage fixed costs.

The Arthroscopic System is the company's only commercial product and will 
account for substantially all of the company's revenue for the foreseeable 
future.  As such, the company is highly dependent on its Arthroscopic System.
The  company has established distribution capability in Europe, Australia,
Korea,  Japan, Canada and parts of South and Central America.  Before the
Arthroscopic  System can be sold outside these regions, the company will have
to obtain  additional international regulatory approvals and establish
additional  distribution capability in other geographic regions.  If such
regulatory approval  is obtained, there can be no assurance that the company
will be able to establish  a successful distribution capability.

Physicians will not use the company's products unless they determine, based on 
experience, clinical data and other factors, that these systems are an
attractive  alternative to conventional means of tissue ablation.  No
independent published  clinical reports exist to support the company's
marketing efforts for its  Arthroscopic Systems, which may have an adverse
effect on its ability to obtain  physician acceptance. The company believes
that continued recommendations and  endorsements by influential physicians are
essential for market acceptance of its  Arthroscopic System.  If the
Arthroscopic System does not continue to receive  broad-based physician
acceptance and endorsement by influential physicians, the  company's business,
financial condition and results of operations would be materially adversely
affected.

ARTHROCARE'S PATENTED TECHNOLOGY

The ArthroCare Arthroscopic System is based on the patented Coblation core 
technology and is designed to achieve precise ablation of soft tissue and 
simultaneous hemostasis while minimizing damage to the surrounding healthy 
tissue. The company believes that its Coblation technology, and the surgical 
tools the company has built based on this technology, offer several advantages 
over other approaches to arthroscopic surgery. The company believes that 
Coblation technology enables surgeons to perform ablation, tissue shrinkage and
hemostasis with a single set of tools, with minimal collateral tissue damage, 
with high degrees of accuracy and precision, with greater control and 
reproducible results and at a lower cost than other surgical alternatives.  
Further, the company believes that patients operated on using Coblation-based 
surgical tools experience improved outcomes compared to conventional surgical 
procedures, characterized by less pain, faster recovery and smoother resumption
of pre-injury activities.

The company's bipolar, multielectrode configuration and power control system 
allow high-frequency electrical energy to be precisely focused on the surface
of  the tissue being treated. Using a bipolar array of electrodes eliminates
the need  to deliver energy through the surgical site to a dispersive electrode
pad located  outside the body, because the energy is directed from the tip of
the probe to a  return electrode contained on its shaft. The electric current
travels a shorter  distance from the electrode array to the target tissue
before returning to the  electrode on the shaft, allowing the Arthroscopic
System to operate at lower  voltages and at a lower temperature than
conventional monopolar electrosurgical  systems.

As illustrated below, the ArthroWand's energy is concentrated only at the tip 
of the electrodes. This configuration allows the energy to be focused on the 
surface layer of the tissue being ablated, thereby minimizing the risk of 
unwanted damage to surrounding healthy tissue. The controller provides power 
individually to each of the electrodes at the tip of the ArthroWand, enabling 
only those electrodes that come into contact with tissue to deliver sufficient 
energy to ablate tissue. During use, the high frequency current flows from the 
controller through each electrode to the tissue, returning to the controller
via  the return electrode on the shaft of the ArthroWand. The operation of a 90
degree  ArthroWand is depicted below.

        [Illustration depicting the operation of an ArthroWand on Tissue]

The company's patented Coblation technology, delivered in the form of 
multielectrode, bipolar, electrosurgical tools, offers a number of benefits
that  the company believes may provide advantages over competing surgical
methods and  devices. The principal benefits include:

   - Ease of Use. The Coblation-based Arthroscopic System performs many of the 
     functions of mechanical tools, power tools and electrosurgery instruments,
     allowing the surgeon to use a single instrument. The lightweight probe is 
     simple to use and complements the surgeon's existing tactile skills 
     without the need for extensive training.

   - Precision. In contrast to conventional tools, the Coblation-based 
     Arthroscopic System permits surgeons to perform more precise tissue 
     ablation and sculpting. The company believes this may result in more rapid
     patient rehabilitation.

   - Safety. Coblation technology, unlike most electrosurgical tools does not 
     work by heating tissue. The company believes that cooler operation can 
     lead to significant benefits for patients being treated with Coblation-
     based surgical tools, in the form of little or no collateral thermal
     burning of tissues near the surgical site. As a result, the company 
     believes that patients are likely to experience less trauma and pain
     following surgery and might be able to recover more quickly to their pre-
     injury activity levels.

   - Simultaneous Ablation and Hemostasis. The Coblation-based Arthroscopic
     System efficiently seals small bleeding vessels during the tissue ablation
     process, which improves the surgeon's visibility of the operative site.

   - Cost Reduction. The Coblation Arthroscopic System eliminates the need to 
     introduce multiple instruments to remove and sculpt tissue and seal small 
     bleeding vessels. The company believes this may reduce operating time and 
     thereby produce cost savings for health care providers.

Despite the benefits of the Arthroscopic System, there can be no assurance 
that doctors and surgical centers will buy the Arthroscopic System. In order to
secure the benefits of the Arthroscopic Systems, however, a hospital or
surgical  center must procure and use a specifically designed controller to
power the  ArthroWand.  At hospital sites or surgical centers where several
arthroscopic  procedures can be performed simultaneously, the procurement of
multiple  controllers is required.  To date, the company has placed its
controllers at  substantial discounts in order to stimulate demand for its
Arthroscopic System.   In addition, motorized and mechanical instruments and
electrosurgery systems  currently used by hospitals and surgical centers for
arthroscopic procedures have  a history of success and have become widely
accepted by orthopedic surgeons.  If  physicians do not determine that the
Arthroscopic System is an attractive  alternative to conventional means of
tissue ablation, the Arthroscopic System  will not be acceptable, and the
company's business, financial condition and  results of operations would be
materially adversely affected.

ARTHROCARE STRATEGY

The company's objective is to use its patented Coblation technology to design, 
develop, manufacture and sell innovative, clinically superior surgical devices 
for the arthroscopic surgical treatment of joint injuries and for the surgical 
treatment of other soft-tissue conditions throughout the body. The key elements
of the company's strategy to achieve this objective include:

   - Continue to Penetrate Existing Arthroscopic Surgical Instrument Market. 
     The company's initial sales efforts are focused on marketing the company's
     products to orthopedic surgeons performing high-volume arthroscopy and to 
     opinion leaders in orthopedic surgery.

   - Expand into New Arthroscopic Surgical Markets. The company encourages 
     surgeons to use its Arthroscopic System to treat joints that have been 
     primarily treated by open surgery, such as the shoulder, elbow and ankle. 
     Because of the small size, varying shapes and tactile feel of the
     company's ArthroWand, the company believes surgeons will be able to 
     arthroscopically access areas difficult to reach by conventional
     arthroscopic surgical tools. In addition, the company has introduced new 
     products that expand the types of arthroscopic surgical procedures to
     which its Coblation technology can be applied. The CAPS wand to shrink 
     collagen in shoulder joints and the small joint wands are an example of 
     this expansion.

   - Target Key International Markets. The company has begun to market its 
     Arthroscopic System in international markets. The company has signed 
     agreements with marketing partners to assist with regulatory requirements
     and to market and distribute the Arthroscopic System in Europe, Japan and 
     Australia.

   - Leverage Broadly Applicable Proprietary Technology. The company plans to 
     leverage its proprietary Coblation technology by developing additional
     wands for use in a variety of non-arthroscopic soft tissue surgical
     procedures.

   - Structure Targeted Strategies to Commercialize the Platform Technology. 
     While the company will continue to focus on the arthroscopy field, it will
     evaluate and plans to pursue additional applications of its technology in 
     other promising fields. On a case-by-case basis, ArthroCare will determine
     the best strategy for entering these additional markets. In some cases,
     the company might choose to establish stable, long-term relationships with
     strong partners to address specific fields outside of arthroscopy. In
     select other areas, the company might bring products to market itself.

RESEARCH AND DEVELOPMENT

The company believes that its core Coblation technology is applicable to a 
range of soft-tissue surgical applications that can use a system substantially 
the same as the Arthroscopic System. The company expects to change the wand 
design to accommodate the specific requirements of the indications in various 
surgical fields. However, the company believes that the design, materials and 
manufacturing methods incorporated into the initial Arthroscopic System should
be applicable to subsequent products and indications.

The company has undertaken preliminary animal studies and development for the 
use of its Coblation technology with its controller in several fields.  The 
company has received 510(k) clearance for use of its technology in certain of 
these fields.  The company has received approval of an investigational Device 
Exemption (IDE) to conduct a clinical study on a specific indication. 
Following  the completion of this study, the company may submit a 510(k)
application to the FDA.

Each of these potential products is in various stages of development, and the 
company may be required to undertake time-consuming and costly development 
activities and seek regulatory approval of these devices.  There can be no 
assurance that product development will ever be successfully completed, that 
premarket applications (PMA) or 510(k) application, if applied for, will be 
granted by the FDA on a timely basis, if at all, or that the products will ever
achieve commercial acceptance.  Failure by the company to develop, obtain 
necessary regulatory approval for or to successfully market new products could 
have a material adverse effect on the company's business, financial condition
and  results of operations.

MANUFACTURING

The company's manufacturing operations consist of an in-house assembly 
operation for the manufacturing of ArthroWands, and a separate in-house
operation  for the manufacturing of the System 2000 controllers. The ArthroWand
is  manufactured by the company from several components. In 1997, the company
ramped  up its manufacturing capacity to double the production levels of
ArthroWands  compared to the previous year. Manufacture of the System 2000
controller, of  which an earlier version was manufactured by a third party, was
brought in-house  in 1997 for the purposes of maintaining process control,
managing availability,  and leveraging fixed costs.

The company has no previous controller manufacturing experience as its 
previous controller model was manufactured under contract by another company.
In  December 1997 the company started manufacture and sale of its System 2000 
controllers. Only a small number of controllers have been manufactured and
sold.  As a result, the company has limited experience manufacturing
controllers in the  volumes necessary for the company to achieve additional
commercial sales, and  there can be no assurance that reliable, high-volume
manufacturing can be  achieved at commercially reasonable cost.  In addition,
there can be no assurance  that the company or its suppliers will not encounter
any manufacturing  difficulties, including problems involving regulatory
compliance, product  recalls, production yields, quality control and assurance,
supplies of components  or shortages of qualified personnel.

The company and its component suppliers are required to operate in conformance 
with Quality System Regulation (QS Regulations) requirements, in order to
produce  products for sale in the United States, and ISO 9001 standards, in
order to  produce products for sale in Europe.  There can be no assurance that
the company  or its component suppliers will remain in compliance with QS
Regulations or ISO  9001 standards.  Any failure by the company or its
component suppliers to remain  in compliance with QS Regulation or ISO 9001
standards could have a material  adverse effect on the company's business,
financial condition and results of  operations.  In addition, the ArthroWand is
sterilized by a single subcontractor,  and the connector housings at each end
of the cable are available only from a  single source.  There can be no
assurance that an alternate sterilizer or  connector housing supplier could be
established if necessary or that available  inventories would be adequate to
meet the company's product needs during any  prolonged interruption of supply. 
A reduction or stoppage in supply of the sole- source component, or the
company's inability to secure an alternative sterilizer,  if required, would
limit its ability to manufacture the Arthroscopic System and  would have a
material adverse effect on the company's business, financial  condition and
results of operations.

Although the company believes that its subcontractor, and component suppliers 
are in compliance with applicable regulations, there can be no assurance that
the  FDA, or a state, local or international regulator, will not take action
against  the subcontractor or a component supplier found to be violating such
regulations.

MARKETING AND SALES

Of the 18,500 orthopedic surgeons in the United States, approximately 80% 
perform arthroscopy and approximately 40% consider arthroscopy to be their
major  practice area. These 40% of orthopedic surgeons perform an estimated 70%
of the  total arthroscopic procedures. In addition to marketing efforts aimed
at these  surgeons, the company also recognizes that purchase decisions are
greatly  influenced by health care administrators, who are subject to
increasing pressures  to reduce costs. Health care administrators must
determine that the Arthroscopic  System and the company's potential products
are cost-effective alternatives to  current means of tissue ablation.

 The company had shipped more than 1,500 Arthroscopic System controller units 
and more than 140,000 ArthroWands by the end of fiscal 1997. The company is 
marketing and selling its Arthroscopic System in the United States through a 
network of independent orthopedic distributors. The company has more than 40 
distributors representing more than 250 field sales representatives. The 
distributors are supervised by 6 sales managers who are employed by the
company.  The company expects that the network of distributors will market
directly to more  than 7,500 orthopedic surgeons who primarily perform
arthroscopic surgery. As of  the end of fiscal 1997, the company believes it
has achieved approximately 5%  share of the market for knee procedures and 25%
share of .the market for shoulder  procedures.

The company's distributors sell orthopedic arthroscopy devices for a number of 
other manufacturers, and there can be no assurance that they will commit the 
necessary resources to effectively market and sell the company's Arthroscopic 
System, or that they will be successful in closing sales with doctors and 
hospitals.  The company has offered its controller to these independent 
distributors at substantial discounts and may be required to continue to offer 
such discounts on its controller to generate demand for its ArthroWands.  The 
inability to sell sufficient quantities of ArthroWands would have a material 
adverse effect on the company's business, financial condition and results of 
operations.

In October 1996, the company signed a distribution agreement with Advanced 
Surgical Technologies Pty Ltd (AST), a large orthopedic distributor based in 
Australia, to exclusively sell the company's Arthroscopic System in Australia.
In  1997, ArthroCare signed a distribution agreement with Arthrex, Inc., a
leading  provider of arthroscopic equipment and training to surgeons and
hospitals  worldwide, to distribute the company's products in Europe. Also in
1997, the  company signed a distribution agreement with Kobayashi
Pharmaceutical Co., Ltd.,  a 110-year-old, $1.5 billion health-care company,
which will use its extensive  medical device distribution operations to sell
the company's products in Japan.  The company has also signed agreements with
regional distributors in Mexico,  Brazil, Argentina and Korea.

If the company is successful in obtaining necessary regulatory approvals in 
additional international markets, it expects to establish a sales and marketing
capability in those markets. In these international markets, the company
intends  to collaborate with one or more marketing partners to establish
marketing and  distribution channels for the Arthroscopic System. However,
regulatory  requirements vary by region, and compliance with such regulations
may be costly  and time-consuming. Accordingly, the distribution, pricing and
marketing  structure to be established by the company may vary from country to
country.

No assurance can be given that the company will successfully sell its product 
through its distributors in Europe, Australia, Mexico, Brazil, Argentina,
Canada,  Japan or Korea, that the company will secure marketing partners for
other  international markets, successfully sell its Arthroscopic System in
global  markets or that any of its international distributors and marketing
partners will  commit the necessary resources to obtain additional necessary
international  regulatory approvals on behalf of the company and successfully
sell the  Arthroscopic System in international markets.

PATENTS AND PROPRIETARY RIGHTS

The company's ability to compete effectively depends in part on developing and 
maintaining the proprietary aspects of its platform Coblation technology. The 
company owns ten issued United States patents, more than 30 pending United
States  patent applications and international patent applications in Europe
(covering 16  separate countries), Japan, Canada, Australia and New Zealand
corresponding to  eight of the United States filings relating to its Coblation
technology. The  initial patent is currently set to expire in 2008, three
issued patents are  currently expected to expire between 2008 and 2012 and the
other six patents are  expected to expire between 2014 and 2016. The company
believes that the issued  patents cover both the core technology used in the
company's Arthroscopic System,  including both multielectrode and
single-electrode configurations of its wand  tools, as well as the use of
Coblation technology in specific surgical  procedures.

The issued patents cover, among other things, systems and methods for applying 
radio frequency energy to tissue in the presence of electrically conductive
fluid  such as isotonic saline and blood; probes having an electrode array and
a means  to supply current independently to individual electrodes; and systems
and methods  for employing radio frequency energy in urological and cardiac
procedures (e.g.  transmyocardial revascularization of the heart). The pending
patent applications  include coverage for the fundamental tissue ablation and
cutting technology as  well as methods and apparatus for specific procedures. 

There can be no assurance that the patents that have been issued to the 
company or any patents which may be issued as a result of the company's United 
States or international patent applications will provide any competitive 
advantages for the company's products or that they will not be successfully 
challenged, invalidated or circumvented in the future.  In addition, there can
be  no assurance that competitors, many of which have substantial resources and
have  made substantial investments in competing technologies, will not seek to
apply  for and obtain patents that will prevent, limit or interfere with the
company's  ability to make, use and sell its products either in the United
States or in  international markets.

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.  If third-party
patents or patent applications contain claims infringed by the company's 
technology and such claims are ultimately determined to be valid, there can be
no  assurance that the company would be able to obtain licenses to those
patents at a  reasonable cost, if at all, or be able to develop or obtain
alternative  technology, either of which would have a material adverse effect
on the company's  business, financial condition and results of operations. 
There can be no  assurance that the company will not be obligated to defend
itself in court  against allegations of infringement of third-party patents.

In addition to patents, the company relies on trade secrets and proprietary 
know-how, which it seeks to protect, in part, through confidentiality and 
proprietary information agreements.  The company requires its key employees and
consultants to execute confidentiality agreements upon the commencement of an 
employment or consulting relationship with the company.  These agreements 
generally provide that all confidential information, developed or made known to
the individual by the company during the course of the individual's
relationship  with the company, 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 the company
shall be the  exclusive property of the company.  There can be no assurance
that such  agreements will not be breached, that the company would have
adequate remedies  for any breach or that the company's trade secrets will not
otherwise become  known to or be independently developed by competitors.

The medical device industry has been characterized by extensive litigation 
regarding patents and other intellectual property rights, and companies in the 
medical device industry have employed intellectual property litigation to gain
a  competitive advantage.  There can be no assurance that the company will not 
become subject to patent infringement claims or litigation or interference 
proceedings declared by the United States Patent and Trademark Office ("USPTO")
to determine the priority of inventions.  On February 13, 1998 the company
filed  a lawsuit (the "Lawsuit") against Ethicon, Inc.  Mitek Surgical
Products, a  division of Ethicon, Inc. and GyneCare, Inc. alleging among other
things,  infringement of several of the company's patents.  See Part I, Item 3
"Legal  Proceedings" of this Annual Report on Form 10-K.  The defense and
prosecution of  the Lawsuit and intellectual property suits generally, USPTO
interference  proceedings and related legal and administrative proceedings are
both costly and  time-consuming.  The company believes that the Lawsuit is
necessary and if others  violate the proprietary rights of the company, further
litigation may be  necessary to enforce patents issued to the company, to
protect trade secrets or  know-how owned by the company or to determine the
enforceability, scope and  validity of the proprietary rights of others.  Any
litigation or interference  proceedings will result in substantial expense to
the company and significant  diversion of effort by the company's technical and
management personnel.  An  adverse determination in the Lawsuit or other
litigation or interference  proceedings to which the company may become a party
could subject the company to  significant liabilities to third parties, require
disputed rights to be licensed  from third parties or require the company to
cease using such technology.   Although patent and intellectual property
disputes in the medical device area  have often been settled through licensing
or similar arrangements, costs  associated with such arrangements may be
substantial and could include ongoing  royalties.  Furthermore, there can be no
assurance that necessary licenses would  be available to the company on
satisfactory terms, if at all.  Adverse  determinations in a judicial or
administrative proceeding or failure to obtain  necessary licenses could
prevent the company from manufacturing and selling its  products, which would
have a material adverse effect on the company's business,  financial condition
and results of operations.

COMPETITION

The arthroscopic medical device industry is intensely competitive. The company 
competes with providers of laser systems, electrosurgical systems, manual 
instruments and power shavers. Many of these competitors have significantly 
greater financial, manufacturing, marketing, distribution and technical
resources  than the company. There can be no assurance that the company can
effectively  compete against such competitors. In addition, there can be no
assurance that  these or other companies will not succeed in developing
technologies and products  that are more effective than the company's or that
would render the company's  technology or products obsolete or uncompetitive.

The company believes that its Arthroscopic System, comprising the controller 
unit and disposable ArthroWands, presents a competitive pricing structure 
compared to alternative tools being used in arthroscopic procedures. The list 
price of the controller, including the cable, is approximately $14,500. The 
disposable ArthroWand, which can be used by surgeons as a conventional probe as
well as to ablate soft tissue, collagen shrinkage and seal small bleeding 
vessels, have list prices ranging from of approximately $125-$195. Motorized 
cutting tools consist of a power source with list prices of approximately
$8,000  to $10,000 and disposable tips, with list prices of approximately $60
to $80.  Reusable mechanical tools have list prices of approximately $150 to
$950 and it  is not unusual for 30 (thirty) different shaped tools to be
resterilized for each  procedure. Neither motorized nor mechanical tools
perform hemostasis, and  therefore additional tools may need to be purchased
for that purpose.  Electrosurgical systems, used to stop the bleeding from
small blood vessels  during surgery, consist of a power source with list prices
of approximately  $4,000 to $9,000 plus a disposable tip with list prices of
approximately $40 to  $50, including a single-use, dispersive electrode pad.
Electrosurgical systems  are not generally used to cut or remove tissue. Laser
systems, with list prices  of approximately $80,000 to $125,000, are used in
conjunction with disposable or  reusable tips, with list prices of
approximately $60 to $300, to ablate soft  tissue and simultaneously achieve
hemostasis.

Smith & Nephew Endoscopy, Inc. (which owns Acufex Microsurgical, Inc. and 
Dyonics, Inc.), Conmed Corporation (including its Linvatec unit) and Stryker 
Corp. each have large shares of the market for manual instruments, power
shavers  and arthroscopes. These companies offer broad product lines, which
they may offer  as a single package; have substantially greater resources and
name recognition  than the company; and frequently offer significant discounts
as a competitive  tactic. In addition, United States. Surgical, Corporation.
(including its Valley  Labs unit) and Conmed Corporation each have large shares
of the market for  electrosurgical systems, and Trimedyne, Inc. and Coherant.
each have large shares  of the market for laser systems. The company expects
that competition from these  and other well-established competitors will
increase as will competition from  start-up and development stage medical
device companies such as Gyrus Medical  Ltd., a company based in the United
Kingdom, and Orotec Interventions, Inc., a  company based in Menlo Park,
California. The company is aware that Johnson &  Johnson (including its Ethicon
unit) is marketing a bipolar electrosurgical tool  developed by Gyrus Medical
Ltd. In order to successfully compete in the  arthroscopic medical device
industry, the company anticipates that it may have to  continue to offer
substantial discounts on its controller in order to increase  demand for the
disposable ArthroWand, and that  such competition could have a  material
adverse effect on the company's business, financial condition and  results of
operations.

The company believes that the primary competition factors in the market for 
tissue ablation are precision, ease of use and price. The company further 
believes that its tissue ablation instruments are easier to use than current 
ablation instruments on the market while also providing the surgeon with a more
precise and efficient means of ablating tissue at lower cost. In addition, the 
company's surgical system features a hemostasis mode and shrinks collagen. As a
result, the company believes that its products compete favorably with respect
to  these factors, although no assurance can be given that they will be able to
continue to do so in the future, or that new instruments that perform more 
favorably will not be introduced.

The company has received 510(k) premarket notifications for clearance to 
market tissue ablation products to treat certain urological, periodontal, 
dermatological, ear/nose/throat and general surgical conditions and has filed 
510(k) premarket notification for clearance to market products for
gynecological  conditions; the FDA has indicated that the 510(k) submission for
certain  gynecological conditions must be supported by data from clinical
trials. These  fields are intensely competitive and no assurance can be given
that these  potential products, if approved, would be successfully marketed.

GOVERNMENT REGULATION

United States

The company's products are regulated in the United States as medical devices 
by the FDA under the Federal Food, Drug, and Cosmetic Act ("FDC Act") and
require  premarket clearance or approval by the FDA prior to commercialization.
In  addition, certain material changes or modifications to medical devices also
are  subject to FDA review and clearance or approval. Pursuant to the FDC Act,
the FDA  regulates the research, testing, manufacture, safety, labeling,
storage, record  keeping, advertising, distribution and production of medical
devices in the  United States. Noncompliance with applicable requirements can
result in warning  letters, fines, injunctions, civil penalties, recall or
seizure of products,  total or partial suspension of production, failure of the
government to grant  premarket clearance or premarket approval for devices, and
criminal prosecution.  Failure to comply with the regulatory requirements could
have a material adverse effect on the company's business, financial condition
and results of operations.

If human clinical trials of a device are required and if the device presents a 
"significant risk," the manufacturer or the distributor of the device is
required  to file an IDE application prior to commencing human clinical trials.
The IDE  application must be supported by data, typically including the results
of animal  and, possibly, mechanical testing. If the FDA does not object to the
IDE  application within 30 days from filing of the application, human clinical
trials  may begin as defined in the IDE. Sponsors of clinical trials are
permitted to  sell investigational devices distributed in the course of the
study, provided  such costs do not exceed recovery of the costs of manufacture,
research,  development and handling. The clinical trials must be conducted
under the  auspices of an independent Institutional Review Board ("IRB")
established  pursuant to FDA regulations, and with appropriate informed consent
of the  patient.

Generally, before a new device can be introduced into the market in the United 
States, the manufacturer or distributor must obtain FDA clearance of a 510(k) 
notification or approval of a PMA application. If a medical device manufacturer
or distributor can establish that a device is "substantially equivalent" to a 
legally marketed Class I or Class II device, or to a Class III device for which
FDA has not called for PMAs, the manufacturer or distributor may seek clearance
from FDA to market the device by filing a 510(k) notification. The 510(k) 
notification will need to be supported by appropriate data establishing the
claim  of substantial equivalence to the satisfaction of FDA. FDA recently has
been  requiring a more rigorous demonstration of substantial equivalence.

Following submission of the 510(k) notification, the manufacturer or 
distributor may not place the device into commercial distribution until an
order  is issued by the FDA. No law or regulation specifies the time limit by
which FDA  must respond to a 510(k) notification. At this time, the FDA
typically responds  to the submission of a 510(k) notification within 90 to 120
days, but it may take  longer. An FDA order may declare that the device is
substantially equivalent to  another legally marketed device and allow the
proposed device to be marketed in  the United States. The FDA, however, may
determine that the proposed device is  not substantially equivalent or require
further information, including clinical  data, to make a determination
regarding substantial equivalence. Such  determination or request for
additional information could delay market  introduction of the products that
are the subject of the 510(k) notification.

The company has received clearance of 510(k) premarket notifications to market 
its Arthroscopic System for surgery of the knee, shoulder, elbow, wrist, hip
and  ankle joints. In addition, the company received clearance of 510(k)
premarket  notifications to market products based upon its proprietary core
technology to  treat certain other soft tissue conditions. There can be no
assurance that the  company will be able to obtain necessary clearances or
approvals to market any  other products on a timely basis, if at all, and
delays in receipt or failure to  receive such clearances or approvals, the loss
of previously received clearances  or approvals, or failure to comply with
existing or future regulatory  requirements could have a material adverse
effect on the company's business,  financial condition and results of
operations.

If a manufacturer or distributor of medical devices cannot establish that a 
proposed device is substantially equivalent to a legally marketed device, the 
manufacturer or distributor must seek premarket approval of the proposed device
through submission of a PMA application. A PMA application must be supported by
extensive data, including, in many instances, preclinical and clinical trial 
data, as well as extensive literature to prove the safety and effectiveness of 
the device. Following receipt of a PMA application, if the FDA determines that 
the application is sufficiently complete to permit a substantive review, the
FDA  will "file" the application. Under the FDC Act, the FDA has 180 days to
review a  PMA application, although the review of such an application more
often occurs  over a protracted time period, and generally takes approximately
two years or  more from the date of filing to complete.

The PMA application approval process can be expensive, uncertain and lengthy. 
A number of devices for which premarket approval has been sought have never
been  approved for marketing. The review time is often significantly extended
by the  FDA, which may require more information or clarification of information
already  provided in the submission. In addition, the FDA will inspect the
manufacturing  facility to ensure compliance with the FDA's Good Manufacturing
Practice (GMP) or  QS Regulations requirements prior to approval of an
application. If granted, the  approval of the PMA application may include
significant limitations on the  indicated uses for which a product may be
marketed.

If necessary, the company will file a PMA application with the FDA for 
approval to sell its potential products commercially in the United States when
it  has developed such products. There can be no assurance that the company
will be  able to obtain necessary PMA application approvals to market such
products on a  timely basis, if at all, and delays in receipt or failure to
receive such  approvals, the loss of previously received approvals, or failure
to comply with  existing or future regulatory requirements could have a
material adverse effect  on the company's business, financial condition and
results of operations.

The company is also required to register as a medical device manufacturer with 
the FDA and state agencies, such as the California Department of Health
Services  ("CDHS") and to list its products with the FDA. As such, the company
is subject  to inspections by both the FDA and the CDHS for compliance with the
FDA's GMP or  QS Regulations and other applicable regulations. These
regulations require that  the company maintain its documents in a prescribed
manner with respect to  manufacturing, testing and control activities. Further,
the company and the third  party manufacturers of its products are required to
comply with various FDA  requirements for design, safety, advertising and
labeling. There can be no  assurance that the company or its component
suppliers will not encounter any  manufacturing difficulties, or that the
company any of its subcontractors or  component suppliers will not experience
similar difficulties, including problems  involving regulatory compliance,
product recalls, production yields, quality  control and assurance, supplies of
components or shortages of qualified  personnel.

Regulations regarding the manufacture and sale of the company's products are 
subject to change. The company cannot predict the effect, if any, that such 
changes might have on its business, financial condition or results of
operations.

International 

International sales of the company's products are subject to the regulatory 
agency product registration requirements of each country. The regulatory review
process varies from country to country. The company has obtained regulatory 
clearance to market the Arthroscopic System in Australia and Europe but has not
obtained any other international regulatory approvals permitting sales of its 
products outside of the United States. The company intends to seek regulatory 
approvals in certain other international markets. There can be no assurance, 
however, that such approvals will be obtained on a timely basis or at all.

For European distribution, the company has received ISO 9001 certification and 
the CE mark. ISO 9001 certification standards for quality operations have been 
developed to ensure that companies know, on a worldwide basis, the standards of
quality to which they will be held. The European Union has promulgated rules 
requiring medical products to receive by mid-1998 the CE mark, an international
symbol of quality and compliance with applicable European medical device 
directives. Failure to maintain the CE mark will prohibit the company from 
selling its products in Europe. ISO 9001 certification in conjunction with 
demonstrated performance to the medical device directive is one of the 
alternatives available to meet the CE mark requirements. There can be no 
assurance that the company will be successful in maintaining certification 
requirements.

THIRD-PARTY REIMBURSEMENT

In the United States, health care providers, such as hospitals and physicians, 
that purchase medical devices, such as the company's Arthroscopic System and 
potential future products, generally rely on third-party payors, principally 
federal Medicare, state Medicaid and private health insurance plans, to
reimburse  all or part of the cost of the procedure in which the medical device
is being  used. Reimbursement for arthroscopic procedures performed using
devices that have  received FDA approval has generally been available in the
United States. In  addition, certain health care providers are moving toward a
managed care system  in which such providers contract to provide comprehensive
health care for a fixed  cost per person. Managed care providers are attempting
to control the cost of  health care by authorizing fewer elective surgical
procedures, such as certain  knee and shoulder, ankle, wrist, elbow and hip
arthroscopic procedures.

The company is unable to predict what changes will be made in the 
reimbursement methods used by third-party health care payors. The company 
anticipates that in a prospective payment system, such as the diagnosis related
group (DRG) system utilized by Medicare, and in many managed care systems used
by  private health care payors, the cost of the company's products will be 
incorporated into the overall cost of the procedure and that there will be no 
separate, additional reimbursement for the company's products. The company 
anticipates that hospital administrators and physicians will justify the use of
the company's products by the attendant cost savings and clinical benefits that
the company believes will be derived from the use of its products. However,
there  can be no assurance that this will be the case. Furthermore, the company
could be  adversely affected by changes in reimbursement policies of
governmental or  private health care payors, particularly to the extent any
such changes affect  reimbursement for procedures in which the company's
products are used. Failure by  physicians, hospitals and other users of the
company's products to obtain  sufficient reimbursement from health care payors
for procedures in which the  company's products are used or adverse changes in
governmental and private third- party payors, policies toward reimbursement for
such procedures would have a  material adverse effect on the company's
business, financial condition and  results of operations.

If the company obtains the necessary international regulatory approvals , 
market acceptance of the company's products in international markets would be 
dependent, in part, upon the availability of reimbursement within prevailing 
health care payment systems. Reimbursement and health care payment systems in 
international markets vary significantly by country, and include both
government- sponsored health care and private insurance. The company intends to
seek  international reimbursement approvals, although there can be no assurance
that  any such approvals will be obtained in a timely manner, if at all.

PRODUCT LIABILITY AND INSURANCE

The development, manufacture and sale of medical products entail significant 
risks of product liability claims. The company's current product liability 
insurance coverage limits are $5,000,000 per occurrence and $5,000,000 in the 
aggregate. There can be no assurance that such coverage limits are adequate to 
protect the company from any liabilities it might incur in connection with the 
development, manufacture and sale of its Arthroscopic System and potential
future  products. In addition, the company may require increased product
liability  coverage if any potential future products are successfully
commercialized.  Product liability insurance is expensive and in the future may
not be available  to the company on acceptable terms, if at all. The company
has been selling its  product since December 1995 and has not experienced any
product liability claims  to date. However, a successful product liability
claim or series of claims  brought against the company in excess of its
insurance coverage could have a  material adverse effect on the company's
business, financial condition and  results of operations.

EMPLOYEES

As of January 3, 1998, the company had 108 employees. 51 people are engaged in 
manufacturing activities, 15 are engaged in research and development
activities,  19 people are engaged in sales and marketing activities, 12
persons are engaged  in regulatory affairs and quality assurance and 11 people
are engaged in  administration and accounting. No employees are covered by
collective bargaining  agreements, and the company believes it maintains good
relations with its  employees.

The company is dependent upon a number of key management and technical 
personnel. The loss of the services of one or more key employees or consultants
could have a material adverse effect on the company. The company's success will
also depend on its ability to attract and retain additional highly qualified 
management and technical personnel. The company faces intense competition for 
qualified personnel, many of whom are often subject to competing employment 
offers, and there can be no assurance that the company will be able to attract 
and retain such personnel. Furthermore, the company's scientific advisory board
members all are otherwise employed on a full-time basis. As a result, the 
scientific advisory board members are not available to devote their full time
or  attention to the company's affairs.

FACILITIES

The company leases approximately 32,000 square feet in two neighboring 
buildings in Sunnyvale, California, which comprise the company's administrative
offices and manufacturing and warehousing space. The company's lease for this 
facility extends through February 2002. The company believes that its existing 
facilities will be sufficient for its operational purposes through 1998.


ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS

History of Losses; Fluctuations in Operating Results; Losses Expected to
Continue

The company has experienced significant operating losses since inception and, 
as of January 3, 1998, had an accumulated deficit of $25.3 million. The company
expects to generate additional losses due to increased operating expenditures 
primarily attributable to the expansion of marketing and sales activities, 
increased research and development, and activities to support regulatory 
applications.  Results of operations may fluctuate significantly from quarter
to  quarter due to the timing of such expenditures, absence of a backlog of
orders,  timing of the receipt of orders, promotional discounts of the
company's products,  re-use of the company's disposable products, in addition
to those detailed above.   The company's revenues and profitability will be
critically dependent on whether  it can successfully continue to market its
Arthroscopic System.  In addition, the  company's gross margins may be
adversely affected due to the necessity to promote  and sell its product at
significantly reduced prices.  There can be no assurance  that significant
profitability will ever be achieved.

Control by Directors, Executive Officers and Affiliated Entities

The company's directors, executive officers and entities affiliated with them, 
in the aggregate, beneficially own approximately 40% of the company's
outstanding  common stock.  These stockholders, if acting together, will have
significant  influence over all matters requiring approval by the stockholders
of the company,  including the election of directors and the approval of
mergers or other business  combination transactions.

Potential Volatility of Stock Price

The stock markets have experienced price and volume fluctuations that have 
particularly affected medical technology companies, resulting in changes in the
market prices of the stocks of many companies that may not have been directly 
related to the operating performance of those companies.  Such broad market 
fluctuations may adversely affect the market price of the company's common
stock.   In addition, the market price of the company's common stock may be
highly  volatile.  Factors such as variations in the company's financial
results,  comments by security analysts, announcements of technological
innovations or new  products by the company or its competitors, changing
government regulations and  developments with respect to FDA submissions,
patents, proprietary rights or  litigation may have a significant adverse
effect on the market price of the common stock.

Anti-Takeover Effect of Stockholder Rights Plan and Certain Charter and Bylaw 
Provisions

In November 1996, the company's Board of Directors adopted a Stockholder 
Rights Plan.  The Stockholder Rights Plan provides for a dividend distribution
of  one Preferred Shares Purchase Right (a "Right") on each outstanding share
of the  company's common stock.  Each Right entitles shareholders to buy
1/1000th of a  share of the company's Series A participating preferred stock at
an exercise  price of $50.00.  The Rights will become exercisable following the
tenth day  after a person or group announces acquisition of 15 percent or more
of the  company's common stock, or announces commencement of a tender offer,
the  consummation of which would result in ownership by the person or group of
15  percent or more of the company's common stock.  The company will be
entitled to  redeem the Rights at $0.01 per Right at any time on or before the
tenth day  following acquisition by a person or group of 15 percent or more of
the company's common stock.

The Stockholder Rights Plan and certain provisions of the company's 
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 the company.  This could limit the price that 
certain investors might be willing to pay in the future for shares of the 
company's common stock.  Certain provisions of the company's Certificate of 
Incorporation and Bylaws allow the company to issue preferred stock without any
vote or further action by the stockholders, eliminate the right of stockholders
to act by written consent without a meeting, specify procedures for director 
nominations by stockholders and submission of other proposals for consideration
at stockholder meetings, and eliminate cumulative voting in the election of 
directors.  Certain provisions of Delaware law applicable to the company could 
also delay or make more difficult a merger, tender offer or proxy contest 
involving the company, 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
Stockholder Rights Plan, the possible issuance of preferred stock, the
procedures  required for director nominations and stockholder proposals and
Delaware law  could have the effect of delaying, deferring or preventing a
change in control of  the company, including without limitation, discouraging a
proxy contest or making  more difficult the acquisition of a substantial block
of the company's common  stock.  These provisions could also limit the price
that investors might be  willing to pay in the future for shares of the
company's common stock.

Lack of Dividends

The company has not paid any dividends and does not anticipate paying any 
dividends in the foreseeable future.


Item 2.        PROPERTIES

The company leases approximately 32,000 square feet in two neighboring
buildings  in Sunnyvale, California, which comprise the company's
administrative offices and  manufacturing and warehousing space. The company's
two leases for these  facilities extend through February 2002. The company
believes that its existing  facilities will be sufficient for its operational
purposes through 1998.

Item 3.        LEGAL PROCEEDINGS

On February 13, 1998, the company filed a lawsuit against Ethicon, Inc. Mitek 
Surgical Products, a division of Ethicon, Inc. and GyneCare, Inc. ("the 
Defendants") in the United States District Court for the Northern District of 
California.   The lawsuit alleges, among other things, that the Defendants have
been and are currently infringing four patents issued to the company in
December  1997.  Specifically, the Defendants use, market and sell two separate
electrosurgical systems under the names of "VAPR" and "VersaPoint" which
infringe  these patents.  The company seeks: (1) a judgment that the Defendants
have  infringed these patents; (2) to preliminarily and permanently restrain
and enjoin  the Defendants from marketing and selling the VAPR and VersaPoint
systems; and  (3) an award of damages (including attorneys' fees) to compensate
the company for  lost profits, the damages to be trebled because of the
Defendants' willful  infringement.  In addition, the company filed a motion on
March 5, 1998 for  preliminary injunction against the Defendants marketing and
selling of the VAPR system.


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

Not applicable

EXECUTIVE OFFICERS

The executive officers of the company who are elected by and serve at the 
discretion of the Board of Directors and their ages are as follows:

        Name                Age                 Position        
---------------------      ------     ------------------------------------
Michael A. Baker             39        President and Chief Executive Officer
Hira V. Thapliyal, Ph.D.     48        Chief Technical Officer
Robert T. Hagan              52        Vice President, Manufacturing
Christine E. Hanni           37        Vice President, Finance  
                                       and Chief Financial Officer
Allan Weinstein              44        Vice President, Sales and Marketing


Michael A. Baker joined the company in July 1997 as President and Chief 
Executive Officer and Director,  From 1989 to 1997, Mr. Baker held several 
positions in planning, corporate development and senior management at
Medtronic,  Inc. a $2.4 billion medical technology company specializing in
implantable and  invasive therapies.  His most recent position at Medtronic,
Inc., was Vice  President, General Manager of Medtronic's Coronary Vascular
Division based in San  Diego, CA.  From 1988 to 1989, Mr. Baker was a
Management Consultant at The  Carroll Group.  From 1986 to 1988, Mr. Baker was
the Corporate Development  Officer at American National Bank & Trust Co.  Prior
to joining American National  Bank & Trust Co., Mr. Baker served in the United
States Army from 1981 to 1986  were he rose to the rank of Captain.  Mr. Baker
holds a bachelor degree from the  United States Military Academy at West Point
and an MBA from the University of Chicago.

Hira V. Thapliyal, Ph.D., a founder of the company, has served as Chief 
Technical Officer of the company since July 1997.  Prior to July 1997, Dr. 
Thapliyal was President, Chief Executive and Officer of the company since its 
inception in April 1993. He has also been a Director of the company since April
1993. From 1989 to 1993, Dr. Thapliyal was President and Chief Executive
Officer  of MicroBionics, Inc., a privately held company developing an in-vivo
continuous  blood gas monitor. In 1986, Dr. Thapliyal founded Cardiovascular
Imaging Systems,  Inc. (CVIS) and served as its President until 1988. CVIS
develops and markets  catheters for ultrasonic intraluminal imaging of human
arteries. From 1984 to  1986, Dr. Thapliyal was Vice President, Engineering of
Devices for Vascular  Interventions, Inc., a leader in marketing atherectomy
systems for treatment of  atherosclerotic disease. Dr. Thapliyal holds an M.S.
degree in Electrical  Engineering from University of Idaho and a Ph.D. in
Materials Science &  Engineering from Cornell University.

Robert T. Hagan joined the company in August 1995 as Vice President, 
Manufacturing. From October 1992 to July 1995, Mr. Hagan was retired. From 
October 1984 to September 1992, Mr. Hagan held several manufacturing oversight 
positions with Haemonetics Corporation, a manufacturer of blood processing 
equipment and sterile disposables. His most recent position at Haemonetics 
Corporation was Director of Advanced Manufacturing Technologies. Mr. Hagan
holds  a B.S. degree in Industrial Engineering from Tennessee Technology
University.

Christine E. Hanni joined the company in January 1998 as Vice President, 
Finance and Chief Financial Officer. From 1992 until 1997, Ms. Hanni first
served  as Corporate Controller and then as Director of International Finance
and Sales  Administration of Target Therapeutics, Inc. (Target), a leading
manufacturer of  disposable medical devices for the treatment of various brain
diseases. Prior to  joining Target, she held several finance and accounting
positions with Tandem  Computers, Inc. including Marketing Accounting Manager. 
From 1983 to 1987 Ms.  Hanni was an auditor for Coopers & Lybrand in San Jose,
California and Portland,  Oregon.  Ms. Hanni holds a B.S. degree in Accounting
from Southern Oregon  University.

Allan Weinstein joined the company in January 1995 as Vice President, Sales 
and Marketing. From December 1982 to December 1994, Mr. Weinstein held various 
marketing positions with Acufex Microsurgical, Inc. (Acufex), a manufacturer of
arthroscopic instruments. His most recent position at Acufex was Director of 
Sales, North and South America. Mr. Weinstein holds a B.A. degree in 
Communications from Seton Hall University.


DISCLOSURE WITH REGARD TO DELINQUENT FILINGS 

Section 16(a) of the Securities Exchange Act of 1934, as amended (the 
"Exchange Act"), requires the company's directors and officers and persons who 
own more than 10% of a registered class of the company's equity securities, to 
file reports of ownership and reports of changes in the ownership with the 
Securities and Exchange Commission (the "SEC"). Such persons are required by
SEC  regulations to furnish the company with copies of all Section 16(a) forms
they  file.

Based solely on its review of the copies of such forms submitted to it during 
the year ended January 3, 1998, the company believes that, during the Last
Fiscal  Year, its director and officer Michael A Baker failed to timely file
one Form 3  disclosing shares of the company common stock aquired by Mr. Baker
before he  became a director and officer of the company.



                                     PART II

Item 5.        MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
               MATTERS

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

<TABLE> 
<CAPTION> 

                                              HIGH        LOW
                                            ---------  ---------
<S>                                         <C>        <C>
 Year Ended December 28, 1996
--------------------------------------
 Quarter Ended March 30, 1996  (1)          $ 25.750   $ 16.875 
 Quarter Ended June 29, 1996                $ 24.750   $ 14.813 
 Quarter Ended September 28, 1996           $ 18.000   $  8.750 
 Quarter Ended December 28, 1996            $ 11.000   $  6.750 

 Year Ended January 3, 1998
--------------------------------------
 Quarter Ended March 29, 1997               $ 10.625   $  5.500 
 Quarter Ended June 28, 1997                $  9.500   $  5.500 
 Quarter Ended September 27, 1997           $ 14.750   $  8.625 
 Quarter Ended January 3, 1998              $ 13.563   $  9.500 

</TABLE>

(1)     Prior to February 5, 1996, there was no established public     
        trading market for the common stock. Market prices presented
        for the quarter ended March 31, 1996 are for the period
        commencing February 5, 1996 and ending March 31, 1996.

As of March 4, 1998, there were no outstanding shares of Preferred Stock and 
231 holders of record of 8,896,386 shares of outstanding Common Stock. The 
company has not paid any dividends since its inception and does not intend to
pay  any dividends on its Common Stock in the foreseeable future.


Item 6.        SELECTED FINANCIAL DATA

The following is a summary of the company's  unaudited quarterly results for
the eight  quarters in the period ended January 3,  1998, the audited annual
results for the  years ended January 3, 1998, December 28,  1996, December 31,
1995 and 1994 and for  the period from April 29, 1993 (date of  inception) to
December 31, 1993. In  management's opinion, the quarterly results  have been
prepared on a basis consistent  with the audited financial statements 
contained elsewhere herein, and include all  adjustments, consisting only of
normal  recurring adjustments, necessary for a fair  presentation of the
information for the  periods presented. The information set  forth below is not
necessarily indicative  of the results of future operations and  should be read
in conjunction with the  audited financial statements and notes  thereto
appearing on pages 21-38 of this  report. 

<PAGE>

<TABLE> 
<CAPTION> 
                                            Three Month Period Ended
                              --------------------------------------------------
                               March 29,    June 28,   September 27, January 3,
                                 1997         1997         1997         1998
                              -----------  -----------  -----------  -----------
                                     (in thousands, except per share data)

<S>                           <C>          <C>          <C>          <C>
Statements of Operations Data:

Net sales                       $  2,261     $  2,832     $  3,366     $  4,337 
Gross margin                         582          838        1,165        1,716
Operating expenses                 3,135        3,186        3,396        3,684
Net loss                          (2,167)      (1,989)      (1,900)      (1,632)
Net loss per common share and
per common share-assuming
dilution(1)                     $  (0.25)    $  (0.23)    $  (0.22)    $  (0.18)


                                            Three Month Period Ended
                              --------------------------------------------------
                               March 30,    June 29,  September 28,  December 28,
                                 1996         1996          1996         1996
                              -----------  -----------  -----------  -----------
                                   (in thousands, except per share data)

Net sales                       $  1,159     $  1,406     $  1,574     $  1,883 
Gross margin                          94          170          209          307
Operating expenses                 2,098        2,349        2,534        3,008
Net loss                          (1,743)      (1,735)      (1,932)      (2,295)
Net loss per common share and
per  common share-assuming
dilution(1)                     $  (0.30)    $  (0.20)    $  (0.22)    $  (0.26)

</TABLE>

(1) Per Share data has been restated to  reflect the company's adoption of
Statement  of Financial Accounting Standard No. 128  "Earnings Per Share" and
the Securities and  Exchange Commission Staff Accounting  Bulletin No. 98. See
Note 2 of the Financial Statements.


<PAGE>
<TABLE> 
<CAPTION> 
                                                                                           For The
                                                                                          Period From
                                                                                          April 29,
                                                                                             1993
                                                                                           (Date of
                                                      Year Ended                         Inception)
                                 ------------------------------------------------------       To
                                  January 3,   December 28,  December 31,  December 31,  December 31,
                                     1998          1996          1995          1994          1993
                                 ------------  ------------  ------------  ------------  ------------
                                                 (in thousands, except per share data)

<S>                              <C>           <C>           <C>           <C>           <C>
Net sales                           $ 12,796      $  6,022      $    218      $     --      $     -- 
Gross margin                           4,301           780          (229)           --            -- 
Total operating expenses              13,401         9,989         6,940         2,247           857
Net loss                              (7,688)       (7,705)       (6,950)       (2,121)         (842)
Net loss per common share and per 
common share-assuming dilution (1)     (0.87)        (0.97)        (1.82)        (0.64)        (0.51)


                                  January 3,   December 28,  December 31,  December 31,  December 31,
                                     1998          1996          1995          1994          1993
                                 ------------  ------------  ------------  ------------  ------------
                                                              (in thousands)
Balance Sheet Data:

Cash and cash equivalents           $  8,188      $ 11,359      $  4,774      $  2,599      $    993 
Working capital                       20,342        23,468         5,119         2,467           858
Total assets                          26,675        33,297         7,800         2,917         1,048
Total stockholders' equity (2)        23,546        30,782         6,325         2,727           890

</TABLE>

(1) Per Share data has been restated to  reflect the company's adoption of
Statement  of Financial Accounting Standard No. 128  "Earnings Per Share" and
the Securities and  Exchange Commission Staff Accounting  Bulletin No. 98. See
Note 2 of the Financial Statements.

(2) The company has not declared any cash  dividends on its common stock since
its  inception and does not anticipate paying  cash dividends in the
foreseeable future.


<PAGE>
Item 7.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
               RESULTS OF OPERATIONS

OVERVIEW

Statements in this Management's Discussion and Analysis of Financial Condition 
and Results of Operations which express that the company "believes", 
"anticipates" or "plans to..." as well as other statements which are not
historical  fact, are forward looking statements within the meaning of the
Private Securities  Litigation Reform Act of 1995. Actual events or results may
differ materially as  a result of the risks and uncertainties described herein
and elsewhere including,  in particular, those factors described under
"Business" and "Additional Factors  That Might Affect Future Results" set forth
in Part I of this Report as well as  other risks and uncertainties in the
documents incorporated herein by reference.

Since commencing operations in April 1993, ArthroCare Corporation (the company)
has primarily engaged in the design, development, clinical testing,
manufacturing  and marketing of its Arthroscopic System. The Arthroscopic
System uses the  company's novel Coblation (TM) technology that allows surgeons
to operate with  increased precision and accuracy with minimal damage to
surrounding tissue. It is  currently being used in closed joint surgery
including many types of knee and  shoulder procedures. The Arthroscopic System
consists of a disposable, bipolar  ArthroWand, a radio frequency controller
that powers the ArthroWand and a cable  that connects the ArthroWand to the
controller. The ArthroWand ablates (removes)  soft tissue with minimal damage
to surrounding healthy tissue and simultaneously  achieves hemostasis (sealing
of small bleeding vessels). After the close of the  1997 fiscal year, the
company entered into a license agreement under which Boston  Scientific
Corporation will develop and market products based on the company's  Coblation
(TM) technology for myocardial revascularization procedures.

The company received clearance of its 510(k) premarket notification from the 
United States Food and Drug Administration (FDA) in March 1995 to market its 
Arthroscopic System in the United States for use in arthroscopic surgery of the
knee, shoulder, elbow and ankle. The company has since received clearance for
use  in the wrist and hip. In December 1995, the company commercially
introduced its  Arthroscopic System through a network of distributors in the
United States. In  light of the for going, the company has a limited history of
operations. The  company's strategy includes placing with arthroscopic
surgeons, controllers that  are intended to generate future wand revenues. The
company's long-term strategy  includes applying its patented platform
technology to a range of other soft  tissue surgical procedures. The company
has received 510(k) clearance for use of  its technology in several fields and
has received approval of an investigational  device exemption (IDE) to conduct
a clinical study which may result in the  company submitting a 510(k)
application to the FDA. There can be no assurance  that any of the company's
clinical studies will lead to 510(k) applications or  that the applications
will be cleared by the FDA on a timely basis, if at all, or  that the products,
if cleared for marketing, will ever achieve commercial  acceptance. 

<PAGE>
RESULTS OF OPERATIONS

The year ended January 3, 1998 was the company's second full year of product 
shipments. The company was in its development stage during the comparable year 
ended December 31, 1995. 

                ArthroCare Corporation Statements of  Operations
                                 (in thousands)
<TABLE> 
<CAPTION> 
                                                                For the Years Ended
                                                    ------------------------------------------
                                                     January 3,    December 28,   December 31,
                                                        1998           1996           1995
                                                    ------------   ------------   ------------
<S>                                                 <C>            <C>            <C>
Net sales                                              $ 12,796       $  6,022       $    218
Cost of sales                                             8,495          5,242            447
                                                    ------------   ------------   ------------
Gross margin                                              4,301            780           (229)
                                                    ------------   ------------   ------------
Operating expenses:
   Research and development                               4,026          3,772          4,009
   Sales and marketing                                    6,263          3,635          1,351
   General and administrative                             3,112          2,582          1,320
   Non-recurring charge for acquired technology             --             --             260
                                                    ------------   ------------   ------------
Total operating expenses                                 13,401          9,989          6,940
                                                    ------------   ------------   ------------
Loss from operations                                     (9,100)        (9,209)        (7,169)
Interest and other expense, net                           1,413          1,505            219
                                                    ------------   ------------   ------------
Loss before income tax provision                         (7,687)        (7,704)        (6,950)
Income tax provision                                         (1)            (1)           --
                                                    ------------   ------------   ------------
Net loss                                               $ (7,688)      $ (7,705)      $ (6,950)
                                                    ============   ============   ============
</TABLE>


Net Sales

Revenues for the year ended January 3, 1998 were $12.8 million compared to 
$6.0 million for the year ended December 28, 1996. The $6.8 million increase
was  due to higher unit volume wand and controller sales resulting from
controller  promotional programs and a larger installed base of controllers.
The company was  in its development stage during 1995 and shipped its first
Arthroscopic System in  December 1995. Revenues for the year ended December 31,
1995 were $0.2 million.

The company's strategy has been and continues to be to increase future wand 
sales by increasing the installed base of controllers through aggressive 
promotional programs. This strategy has and will continue to have an adverse 
impact on controller revenue and on gross margins, partially offsetting the 
positive impact of increased wand sales. 

Overall, wands were sold at or near list price during the years ended January 
3, 1998 and December 28, 1996. The company expects to sell wands at discounted 
prices to international dealers in the future.

For the years ended January 3, 1998 and December 28, 1996 wands sales 
comprised the vast majority of revenues. The company believes increased wand 
sales are a result of the company's strategic plan to build market share
through  continued promotional programs of controllers. The company expects
wand sales to  remain the primary component of revenues in the future.

The company believes that, in its second full year of product shipments, it 
has penetrated 15% to 20% of hospitals that perform arthroscopic procedures in 
the United States and that more than half of the company's wand revenue is
being  generated by wands purchased for use in shoulder procedures. The company
believes  that shoulder procedures are the fastest growing segment of the
arthroscopic  market and knee procedures represent the largest segment of the
arthroscopic  market. In order to achieve increasing wand sales over time, the
company believes  it must further penetrate the market for knee procedures.

The company has introduced additional wand styles including its new Turbo Dome 
wands designed to be used in both knee and shoulder arthroscopic procedures. In
November 1997, the company introduced its System 2000 controller designed for 
more aggressive ablation and hemostasis. The company believes these features
will  increase wand sales in the market for knee and shoulder procedures. In
addition,  the company has introduced wand styles for small joint and for
capsular shrinkage  procedures. The new wand styles and the new System 2000
controller are intended  to increase the market for the company's products.
There can be no assurance that  the use of these new products will be adopted
by doctors.

The company has limited sales and marketing experience and can make no 
assurance that current trends in sales and product acceptance will continue. 

Cost of Sales

Cost of sales for the year ended January 3, 1998 was $8.5 million, or 66% of 
sales. During the year ended December 28, 1996, cost of sales was $5.2 million,
or 87% of sales. The company was in its development stage during 1995 and
shipped  its first Arthroscopic System in December 1995. Cost of sales for the
year ended  December 31, 1995 was $0.4 million. The $3.3 million increase in
cost of sales  for the year ended January 3, 1998 over the year ended December
28, 1996 was due  to increased shipments of both wands and controllers. Cost of
sales as a  percentage of sales decreased 21 percentage points during the year
ended January  3, 1998 as compared to the year ended December 28, 1996
resulting from the fixed  and semi-fixed costs being spread over higher
manufacturing volume. Improvements  to the manufacturing process also reduced
costs by improving efficiency.

In 1997 the company made a strategic decision to manufacture its new System 
2000 controller in-house and introduced this  new product in November 1997.
While the shipments of System 2000 controllers did  not have a material impact
on controller cost or gross margin in the year ended  January 3, 1998, the
company believes it can reduce controller unit cost in the  future  by
manufacturing the new controller in-house. However, there can be no assurance 
that the company will be able to achieve  this objective. 

The improvement in gross margin in 1997 includes the effect of the controller 
promotional programs. The company believes that if its promotional programs 
maintain the same or higher number of wands bundled with a discounted
controller,  and if  the demand for disposable wands increases over a growing
installed base of  controllers, then the cost of sales will continue to
decrease as a percentage of  sales and gross margins will continue to increase.
However, there can be no  assurance the company will be successful in
maintaining the mix of wands to  discounted controllers in its promotional
programs or in increasing demand for  its disposable wands. Further, production
of future new products may adversely  impact gross margin due to the
inefficiencies in manufacturing new products. 

Operating Expenses

Research and development expense, which includes expenditures for regulatory 
compliance and quality assurance, increased 7%  to $4.0 million for the year
ended January 3, 1998 compared to $3.8 million for  the year ended December 28,
1996. The  $0.2 million increase is attributed to the development and
introduction of seven  new wand styles and the System 2000 controller as well
as the development and  investigation of products suitable for additional
markets. This increase was  partially offset by reduced spending for outside
design and engineering services.  Research and development expenses decreased 6
% or $0.2 million during the year  ended December 28, 1996 as compared to $4.0
million for the year ended December  31, 1995. The decrease was due to the
inclusion of manufacturing startup costs in  research and development in the
year ended December 31, 1995 when the company was  in its development stage, as
well as a non-recurring charge of $260,000 in March  1995, for acquired
technology.

The company believes that continued investment in its platform technology is 
essential if it is to maintain its competitive position. The company expects to
continue increasing research and development spending through substantial 
expenditures on new product development, regulatory affairs, clinical studies
and  patents, although not at the rate seen in the past year. The company
believes  that its ability to attract and retain qualified engineers in the
future is  critical to the continued success of the company. 

Sales and marketing expense increased 72% to $6.3 million in the year ended 
January 3, 1998 as compared to $3.6 million for the year ended December 28,
1996.  The $2.7 million increase was primarily due to higher dealer commissions
resulting from increased sales, higher staffing, and promotional and trade show
expenses reflecting an increased level of sales and marketing activity. Sales
and  marketing expenses increased 169% or $2.3 million during the year ended
December  28, 1996 as compared to $1.4 million in the year ended December 31,
1995 when the  company was in its development stage. The increase was primarily
due to dealer  commissions and promotional, demonstration and sample expenses.

The company anticipates that sales and marketing spending will continue to 
increase due to higher dealer commissions from increased sales, the additional 
cost of penetrating international markets for the company's products, higher 
promotional, demonstration and sample expenses, and additional investments in
the  sales, marketing and support staff necessary to market  its current
products and commercialize future products.

General and administrative expense increased 21% to $3.1 million in the year 
ended January 3, 1998 as compared to $2.6 million for the year ended December
28,  1996. The $0.5 million increase is primarily due to the expense of
attracting,  recruiting and relocating a Chief Executive Officer and increased
staffing.  Higher expenditures also include the cost of legal service, business
development  activities, insurance and expenses necessary to expand the
corporate  infrastructure. General and administrative expenses nearly doubled
to $2.6  million for the year ended December 28, 1996 from $1.3 million for the
year ended  December 31, 1995 due to additional staffing including management
personnel, the  increased cost of being a public company, business development
activities,  consulting fees and expenses necessary to expand the corporate
infrastructure.  The company expects that general and administrative expenses
will continue to  increase as a result of a patent litigation claim against
certain competitors  filed by the company after the close of the year, further
expansion of its staff,  and business development activities. See Part I, Item
3 of this report for a  description of the patent litigation.

Interest and Other Expense

Net interest income decreased slightly to $1.4 million for the year ended 
January 3, 1998 as compared to $1.5 million for the year ended December 28,
1996.  The $0.1 million decrease is attributable to the conversion of
investments to  cash for use in business operations during the year. Interest
income increased  $1.3 million in fiscal 1996 from $0.2 million for the year
ended  December 31, 1995 due to interest received on investment of the proceeds
from  the 1996 initial public offering of the company's common stock. At the
end of  fiscal 1997, the company had $19.9 million in cash, cash equivalents,
and  available-for-sale securities (which included long-term available-for-sale
securities) as compared to $29.3 million at the end of fiscal 1996 and $4.8 
million at the end of fiscal 1995. The company expects that interest income
will  decrease as the company reduces its investments to meet the future cash
needs of  the business.

Net Loss

Net loss remained unchanged at $7.7 million for the years ended January 3, 
1998 and December 28, 1996. During fiscal 1997, sales doubled, gross margin
grew  four and a half times and operating expenses increased only 34%. The net
loss of  $7.7 million for the year ended December 28, 1996 compares to $7.0
million in the  year ended December 31, 1995. The increased loss is due  to
higher operating expenses resulting from increased business activity including 
product development, manufacturing ramp-up, higher dealer commissions, the
sales  and marketing expenses necessary to promote products and the building of
corporate infrastructure. The higher operating expense was partially offset by
an  increase in gross margin and higher interest income.

The company expects net losses to continue to decrease as sales increase 
faster than operating expenses and gross margin continues to improve. However, 
there can be no assurance the company will be successful in its efforts to 
increase sales and gross margin or control the growth of operating expenses.

LIQUIDITY AND CAPITAL RESOURCES

At January 3, 1998 the company had $20.3 million in working capital and its 
principal sources of liquidity consisted of $19.9 million in cash, cash 
equivalents, and available-for-sale securities which include long-term
available- for-sale securities. The cash and cash equivalents are highly liquid
with  original maturities of ninety days or less. 

The company's cash used in operations increased to $8.5 million for the year 
ended January 3, 1998 from $6.4 million for the year ended December 28, 1996
due  to a higher inventory balance resulting from increased sales activity, the
build- up of controller component inventory in anticipation of volume, in-house
manufacturing of the new System 2000 controller and higher accounts receivable 
balances resulting from higher sales. This was partially offset by higher
accrued  compensation due to increased staffing levels and higher accrued
commissions due  to increased sales. Cash used in operations during the year
ended December 28,  1996 decreased slightly to $6.4 million from $6.6 million
for the year ended  December 31, 1995 reflecting higher accounts receivable,
net loss, and inventory  at the end of fiscal year 1996, offset by higher
accrued compensation, accounts  payable and financial reporting expenses, and
lower prepayments to a supplier of  the company's inventory.

Net accounts receivable increased to $2.2 million as of January 3, 1998 from 
$1.3 million as of December 28, 1996. Accounts receivable were $0.2 million as
of  December 31, 1995. The increase in accounts receivable between the fiscal
years  was due to sequentially increasing sales and the timing of sales within
the last  few months of the year. 

Inventories increased to $2.0 million as of January 3, 1998 compared to $0.8 
million at December 28, 1996 due to higher product sales activity and higher 
parts inventory in anticipation of volume, in-house manufacturing of the new 
System 2000 controller. Inventories were $0.5 million at December 31, 1995. The
increase in fiscal year 1996 was due to the higher level of product sales 
activity compared to the prior year during which the company began shipping 
product in December. The company expects future inventory levels to grow both
in  absolute value and as a percentage of total assets as sales volume
increases.

Net property and equipment decreased to $1.4 million as of January 3, 1998 
compared to $1.5 million at December 28, 1996. The slight decrease in fiscal
1997  was due to an increase in accumulated depreciation partially offset by
the  acquisition of capital equipment. Net property and equipment was $1.1
million as  of December 31, 1995. The increase in fiscal 1996 was primarily due
to purchases  of computer equipment, manufacturing equipment and machinery, and
furniture and  fixtures. In 1998, the company has planned but not committed to
approximately  $0.7 million in capital expenditures.

On February 11, 1998 the company and Boston Scientific Corporation (BSC) 
announced an agreement in which BSC will develop and market the company's 
proprietary Coblation (TM) technology for use in myocardial revascularization.
Under  the agreement, BSC acquires exclusive licensing rights to the company's 
intellectual property in this field. BSC will pay license fees, a portion of 
which will be classified as prepaid royalties, to the company upon achievement
of  designated milestones and royalties on sales of resulting products. There
can be  no assurance the company and BSC will achieve the milestones required
for the  company to receive the license fees or that a product will be
developed, cleared  for marketing and achieve sufficient commercial acceptance
for the company to  receive royalties.

The company relies on computers and computer software to run its business as 
do its vendors, suppliers and customers. These computers and computer software 
may not be able to properly recognize the dates commencing in the Year 2000.
The company has not completed an assessment of the impact this may have on its
business and does not have a reasonable basis to conclude whether the impact of
the year 2000 will or will not materially effect future financial results. To
date the company has not found any material impact which may result from the 
failure of its computers and computer software or that of its vendors,
suppliers, and customers. However, the company plans to make an  assessment of
this issue during 1998 and, if appropriate, develop an action plan  to correct
it.

The company plans to finance its capital needs principally from cash from 
product sales, cash, cash equivalents, and available-for-sale securities which 
include long-term available-for-sale securities and related interest, existing 
capital resources and licensing arrangements which the company believes will be
sufficient to fund its operations at least through fiscal year 1999. The
company  currently has no commitments for any credit facilities such as
revolving credit  agreements or lines of credit that could provide additional
working capital. The  company's future liquidity and capital requirements will
depend on numerous  factors including the company's success of commercializing
the Arthroscopic  System, development and commercialization of products in
fields other than  arthroscopy, the ability of the company's suppliers to
continue to meet the  demands of the company at current prices, the cost
associated with the company's  ongoing patent litigation, obtaining and
enforcing patents important to the  company's business, the status of
regulatory approvals and competition. There can  be no assurance that the
company will not be required to raise additional capital  or that such capital
will be available on acceptable terms, if at all.

In June 1997, the Financial Accounting Standards Board issued Statement of 
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive 
Income", and Statement of Financial Accounting Standards No. 131 (SFAS 131), 
"Disclosure about Segments of an Enterprise and Related Information". SFAS 130 
establishes requirements for disclosure of comprehensive income and becomes 
effective for the company's fiscal year 1998 with reclassification of earlier 
financial statements for comparative purposes. Comprehensive income generally 
represents all changes in stockholders' equity except those resulting from 
investments or contributions by stockholders. SFAS 131 establishes standards
for  disclosure about operating segments in annual financial statements and
selected  information in interim financial reports and standards for related
disclosures  about products and services, geographic areas and major customers.
This statement  supersedes Statement of Financial Accounting Standards No. 14,
"Financial  Reporting for Segments of a Business Enterprise". The new standard
becomes  effective for the company's fiscal year 1998, and requires that
comparative  information from earlier years be restated to conform to
requirements of this  standard. The company is evaluating the requirements of
SFAS 130 and SFAS 131 and  the effects, if any, on the company's current
reporting and disclosures.


Item 8.        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Certain information required by this Item is included in Item 6 of Part II of 
this Report and is incorporated herein by reference. All other information 
required by this Item is included on pages    to    in Item 14 of Part IV of
this  Report and is incorporated herein by reference.


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

None 



                                    PART III

Item 10.       EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT

Information regarding the Directors of the Company is incorporated by 
reference from the information set forth under the caption "Proposal No. 1: 
Election of Directors" in the Proxy Statement. Information regarding the 
executive officers of the Company is incorporated by reference from the 
information set forth under the caption "Executive Officers of the Company" at 
the end of Part I of this Report. Information with respect to Directors and 
Officers of the Company required by Item 405 of Regulation S-K is set forth
under  the captin "Disclosure with Regard to Delinquent Filings" at the end of
Part I of  this Report


Item 11.       EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference from the 
discussion in the Proxy Statement captioned "Executive Compensation."


Item 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated by reference from the 
discussion in the Proxy Statement captioned "Share Ownership of Directors, 
Officers and Certain Beneficial Owners."


Item 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference from the 
discussion in the Proxy Statement captioned "Certain Transactions."



                                    PART IV

Item 14.       EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 
               8-K

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

1.  Financial Statements. The following financial statements of the Company
and  the Report of Independant Accountants, are included in Part IV of this
Report on the pages indicated. 

                                                                       Page
                                                                      ------
    Report of Independent Accountants            

    Balance Sheets as of January 3, 1998 and December 28, 1996           

    Statements of Operations for the years ended January 3, 1998,     
    December 28, 1996, and December 31, 1995                         

    Statement of Stockholders' Equity for the years ended 
    January 3, 1998, December 28, 1996 and December 31, 1995             

    Statements of Cash Flows for the years ended January 3, 
    1998, December 28, 1996 and December 31, 1995

    Notes to Financial Statements                




2.  Financial Statement Schedule.  The following financial statement schedule
of  the Company as of and for the years ended January 3, 1998, December 28,
1996  and December 31, 1995, and the Report of Independent Accountants on
Financial  Statements Schedule are included in Part IV of this Report on the
pages  indicated. This financial statement schedule should be read in
conjunction with  the Financial Statements, and notes thereto, of the Company.



Schedule                     Title                                     Page
--------       ------------------------------------                   ------
 II             Valuation and Qualifying Accounts


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


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

    (1)  3.2        Certificate of Incorporation of the Registrant.

    (1)  3.3        Bylaws of the Registrant.

    (1)  4.1        Specimen Common Stock Certificate.

    (1) 10.1        Form of Indemnification Agreement between the Registrant 
                    and each of its directors and officers.

    (1) 10.2        Incentive Stock Plan and form of Stock Option Agreement 
                    thereunder.

    (1) 10.3        Director Option Plan and form of Director Stock Option 
                    Agreement thereunder.

    (1) 10.4        Employee Stock Purchase Plan and forms of agreements 
                    thereunder.

    (1) 10.5        Form of Exclusive Distribution Agreement.

    (1) 10.6        Form of Exclusive Sales Representative Agreement.

    (1) 10.7        Consulting Agreement, dated May 10, 1993, between the 
                    Registrant and Philip E. Eggers, and amendment thereto.

    (1) 10.8        Consulting Agreement, dated May 20, 1993, between the 
                    Registrant and Eggers & Associates, Inc., and amendment
                    thereto.

    (1) 10.9+       Development and Supply Agreement, dated March 1, 1994, 
                    between the Registrant and SeaMed Corporation.

    (1) 10.10       Lease Agreement, dated September 15, 1994, between 
                    Registrant and The Arrillaga Foundation and the Perry
                    Foundation for the Registrant's facility located at 595
                    North Pastoria Avenue, Sunnyvale, California 94086.

    (1) 10.11       Employment Letter Agreement, dated October 21, 1994, 
                    between the Registrant and Allan Weinstein and amendment 
                    thereto.

    (1) 10.12       Purchase Assistance Promissory Note, dated January 19, 
                    1995, between Registrant and Allan Weinstein.

    (1) 10.13       Sublease Agreement, dated February 1, 1995, between 
                    Registrant and Guided Medical Systems, Inc. for the 
                    Registrant's former facility at 453 Ravendale Drive,
                    Mountain View, California 94043.

    (1) 10.14       Mortgage Assistance Promissory Note Agreement, dated 
                    February 5, 1995, between the Registrant and Allan 
                    Weinstein.

    (1) 10.15       Restricted Stock Purchase and Security Agreement, dated 
                    February 5, 1995, between the Registrant and Allan 
                    Weinstein.

    (1) 10.16       Employment Letter Agreement, dated July 18, 1995, between 
                    the Registrant and Robert T. Hagan.

    (1) 10.17       Restricted Stock Purchase and Security Agreement, dated 
                    August 1, 1995, between the Registrant and Robert T. Hagan.

    (1) 10.18       Employment Letter Agreement, dated September 3, 1995, 
                    between the Registrant and A. Larry Tannenbaum.

    (1) 10.19+      Radiation Services Agreement, dated September 13, 1995, 
                    between the Registrant and SteriGenics International.

    (1) 10.20       Amended and Restated Stockholder Rights Agreement, dated 
                    October 16, 1995, between the Registrant and certain 
                    holders of the Registrant's securities.

    (1) 10.21       Contribution Agreement, dated March 31, 1995, by and among 
                    Philip E. Eggers, Robert S. Garvie, Anthony J. Manlove, 
                    Hira V. Thapliyal and the Registrant.

    (2) 10.22       Preferred Stock Rights Agreement, dated November 14, 1996, 
                    between the Registrant and Norwest Bank Minnesota, N.A.

    (3) 10.23+      Exclusive Distributor Agreement, dated April 15, 1997, 
                    between the Registrant and Arthrex, Gmbh.

    (4) 10.24++     Employment Letter Agreement, dated June 20, 1997, between 
                    the Registrant and Michael A. Baker. 

    (5) 10.25+      Exclusive Distributor Agreement, dated August 21, 1997, 
                    between the Registrant and Kobayashi Pharmaceutical 
                    Company, Ltd.   

        10.26++     License Agreement dated February 9, 1998, between the 
                    Registrant and Boston Scientific Corporation.

        10.27++     Development and Supply Agreement Agreement dated February 
                    9, 1998, between the Registrant and Boston Scientific 
                    Corporation.

        10.28       Lease Agreement date March 25, 1998 between the Registrant 
                    and Aetna Life Insurance Company for the Registrant's 
                    facility located at 840 Del Rey Avenue, Sunnyvale,
                    California 94086.

        23.1        Consent of Coopers & Lybrand L.L.P., Independent
                    Accountants.

        24.1        Power of Attorney (see Page 34).

        27.1        Financial Data Schedule.

        27.2        Restated Financial Data Schedule (1996).

        27.3        Restated Financial Data Schedule (1997).


 (1)    Incorporated herein by reference to the same-numbered exhibit
        previously  filed with the Registrant's Registration Statement on Form
        S- 1 (Registration No. 33-80453).

 (2)    Incorporated here in by reference to exhibit 5 previously filed with the
        Registrant's Registration Statement on Form 8-A (Registration No. 000-
        27422).

 (3)    Incorporated herein by reference to the same-numbered exhibit
        previously filed with the Registrant's Quarterly Report on Form 10-Q
        for the period ended March 29, 1997.

 (4)    Incorporated herein by reference to the same-numbered exhibit
        previously filed with the Registrant's Quarterly Report on Form 10-Q
        for the period ended June 28, 1997.

 (5)    Incorporated herein by reference to the same numbered exhibit
        previously filed with the Registrant's Quarterly Report on Form 10-Q
        for the period ended September 27, 1997.

  +     Confidential treatment granted.

  ++    Confidential treatment requested.


<PAGE>
                         REPORT OF INDEPENTANT ACCOUNTANTS

To the Board of Directors and Stockholders
ArthroCare Corporation:


We have audited the accompanying balance sheets of ArthroCare Corporation as of
January 3, 1998 and December 28, 1996, and the related statements of
operations, stockholders equity and cash flows for each of the three years in
the period ended January 3, 1998. These financial statements are the
responsibility of the companys management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ArthroCare Corporation as of
January 3, 1998 and December 28, 1996, and the results of its operations and
its cash flows for each of the three years in the period ended January 3, 1998,
in conformity with generally accepted accounting principles.


/s/ COOPERS & LYBRAND L.L.P.

San Jose, California
January 27, 1998
except for Note 11 for which
the date is March 25, 1998




<PAGE>
                             ARTHROCARE CORPORATION
                                 BALANCE SHEETS
                     (in thousands, except per share data)
<TABLE>
<CAPTION>
                                                       January 3,  December 28,
                                                         1998         1996
                                                      -----------  -----------
<S>                                                   <C>          <C>
                                                                                                                     Assets
Current assets:
   Cash and cash equivalents                             $ 8,188      $11,359
   Available-for-sale securities                          10,674       12,281
   Accounts receivable, net of allowance for bad
     debt of $115 in 1997 and $142 in 1996                 2,223        1,251
   Inventories                                             2,019          759
   Prepaid expenses and other current assets                 210          155

   Total current assets                                   23,314       25,805

Available-for-sale securities                              1,010        5,641
Property and equipment, net                                1,412        1,484
Related party receivables                                    876          298
Other assets                                                  63           69
                                                      -----------  -----------
     Total assets                                        $26,675      $33,297
                                                      ===========  ===========
                                                                                                                  Liabilities
Current liabilities:
   Accounts payable:
     Trade                                               $   950      $ 1,001
     Related parties                                          18           54
   Accrued liabilities                                     1,987        1,245
   Capital lease obligation, current portion                  17           37
                                                      -----------  -----------
   Total current liabilities                               2,972        2,337

Capital lease obligation, less current portion                --           21
Deferred rent                                                157          157
                                                      -----------  -----------
   Total liabilities                                       3,129        2,515
                                                      -----------  -----------
Commitments (Note 5 and Note 11)

                                                                                                              Stockholders' Equity

Preferred stock, par value $0.001:
   Authorized: 5,000 shares;
   Issued and outstanding: 0 shares in 1997 and 1996          --           --
Common stock, par value $0.001:
   Authorized: 20,000 shares;
   Issued and outstanding: 8,869 shares in 1997 
   and 8,778 shares in 1996                                    9            9
Additional paid-in capital                                49,153       48,862
Notes receivable from stockholders                           (92)         (92)
Deferred compensation                                       (228)        (388)
Unrealized gain on available-for-sale securities              10            9
Accumulated deficit                                      (25,306)     (17,618)
                                                      -----------  -----------
   Total stockholders' equity                              23,546       30,782
                                                      -----------  -----------
     Total liabilities and stockholders' equity           $26,675      $33,297
                                                      ===========  ===========
</TABLE>

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


<PAGE>
                             ARTHROCARE CORPORATION
                            STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
<TABLE> 
<CAPTION> 
                                                                For the Years Ended
                                                    ------------------------------------------
                                                     January 3,    December 28,   December 31,
                                                        1998           1996           1995
                                                    ------------   ------------   ------------
<S>                                                 <C>            <C>            <C>
Net sales                                              $ 12,796       $  6,022       $    218
Cost of sales                                             8,495          5,242            447
                                                    ------------   ------------   ------------
Gross margin                                              4,301            780           (229)
                                                    ------------   ------------   ------------
Operating expenses:
   Research and development                               4,026          3,772          4,009
   Sales and marketing                                    6,263          3,635          1,351
   General and administrative                             3,112          2,582          1,320
   Non-recurring charge for acquired technology             --             --             260
                                                    ------------   ------------   ------------
Total operating expenses                                 13,401          9,989          6,940
                                                    ------------   ------------   ------------
Loss from operations                                     (9,100)        (9,209)        (7,169)
Interest income                                           1,418          1,514            219
Other expense                                                (5)            (9)           --
                                                    ------------   ------------   ------------
Loss before income tax provision                         (7,687)        (7,704)        (6,950)
Income tax provision                                         (1)            (1)           --
                                                    ------------   ------------   ------------
Net loss                                               $ (7,688)      $ (7,705)      $ (6,950)
                                                    ============   ============   ============
Net loss per common share and per common 
share-assuming dilution                                $  (0.87)      $  (0.97)      $  (1.82)
                                                    ============   ============   ============
Shares used in computing net loss per common
share and per common share-assuming dilution              8,813          7,936          3,812
                                                    ============   ============   ============


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


<PAGE>
                             ARTHROCARE CORPORATION
                        STATEMENT OF STOCKHOLDERS' EQUITY
  for the years ended January 3, 1998, December 28, 1996, and December 31, 1995
                      (in thousands, except per share data)

</TABLE>
<TABLE>
<CAPTION>
                                                                                                    Unreal-
                                                                                                     ized
                                                                                  Notes             Gain on
                                                                                 Receiv-             Avail-
                                                                         Addi-     able              able-              Total
                                       Preferred Stock   Common Stock    tional    from   Deferred  for-Sale  Accum-    Stock-
                                      --------------- ----------------- Paid-In   Stock-  Compensa-  Secur-   ulated   holders'
                                      Shares  Amount   Shares   Amount  Capital  holders    tion     ities    Deficit   Equity
                                      ------- ------- -------- -------- -------- -------- --------- -------- --------- --------
<S>                                   <C>     <C>     <C>      <C>      <C>      <C>       <C>       <C>     <C>       <C>
Balances, December 31, 1994            4,356    $  4    1,186     $  1  $ 5,685    $  --    $  --     $  --  $ (2,963)  $ 2,727

  Issuance of Series C preferred
  stock for cash  at $2.00 per share
  in March and June 1995, net of
  issuance costs of $17                2,923       3       --       --    5,825       --       --        --        --     5,828

  Issuance of notes receivable in
  exchange for  exercise of options
  to purchase common stock at $0.32
  per share in February 1995 and 
  $0.80 per share in August 1995          --      --      190       --      104     (104)      --        --        --        --

  Issuance of common stock through:

    Exchange of intellectual
    property rights  at $0.40 per
    share in March 1995                   --      --      400        1      160       --       --        --        --       161

    Exercise of options                   --      --       16       --       24       --       --        --        --        24

  Issuance of Series D preferred
  stock for cash  at $3.00 per
  share in October 1995, net of 
  issuance cost of $7                  1,399       2       --       --    4,189       --       --        --        --     4,191

  Repayment of notes receivable  
  from stockholder in November 1995       --      --       --       --       --       12       --        --        --        12

  Deferred compensation related to
  grants of  stock options                --      --       --       --      882       --     (882)       --        --        --

  Amortization of deferred
  compensation                            --      --       --       --       --       --      332        --        --       332

  Net Loss                                --      --       --       --       --       --       --        --    (6,950)   (6,950)
                                      ------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, December 31, 1995            8,678       9    1,792        2   16,869      (92)    (550)       --    (9,913)    6,325

  Issuance of common stock through:

    Initial public offering at     
    $14.00 per share  in February
    1996, net of issuance costs of
    $3,563                                --      --    2,530        3   31,854       --       --        --        --    31,857

    Conversion of preferred stock  
    in connection with the initial 
    public offering in February 1996  (8,678)     (9)   4,339        4        5       --       --        --        --        --

    Exercise of options                   --      --      107       --       63       --       --        --        --        63

    Employee stock purchase plan          --      --       10       --       66       --       --        --        --        66

  Deferred compensation related to
  issuance of  common stock and
  grants of stock options                 --      --       --       --        5       --       (5)       --        --        --

  Amortization of deferred
  compensation                            --      --       --       --       --       --      167        --        --       167

  Change in unrealized gain on
  available-for-sale securities           --      --       --       --       --       --       --         9        --         9

  Net Loss                                --      --       --       --       --       --       --        --    (7,705)   (7,705)
                                      ------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, December 28, 1996               --      --    8,778        9   48,862      (92)    (388)        9   (17,618)   30,782

  Issuance of common stock through: 

    Exercise of options                   --      --       74       --      201       --       --        --        --       201

    Employee stock purchase plan          --      --       17       --       90       --       --        --        --        90

  Amortization of deferred
  compensation                            --      --       --       --       --       --      160        --        --       160

  Change in unrealized gain on
  available-for-sale securities           --      --       --       --       --       --       --         1        --         1

  Net Loss                                --      --       --       --       --       --       --        --    (7,688)   (7,688)
                                      ------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, January 3, 1998                 --    $ --    8,869     $  9  $49,153    $ (92)   $(228)    $  10  $(25,306)  $23,546
                                      ======= ======= ======== ======== ======== ======== ========= ======== ========= ========
</TABLE>
   The accompanying notes are an integral part of these financial statements.


<PAGE>
                             ARTHROCARE CORPORATION
                            STATEMENTS OF CASH FLOWS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                   For the Years Ended
                                                       --------------------------------------
                                                        January 3,   December 28, December 31,
                                                           1998         1996         1995
                                                       ------------ ------------ ------------
<S>                                                    <C>          <C>          <C>
Cash flows from operating activities:
   Net loss                                             $   (7,688)   $  (7,705)   $  (6,950)
   Adjustments to reconcile net loss to net
   cash used in operating activities:
      Depreciation and amortization                            615          370          173
      Provision for doubtful accounts
        receivable and product returns                         276          313            5
      Forgiveness of notes receivable                           11           --           -- 
      Provision for excess and obsolete
        inventory                                              249           50           50
      Loss on disposal of property and
        equipment                                               19          309           -- 
      Amortization of deferred compensation                    160          167          332
      Deferred rent                                             --            9          137
      Non-recurring charge for acquired
        technology                                              --           --          260
      Changes in operating assets and
        liabilities:
          Accounts receivable                               (1,248)      (1,352)        (217)
          Inventory                                         (1,509)        (293)        (566)
          Prepaid expenses and other current
            assets                                             (55)         736         (860)
          Accounts payable                                     (87)         288          647
          Accrued liabilities                                  742          772          437
          Other assets                                           6          (20)         (37)
                                                       ------------ ------------ ------------
            Net cash used in operating
              activities                                    (8,509)      (6,356)      (6,589)
                                                       ------------ ------------ ------------
Cash flows from investing activities:
   Purchases of property and equipment                        (562)      (1,028)        (920)
   Purchases of available-for-sale securities             (113,117)    (189,648)      (2,500)
   Sales or maturities of available-for-sale
     securities                                            119,356      171,735        2,500
   Purchase of intellectual property rights                     --           --         (100)
                                                       ------------ ------------ ------------
            Net cash provided by (used in)
              investing activities                           5,677      (18,941)      (1,020)
                                                       ------------ ------------ ------------
Cash flows from financing activities:
   Issuance of notes receivable to related
     parties                                                  (686)         (75)        (223)
   Repayment of capital leases                                 (41)         (29)         (47)
   Repayment of notes receivable from
     related parties                                            97           --           -- 
   Repayment of notes receivable from
     stockholder                                                --           --           12
   Proceeds from issuance of common stock
     and preferred stock, net of issuance
     costs                                                      90       31,923       10,018
   Proceeds from exercise of options to
     purchase common stock                                     201           63           24
                                                       ------------ ------------ ------------
            Net cash provided by (used in)
              financing activities                            (339)      31,882        9,784
                                                       ------------ ------------ ------------
Net increase (decrease) in cash and cash
  equivalents                                               (3,171)       6,585        2,175
Cash and cash equivalents, beginning of period              11,359        4,774        2,599
                                                       ------------ ------------ ------------
Cash and cash equivalents, end of period                $    8,188    $  11,359    $   4,774 
                                                       ============ ============ ============
</TABLE>

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



<PAGE>
                             ARTHROCARE CORPORATION
                        NOTES TO THE FINANCIAL STATEMENTS


1.      Formation and Business of the Company:

ArthroCare Corporation (the company) was  incorporated on April 29, 1993. The
company  designs, develops, manufactures and markets  medical devices for use
in arthroscopic and  orthopedic procedures. The company's principal  operations
commenced in August 1995, at which  time it emerged from the development stage.

On November 22, 1995, the company was  reincorporated in the state of Delaware
with  the associated exchange of shares of each class  and series of stock of
the predecessor company  for one share of each identical class and  series of
stock of the Delaware successor  company having a par value of $0.001 per share
for both common stock and preferred stock.

The company sold 2,530,000 shares of common  stock (including 330,000 shares
from the  exercise of the underwriter's overallotment  option) at $14.00 per
share through an initial  public offering in February 1996. Net proceeds 
(after underwriter's commissions and fees along  with other costs associated
with the offering)  totaled $31,857,000. Upon completion of the  offering, all
outstanding shares of preferred  stock (a total of 8,678,000 shares) were 
converted into shares of common stock on a two-for-one basis.

In the course of its development activities,  the company has sustained
operating losses and  expects such losses to continue through fiscal  year
1998. The company intends to finance its  operations primarily through its
cash, cash  equivalents and available-for-sale securities,  together with
future revenues and licensing  fees. There can be no assurance that the 
company will not require additional funding and  should this prove necessary,
the company may  sell additional shares of its common or  preferred stock
through private placement or  further public offerings. Such offerings could 
cause additional dilution of the company's  capital.


2.      Summary of Significant Accounting Policies:

BASIS OF PRESENTATION  
The company maintains a fifty-two/fifty-three week fiscal year cycle ending on
a Saturday. To conform the company's  fiscal year ends, the company must add a
fifty- third week to every fifth or sixth fiscal year.  Accordingly, fiscal
1997 was a fifty-three week fiscal year.

STOCK SPLIT 
On December 12, 1995, the company effected a one-for-two reverse common stock
split and a corresponding change in the preferred stock conversion ratios. All
common  stock data in the accompanying financial statements has been
retroactively adjusted to  reflect the reverse stock split.

USE OF ESTIMATES  
The preparation of financial statements in conformity with generally accepted
accounting principles requires  management to make estimates and assumptions 
that affect the reported amounts of assets and  liabilities and disclosure of
contingent assets  and liabilities as of the date of the financial  statements
and the reported amounts of revenues  and expenses during the reporting period.
Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS AND AVAILABLE-FOR- SALE SECURITIES  
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.

The company has classified its investments as  "available-for-sale." Such
investments are  recorded at fair value and unrealized gains and  losses, if
material, are recorded as a separate  component of equity until realized.
Interest  income is recorded using an effective interest  rate, with the
associated premium or discount  amortized to "interest income".   The cost of 
securities sold is based upon the specific  identification method.

INVENTORIES  
Inventories are stated at the lower of cost (determined on a first-in, first-
out basis) or market value.

PROPERTY AND EQUIPMENT  
Property and equipment  are stated at cost and are depreciated on a 
straight-line basis over their estimated useful  lives of three to five years.
Leasehold  improvements are amortized over the shorter of  their estimated
useful lives or the lease term.  Maintenance and repair costs are charged to 
operations as incurred.

REVENUE RECOGNITION  
The company recognizes revenue upon shipment of product to the customer, upon
fulfillment of acceptance terms,  if any, and when no significant contractual 
obligations remain. Revenue is reported net of  a provision for estimated
product returns.

RESEARCH AND DEVELOPMENT   
Research and development costs are charged to operations as  incurred.

RECLASSIFICATIONS   
Certain amounts in the financial statements have been reclassified to  conform
with the current year presentation.  These classifications and restatements did
not  impact previously reported total assets,  liabilities, stockholders'
equity or net loss.

CONCENTRATION OF RISKS AND UNCERTAINTIES   
The company's cash and cash equivalents are  maintained at five financial
institutions in  the United States. Deposits at these  institutions may exceed
the amount of insurance  provided on such deposits. The company has not 
experienced any losses on its deposits of cash  and cash equivalents.

The company's Sunnyvale facility currently  accounts for all of its product
manufacturing.  Disruption of operations at the company's  production facility
could cause delays in, or  an interruption of, production and shipment of 
products which could have a material adverse  impact on the company's business,
operating  results and financial condition.

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

Sales to both international and domestic  customers are generally made on open
credit  terms. Management performs ongoing credit  evaluations of the company's
customers and  maintains an allowance for potential credit  losses when needed
but historically has not  experienced any significant losses related to 
individual customers or a group of customers in  any particular geographic
area. Export sales totalled approximately $900,000 for 1997.

The company operates in an industry with rapid  technological changes which may
render  inventories maintained by the company obsolete.

FAIR VALUE OF FINANCIAL INSTRUMENTS   
The amounts for cash equivalents and accrued  liabilities are a reasonable
estimate of their  fair value due to their short-term nature. The  estimated
fair value amounts of the company's  financial instruments have been determined
by  the company, using appropriate market  information and valuation
methodologies.  Considerable judgment is required to develop  the estimates of
fair value, thus, the  estimates provided herein are not necessarily 
indicative of the amounts that could be  realized in a current market exchange.

INCOME TAXES   
The company accounts for income taxes under Statement of Financial Accounting 
Standard (SFAS) No. 109, "Accounting for Income  Taxes," which prescribes the
use of the  liability method whereby deferred tax asset or  liability account
balances are calculated at  the balance sheet date using current tax laws  and
rates in effect for the year in which the  differences are expected to affect
taxable  income. Valuation allowances are established  when necessary to reduce
deferred tax assets to  the amounts expected to be realized.

COMPUTATION OF NET LOSS PER COMMON SHARE AND  PER COMMON SHARE-ASSUMING
DILUTION   
The company adopted SFAS No. 128 "Earnings Per Share" and  the Securities and
Exchange Commission Staff  Accounting Bulletin No. 98 (SAB No. 98)  effective
January 3, 1998; accordingly, all  prior periods have been restated. Net loss
per  common share and per common share-assuming  dilution are computed using
the weighted  average number of shares of common stock  outstanding. Common
equivalent shares from  stock options and preferred stock are excluded  from
the computation of net loss per common  share-assuming dilution as their effect
is  antidilutive. No additional shares are  considered to be outstanding for
either  computation under the provisions of SAB No. 98.

RECENT ACCOUNTING PRONOUNCEMENTS   
In June 1997, the Financial Accounting Standards Board (FASB)  issued SFAS No.
130, "Reporting Comprehensive  Income". This statement establishes 
requirements for disclosure of comprehensive  income and becomes effective for
the company's  fiscal year 1998, with reclassification of  earlier financial
statements for comparative  purposes. Comprehensive income generally 
represents all changes in stockholders' equity  except those resulting from
investments or  contributions by stockholders. The company is  evaluating
alternative formats for presenting  this information but does not expect this 
pronouncement to materially impact the  company's reporting of results of
operations.

In June 1997, the FASB issued SFAS No. 131,  "Disclosure about Segments of an
Enterprise and  Related Information". This statement  establishes standards for
disclosure about  operating segments in annual financial  statements and
selected information in interim  financial reports. It also establishes 
standards for related disclosures about  products and services, geographic
areas and  major customers. This statement supersedes SFAS  No. 14, "Financial
Reporting for Segments of a  Business Enterprise". The new standard becomes 
effective for the company's fiscal year 1998  and requires that comparative
information from  earlier years be restated to conform to  requirements of this
standard. The company is  evaluating the requirements of SFAS No. 131 and  the
effects, if any, on the company's current  reporting and disclosures.


<PAGE>
3.      Available-For-Sale Securities (in  thousands):

The following summarizes the company's  available-for-sale securities:

<TABLE>
<CAPTION>
                                                                Gross       Gross
                                                  Amortized   Unrealized  Unrealized   Accrued    Market
                                                     Cost       Gains       Losses    Interest     Value
                                                  ----------  ----------  ----------  ---------  ---------
<S>                                               <C>         <C>         <C>         <C>        <C>
January 3, 1998:
Corporate notes and bonds.............            $ 11,550    $     10    $     --    $    124   $ 11,684 
                                                  ==========  ==========  ==========  =========  =========
December 28, 1996:
U.S. government notes and bonds.......            $  1,588    $      7    $     --    $     42   $  1,637 
Corporate notes and bonds.............              13,040          12         (10)        336     13,378
Corporate equities....................               2,900          --          --           7      2,907
                                                  ----------  ----------  ----------  ---------  ---------
                                                  $ 17,528    $     19    $    (10)   $    385   $ 17,922 
                                                  ==========  ==========  ==========  =========  =========
</TABLE>

Available-for-sale debt securities by contractual maturity at January 3, 1998
are shown below :

<TABLE>
<CAPTION>
                                                  Amortized     Market
                                                     Cost       Value
                                                  ----------  ----------
<S>                                               <C>         <C>
Less than one year....................            $ 10,550    $ 10,674 
One to five years.....................               1,000       1,010
                                                  ----------  ----------
                                                  $ 11,550    $ 11,684 
                                                  ==========  ==========
</TABLE>


<PAGE>
4.      Balance Sheet Detail (in thousands):

<TABLE>
<CAPTION>
                                                  January 3,  December 28,
                                                       1998        1996
                                                  ----------  ----------
<S>                                               <C>         <C>
Inventories:

   Raw materials......................              $   921     $   345
   Work-in-process....................                  165          32
   Finished goods.....................                  933         382
                                                  ----------  ----------
                                                    $ 2,019     $   759 
                                                  ==========  ==========

Prepaid expenses and other current assets:

   Prepaid insurance..................              $   125     $    45  
   Prepaid rent.......................                   28          34
   Other..............................                   57          76
                                                  ----------  ----------
                                                    $   210     $   155 
                                                  ==========  ==========

Property and equipment:

   Machinery and equipment............              $ 1,123     $   877 
   Tooling and molds..................                  216         258
   Computer equipment.................                  898         732
   Furniture and fixtures.............                  205         165
   Leasehold improvements.............                  148          25
                                                  ----------  ----------
                                                      2,590       2,057
   Less accumulated depreciation and
   amortization.......................               (1,178)       (573)
                                                  ----------  ----------
                                                    $ 1,412     $ 1,484 
                                                  ==========  ==========

Equipment acquired under capital leases included in property and equipment
above:

   Machinery and equipment............              $   109     $   109 
   Less accumulated depreciation......                  (85)        (54)
                                                  ----------  ----------
                                                    $    24     $    55 
                                                  ==========  ==========

Accrued liabilities:

   Accrued professional fees..........              $   164     $   163 
   Accrued compensation...............                1,314         777
   Accrued warranty...................                  316         123
   Other..............................                  193         182
                                                  ----------  ----------
                                                    $ 1,987     $ 1,245 
                                                  ==========  ==========
</TABLE>


5.      Commitments:

CAPITAL LEASE  
The company leases certain of  its office and computer equipment from finance 
companies under capital lease agreements which  expire in November 1998. At
January 3, 1998,  the total future minimum payments under capital  leases for
1998 is $18,000 with $1,000  representing interest.

OPERATING LEASE   
The company rents its office facility under an operating lease which expires 
in February 2002. Under the terms of the lease,  the company is responsible for
taxes, insurance  and maintenance expenses. At January 3, 1998,  total future
minimum lease payments are as  follows (in thousands):

<TABLE>
<CAPTION>
<S>                                               <C>
              1998....................              $   302 
              1999....................                  341
              2000....................                  354
              2001....................                  367
              2002....................                   62
                                                  ----------
                                                    $ 1,426 
                                                  ==========
</TABLE>

Rent expense for the years ended January 3,  1998, December 28, 1996 and
December 31, 1995  was $349,000, $345,000 and $263,000,  respectively.


<PAGE>
6.      Supplemental Cash Flow Disclosures (in  thousands):

<TABLE>
<CAPTION>
                                                                           Year Ended
                                                            -----------------------------------------
                                                  January 3, December 28, December 31,
                                                     1998        1996         1995
                                                  ----------  ----------  ----------
<S>                                               <C>         <C>         <C>
Non-cash financing and investing activities:
   Additions to property and equipment
     acquired  under capital lease                 $    --     $    --     $   113 
   Common stock issued for note
     receivable                                    $    --     $    --     $   104 
   Common stock issued in exchange for
     intellectual property rights                  $    --     $    --     $   160 
   Conversion of preferred stock to 
     common stock in connection with the
     company's initial public offering              $    --     $    --     $15,750 
   Change in unrealized gain on
     available-for-sale securities                 $     1     $     9     $    -- 

Cash paid during the period for:

   Interest                                        $     5     $     9     $     7 
   Income Tax                                      $     1     $     1     $    -- 

</TABLE>


7.      Stockholders' Equity:

PREFERRED STOCK   
Under the company's Articles of Incorporation, the company is authorized to 
issue preferred stock. At January 3, 1998,  5,000,000 shares of preferred stock
were  authorized and no preferred stock was issued  and outstanding as the
previously outstanding  preferred stock was converted into common stock  in
connection with the company's initial public  offering effective February 5,
1996.

STOCK OPTION PLANS
In May 1993, the company  approved the 1993 Stock Plan (1993 Plan) under  which
the Board of Directors of the company is  authorized and directed to enter into
stock  option agreements with selected individuals.  136,000 shares were
authorized at the inception  of the Plan with 250,000 and 1,150,000  additional
shares authorized in 1994 and 1995,  respectively. Options granted under the
1993  Plan generally become exercisable over a 48- month period.

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

<PAGE>
<TABLE>
<CAPTION>
                                  Shares              Outstanding Options
                                 Available -------------------------------------
                                   For      Number      Exercise      Aggregate
                                  Grant    Of Shares     Price          Price
                                 --------  -------- ----------------  ----------
<S>                              <C>       <C>      <C>               <C>
Balances, December 31, 1994          225       153     $0.20-$ 0.32     $    36 
   Additional shares authorized    1,150        --               --          -- 
   Options granted                  (363)      363     $0.32-$ 9.00         826
   Options exercised                  --       (16)    $0.32-$ 1.60         (24)
   Options canceled                    9        (9)    $0.32-$ 3.00          (5)
                                 --------  --------                   ----------
Balances, December 31, 1995        1,021       491     $0.20-$ 9.00         833
   Options granted                  (218)      218     $9.50-$24.25       2,867
   Options exercised                  --      (107)    $0.20-$ 5.00         (34)
   Options canceled                   58       (58)    $0.20-$24.25        (225)
                                 --------  --------                   ----------
Balances, December 28, 1996          861       544     $0.20-$24.25       3,441
   Options granted                  (723)      723     $6.25-$11.88       6,147
   Options exercised                  --       (74)    $0.32-$11.00        (201)
   Options canceled                  162      (162)    $0.40-$24.25        (881)
                                 --------  --------                   ----------
Balances, January 3, 1998            300     1,031     $0.20-$24.25     $ 8,506 
                                 ========  ========                   ==========
</TABLE>

At January 3, 1998, 314,000 options were  exercisable under the 1993 Plan.

In December 1995, the company adopted the  Director Option Plan (Director Plan)
and  reserved 100,000 shares of common stock for  issuance to directors under
this plan. The plan  allows for an initial grant and automatic  annual grants
of options to outside directors  of the company. As of January 3, 1998 and 
December 28, 1996, outstanding options under  the Director Plan were 24,000 and
12,000,  respectively, with 13,000 options exercisable  as of January 3, 1998.

In February 1995, pursuant to a restricted  stock purchase agreement, 100,000
shares of  common stock were purchased by an officer of  the company at $0.32
per share. The restricted  stock purchase agreement contains provisions  for
the repurchase of common stock by the  company in the event of termination of 
employment during the four years following the  date of the agreement. At
January 3, 1998,  21,667 shares were subject to repurchase under  this
restricted stock purchase agreement. Those  shares will be released ratably
over the following 13 months.

In August 1995, 90,000 shares of common stock  were purchased by an officer of
the company at  $0.80 per share pursuant to a restricted stock  purchase
agreement. The restricted stock  purchase agreement contains provisions for the
repurchase of common stock by the company in  the event of termination of
employment during  the four years following the date of the  agreement. At
January 3, 1998, 29,688 shares  were subject to repurchase under this 
restricted stock purchase agreement. These  shares will be released ratably
over the following 19 months.

EMPLOYEE STOCK PURCHASE PLAN  
In December 1995,  the company approved the Employee Stock  Purchase Plan and
reserved 150,000 shares of  common stock for issuance under this plan. For the
years ended January 3, 1998 and December  28, 1996, 16,865 shares and 10,101
shares of  common stock were sold under the Employee Stock  Purchase Plan,
respectively.

SHAREHOLDERS RIGHTS PLAN   
In November 1996, the Board of Directors approved a Shareholders  Rights Plan
declaring a dividend distribution  of one Preferred Share Purchase Right for
each  outstanding share of the company's Common  Stock. Each right will entitle
stockholders to  buy one-thousandth of one share of the  company's Series A
Participating Preferred  Stock at an exercise price of $50.00. This Plan  was
designed to assure that the company's  stockholders receive fair and equal
treatment  in the event of any proposed takeover of the  company and to guard
against partial tender  offers and other abusive tactics to gain  control of
the company without paying all  stockholders the fair value of their shares, 
including a "control premium."

STOCK-BASED COMPENSATION   
The company has adopted the disclosure-only provisions of SFAS  No. 123
"Accounting for Stock-Based  Compensation." Had compensation cost for the  1993
Plan, the Director Plan and the Employee  Stock Purchase Plan been determined
based on  the fair value at the grant date for awards in  fiscal year 1997,
1996 and 1995 consistent with  the provisions of SFAS No. 123, the company's 
net loss per common share and per common share- assuming dilution for the years
ended January  3, 1998, December 28, 1996 and December 31, 1995 would have
been increased to the pro forma  amounts indicated below (in thousands, except 
per share data):

<PAGE>
<TABLE>
<CAPTION>
                                                        Year Ended
                                        -------------------------------------------
                                         January 3,    December 28,   December 31,
                                            1998           1996           1995
                                        -------------  -------------  -------------
<S>                                     <C>            <C>            <C>

Net loss  as reported                       $ 7,688        $ 7,705        $ 6,950 
Net loss  pro forma                         $ 8,466        $ 7,962        $ 6,959 
Net loss per common share and per common 
share-assuming dilution as reported         $  0.87        $  0.97        $  1.82 
Net loss per common share and per common 
share-assuming dilution pro forma           $  0.96        $  1.00        $  1.83 

</TABLE>

The effects of the pro forma disclosure of  applying SFAS No. 123 are not
likely to be  representative of the effects of the pro forma  disclosures of
future years. Because SFAS No.  123 reflects only options granted after January
1, 1995, the pro forma effect will not be fully  reflected until 1999.

The fair value of each option grant is  estimated on the date of grant using
the Black  Scholes model with the following weighted  average assumptions:


     Risk-free interest rate                         4.98%-7.13%
     Expected life                                       4 years
     Expected dividends                                      --
     Expected volatility                                     50%

The options outstanding and currently  exercisable by exercise price for both
the 1993  Plan and the Director Plan at January 3, 1998  are as follows (in
thousands, except per share data and contractual life):

<PAGE>
<TABLE>
<CAPTION>
                      Options Outstanding               Options Currently Exercisable
------------------------------------------------------    ------------------------
                                Weighted
                                 Average    Weighted                    Weighted
                                Remaining    Average                     Average
    Exercise         Number    Contractual  Exercise         Number     Exercise
      Price       Outstanding     Life        Price       Exercisable     Price
----------------- ------------ ----------- -----------    ------------ -----------
<S>               <C>          <C>         <C>            <C>          <C>
         $ 0.20            43         5.4     $ 0.20               43     $ 0.20 
  $ 0.32-$ 0.40            58         7.3     $ 0.39               38     $ 0.39 
         $ 0.80             9         7.5     $ 0.80                5     $ 0.80 
         $ 1.60            40         7.6     $ 1.60               23     $ 1.60 
         $ 3.00             5         7.7     $ 3.00                3     $ 3.00 
  $ 5.00-$ 7.38           204         9.0     $ 6.90               68     $ 6.77 
  $ 8.00-$11.88           627         9.2     $ 9.39              120     $ 9.64 
  $14.00-$19.75            36         8.3     $16.87               13     $16.62 
         $24.25            33         8.3     $24.25               14     $24.25 
                  ------------                            ------------
                        1,055         8.8     $ 8.37              327     $ 6.82 
                  ============                            ============
</TABLE>

Deferred compensation recognized as a result of  stock options granted and
common stock issued  subject to repurchase provisions as of January  3, 1998
and December 28, 1996 is $887,000.  Deferred compensation is generally
amortized  over vesting periods of one to four years,  which resulted in
compensation expense of  $160,000, $167,000 and $332,000 recognized in  the
years ended January 3, 1998, December 28,  1996 and December 31, 1995,
respectively. As of  December 28, 1996, options to purchase 147,000  shares of
common stock were exercisable at a  weighted average exercise price of $2.09
per  share.


8.      Related Parties:

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

Also in connection with its incorporation, the  company entered into a
consulting agreement  with a consulting and research firm, which is  headed by
one of the company's founders. This  consulting and research firm was
contracted to  perform research related to the development of  hand-held
instruments used in arthroscopic  procedures. Research and development costs 
incurred on this contract in fiscal 1997, 1996  and 1995 were approximately
$457,000, $456,000  and $481,000, respectively.

In January 1995, the company loaned to an  officer $120,000 pursuant to a
provision in the  officer's employment agreement.  The resulting promissory
note bears interest at  6% per annum and is due on the earlier of  January 31,
1999 or termination of employment.  At January 3, 1998, $142,000 of principal
and  interest was outstanding on this note. In  February 1995, the company
agreed to loan this  officer up to an additional $144,000 in monthly 
increments of $3,000 at 6% per annum. In  December 1997, the company amended
this  officer's employment agreement to terminate the  increments effective
January 31, 1998 and  forgive 10% of the principal and interest at  the end of
each fiscal year in which the  officer is employed by the company and in which 
the company meets certain performance targets.  In fiscal 1997, $11,000 of
principal and  interest was forgiven. At January 3, 1998,  $103,000 of
principal and interest was  outstanding on this note. Both aforementioned 
notes are secured by shares of the company's  common stock and a mortgage on
the officer's  residence.

On March 31, 1995, the company issued 400,000  shares of common stock for $0.40
per share and  $100,000 cash in exchange for certain  intellectual property
rights of a related  research firm headed by several of the  company's
directors and co-founders. This  transaction was accounted for as a non-
recurring charge to operating expense.

In December 1995, the company loaned an  employee $62,000 pursuant to a
provision in the  employee's employment agreement. The resulting  promissory
note bears interest at the rate of  6% per annum and is due on the earlier of
July  24, 2000 or the termination of employment. The  note also permits the
company to loan this  employee up to an additional $34,000 in $2,000  monthly
increments. The aforementioned notes  are secured by a pledge of this
employee's  option for 50,000 shares of the company's  common stock and any
shares issued upon  exercise of such options. In May 1997, all  principal and
interest were repaid in full.

In June 1997, the company loaned an officer  $500,000 pursuant to a provision
in the  officer's employment agreement. The promissory  note, which bears no
interest, is secured by a  mortgage on the officer's residence and is due  and
payable upon either the officer's  termination of employment or the sale of the
officer's residence. If the officer is  terminated by the company or the
company is  acquired, the loan is due and payable within 12  months thereafter.
As of January 3, 1998,  $500,000 of principal was outstanding on this  note.

In November 1997, the company issued a  relocation loan of $130,000 to an
employee.  This loan is secured by the employee's  residence and is due and
payable upon either  the sale or transfer of the property or the  termination
of the officer's employment with  the company. As of January 3, 1998, $130,000
of  principal was outstanding on this loan.


9.      Income Taxes:

At January 3, 1998, the company has  approximately $16,000,000 and $4,500,000
in  federal and state net operating loss  carryforwards, respectively, which
expire in  the years 2004 through 2013. The Tax Reform Act of 1986
substantially  changed the rates relative to net operating  loss and tax credit
carryforwards in the case  of an "ownership change" of a corporation. Any 
ownership changes, as defined, may restrict  utilization of carryforwards.

Temporary differences and carryforwards which  gave rise to significant
portions of deferred  tax assets and liabilities are as follows (in  thousands):

<TABLE>
<CAPTION>
                                                   January 3, December 28,
                                                        1998        1996
                                                   ---------- -----------
<S>                                                <C>        <C>
Deferred tax assets:
   Net operating loss carryforwards                 $  5,612    $  2,167 
   Capitalized research and development costs          1,154       3,036
   Capitalized start-up costs                            499         710
   Purchased patents                                     --          104
   Research and development credit                       567         446
   Allowances and reserves                             1,806         699
   Other                                                  --         130
   Less: valuation allowance                          (9,638)     (7,292)
                                                   ---------- -----------
Net deferred tax assets                             $     --    $     -- 
                                                   ========== ===========
</TABLE>

In accordance with generally accepted  accounting principles, a valuation
allowance  must be established for a deferred tax asset  if it is more likely
than not that a tax  benefit may not be realized from the asset in  the future.
The company has established a  valuation allowance to the extent of its 
deferred tax assets since it is more likely  than not that a benefit can not be
realized in  the future due to the company's recurring  operating losses. The
company's valuation  allowance increased from $7,292,000 at December  28, 1996
to $9,638,000 at January 3, 1998.


10.     Employee Benefit Plan:

The company maintains a Retirement Savings and  Investment Plan (401(k) Plan)
which covers  substantially all employees. Eligible employees  may defer salary
(before tax) up to a specified  maximum. The company, at its discretion, may 
make matching contributions on behalf of the  participants in the 401(k) Plan.
To date, the  company has not made any contributions to the  401(k) Plan.


11.     Subsequent Events:

In February 1998, the company entered into a  partnership agreement with Boston
Scientific  Corporation (BSC) in which BSC will develop and  market the
company's proprietary Coblation (TM)  technology for use in myocardial 
revascularization. Under the agreement, BSC  acquires exclusive licensing
rights to the  company's intellectual property in this field.  BSC will pay a
licensing fee, a portion of  which will be treated as prepaid royalties, to 
the company upon achievement of certain  milestones and pay royalties on sales
of any  resulting product.

In March 1998 the company entered into a 47- month operating lease agreement
for an  additional office and manufacturing facility in  Sunnyvale. Under the
agreement, the company is  responsible for taxes, insurance and  maintenance
expenses. Total future minimum  payments over the term of the lease is $963,000
which is subject to annual increases based on  changes in the Consumer Price
Index.


<PAGE>
                                 SCHEDULE II
                             ARTHROCARE CORPORATION
                       VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)
<TABLE> 
<CAPTION> 
                                              Additions
                                Balance at   Charged to                Balance
                                 Beginning  Statement of               at end
                                  of Year    Operations   Deductions   of Year
                                ----------- ------------- ----------- ---------
<S>                             <C>         <C>           <C>         <C>
Year ended January 3, 1998
Deducted from asset accounts:                                       
 Allowance for doubtful
  accounts and product returns        $318          $276       $ --       $594
 Allowance for excess and
  obsolete inventory                  $100          $249       $ --       $349


Year ended December 28, 1996
Deducted from asset accounts:                                       
 Allowance for doubtful
  accounts and product returns          $5          $313       $ --       $318
 Allowance for excess and
  obsolete inventory                   $50           $50       $ --       $100


Year ended December 31, 1995
Deducted from asset accounts:                                       
 Allowance for doubtful
  accounts and product returns         $--            $5       $ --         $5
 Allowance for excess and
  obsolete inventory                   $--           $50       $ --        $50

</TABLE>











<PAGE>
 REPORT OF INDEPENTANT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

In connection with our audit of the financial statements of ArthroCare 
Corporation as of January 3, 1998 and December 28, 1996 and for each of the
three  years in the period ended January 3, 1998 which financial statements are
included  in this Annual Report on Form 10-K, we have also audited the
financial statement schedule listed in item 14 (a) herein.

In our opinion, the financial statement schedule, when considered in relation
to  the basic financial statements taken as a whole, presents fairly, in all
material  respects, the information required to be included therein.

COOPERS & LYBRAND L.L.P.

San Jose, California
January 27, 1998


<PAGE>
                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:


ARTHROCARE CORPORATION
a Delaware Corporation

/s/  MICHAEL A. BAKER           
-------------------------------
Michael A. Baker 
President and Chief Executive Officer 
Date:  April 2, 1998

                                POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Michael A Baker and Christine E. Hanni
as his attorney-in-fact for him, in any and all capacities, to sign each
amendment to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that said
attorney-in-fact or his substitute or substitutes may lawfully  do or cause to
be done by virtue hereof.

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

<TABLE>
<CAPTION>
           Signature                          Title                    Date
------------------------------- ---------------------------------- -------------
<S>                             <C>                                <C>
/s/  MICHAEL A. BAKER           President, Chief Executive Officer April 2, 1998
------------------------------- and Director (Principal Executive
     Michael A. Baker           Officer)

/s/  CHRISTINE E. HANNI         Chief Financial Officer and        April 2, 1998
------------------------------- Assistant Secretary (Principal
     Christine E. Hanni         Financial and Accounting Officer)

/s/  HIRA V. THAPLIYAL          Director                           April 2, 1998
-------------------------------
     Hira V. Thapliyal

/s/  ANNETTE J. CAMPBELL-WHITE  Director                           April 2, 1998
-------------------------------
     Annette J. Campbell-White

/s/  PHILIP E. EGGERS           Director                           April 2, 1998
-------------------------------
     Philip E. Eggers

/s/  C. RAYMOND LARKIN, Jr.     Director                           April 2, 1998
-------------------------------
     C. Raymond Larkin, Jr.

/s/  JOHN S. LEWIS              Director                           April 2, 1998
-------------------------------
     John S. Lewis

/s/  ROBERT R. MOMSEN           Director                           April 2, 1998
-------------------------------
     Robert R. Momsen
</TABLE>


<PAGE>
                             ARTHROCARE CORPORATION
                             Report on Form 10-K for
                        the year ended January 3, 1998


                               INDEX TO EXHIBITS*



<TABLE>
<CAPTION>

        EXHIBIT     
         NUMBER                       EXHIBIT NAME                             
        --------    -----------------------------------------------------------
        <S>         <C>    
        10.26++     License Agreement dated February 9, 1998, between the 
                    Registrant and Boston Scientific Corporation.

        10.27++     Development and Supply Agreement Agreement dated February 
                    9, 1998, between the Registrant and Boston Scientific 
                    Corporation.

        10.28       Lease Agreement date March 25, 1998 between the Registrant 
                    and Aetna Life Insurance Company for the Registrant's 
                    facility located at 840 Del Rey Avenue, Sunnyvale,
                    California 94086.

        23.1        Consent of Coopers & Lybrand L.L.P., Independent Public 
                    Accountants.

        24.1        Power of Attorney (see Page 34).

        27.1        Financial Data Schedule.

        27.2        Restated Financial Data Schedule (1996).

        27.3        Restated Financial Data Schedule (1997).

</TABLE>

  *     Only exhibits actually filed are listed. Exhibits incorporated by
        reference are set forth in the exhibit listing included in Item 14 of
        the Report on Form 10-K.

  ++    Confidential treatment requested.