**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**Form
      10-Q**





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




For
      the
      quarterly period ended March 31, 2008





**OR**





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


For
      the
      transition period from ________ to _______





Commission
      File Number: 0-27422





**ArthroCare
      Corporation**


*(Exact
      name of registrant as specified in its charter)*




**Delaware**
            
            **94-3180312***(State
                of incorporation)*
            
            *(I.R.S.
                Employer Identification No.)*





**7500
      Rialto Blvd., Building Two, Suite 100, Austin, Texas 78735**


*(Address
      of principal executive offices)*





**(512)
      391-3900**


*(Registrant's
      telephone number, including area code)*











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 whether the Registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company.  See definitions of “large accelerated filer,” “accelerated
      filer” and “smaller reporting company” in Rule 12b.2 of the Exchange Act (check
      one): Large accelerated filer  x  Accelerated
      filer   ̈  Non-accelerated
      filer   ̈  Smaller
      reporting company   ̈





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





The
      number of shares outstanding of the registrant's common stock as of April 24,
      2008 was 26,627,468.

















**ARTHROCARE
      CORPORATION**





**Form
      10-Q Quarterly Report**


**For
      the quarter ended March 31, 2008**





**TABLE
      OF CONTENTS**














**Page****PART
                I:**
            **Financial
                Information**
            ****Item
                1.
            Financial
                StatementsCondensed
                Consolidated Balance Sheets as of March 31, 2008 and December 31,
                2007
            
            1Condensed
                Consolidated Statements of Operations for the three month periods
                ended
                March 31, 2008 and 2007
            
            2Condensed
                Consolidated Statements of Cash Flows for the three month periods
                ended
                March 31, 2008 and 2007
            
            3Notes
                to Condensed Consolidated Financial Statements
            
            4Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            
            13Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            19Item
                4.
            Controls
                and Procedures
            
            20**PART
                II:**
            **Other
                Information**
            ****Item
                1.
            Legal
                Proceedings
            
            21Item
                1A.
            Risk
                Factors
            
            21Item
                2
            Unregistered
                Sales of Securities and Use of Proceeds
            
            21Item
                3
            Defaults
                Upon Senior Securities
            
            21Item
                4
            Submission
                of Matters to a Vote of Security Holders
            
            21Item
                5.
            Other
                Information
            
            21Item
                6.
            Exhibits
            
            21SignaturesCertifications








**PART
      I.    FINANCIAL INFORMATION**


**ITEM
      1.    FINANCIAL STATEMENTS**





**ARTHROCARE
                CORPORATION**
              **CONDENSED
                CONSOLIDATED BALANCE SHEETS**
              **(unaudited)**
              *(in
                thousands, except per share data)***March
                31,**
            
            **December
                31,****2008**
            
            **2007****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            32,125
            
            $
            39,375Short-term
                investments
            
            
            1,043
            
            
            3,875Accounts
                receivable, net of allowances of $4,437 at 2008 and $3,980 at
                2007
            
            
            80,483
            
            
            69,924Inventories,
                net
            
            
            57,206
            
            
            61,776Deferred
                tax assets
            
            
            10,406
            
            
            10,406Prepaid
                expenses and other current assets
            
            
            4,851
            
            
            5,164Total
                current assets
            
            
            186,114
            
            
            190,520Property
                and equipment, net
            
            
            45,239
            
            
            43,405Intangible
                assets, net
            
            
            35,946
            
            
            37,705Goodwill
            
            
            166,710
            
            
            166,771Deferred
                tax assets
            
            
            4,940
            
            
            4,940Other
                assets
            
            
            6,643
            
            
            6,727Total
                assets
            
            $
            445,592
            
            $
            450,068**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            13,626
            
            $
            15,876Accrued
                liabilities
            
            
            11,197
            
            
            12,909Accrued
                compensation
            
            
            8,562
            
            
            12,727Deferred
                tax liabilities
            
            
            530
            
            
            530Income
                taxes payable
            
            
            281
            
            
            130Total
                current liabilities
            
            
            34,196
            
            
            42,172Notes
                payable
            
            
            60,000
            
            
            60,000Deferred
                tax liabilities
            
            
            383
            
            
            383Other
                non-current liabilities
            
            
            6,981
            
            
            7,010Total
                liabilities
            
            
            101,560
            
            
            109,565Stockholders'
                equity:Preferred
                stock, par value $ 0.001: Authorized, 5,000 shares;Issued
                and outstanding: none
            
            
            -
            
            
            -Common
                stock, par value $ 0.001: Authorized, 75,000 shares;Issued
                and outstanding, 26,629 shares at 2008 and 26,808 shares at
                2007
            
            
            27
            
            
            27Treasury
                stock: 4,173 shares at 2008 and 3,936 shares at 2007
            
            
            (112,355
            )
            
            (100,682
            )Additional
                paid-in capital
            
            
            366,082
            
            
            360,374Accumulated
                other comprehensive income
            
            
            2,612
            
            
            2,382Retained
                earnings
            
            
            87,666
            
            
            78,402Total
                stockholders’ equity
            
            
            344,032
            
            
            340,503Total
                liabilities and stockholders’ equity
            
            $
            445,592
            
            $
            450,068





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


1


**ARTHROCARE
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(unaudited)**


*(in
      thousands, except per share data)*





**Three
                Months Ended**
              **March
                31,****2008**
            
            **2007**RevenuesProduct
                sales
            
            $
            88,492
            
            $
            71,001Royalties,
                fees and other
            
            
            2,543
            
            
            2,742Total
                revenues
            
            
            91,035
            
            
            73,743Cost
                of product sales
            
            
            25,705
            
            
            20,756Gross
                profit
            
            
            65,330
            
            
            52,987Operating
                expensesResearch
                and development
            
            
            7,727
            
            
            6,464Sales
                and marketing
            
            
            35,237
            
            
            29,494General
                and administrative
            
            
            7,604
            
            
            6,180Amortization
                of intangible assets
            
            
            2,214
            
            
            1,911Total
                operating expenses
            
            
            52,782
            
            
            44,049Income
                from operations
            
            
            12,548
            
            
            8,938Interest
                and other income (expense), net
            
            
            (158
            )
            
            330Income
                before income tax provision
            
            
            12,390
            
            
            9,268Income
                tax provision
            
            
            3,126
            
            
            2,132Net
                income
            
            $
            9,264
            
            $
            7,136Basic
                net income per share
            
            $
            0.35
            
            $
            0.26Shares
                used in computing basic net income per share
            
            
            26,516
            
            
            27,164Diluted
                net income per share
            
            $
            0.34
            
            $
            0.25Shares
                used in computing diluted net income per share
            
            
            27,391
            
            
            28,177








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


2


**ARTHROCARE
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(unaudited)**


*(in
      thousands)*





**Three
                Months Ended**
              **March
                31,****2008**
            
            **2007**Cash
                flows from operating activities:Net
                income
            
            $
            9,264
            
            $
            7,136Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            5,775
            
            
            5,453Provision
                for doubtful accounts and product returns
            
            
            435
            
            
            1,510Provision
                for inventory reserves
            
            
            1,004
            
            
            915Excess
                tax benefits from stock-based compensation
            
            
            (891
            )
            
            (176
            )Stock-based
                compensation expense
            
            
            2,704
            
            
            2,466Other
            
            
            (352
            )
            
            436Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (10,220
            )
            
            (1,388
            )Inventories
            
            
            3,543
            
            
            688Prepaid
                expenses and other current assets
            
            
            313
            
            
            2,025Other
                assets
            
            
            125
            
            
            (688
            )Accounts
                payable
            
            
            (2,252
            )
            
            (1,100
            )Accrued
                and other liabilities
            
            
            (5,843
            )
            
            (2,794
            )Income
                taxes payable
            
            
            2,285
            
            
            1,209Net
                cash provided by operating activities
            
            
            5,890
            
            
            15,692Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (5,573
            )
            
            (4,283
            )Sales
                or maturities of available for sale securities
            
            
            2,826
            
            
            2,125Purchases
                of intangible assets
            
            
            (500
            )
            
            (1,795
            )Net
                cash used in investing activities
            
            
            (3,247
            )
            
            (3,953
            )Cash
                flows from financing activities:Payments
                for purchases of treasury stock
            
            
            (11,778
            )
            
            -Proceeds
                from issuance of common stock, net of issuance costs
            
            
            171
            
            
            143Excess
                tax benefits from stock-based compensation
            
            
            891
            
            
            176Proceeds
                from exercise of options to purchase common stock
            
            
            614
            
            
            894Net
                cash (used in) provided by financing activities
            
            
            (10,102
            )
            
            1,213Effect
                of exchange rate changes on cash and cash equivalents
            
            
            209
            
            
            12Net
                (decrease) increase in cash and cash equivalents
            
            
            (7,250
            )
            
            12,964Cash
                and cash equivalents, beginning of period
            
            
            39,375
            
            
            15,531Cash
                and cash equivalents, end of period
            
            $
            32,125
            
            $
            28,495





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





3


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**







**NOTE
      1 - DESCRIPTION OF BUSINESS**





ArthroCare
      Corporation (“ArthroCare” or the “Company”) was incorporated on April 29, 1993
      and its principal operations commenced in August 1995. The Company designs,
      develops, manufactures and markets medical devices for use in soft-tissue
      surgery. Its products are based on the Company’s patented soft-tissue surgical
      controlled ablation technology, which it calls Coblation technology. Coblation
      technology involves an innovative use of a non-thermal process and has the
      capability of performing at temperatures lower than traditional electrosurgical
      tools. ArthroCare’s strategy includes applying Coblation technology to a broad
      range of soft-tissue surgical markets, including sports medicine, spinal
      surgery, cavity surgery, neurosurgery, cosmetic surgery, ear, nose and throat,
      or ENT, surgery, gynecology, urology, general surgery and various cardiology
      applications. ArthroCare is a global company with manufacturing facilities
      in
      Costa Rica and the United States and sales offices in the United States, Europe
      and the South Pacific.





**NOTE
      2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





***Basis
      of Presentation***





The
      unaudited interim condensed consolidated financial statements include the
      accounts of ArthroCare Corporation and its wholly-owned subsidiaries. All
      significant intercompany accounts and transactions have been eliminated in
      consolidation.





The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in accordance with accounting principles generally accepted in the
      United States of America for interim financial information and with the
      instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
      do
      not include all of the information and footnotes required by accounting
      principles generally accepted in the United States of America for complete
      financial statements. In the opinion of management, the unaudited interim
      condensed consolidated financial statements reflect all adjustments (consisting
      of only normal recurring adjustments) necessary for a fair statement of the
      Company’s financial position, results of operations and cash flows for the
      periods presented. These financial statements should be read in conjunction
      with
      the Company’s consolidated financial statements and notes thereto filed with the
      United States Securities and Exchange Commission, or SEC, in the Company’s
      annual report on Form 10-K for the year ended December 31, 2007. Operating
      results for the three-month period ended March 31, 2008 are not necessarily
      indicative of the results that may be expected for the year ended December
      31,
      2008.





The
      unaudited condensed consolidated balance sheet at December 31, 2007 was derived
      from the Company’s audited consolidated financial statements as of that date;
      however, the accompanying financial statements do not include all annual
      disclosures required by accounting principles generally accepted in the United
      States of America.





***Use
      of Estimates***





The
      unaudited condensed consolidated financial statements have been prepared in
      conformity with accounting principles generally accepted in the United States
      of
      America, using management’s best estimates and judgments where appropriate.
      These estimates and judgments affect the reported amounts of assets and
      liabilities and disclosure of the contingent assets and liabilities at the
      date
      of the financial statements. The estimates and judgments will also affect the
      reported amounts for certain revenues and expenses during the reporting period.
      Actual results could differ materially from these estimates and judgments.







4




**ARTHROCARE
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


***Recently
      Adopted Accounting Pronouncements***





In
      September 2006, the Financial Accounting Standards Board, or FASB, issued
      Statement of Financial Accounting Standards No. 157, *Fair
      Value Measurements* ,
      or FAS
      157. FAS 157 defines fair value, establishes a consistent framework for
      measuring fair value in generally accepted accounting principles and expands
      disclosures about fair value measurements for each major asset and liability
      category. FAS 157 became effective for the Company on January 1, 2008 for
      financial assets and liabilities and will become effective on January 1, 2009
      for non-financial assets and liabilities. The implementation for financial
      assets and liabilities on January 1, 2008 did not have a material effect on
      the
      Company’s operating results or financial position. The Company is currently
      evaluating the impact, if any, that the adoption of FAS 157 for non-financial
      assets and liabilities will have on its operating results and financial
      position. For additional information regarding FAS 157, see Note
      12.





In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      159, *The
      Fair Value Option for Financial Assets and Financial Liabilities - Including
      an
      amendment of FASB No. 115* ,
      or FAS
      159. FAS 159 permits companies to choose to measure many financial instruments
      and certain other items at fair value in order to mitigate volatility in
      reported earnings caused by measuring related assets and liabilities differently
      without having to apply complex hedge accounting provisions. FAS 159 became
      effective for the Company on January 1, 2008. The adoption of FAS 159 did not
      affect the Company’s operating results or financial position.





***Recently
      Issued Accounting Pronouncements***





In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      141(R), *Business
      Combinations* ,
      or FAS
      141R. FAS 141R will become effective for us on January 1, 2009 and is
      applied prospectively for business combinations completed after January 1,
      2009.
      Under FAS 141R, organizations utilized the announcement date as the measurement
      date for the purchase price of the acquired entity. FAS 141R requires
      measurement at the date the acquirer obtains control of the acquiree, generally
      referred to as the acquisition date. FAS 141R will have a significant
      impact on the accounting for transaction costs, restructuring costs as well
      as
      the initial recognition of contingent assets and liabilities assumed during
      a
      business combination completed after January 1, 2009.





In
      December 2007, the FASB ratified Emerging Issues Task
      Force Issue No. 07-01, *Accounting
      for Collaborative Arrangements* ,
      or EITF
      07-01, which will become effective for us on January 1, 2009. EITF 07-01
      requires that transactions with third parties (i.e., revenue generated and
      costs
      incurred by the partners) should be reported in the appropriate line item in
      each company’s financial statement pursuant to the guidance in EITF Issue
      No. 99-19, *Reporting
      Revenue Gross as a Principal versus Net as an Agent* .
      EITF
      07-01 also requires enhanced disclosure requirements regarding the nature and
      purpose of the arrangement, rights and obligations under the arrangement,
      accounting policy, amount and income statement classification of collaboration
      transactions between the parties. The Company is currently evaluating the
      impact, if any, that the adoption of EITF 07-01 will have on its operating
      results and financial position.





**NOTE
      3 - COMPREHENSIVE INCOME**





The
      Company’s comprehensive income is included as a component of stockholders’
equity and is composed of (i) net income, (ii) unrealized gains and losses
      on
      investments designated as available-for-sale, including reclassification
      adjustments, and (iii) foreign currency translation adjustments.





5


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





The
      following table presents the calculation of comprehensive income (in
      thousands):





**Three
                Months Ended March 31,****2008**
            
            **2007**Net
                income
            
            $
            9,264
            
            $
            7,136Net
                unrealized loss on available-for-sale securities, net of tax
            
            
            (9
            )
            
            (2
            )Foreign
                currency translation adjustment
            
            
            239
            
            
            (162
            )Comprehensive
                income
            
            $
            9,494
            
            $
            6,972








**NOTE
      4 - COMPUTATION OF NET INCOME PER SHARE**





Basic
      net
      income per share is computed using the weighted-average number of shares of
      common stock outstanding less the weighted-average unvested restricted stock
      outstanding. Diluted net income per share is computed using the weighted-average
      number of shares of common stock outstanding and potential dilutive shares
      of
      common stock.





The
      following is a reconciliation of the numerator (net income) and the denominator
      (number of shares) used in the calculation of basic and diluted net income
      per
      share (in thousands, except per share data):





**Three
                Months Ended March 31,****2008**
            
            **2007**Net
                Income
            
            $
            9,264
            
            $
            7,136Basic:Weighted-average
                shares outstanding
            
            
            26,516
            
            
            27,164Basic
                net income per share
            
            $
            0.35
            
            $
            0.26Diluted:Weighted-average
                shares outstanding used in basic calculation
            
            
            26,516
            
            
            27,164Dilutive
                effect of options
            
            
            800
            
            
            919Dilutive
                effect of unvested restricted stock
            
            
            75
            
            
            94Weighted-average
                common stock and common stock equivalents
            
            
            27,391
            
            
            28,177Diluted
                net income per share
            
            $
            0.34
            
            $
            0.25Options
                excluded from calculation as their effect would be
                anti-dilutive
            
            
            1,028
            
            
            937Price
                range of excluded options
            
            $
            41.47
                - $54.15
            
            $
            36.93
                - $48.56





6


**ARTHROCARE
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      5 - INVENTORIES**





The
      Company’s inventories consist of the following (in thousands):





**March
                31,**
              **2008**
            
            **December
                31,**
              **2007**Raw
                materials
            
            $
            12,642
            
            $
            11,201Work-in-process
            
            
            4,156
            
            
            4,308Finished
                goods
            
            
            43,692
            
            
            52,04060,490
            
            
            67,549Inventory
                reserves
            
            
            (3,284
            )
            
            (5,773
            )Inventories,
                net
            
            $
            57,206
            
            $
            61,776





The
      decrease in inventory reserves during the three months ended March 31, 2008
      is a
      result of write-offs of fully-reserved inventory items, partially offset by
      an
      additional $1.0 million provision for inventory reserves.





**NOTE
      6 - PROPERTY AND EQUIPMENT**




The
      following summarizes the Company’s property and equipment (in thousands, except
      lives):





**March
                31,**
            
            **December
                31,**
            
            **Estimated
                Useful Life****2008**
            
            **2007**
            
            **(Years)**Controller
                placements
            
            $
            61,168
            
            $
            59,593
            
            
            3-4Computer
                equipment and software
            
            
            15,340
            
            
            15,578
            
            
            3-5Machinery
                and equipment
            
            
            12,225
            
            
            11,665
            
            
            5Construction
                in process
            
            
            11,554
            
            
            8,520
            
            
            -Furniture,
                fixtures and leasehold improvements
            
            
            10,849
            
            
            10,386
            
            
            5
                (a)Building
                and improvements
            
            
            6,121
            
            
            5,991
            
            
            30Tooling
                and molds
            
            
            5,430
            
            
            5,430
            
            
            5Land
            
            
            745
            
            
            745
            
            
            -123,432
            
            
            117,908Accumulated
                depreciation
            
            
            (78,193
            )
            
            (74,503
            )Property
                and equipment, net
            
            $
            45,239
            
            $
            43,405





(a)
            The
                estimated useful life for leasehold improvements is the shorter of
                five
                years or the term of the lease.





Depreciation
      expense related to the Company’s property and equipment was $3.6 million and
      $3.5 million for the three months ended March 31, 2008 and 2007,
      respectively.





7


**ARTHROCARE
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      7 - GOODWILL AND INTANGIBLE ASSETS**





*Goodwill*





During
      the quarter ended March 31, 2008, the Company’s goodwill balance decreased by
      approximately $0.1 million due to adjustments to purchase price allocations
      of
      recent acquisitions partially offset by foreign currency translation. As
      of March 31, 2008, there were no indications that the Company’s goodwill was
      impaired.





*Intangible
      Assets With Definite Lives*





Intangible
      assets are originally recorded at historical cost, in the case of separately
      purchased intangible assets, or at estimated fair value, in the case of assets
      acquired in the purchase of a business, and are subject to amortization.
      Intangible assets consist of the following (in thousands):





**March
                31,**
            
            **December
                31,**
            
            **Estimated
                Useful Life****2008**
            
            **2007**
            
            **(Years)**Intellectual
                property rights
            
            $
            31,326
            
            $
            30,826
            
            
            7-8Patents
            
            
            11,700
            
            
            11,700
            
            
            8-10Trade
                name/trademarks
            
            
            6,700
            
            
            6,800
            
            
            7-10Distribution/customer
                relationships and backlog
            
            
            6,128
            
            
            6,042
            
            
            1-6Licensing,
                employment and non-competition agreements
            
            
            2,578
            
            
            2,588
            
            
            2-1058,432
            
            
            57,956Accumulated
                amortization
            
            
            (22,486
            )
            
            (20,251
            )Net
                intangible assets
            
            $
            35,946
            
            $
            37,705





**NOTE
      8 - ACCRUED LIABILITIES**





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





**March
                31,**
              **2008**
            
            **December
                31,**
              **2007**Accrued
                acquisition costs
            
            $
            1,635
            
            $
            1,639Accrued
                dealer commissions
            
            
            2,275
            
            
            2,592Accrued
                legal fees
            
            
            1,359
            
            
            502Accrued
                professional fees and other
            
            
            5,928
            
            
            8,176Accrued
                liabilities
            
            $
            11,197
            
            $
            12,909





8


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      9 - COMMITMENTS AND CONTINGENCIES**





*Operating
      Leases*





The
      Company leases certain facilities and equipment under operating leases. The
      Company recognizes rent expense on a straight-line basis over the lease term.
      Rent expense was $1.6 million for both quarters ended March 31, 2008 and 2007.
      There were no significant changes to the Company’s future lease commitments
      during the quarter ended March 31, 2008.





*Contingent
      Payments*





Certain
      of the Company’s agreements for purchase business combinations and intangible
      asset purchases include provisions to provide additional consideration if
      contractually specified conditions related to the acquired business or assets
      are achieved. At March 31, 2008, liabilities have been recorded for conditions
      which have been met or are expected to be met based on current information
      available.





*Warranties*





The
      Company generally provides customers with a limited 90-day warranty on devices
      sold and a limited 1-year warranty on controller units sold. The estimated
      cost
      of product warranties is accrued at the time revenue is recognized. The
      Company’s warranty obligation is impacted by product failure rates, material
      usage and service delivery costs incurred in correcting a product failure.
      The
      Company periodically evaluates and adjusts the warranty reserve to the extent
      actual warranty expense varies from the original estimates.





The
      activity in its warranty accrual for the three months ended March 31, 2008
      and
      2007 was as follows (in thousands):





**Three
                Months Ended**
              **March
                31,****2008**
            
            **2007**Balance
                at beginning of period
            
            $
            441
            
            $
            250Accruals
                for warranties issued during the period
            
            
            359
            
            
            224Warranty
                costs incurred during the period
            
            
            (304
            )
            
            (199
            )Balance
                at end of period
            
            $
            496
            
            $
            275





*Litigation*





On
      April
      4, 2008, John McIlvaine filed a lawsuit against the Company, Michael Baker
      and
      Michael Gluk in the United States District Court for the Southern District
      of
      Florida.  The plaintiff filed the lawsuit as a class action on behalf of
      purchasers who purchased the Company’s stock between August 4, 2006 and January
      23, 2008.  The lawsuit claims that the Company’s financial results were
      materially overstated during this time period.  The lawsuit seeks money
      damages in an unspecified amount.  The Company has reviewed the lawsuit and
      believes it is without merit and intends to vigorously defend itself.  The
      Company filed a motion to dismiss the lawsuit on April 7, 2008.





From
      time
      to time, the Company is a defendant in certain lawsuits alleging product
      liability, patent infringement or other claims incurred in the ordinary course
      of business. These claims are generally covered by certain insurance policies,
      subject to certain deductible amounts and maximum policy limits. The Company
      establishes sufficient reserves to cover probable losses with such claims.
      Except as otherwise described above, the Company has product liability insurance
      coverage in amounts it considers necessary to prevent material losses. The
      Company recognizes losses when they are known or considered probable and the
      amount can be reasonably estimated.





9


**ARTHROCARE
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




Defending
      and prosecuting intellectual property suits, United States Patent and Trademark
      office, or USPTO, interference proceedings and related legal and administrative
      proceedings is generally costly and time-consuming. Further litigation may
      be
      necessary to enforce the Company’s patents, to protect its trade secrets or
      know-how or to determine the enforceability, scope and validity of the
      proprietary rights of others. Any litigation or interference proceedings will
      be
      costly and will result in significant diversion of effort by technical and
      management personnel. An adverse determination in any of the litigation or
      interference proceedings to which ArthroCare may become a party could subject
      the Company to significant liabilities to third parties, require the Company
      to
      license disputed rights from third parties or require the Company to cease
      using
      such technology, which could have a material adverse effect on the Company’s
      business, financial condition, results of operations and future growth
      prospects. Patent and intellectual property disputes in the medical device
      area
      have often been settled through licensing or similar arrangements, and could
      include ongoing royalties. There can be no assurance ArthroCare can obtain
      any
      necessary licenses on satisfactory terms, if at all.





**NOTE
      10 - STOCKHOLDERS’ EQUITY**





*Treasury
      Stock*





In
      December 2007, the Board of Directors authorized the purchase of up to $75.0
      million in shares of the Company’s common stock.  In December 2007, the
      Company purchased 1,255,982 treasury shares at a cost of $59.6 million and
      in
      January 2008, the Company purchased an additional 243,918 treasury shares at
      a
      cost of $11.8 million to complete the share repurchase program.  The
      Company repurchased shares based on an evaluation of the Company’s long-term
      cash forecast and balance sheet capacity, including anticipated capital
      requirements.  In February 2008, the Board of Directors authorized an
      additional repurchase of up to $75.0 million in shares of the Company’s stock
      based upon full utilization of the December 2007 share repurchase program.
       No shares have been repurchased under the February 2008 share repurchase
      authorization.





In
      the
      quarter ended March 31, 2008, the Company issued 6,010 shares at an aggregate
      value of $0.2 million in order to fulfill the Company’s obligations to match
      employees’ 401(k) contributions with shares of Company stock.





**NOTE
      11 - DEBT**





On
      January 13, 2006, the Company entered into a Revolving Credit Agreement, or
      the Credit Agreement, with a syndicate of banks, collectively referred to as
      the
      Lenders. Under the terms of the Credit Agreement, the Company may borrow up
      to
      $100.0 million under a revolving line of credit from the named Lenders at the
      lead Lender’s Prime Rate or the British Bankers Association LIBOR Rate, plus a
      spread. The spread over the Prime Rate or LIBOR Rate is determined by the
      Company’s leverage ratio, as defined in the Credit Agreement. At March 31, 2008,
      the Company had $60.0 million in outstanding balances under the Credit Agreement
      and the weighted average interest rate applicable to borrowings under the Credit
      Agreement was 5.5 percent.





The
      Credit Agreement has a five-year maturity date and includes additional terms
      under which the Company may request an increase of up to $75.0 million in
      commitments from the Lenders, as business needs dictate. The Credit Agreement
      also contains various covenants that specify minimum or maximum financial
      ratios.  The Company was in compliance with all such covenants at March 31,
      2008.





10


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




**NOTE
      12 - FAIR VALUE MEASUREMENTS**





As
      described in Note 2, the Company adopted FAS 157 on January 1, 2008. FAS
      157, among other things, defines fair value, establishes a consistent
      framework for measuring fair value and expands disclosure for each major asset
      and liability category measured at fair value on either a
      recurring or nonrecurring basis. The Company had no assets or liabilities
      that were measured at fair value on a nonrecurring basis. FAS 157 clarifies
      that fair value is an exit price, representing the amount that would be received
      to sell an asset or paid to transfer a liability in an orderly transaction
      between market participants. As such, fair value is a market-based
      measurement that should be determined based on assumptions that market
      participants would use in pricing an asset or liability. As a basis for
      considering such assumptions, FAS 157 establishes a three-tier fair value
      hierarchy, which prioritizes the inputs used in measuring fair value as follows:





·
            Level
                1 - observable inputs such as quoted prices in active markets for
                identical assets or liabilities;


·
            Level
                2 - inputs, other than the quoted prices in active markets that are
                observable for the asset or liability, either directly or indirectly;
                and


·
            Level
                3 - unobservable inputs in which there is little or no market data,
                which
                require the reporting entity to develop its own
                assumptions.





Assets
      and liabilities measured at fair value are based on one or more of three
      valuation techniques noted in FAS 157. The three valuation techniques include
      the market approach (prices and other relevant information generated by market
      transactions involving identical or comparable assets or liabilities), the
      income approach (techniques to convert future amounts to a single present amount
      based on market expectations, including present value techniques, option-pricing
      and excess earnings models), and the cost approach (cost to replace the service
      capacity of an asset or replacement cost). Assets and liabilities measured
      at
      fair value on a recurring basis are as follows (in thousands):




**March 31,**
              **2008**
            
            **Quoted Prices**
              **In
                Active**
              **Markets for**
              **Identical
                Items**
              **(Level
                1)**
            
            **Significant**
              **Other**
              **Observable**
              **Inputs**
              **(Level
                2)**
            
            **Unobservable**
              **Inputs**
              **(Level
                3)**
            
            **Valuation**
              **Technique**Asset
                and mortgage-backed
              corporate
                bonds
            
            $
            1,043
            
            $
            1,043
            
            $
            -
            
            $
            -
            
            
            Market





There
      were no changes in the Company’s valuation techniques used to measure fair
      values on a recurring basis as a result of adopting FAS 157.





**NOTE
      13 - SEGMENT INFORMATION**





The
      Company has organized its marketing and sales efforts based on four operating
      segments which are aggregated into one reportable segment—developing,
      manufacturing, and marketing of disposable devices for less invasive surgical
      procedures. Each of the Company’s business units has similar economic
      characteristics, technologies, manufacturing processes, customers, distribution
      and marketing strategies, regulatory environments, and shared infrastructures.
      These business units are sports medicine (shoulder and knee arthroscopic
      products), ENT (to include ear, nose and throat and the Visage ® cosmetic
      products), spine (to include spinal and neurosurgery products) and Coblation
      technology (to include gynecology, urology, laparoscopic, general surgical
      and
      cardiology products).





11


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





Product
      sales by product market for the periods shown were as follows (in
      thousands):





**Three
                Months Ended March 31,****2008**
            
            **2007**Sports
                medicine
            
            $
            54,995
            
            
            62.1
            %
            $
            43,925
            
            
            61.9
            %ENT
            
            
            21,042
            
            
            23.8
            %
            
            17,126
            
            
            24.1
            %Spine
            
            
            12,388
            
            
            14.0
            %
            
            9,962
            
            
            14.0
            %Coblation
                technology
            
            
            67
            
            
            0.1
            %
            
            (12
            )
            
            0.0
            %Total
                product sales
            
            $
            88,492
            
            
            100.0
            %
            $
            71,001
            
            
            100.0
            %





Internationally,
      the Company markets and supports its products primarily through its subsidiaries
      and various distributors. Product sales by geography for the periods shown
      were
      as follows (in thousands):





**Three
                Months Ended March 31,****2008**
            
            **2007**Americas
            
            $
            68,637
            
            
            77.6
            %
            $
            55,886
            
            
            78.7
            %United
                Kingdom
            
            
            5,530
            
            
            6.2
            %
            
            4,301
            
            
            6.1
            %Germany
            
            
            4,433
            
            
            5.0
            %
            
            3,435
            
            
            4.8
            %Rest
                of world
            
            
            9,892
            
            
            11.2
            %
            
            7,379
            
            
            10.4
            %Total
                product sales
            
            $
            88,492
            
            
            100.0
            %
            $
            71,001
            
            
            100.0
            %





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





**March
                31,**
              **2008**
            
            **December
                31,**
              **2007**United
                States
            
            $
            38,325
            
            
            73.9
            %
            $
            36,843
            
            
            73.5
            %Costa
                Rica
            
            
            9,517
            
            
            18.3
            %
            
            9,400
            
            
            18.8
            %Rest
                of world
            
            
            4,040
            
            
            7.8
            %
            
            3,889
            
            
            7.7
            %Total
                long-lived assets
            
            $
            51,882
            
            
            100.0
            %
            $
            50,132
            
            
            100.0
            %







12


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





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





*The
      following discussion should be read in conjunction with the condensed
      consolidated financial statements and notes thereto appearing elsewhere in
      this
      Form 10-Q. Statements in this Management’s Discussion and Analysis of Financial
      Condition and Results of Operations and elsewhere in this quarterly report
      on
      Form 10-Q which express that we “believe,” “anticipate,” “expect” or “plan to”
as well as other statements which are not historical fact, are forward-looking
      statements within the meaning of the Private Securities Litigation Reform Act
      of
      1995 and are subject to the safe harbors created under the Securities Act of
      1933 and the Securities Exchange Act of 1934.  Readers are cautioned that
      these forward-looking statements are only predictions and are subject to risks,
      uncertainties, and assumptions that are difficult to predict.  As such,
      actual events or results may differ materially as a result of the risks and
      uncertainties described herein and elsewhere including, but not limited to,
      those factors discussed in “Risk Factors” set forth in Part I of our annual
      report on Form 10-K for the year ended December 31, 2007. In this quarterly
      report on Form 10-Q, the terms the “Company”, “we”, “us” and “our” refer to
      ArthroCare Corporation and its subsidiaries.*





***Company
      Overview***





We
      are a
      multi-business medical device company that designs, develops, manufactures
      and
      markets minimally invasive surgical products, many of which are based on our
      patented Coblation® technology. We have grown well beyond our roots in
      arthroscopy to capitalize on numerous market opportunities across several
      medical specialties, significantly improving many existing soft-tissue surgical
      procedures and enabling new minimally invasive procedures. With our highly
      innovative technologies, we are committed to improving the lives of individuals
      suffering from conditions as diverse as torn rotator cuffs and anterior cruciate
      ligaments, or ACL’s, to herniated discs and enlarged tonsils/tonsillitis.





We
      currently market minimally invasive surgical products across three core business
      units — ArthroCare Sports Medicine, ArthroCare Spine and ArthroCare Ear, Nose
      and Throat, or ENT — but also have developed, manufactured and marketed
      Coblation-based and complementary products for application in neurology,
      cosmetic surgery, urology and gynecology, with research continuing in additional
      areas. In each of our core business units we are focused on driving the
      application of enabling technologies, primarily for plasma-based soft tissue
      removal, and increasing the number of minimally invasive procedures being
      performed.





We
      focus
      on executing a mission-driven business strategy featuring the following key
      elements:





·
            expanding
                our product offering to address large and rapidly growing
                markets;


·
            targeting
                established procedures and replacing current technology with value-added
                ArthroCare technologies;


·
            driving
                disposable device sales with a direct sales
                force;


·
            augmenting
                growth with complementary and compatible acquisitions to expand margins
                and provide additional opportunity to capitalize on emerging and
                existing
                business opportunities; and


·
            establishing
                strategic partnerships to further commercialize our minimally invasive
                technologies.





ArthroCare
      was incorporated in California in 1993 and reincorporated in Delaware in 1995.
      We maintain an Internet website at *www.arthrocare.com* .
      On our
      website we make available, free of charge, the following filings as soon as
      reasonably practicable after they are electronically filed with or furnished
      to
      the Securities and Exchange Commission, or SEC: our annual reports on Form
      10-K,
      our quarterly reports on Form 10-Q, our current reports on Form 8-K and any
      amendments to those reports filed or furnished pursuant to Section 13(a) or
      15(d) of the Securities Exchange Act of 1934, as amended. You may also read
      and
      copy any materials that we file with the SEC at the SEC’s Public Reference Room
      at Room 1580, 100 F Street, NE, Washington DC 20549. You may obtain information
      on the operation of the Public Reference Room by calling the SEC at
      1-800-SEC-0330. Our reports, proxy statements and other documents filed
      electronically with the SEC are available at the website maintained by the
      SEC
      at *www.sec.gov.*




13


In
      December 1995, we introduced our Arthroscopy System commercially in the United
      States and have derived a significant portion of our sales from this system.
      Our
      strategy includes placing controller units, which enable use of our disposable
      coblation products, at substantial discounts or placing controllers at customer
      sites at no cost in order to generate future disposable product revenue. Our
      strategy also includes applying our patented Coblation technology to a range
      of
      other soft-tissue surgical markets, including the products we have introduced
      in
      the fields of spinal surgery, neurosurgery, gynecology, urology, cosmetic
      surgery, ENT surgery, cardiology and general surgery. We cannot be sure that
      any
      of our clinical studies in other fields will lead to 510(k) applications or
      that
      the applications will be cleared by the U.S Food and Drug Administration, or
      FDA, on a timely basis, if at all. In addition, we cannot be sure that the
      products, if cleared for marketing, will ever achieve commercial
      acceptance.





In
      May 1998, we announced that we had entered the ENT market and had formed a
      business unit called ENTec to commercialize Coblation technology in this field.
      In September 1999, we announced that we had entered the spinal surgery market.
      In February 2000, we announced that we were expanding our marketing efforts
      for
      our spinal surgery system to specifically address selected applications in
      neurosurgery. We are marketing and selling our spinal surgery products through
      a
      network of independent distributors and direct sales representatives supported
      by regional managers worldwide. In January 2004, we acquired MDA and its
      majority-owned subsidiary, Parallax, a business focused on the treatment of
      vertebral compression fractures. In November 2004, we acquired Opus Medical,
      a
      business focused on soft tissue to bone repair systems, including systems for
      the treatment of rotator cuff injuries. In
      August 2005, we completed the purchase of substantially all of the assets of
      Applied Therapeutics, Inc., or ATI, a maker of sinus surgery treatment products.





We
      have
      received 510(k) clearance from the FDA to market several of our products and
      several of our products are CE marked, which is a requirement to sell our
      products in most of Western Europe. Specifically, we have received 510(k)
      clearance from the FDA to market our Coblation-based Arthroscopic Surgery
      System, or Arthroscopic System, for use in arthroscopic surgery of the knee,
      shoulder, ankle, elbow, wrist and hip. In addition, our Arthroscopic System
      is
      CE marked for use in arthroscopic surgery. We have also received 510(k)
      clearances in the United States and a CE mark in Europe to market and sell
      our
      Coblation-based Spinal Surgery System for spinal surgery and neurosurgery.
      Our
      ENT Surgery System has received 510(k) clearances from the FDA and a CE mark
      for
      use in general head, neck, oral and sinus surgery procedures, including
      tonsillectomy and adenoidectomy, turbinate reduction to relieve nasal
      obstruction, and soft tissue removal to treat snoring. The FDA also has cleared
      our Cosmetic Surgery System for general dermatologic procedures and skin
      resurfacing in connection with wrinkle reduction procedures. In addition, the
      Cosmetic Surgery System has received a CE Mark. We also have received 510(k)
      clearance from the FDA, and applied for a CE mark, to market products based
      on
      our Coblation technology for use in urology, gynecology, plastic and
      reconstructive surgery, orthopedic surgery and general surgery.





***Evaluation
      of Financial and Strategic Alternatives***





In
      March
      2008, the Company announced that its Board of Directors had begun an evaluation
      of the Company’s financial and strategic alternatives to enhance shareholder
      value. The Board at that time announced its intention to consider the full
      range
      of available options, including a recapitalization, a stock repurchase, a sale
      or disposition of one or more corporate assets and/or a strategic business
      combination. The Company continues to be engaged in the process of exploring
      alternatives with a number of parties. These activities include entering into
      confidentiality agreements and permitting due diligence to be performed. 
These activities may include discussion and negotiation of agreements with
      respect to financial or strategic alternatives.   There can be no
      assurance that any of these activities will result in a financial or strategic
      alternative being accepted and, if a financial or strategic alternative is
      accepted, there can be no assurance that such financial or strategic alternative
      or any other alternative will be consummated and, if consummated, there is
      no
      assurance shareholder value will be enhanced.





***Overview
      of First Quarter Results***





First
      quarter of 2008 product sales of $88.5 million increased 24.6 percent from
      $71.0
      million in the first quarter of 2007. Royalties, fees, and other revenue were
      $2.5 million in the first quarter of 2008 compared with $2.7 million in the
      first quarter of 2007 and represented 2.8 percent of total revenue for the
      first
      quarter of 2008 and 3.7 percent of total revenue for the first quarter of 2007.
      International product sales increased 31.4 percent in the first quarter over
      the
      first quarter of 2007, led by the sale of sports medicine products in the
      Company’s direct distribution markets and ENT tonsillectomy sales in the United
      Kingdom. The sports medicine business unit produced sales growth of 25.2 percent
      during the quarter ended March 31, 2008 compared with the same period of 2007,
      and represented 62.1 percent of total product sales. Sales in the spine business
      unit during the first quarter of 2008 grew 24.4 percent compared to the same
      period in 2007, with spine sales representing 14.0 percent of total product
      sales. The increase in ENT product sales in the first quarter of 2008 over
      the
      comparable period of 2007 was 22.9 percent, with ENT sales representing 23.8
      percent of total product sales.




14


Product
      margin was 71.8 percent in the first quarter of 2008, virtually consistent
      with
      71.9 percent in the first quarter of 2007. Operating expenses were $52.8 million
      in the first quarter 2008, or approximately 58.0 percent of total revenue
      compared to $44.0 million, or 59.8 percent of total revenue, in the first
      quarter of 2007. Accordingly, operating profit margin in the first quarter
      of
      2008 improved to 13.8 percent from 12.1 percent in the first quarter of 2007.
      Other expense of $0.2 million increased $0.5 million from $0.3 million of other
      income in the first quarter of 2007. The Company’s tax rate for the quarter was
      25.2 percent compared to 23.0 percent in the first quarter of 2007. Earnings
      per
      share of $0.34 increased 36.0 percent over the first quarter of 2007 earnings
      per share of $0.25.




Our
      headcount at March 31, 2008 was 1,088, an increase of 1.3 percent from 1,074
      at
      December 31, 2007 and an increase of 15.4 percent from 943 at March 31,
      2007.  Headcount increases are primarily attributable to additions of
      personnel in sales and marketing as well as research and
      development. ****





***Results
      of Operations***





The
      following is a comparison of our results of operations for the three months
      ended March 31, 2008 to the three months ended March 31, 2007 (in
      thousands).





**Three
                Months Ended March 31,****2008**
            
            **2007**Product
                sales
            
            $
            88,492
            
            
            97.2
            %
            $
            71,001
            
            
            96.3
            %Royalties,
                fees, and other
            
            
            2,543
            
            
            2.8
            %
            
            2,742
            
            
            3.7
            %Total
                revenues
            
            
            91,035
            
            
            100.0
            %
            
            73,743
            
            
            100.0
            %Cost
                of product sales
            
            
            25,705
            
            
            28.2
            %
            
            20,756
            
            
            28.1
            %Gross
                profit
            
            
            65,330
            
            
            71.8
            %
            
            52,987
            
            
            71.9
            %Operating
                expensesResearch
                and development
            
            
            7,727
            
            
            8.5
            %
            
            6,464
            
            
            8.8
            %Sales
                and marketing
            
            
            35,237
            
            
            38.7
            %
            
            29,494
            
            
            40.0
            %General
                and administrative
            
            
            7,604
            
            
            8.4
            %
            
            6,180
            
            
            8.4
            %Amortization
                of intangible assets
            
            
            2,214
            
            
            2.4
            %
            
            1,911
            
            
            2.6
            %Total
                operating expenses
            
            
            52,782
            
            
            58.0
            %
            
            44,049
            
            
            59.8
            %Income
                from operations
            
            
            12,548
            
            
            13.8
            %
            
            8,938
            
            
            12.1
            %Interest
                and other income (expense), net
            
            
            (158
            )
            
            (0.2
            )%
            
            330
            
            
            0.5
            %Income
                before income tax provision
            
            
            12,390
            
            
            13.6
            %
            
            9,268
            
            
            12.6
            %Income
                tax provision
            
            
            3,126
            
            
            3.4
            %
            
            2,132
            
            
            2.9
            %Net
                income
            
            $
            9,264
            
            
            10.2
            %
            $
            7,136
            
            
            9.7
            %


15


**ARTHROCARE
      CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





***Revenues***





*Product
      sales* consist
      primarily of sales of disposable devices and controllers. Product sales for
      the
      quarter ended March 31, 2008 were $88.5 million, compared to $71.0 million
      for
      the quarter ended March 31, 2007. Product sales by product market for the
      periods shown were as follows (in thousands):





**Three
                Months Ended March 31,****2008**
            
            **2007**Sports
                medicine
            
            $
            54,995
            
            
            62.1
            %
            $
            43,925
            
            
            61.9
            %ENT
            
            
            21,042
            
            
            23.8
            %
            
            17,126
            
            
            24.1
            %Spine
            
            
            12,388
            
            
            14.0
            %
            
            9,962
            
            
            14.0
            %Coblation
                technology
            
            
            67
            
            
            0.1
            %
            
            (12
            )
            
            0.0
            %Total
                product sales
            
            $
            88,492
            
            
            100.0
            %
            $
            71,001
            
            
            100.0
            %





Product
      sales by geography for the periods shown were as follows (in
      thousands):





**Three
                Months Ended March 31,****2008**
            
            **2007**Americas
            
            $
            68,637
            
            
            77.6
            %
            $
            55,886
            
            
            78.7
            %United
                Kingdom
            
            
            5,530
            
            
            6.2
            %
            
            4,301
            
            
            6.1
            %Germany
            
            
            4,433
            
            
            5.0
            %
            
            3,435
            
            
            4.8
            %Rest
                of world
            
            
            9,892
            
            
            11.2
            %
            
            7,379
            
            
            10.4
            %Total
                product sales
            
            $
            88,492
            
            
            100.0
            %
            $
            71,001
            
            
            100.0
            %





Our
      sustained increase in direct sales presence has continued to have a positive
      effect on product sales since inception, as did the execution of our strategic
      plan to build market share through promotional programs of controller
      placements, commercialization of our technology in fields outside of
      arthroscopy, and the introduction of new products designed to address surgical
      procedures that have traditionally been difficult to perform. Additionally,
      our
      acquisitions of Atlantech, Parallax, Opus Medical and ATI product lines have
      continued to have a positive effect on sales growth. No
      single
      customer accounted for more than 10 percent of our net product sales during
      the
      three months ended March 31, 2008 or 2007.





We
      generally sell our disposable devices at or near list price, except for sales
      to
      international distributors and marketing partners, which are
      sold at discounted prices . We
      anticipate that disposable device sales will remain a key component of our
      product sales in the near future.





*Royalties,
      fees and other revenues* consist
      primarily of revenue from the licensing of our products and technology.
      Royalties, fees and other revenues were $2.5 million for the quarter ended
      March
      31, 2008, compared to $2.7 million for the quarter ended March 31, 2007. The
      percentage of royalties, fees and other revenues as a percentage of income
      was
      2.8 percent and 3.7 percent for the quarter ended March 31, 2008 and March
      31,
      2007, respectively. The decrease is related to a reduction in license revenues,
      which we believe is a result of the Company’s growth in product sales that
      compete with the products for which competitors pay us license
      fees.





***Cost
      of Product Sales***





*Cost
      of product sales*  consists
      of manufacturing costs, material costs, labor costs, manufacturing overhead,
      warranty and other direct product costs. Additionally, cost of product sales
      includes amortization of controller unit placements under a program whereby
      we
      maintain ownership of controller units shipped to customers, with the costs
      being capitalized and amortized into cost of product sales over the useful
      life
      of the controller unit. Amortization
      of controllers was $1.8 million in the first quarter of 2008, compared to $1.9
      million in the first quarter of 2007. Controller amortization represented 2.1
      percent of product sales for the quarter ended March 31, 2008 and 2.7 percent
      of
      product sales for the quarter ended March 31, 2007. The percentage decrease
      in
      controller amortization for the quarter ended March 31, 2008 compared to the
      same period in 2007 was driven by higher product sales per outstanding
      controller combined with a backlog of requests from customers who were
      requesting new Quantum controllers to replace their fully amortized controllers.





16


Cost
      of product sales was $25.7 million, or 28.2 percent of revenue for the quarter
      ended March 31, 2008, as compared to $20.8 million, or 28.1 percent of revenue
      for the quarter ended March 31, 2007. Gross product margin as a percentage
      of
      product sales remained essentially flat at 71.8 percent in the first quarter
      of
      2008 versus 71.9 percent in the first quarter of 2007. We expect gross product
      margin to increase as a result of higher average selling prices and as we
      improve operating efficiencies.





***Operating
      Expenses***





*Research
      and development* expenses were $7.7 million, or 8.5 percent of total revenues, for the quarter
      ended March 31, 2008, compared to $6.5 million, or 8.8 percent of total
      revenues, for the quarter ended March 31, 2007. The increase in absolute dollars
      is primarily attributable to $0.7 million of additional wages and other employee
      related costs due to increased headcount, $0.3 million of additional prototype
      materials costs and $0.2 million of additional outside services. We expect
      to
      increase the dollar amount of research and development expenses through
      continued expenditures on new product development, regulatory affairs, clinical
      studies and patents. We expect these expenses as a percentage of product sales
      to remain essentially flat.





*Sales
      and marketing* expenses were $35.2 million, or 38.7 percent of total revenues, for the quarter
      ended March 31, 2008, compared to $29.5 million, or 40.0 percent of total
      revenues, for the quarter ended March 31, 2007. The increase in absolute dollars
      for the first quarter of 2008 compared to the first quarter of 2007 related
      primarily to $4.7 million in increased sales commissions and other compensation
      expenses associated with our increased sales volume and larger direct sales
      force, $1.2 million related to trade shows, surgical training, samples and
      demos, promotions, and other advertising expenses, $0.4 million in increased
      outside services and consulting, all partially offset by a reduction of $0.9
      million in the provision for doubtful accounts. We anticipate that sales and
      marketing spending will continue to increase in absolute dollars as a result
      of
      the expansion of our distribution capabilities to address the spinal surgery
      and
      ear, nose and throat markets, higher dealer commissions from increased sales,
      the additional cost of penetrating international markets, higher training,
      promotional, demonstration and sample expenses, and additional investments
      in
      the sales, marketing and support staff necessary to commercialize and market
      future products.





*General
      and administrative* expenses
      were $7.6 million, or 8.4 percent of total revenues, for the quarter ended
      March
      31, 2008, compared to $6.2 million, or 8.4 percent of total revenues, for the
      quarter ended March 31, 2007. The increase in absolute dollars for the quarter
      ended March 31, 2008 compared to the quarter ended March 31, 2007 is due
      primarily to $1.4 million in additional legal and consulting expenses as a
      result of the NASDAQ inquiry which was initiated and subsequently closed during
      the quarter ended March 31, 2008 as well as the strategic and financial
      alternatives review being conducted by our Board of Directors. We expect general
      and administrative expenses to decrease as a percentage of total revenues due
      to
      continued leveraging of our existing infrastructure and operating
      procedures.





*Amortization
      of intangible assets* increased to $2.2 million, or 2.4 percent of total revenues, during the first
      quarter of 2008, compared to $1.9 million, or 2.6 percent of total revenues,
      in
      the first quarter of 2007. The increase in amortization for the quarter ended
      March 31, 2008 as compared to the same period in 2007 is attributable to
      additional license agreements and intangible assets acquired in purchase
      business combinations.





*Interest
      and other income (expense), net* ,
      represented a net expense of $0.2 million for the quarter ended March 31, 2008,
      compared to a net benefit of $0.3 million for the quarter ended March 31, 2007.
      The increase in net expense of $0.5 million for the quarter ended March 31,
      2008
      compared to the quarter ended March 31, 2007 was due primarily to interest
      expense associated with $60.0 million in borrowings under the Company’s
      revolving credit facility.





17


*Income
      tax provision* .
      The
      provision for income taxes was $3.1 million for an effective tax rate of
      approximately 25.2 percent for the quarter ended March 31, 2008, compared to
      $2.1 million for an effective tax rate of 23.0 percent for the quarter ended
      March 31, 2007. The increase in the effective tax rate was due
      primarily to the research and development tax credit expiring at the end of
      2007.





***Liquidity
      and Capital Resources***





As
      of
      March 31, 2008, we had $151.9 million in working capital, compared to $148.3
      million at December 31, 2007. Our
      principal sources of liquidity consisted of $33.2 million in cash, cash
      equivalents, and short-term investments at March 31, 2008. Cash equivalents
      are
      highly liquid with original maturities of ninety days or less. Our short-term
      investments consist primarily of corporate bonds.





Cash
      provided by operating activities for the quarter ended March 31, 2008 was $5.9
      million, primarily attributable to net income adjusted for non-cash items
      including depreciation and amortization, stock-based compensation expense,
      and
      provisions for doubtful accounts and inventory reserves, partially offset by
      an
      increase in accounts receivable and a decrease in accounts payable and accrued
      liabilities. Cash generated by operating activities for the quarter ended March
      31, 2007 was $15.7 million, primarily attributable to net income adjusted for
      non-cash items including depreciation and amortization, stock-based compensation
      expense, and provisions for doubtful accounts and inventory reserves, partially
      offset by a decrease in accrued liabilities.





Cash
      used
      in investing activities for the quarter ended March 31, 2008 was $3.2 million,
      due primarily to purchases of property and equipment and intangible assets,
      partially offset by sales and maturities of available for sale securities.
      Cash
      used in investing activities for the quarter ended March 31, 2007 was $4.0
      million, which was also due primarily to purchases of property and equipment
      and
      intangible assets, partially offset by sales and maturities of available for
      sale securities.





Cash
      used
      by financing activities for the quarter ended March 31, 2008 was $10.1 million,
      due primarily to cash used for the Company’s share repurchase program, partially
      offset by cash received from the exercise of stock options and the financing
      impact of excess tax benefits resulting from stock compensation expense. Cash
      provided by financing activities for the quarter ended March 31, 2007 was $1.2
      million, due primarily cash proceeds from the exercise of stock
      options.





**Critical
      Accounting Policies and Estimates**




The
      preparation of financial statements and related disclosures in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make judgments, assumptions and estimates that affect
      the
      amounts reported in the consolidated financial statements and accompanying
      notes. Note 2 to the condensed consolidated financial statements of this Form
      10-Q and Note 2 to the consolidated financial statements of our Form 10-K for
      the year ended December 31, 2007 describe the significant accounting policies
      and methods used in the preparation of the condensed consolidated financial
      statements. The most significant areas involving management judgments and
      estimates are described in Item 7 of our Form 10-K for the year ended December
      31, 2007 under the caption “Critical Accounting Policies and Estimates” with
      updates provided below or in the accompanying condensed consolidated financial
      statements.





As
      of
      March 31, 2008, there were no undelivered bill and hold
      transactions.





**Disclosures
      about Contractual Obligations and Commercial Commitments**





We
      have
      various contractual obligations, which are recorded as liabilities in our
      consolidated financial statements. Other items, such as certain purchase
      commitments with suppliers and minimum lease payments under operating leases,
      are not recognized as liabilities in our consolidated financial statements
      but
      are required to be disclosed. During the quarter ended March 31, 2008,
      there were no material changes from our contractual obligations presented in
      our
      2007 Annual Report on Form 10-K. As of December 31, 2007 and March 31,
      2008, we had $4.6 million of non-current income tax liabilities recorded in
      accordance with Financial Accounting Standards Board, or FASB, Interpretation
      No. 48, *Accounting
      for Uncertainty in Income Taxes* ,
      or
      FIN 48, which because of the uncertainty of the amounts to be ultimately
      paid as well as the timing of such payments, are excluded from our contractual
      obligations table.





18


**Recently
      Adopted Accounting Pronouncements**





In
      September 2006, the FASB issued Statement of Financial Accounting Standards
      No.
      157, *Fair
      Value Measurements* ,
      or FAS
      157. FAS 157 defines fair value, establishes a consistent framework for
      measuring fair value in generally accepted accounting principles and expands
      disclosures about fair value measurements for each major asset and liability
      category. FAS 157 became effective for the Company on January 1, 2008 for
      financial assets and liabilities and will become effective on January 1, 2009
      for non-financial assets and liabilities. The implementation for financial
      assets and liabilities on January 1, 2008 did not have a material effect on
      the
      Company’s operating results or financial position. The Company is currently
      evaluating the impact, if any, that the adoption of FAS 157 for non-financial
      assets and liabilities will have on its operating results and financial
      position. For additional information regarding FAS 157, see Note 12 of the
      condensed consolidated financial statements.





In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      159, *The
      Fair Value Option for Financial Assets and Financial Liabilities - Including
      an
      amendment of FASB No. 115* ,
      or FAS
      159. FAS 159 permits companies to choose to measure many financial instruments
      and certain other items at fair value in order to mitigate volatility in
      reported earnings caused by measuring related assets and liabilities differently
      without having to apply complex hedge accounting provisions. FAS 159 became
      effective for the Company on January 1, 2008. The adoption of FAS 159 did not
      affect the Company’s operating results or financial position.





**Recently
      Issued Accounting Pronouncements**





In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      141(R), *Business
      Combinations,* or ** FAS
      141R.
      FAS 141R will become effective for us on January 1, 2009 and is applied
      prospectively for business combinations completed after January 1, 2009. Under
      FAS 141R, organizations utilized the announcement date as the measurement date
      for the purchase price of the acquired entity. FAS 141R requires
      measurement at the date the acquirer obtains control of the acquiree, generally
      referred to as the acquisition date. FAS 141R will have a significant
      impact on the accounting for transaction costs, restructuring costs as well
      as
      the initial recognition of contingent assets and liabilities assumed in a
      business combination completed after January 1, 2009.





In
      December 2007, the FASB ratified Emerging Issues Task
      Force Issue No. 07-01, *Accounting* *for* *Collaborative* *Arrangements*,
      or EITF
      07-01, which will become effective for us on January 1, 2009. EITF 07-01
      requires that transactions with third parties (i.e., revenue generated and
      costs
      incurred by the partners) should be reported in the appropriate line item in
      each company’s financial statement pursuant to the guidance in EITF Issue
      No. 99-19,*Reporting
      Revenue Gross as a Principal versus Net as an Agent*.
      EITF
      07-01 also requires enhanced disclosure requirements regarding the nature and
      purpose of the arrangement, rights and obligations under the arrangement,
      accounting policy, amount and income statement classification of collaboration
      transactions between the parties. The Company is currently evaluating the
      impact, if any, that the adoption of EITF 07-01 will have on its operating
      results and financial position.





**ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





Our
      exposure to market risk for changes in interest rates relates primarily to
      our
      borrowings under the Revolving Credit Agreement, dated January 13, 2006, and
      to
      our investment portfolio, which includes cash, cash equivalents and short-term
      investments. Our investment portfolio does not currently include derivative
      financial instruments.


19


We
      are
      subject to fluctuating interest rates that may significantly impact, adversely
      or otherwise, our results of operations or cash flows, as well as our ability
      to
      borrow needed capital at a critical time. The table below presents principal
      amounts and related weighted average interest rates as of March 31, 2008 for
      our
      cash, cash equivalents and short-term investments and our notes payable (in
      thousands):





Principal
              Balance
            
            Average
              Interest
                RateCash,
                cash equivalents, and short-term investments
            
            $
            33,168
            
            
            2.7
            %Notes
                payable
            
            
            60,000
            
            
            5.5
            %




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




*Foreign
      Currency Risk*





A
      significant portion of our international sales and operating expenses are
      denominated in currencies other than the U.S. Dollar. During the first quarter
      of 2008, most of these currencies strengthened relative to the U.S. Dollar.
      To
      the extent that the strength of these currencies fluctuates as compared to
      the
      U.S. Dollar, we will experience variations in our results of operations and
      financial condition.





Our
      cash
      and cash equivalents at the quarter ended March 31, 2008 were denominated
      primarily in U.S. Dollars; however, we also maintain significant balances in
      Euros, British Pounds, Swedish Krona, Australian Dollars and Costa Rican
      Colones. A 10 percent change in the March 31, 2008 exchange rates for these
      currencies would have an impact on pre-tax income of approximately $0.9
      million.





**ITEM
      4. CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**





We
      maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
      and
      15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange
      Act, that are designed to ensure that information required to be disclosed
      in
      our filings under the Exchange Act is recorded, processed, summarized and
      reported within the time periods specified in the SEC’s rules and forms, and
      that such information is accumulated and communicated to management, including
      our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, as
      appropriate, to allow timely decisions regarding required disclosure.





We
      carried out an evaluation under the supervision and with the participation
      of
      our management, including our CEO and CFO, of the effectiveness of the design
      and operation of our disclosure controls and procedures as of March 31, 2008.
      Based upon this evaluation, our CEO and CFO have concluded that the design
      and
      operation of our disclosure controls and procedures were effective as of March
      31, 2008. Accordingly, management believes that the financial statements
      included in this report fairly present in all material respects our financial
      condition, results of operations and cash flows for the periods
      presented.





**Changes
      in Internal Control Over Financial Reporting**





There
      were no changes in our internal control over financial reporting that occurred
      during the quarter ended March 31, 2008 that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.





20


**PART
      II. OTHER INFORMATION**





**ITEM
      1. LEGAL PROCEEDINGS**





Information
      with respect to this item is incorporated into this Part II, Item I by reference
      to the section entitled “Litigation” in Note 9 to the condensed consolidated
      financial statements contained in Part I above.





**ITEM
      1A. RISK FACTORS**





There
      are
      many factors that affect our business and the results of our operations, many
      of
      which are beyond our control. In this regard, “Item 1A. Risk Factors” to Part I
      of our Annual Report on Form 10-K for the year ended December 31, 2007 contained
      a description of significant factors that might cause the actual results of
      operations in future periods to differ materially from those currently expected
      or desired. We urge you to read the risk factors contained in our 2007 Annual
      Report on Form 10-K, as there have not been any material changes in our risk
      factors from such report. Additionally, the Company continues to be engaged
      in
      the process of exploring financial and strategic alternatives, considering
      a
      full range of options, including a recapitalization, a stock repurchase, a
      sale
      or disposition of one or more corporate assets and/or a strategic business
      combination. There can be no assurance that any of these activities will result
      in a financial or strategic alternative being accepted and, if a financial
      or
      strategic alternative is accepted, there can be no assurance that such financial
      or strategic alternative or any other alternative will be consummated and,
      if
      consummated, there is no assurance shareholder value will be enhanced.





**ITEM
      2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS**





None.





**ITEM
      3. DEFAULTS UPON SENIOR SECURITIES**





None.





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS**





None.





**ITEM
      5. OTHER INFORMATION**





None.





**ITEM
      6. EXHIBITS**





**Exhibit
                Number**
            
            **Description**31.1
            
            Certification
                of the Chief Executive Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of the Chief Financial Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.32.1
            
            Certification
                of the Chief Executive Officer pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.32.2
            
            Certification
                of the Chief Financial Officer pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.











21


**SIGNATURES**





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


**ARTHROCARE
                CORPORATION**
              *a
                Delaware corporation*Date:May 12, 2008
            
            
            /s/
              Michael A.
              BakerMichael
                A. Baker
              President,
                Chief Executive Officer and Director
              (Principal
                Executive Officer)


Date:May 12, 2008
              
              
              /s/
                Michael GlukMichael Gluk
                Senior
                    Vice President, Finance and
                  Chief
                    Financial Officer
                  (Principal
                    Financial and Accounting Officer)
  22