ARROW INTERNATIONAL INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

FOR THE FISCAL YEAR ENDED AUGUST 31, 2002

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

Commission File Number 0-20212

ARROW INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

PENNSYLVANIA 23-1969991
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)

2400 BERNVILLE ROAD
READING, PENNSYLVANIA 19605
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE NUMBER: (610) 378-0131
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Name of Each Exchange
Title of Each Class: on Which Registered:
-------------------- --------------------
None None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, No Par Value
(Title of Class)

Name of Exchange on which registered: The Nasdaq Stock Market

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

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

The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of November 1, 2002 was approximately $436,748,633.

The number of shares of Registrant's Common Stock outstanding on November
1, 2002 was 21,798,996.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on January 15, 2003, which will be filed with the
Securities and Exchange Commission within 120 days after August 31, 2002, are
incorporated by reference in Part II, Item 10, and Part III of this report.

ITEM 1. BUSINESS

CERTAIN OF THE INFORMATION CONTAINED IN THIS FORM 10-K, INCLUDING THE
DISCUSSION WHICH FOLLOWS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" FOUND IN ITEM 7 OF THIS REPORT, CONTAIN
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS,
CAREFULLY REVIEW THIS REPORT, INCLUDING EXHIBIT 99.1 HERETO, AS WELL AS OTHER
INFORMATION CONTAINED IN ARROW INTERNATIONAL, INC.'S PERIODIC REPORTS FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION (THE "SEC" OR "COMMISSION").

Arrow International, Inc. (together with its subsidiaries, "Arrow" or the
"Company") was incorporated as a Pennsylvania corporation in 1975. Arrow
develops, manufactures and markets a broad range of clinically advanced,
disposable catheters and related products for critical and cardiac care. The
Company's critical care products are used principally for central vascular
access in the administration of fluids, drugs, and blood products, patient
monitoring and diagnostic purposes. These products are used by
anesthesiologists, critical care specialists, surgeons, cardiologists,
nephrologists, emergency and trauma physicians and other health care providers.
Arrow's cardiac care products are used by interventional cardiologists, cardiac
surgeons, interventional radiologists and electrophysiologists for such purposes
as the diagnosis and treatment of heart and vascular disease and to provide
short-term cardiac assist following cardiac surgery, serious heart attack or
balloon angioplasty.

Arrow's critical care products, which were originally introduced in 1977,
accounted for 83.3%, 82.7% and 82.5% of net sales in fiscal 2002, 2001 and 2000,
respectively. The majority of these products are vascular access catheters and
related devices which consist principally of the following: the Arrow-Howes(TM)
Multi-Lumen Catheter, a catheter equipped with three or four channels that
enables the simultaneous administration of multiple critical care therapies
through a single puncture site; double-and single-lumen catheters, which are
designed for use in a variety of clinical procedures; percutaneous sheath
introducers, which are used as a means for inserting cardiovascular and other
catheterization devices into the vascular system during critical care
procedures; radial artery catheters, which are used for measuring arterial blood
pressure and taking blood samples; FlexTip Plus(TM) epidural catheters, which
are designed to minimize indwelling complications associated with conventional
epidural catheters; and Percutaneous Thrombolytic Devices ("PTD"), which are
designed for clearance of thrombosed hemodialysis grafts in chronic hemodialysis
patients. Many of the Company's vascular access catheters are treated with the
ARROWg+ard(TM) or ARROWg+ard Blue Plus(TM) antiseptic surface treatments to
reduce the risk of catheter related infection. ARROWg+ard Blue Plus(TM) is a
stronger, longer lasting formulation of ARROWg+ard(TM) and provides
antimicrobial treatment of the interior lumens and hubs of each catheter.

The Company's critical care product line also includes custom tubing sets
used to connect central venous catheters to blood pressure monitoring devices
and drug infusion systems, and the HemoSonic(TM) 100, a hemodynamic monitoring
device that continuously measures descending aortic blood flow using a
non-invasive esophageal ultrasound probe. In April 2002, the Company divested
its implantable constant flow drug delivery pump product business (see Item 8.
Notes to Consolidated Financial Statements - Note 19).

Arrow's cardiac care products accounted for 16.7%, 17.3% and 17.5% of net
sales in fiscal 2002, 2001 and 2000, respectively. These products include
cardiac assist products, such as intra-aortic balloon (IAB) pumps and catheters,
which are used primarily to augment temporarily the pumping capability of the
heart following cardiac surgery, serious heart attack or balloon angioplasty.
The most recent of these products is the AutoCAT(TM), the Company's advanced
automatic IAB pump which features AutoPilot(TM), a mode of operation that
automatically selects operating parameters for optimal cardiac assist. The
AutoCAT(TM) continuously monitors and selects the best signal from multiple
electrocardiogram and arterial pressure sources to automatically adjust balloon
inflation and deflation timing points. Other currently available pumps require
manual intervention on the part of the clinician to switch signal sources and
initiate balloon timing. The Company also distributes a high performance 8
French intra-aortic balloon catheter. This balloon catheter, the Ultra 8(TM), is
configured to enable it to be introduced through standard 8 French Cath Lab
sheaths used for therapeutic interventions as well as through a separate balloon
sheath. The Ultra 8(TM) provides faster inflation and deflation times than
competitive catheters and has a larger central lumen that reduces the potential
for aortic pressure waveform dampening and facilitates placement over standard
size springwire guides.

(2)

ITEM 1. BUSINESS (CONTINUED)

The Company's cardiac care product line also includes electrophysiology
products, which are used primarily to map the electrical signals which activate
the heart. The Berman(TM) Angiographic Catheter is used for pediatric cardiac
angiographic procedures and the Super Arrow-Flex(TM) sheath provides a
kink-resistant passageway for the introduction of cardiac and other catheters
into the vascular system. In addition, as further discussed below under
"Research and Product Development," the Company currently has under development
new cardiac care products, including the Arrow LionHeart(TM), a fully
implantable Left Ventricular Assist System ("LVAS") capable of taking over the
entire work load of the left ventricle, and CorAide(TM), a non-pulsatile
centrifugal flow ventricular assist device designed to be used for the treatment
of congestive heart failure.

SALES AND MARKETING

Arrow markets its products to physicians and hospitals through a
combination of direct selling, independent distributors and a group purchasing
organization. Within each hospital, marketing efforts are targeted to those
physicians, including critical care specialists, cardiologists,
anesthesiologists, interventional radiologists, electrophysiologists and
surgeons, most likely to use the Company's products. Arrow's products are
generally sold in the form of pre-sterilized procedure kits containing the
catheters and virtually all of the related medical components and accessories
needed by the clinician to prepare for and perform the intended medical
procedure. Additional sales revenue is derived from equipment provided for use
in connection with certain of the Company's disposable products.

In fiscal 2002, 2001 and 2000, 65.5%, 65.9% and 64.1%, respectively, of the
Company's net sales were to U.S. customers. In this market, approximately 78.9%
of the Company's fiscal 2002 revenue was generated by its direct sales force.
The remainder resulted from shipments to independent distributors. For the
majority of such distributors, the Company's products represent a principal
product line. Direct selling generally yields higher gross profit margins than
sales made through independent distributors. On September 3, 2002, the Company
purchased the net assets of its former New York City distributor, Stepic
Medical, from Horizon Medical Products for $12.7 million in cash and relief from
$5.5 million of accounts receivable that had been due from this distributor
subject to post-closing adjustments (see Item 8. Notes to Consolidated Financial
Statements - Note 22). With this acquisition, 84% of the Company's U.S. business
will be sold to hospitals by direct sales representatives.

Internationally, the Company sells its products through 11 direct sales
subsidiaries serving markets in Japan, Germany, the Netherlands, France, Spain,
Greece, Africa, Canada, Mexico, the Czech Republic and Slovakia. As of November
1, 2002, independent distributors in 92 additional countries sell the Company's
products in the remainder of the world.

To support growth in international sales, the Company operates a 40,000
square foot manufacturing facility in Chihuahua, Mexico and has leased 22,500
square feet of additional manufacturing space in Mexico since fiscal 2001. The
Company also operates a manufacturing and research facility in the Czech
Republic. In fiscal 2002, the Company completed construction of additional
manufacturing space at this facility which expanded the manufacturing capacity
to 88,000 square feet.

Revenues, profitability and long-lived assets attributable to significant
geographic areas are presented in Note 13 to the Company's Consolidated
Financial Statements included in Item 8.

In general, Arrow does not produce against a backlog of customer orders;
production is based primarily on the level of inventories of finished products
and projections of future customer demand with the objective of shipping from
stock upon receipt of orders. No single customer accounts for a material part of
the Company's sales. Usage of the Company's products by hospitals and physicians
has not been materially influenced by seasonal factors.

(3)

ITEM 1. BUSINESS (CONTINUED)

SALES AND MARKETING (CONTINUED)

Government and private sector initiatives to limit the growth of health
care costs, including price regulation, competitive pricing, coverage and
payment policies, and managed-care arrangements, are continuing in the United
States and in many other countries where the Company does business. As a result
of these changes, the marketplace has placed increased emphasis on the delivery
of more cost-effective medical therapies. Government programs, including
Medicare and Medicaid, private health care insurance and managed-care plans have
attempted to control costs by limiting the amount of reimbursement such third
party payors will pay to hospitals, other medical institutions and physicians
for particular products, procedures or treatments. The increased emphasis on
health care cost containment has resulted in reduced growth in demand for
certain of the Company's products in markets in the U.S. where Arrow has 80% or
greater market shares, and protecting that market share has affected the
Company's pricing in some instances. The Company also continues to face pricing
pressures in certain product lines in European markets as governments strive to
curtail increases in health care costs. The Company anticipates that the U.S.
Congress, state legislatures, foreign governments and the private sector will
continue to review and assess alternative health care delivery and payment
systems. The Company cannot predict what additional legislation or regulation,
if any, relating to the health care industry may be enacted in the future or
what impact the adoption of any federal, state or foreign health care reform,
private sector reform or market forces may have on its business. No assurance
can be given that any such reforms will not have a material adverse effect on
the Company's business, financial condition or results of operations.

RESEARCH AND PRODUCT DEVELOPMENT

Arrow is engaged in ongoing research and development to introduce
clinically advanced new products, to enhance the effectiveness, ease of use,
safety and reliability of its existing products and to expand the clinical
applications for which use of its products is appropriate. The principal focus
of the Company's research and development effort is to identify and analyze the
needs of physicians in critical and cardiac care medicine, and to develop
products that address these needs. The Company views ideas submitted by
physicians and other health care professionals as an important source of
potential research and development projects. The Company believes that these
end-users are often in the best position to conceive of new products and to
recommend ways to improve the performance of existing products. Most of the
Company's principal products and product improvements have resulted from
collaborative efforts with physicians, other health care professionals or other
affiliated entities. For certain proprietary ideas, the Company pays royalties
to such persons, and in many instances, incorporates such persons' names in the
tradename or trademark for the specific product. The Company also utilizes other
outside consultants, inventors and medical researchers to carry on its research
and development effort and sponsors research through medical associations and at
various universities and teaching hospitals.

Certain of the Company's strategic acquisitions and investments have
provided the basis for its introduction of significant new products. The Company
entered the field of cardiac care with the acquisition of Kontron Instruments
and supplemented this acquisition with its acquisition of the cardiac assist
divisions of Boston Scientific and C.R. Bard, Inc. The Company's acquisition of
Sometec, S.A. enabled it to introduce to the market its innovative, ultrasound
hemodynamic monitoring device.

Research and development expenses totaled $26.2 million (7.7% of net
sales), $25.2 million (7.5% of net sales) and $19.8 million (6.1% of net sales)
in fiscal 2002, 2001 and 2000, respectively. Such amounts were used to develop
new products, improve existing products and implement new technology to produce
these products.

(4)

ITEM 1. BUSINESS (CONTINUED)

RESEARCH AND PRODUCT DEVELOPMENT (CONTINUED)

In January 1994, the Company formed a cooperative relationship with
Pennsylvania State University's Hershey Medical School for the commercial
development of a fully implantable long-term LVAS. The Company's efforts are
aimed at developing a fully implantable device to provide long-term cardiac
assist for patients having insufficient left ventricular heart function. The
Arrow LionHeart(TM), the LVAS currently under development by the Company, is not
intended as a bridge-to-heart transplant, but is designed, upon receipt of
necessary regulatory approvals, to serve as a long-term cardiac assist device
for certain patients. The Arrow LionHeart(TM) has been in development by the
Company for over 9 years and has undergone extensive preclinical studies and
testing. The Company believes that its Arrow LionHeart(TM) LVAS, which is
capable of taking over the entire workload of the left ventricle, represents a
significant advance in mechanical circulatory assist technology. Because the
Arrow LionHeart(TM) is the first fully implantable "destination therapy" device,
the ability of the patient to experience an improved quality of life for an
extended period of time may be enhanced. The device has no lines or cables
protruding through the skin to power the system, thus eliminating a potential
source of infection. It is fully implanted in the body and does not replace the
heart, but assists in the pumping function of the heart's left ventricle. The
device is electrically driven by a wearable battery pack that transmits power
non-invasively through the skin to charge internal batteries and power the blood
pump. In addition, the Arrow LionHeart(TM) enables patients to experience
limited periods of untethered movement with energy supplied from rechargeable
batteries implanted as part of the device.

The first human implant of the LionHeart(TM) took place in Germany in
October 1999 as part of an ongoing European clinical investigation, sponsored by
the Company, to demonstrate the safety and performance of the LionHeart(TM) for
the purpose of obtaining a European Conformity (CE) mark.

In February 2001, the Company received U.S. Food and Drug Administration
(FDA) approval under an Investigational Device Exemption (IDE) to begin Phase I
human clinical trials in the United States of the LionHeart(TM). The Phase I
trial was initially limited to seven patients at up to five U.S. sites. In
February 2001, the Company announced the first U.S. human implant of the
LionHeart(TM) under the IDE. By August 2001, the Company had enrolled all seven
U.S. patients in the Phase I U.S. feasibility trial authorized in February under
the IDE.

In December 2001, the FDA approved the Company's request to expand this
Phase I clinical trial for an additional seven patients to be implanted with the
LionHeart(TM) in the U.S. The first of these seven additional implants was
performed in July 2002, bringing the total number of patients who have received
the LionHeart(TM) in the U.S. to eight. A total of five U.S. sites have been
approved to perform the remaining six implants under the Phase I trial and these
institutions are presently screening for appropriate patients. The Company
anticipates that a Phase II trial will follow the Phase I trial.

In June 2002, the Company announced that its European Notified Body, TUV
Product Service, had completed a preliminary review of the clinical data
supporting the Company's application for CE mark approval to sell the
LionHeart(TM) in Europe. TUV Product Service concluded that while the
LionHeart(TM) had accumulated 50% more patient months of operation than called
for in the trial protocol, the recent publishing of Randomized Evaluation of
Mechanical Assistance for the Treatment of Congestive Heart Failure (REMATCH)
trial data had established a new benchmark against which other mechanical
cardiac assist devices, such as the LionHeart(TM), should be measured. The
REMATCH data, published in November 2001 in The New England Journal of Medicine,
compared optimal medical management with Thoratec Corporation's mechanical
assist device in a randomized study of end-stage heart failure patients. TUV
Product Service's primary concern relates to the number of mechanically assisted
patients and the number of patients benefiting from mechanical assist for more
than one year under the Lionheart(TM) trial as compared to the REMATCH trial. To
address TUV Product Service's concerns, the Company extended the LionHeart(TM)
trial for an additional six months, to December 30, 2002, which is anticipated
to increase the number of LionHeart(TM) patients living more than one year with
the device.

(5)

ITEM 1. BUSINESS (CONTINUED)

RESEARCH AND PRODUCT DEVELOPMENT (CONTINUED)

Although TUV Product Service's decision to request additional trial data
has delayed the Company's ability to sell the LionHeart (TM) in Europe, the
Company continues to train additional European implant sites, complete
improvements to the device designed to downsize both internal and external power
sources, and broaden the exposure of the LionHeart(TM) to the medical community.
In fiscal 2002, the total number of implants of the device performed in Europe
was eleven, bringing the total number of European implants to 25 and the total
number of worldwide implants to 33. Six additional European sites have been
approved to implant the LionHeart(TM) during fiscal 2002, bringing the total
number of approved European sites to ten and the total number of worldwide
approved sites to 15.

Based on the current status of the Arrow LionHeart(TM) program, the Company
believes that sufficient additional clinical trial data will be assembled from
both new and existing patients to facilitate the approvals required to CE mark
the product for European sale in the first half of calendar year 2003.

In April 2001, the Company entered into an agreement with The Cleveland
Clinic Foundation ("CCF") for the exclusive license of CCF's patents in the
field of non-pulsatile centrifugal flow ventricular assist devices for the
treatment of congestive heart failure and a related agreement for continued
research and development on the CorAide(TM) ventricular assist device that had
been a joint development effort of CCF and the National Institute of Health.

The CorAide(TM) device utilizes a unique magnetically suspended flow
pumping mechanism that uses the moving blood as its lubricating system. Arrow
considers the CorAide(TM) device to be one of the most promising continuous flow
bridge-to-transplant devices currently in development and believes it may
represent a future generation permanent ventricular assist device if human organ
systems prove to be adaptable to non-pulsatile blood flow over a long period of
time. In in vivo trials to date, the CorAide(TM) device has shown excellent
performance without the use of anticoagulant drug therapy. Moreover, its smaller
size, low power requirements and lower cost relative to other ventricular assist
devices currently under development provide a promising approach for
bridge-to-transplant patients.

The initial goal of the new joint CCF/Arrow development program is to
commence human clinical trials of the device with patients needing ventricular
support prior to receiving a donor heart. These trials should provide better
understanding of human tolerance for non-pulsatile flow devices. The development
program presently anticipates beginning human clinical trials of the device in
Europe early in calendar year 2003.

The Company believes the CorAide(TM) development program is complimentary
to its ongoing program to develop and market the Arrow LionHeart(TM) LVAS. The
first version of this device is not fully implantable and is intended to provide
support for patients waiting for heart transplantation or considered candidates
for bridging to natural recovery of ventricular function. Successful development
of the CorAide(TM) device would provide a lower cost, less invasive approach to
ventricular assist than pulsatile devices.

Since 1988, the Company has been developing the Arrow(R)-Fischell Pullback
Atherectomy Catheter (the "PAC") for the removal of atherosclerotic plaque. The
Company acquired certain patents relating to the technology underlying the PAC
in 1990. In the fourth quarter of 1998, the Company began a European
multi-center randomized study to evaluate the effectiveness of the PAC for the
removal of plaque from restenosed coronary stents. In the fourth quarter of
fiscal 2002, the Company decided to discontinue its support for this development
project as a result of changes in the market outlook for this device (see Item
8. Notes to Consolidated Financial Statements - Note 2).

(6)

ITEM 1. BUSINESS (CONTINUED)

RESEARCH AND PRODUCT DEVELOPMENT (CONTINUED)

In recent years, the Company had conducted research to determine whether
the use of microwave energy catheters for the ablation of cardiac tissue
responsible for ventricular tachycardia represented a potentially more effective
treatment for ventricular tachycardia than currently marketed radio frequency
ablation catheters. Based on the results of this research, the Company elected
to discontinue this research program during fiscal 2000. The Company then
continued to evaluate the technological feasibility of liver ablation using this
technology. In the fourth quarter of fiscal 2002, the Company decided to
discontinue its efforts to further develop the microwave ablation technology for
treating liver disease (see Item 8. Notes to Consolidated Financial Statements -
Note 2).

During fiscal 2002, the Company continued separate U.S. and European
clinical trials of its Percutaneous Thrombolytic Device for the treatment of
deep vein thrombosis. The U.S. study is a feasibility study involving three
clinical sites and a total of ten patients. The primary objective of the studies
is to determine the initial safety and feasibility of the Percutaneous
Thrombactomy Device for the treatment of iliofemoral deep vein thrombosis. As of
November 1, 2002, there have been three patients enrolled in the U.S. study and
an additional seven patients have been enrolled in the European clinical trial.

In fiscal 2002, the Company began development of the Magnaflow(R), a new
technology for magnetically guiding and facilitating the placement of enteral
nutrition catheters in patients in intensive care units. The Magnaflow(R)
catheter's embedded metallic tip is placed into a patient's esophagus and, by
means of an external permanent magnet, the device is pulled through the stomach
and into the patient's bowel where administered nutrients can best be absorbed
into the body. The Company is targeting clinical evaluations of the Magnaflow(R)
during the first half of fiscal 2003.

There can be no assurance that the FDA or any foreign government regulatory
authority will grant the Company authorization to market products under
development or, if such authorization is obtained, that such products will prove
competitive when measured against other available products.

ENGINEERING AND MANUFACTURING

Arrow has developed the core technologies that the Company believes are
necessary for it to design, develop and manufacture complex, high quality
catheter-related medical devices. This technological capability has enabled the
Company to develop internally many of the major components of its products and
reduce its unit manufacturing costs. To help further reduce manufacturing costs
and improve efficiency, the Company has increasingly automated the production of
its high-volume products and plans to continue to make significant capital
expenditures to promote efficiency and reduce operating costs.

Raw materials and purchased components essential to Arrow's business have
typically been available within the lead times required by the Company and,
consequently, procurement has not historically posed any significant problems in
the operation of the Company's business. Although the Company currently
maintains only one supplier for certain of its out-sourced components, it has
identified alternative vendors for most of these items and, therefore, does not
believe that it is dependent on any single supplier for major raw materials or
components.

(7)

ITEM 1. BUSINESS (CONTINUED)

PATENTS, TRADEMARKS, PROPRIETARY RIGHTS AND LICENSES

Arrow believes that patents and other proprietary rights are important to
its business. The Company also relies upon trade secrets, know-how, continuing
technological innovations and licensing opportunities to develop and maintain
its competitive position. Arrow currently holds numerous U.S. patents and patent
applications, as well as several foreign patents and patent applications which
relate to aspects of the technology used in certain of the Company's products,
including its radial artery catheter, percutaneous sheath introducer,
interventional diagnostic catheter products, left ventricular assist device, and
esophageal ultrasound probe jacket. There can be no assurance that patent
applications filed by the Company will result in the issuance of patents or that
any patents owned by or licensed to the Company will provide competitive
advantages for the Company's products or will not be challenged or circumvented
by others.

In addition, Arrow is a party to several license agreements with unrelated
third parties pursuant to which it has obtained, for varying terms, the
exclusive rights to certain patents held by such third parties in consideration
for royalty payments. Many of the Company's major products, including its
Arrow-Howes(TM) Multi-Lumen Catheters and antiseptic surface treatment for
catheters, have been developed pursuant to such license agreements. The Company
has in the past granted rights in certain patents relating to its
Arrow-Howes(TM) Multi-Lumen Catheters to others in consideration for royalty
payments. The Company's U.S. patent for its Quick Flash(TM) Radial Artery
Catheter expired in November 2001 and various patents relating to the technology
underlying other of the Company's critical care and cardiac assist products
expired in fiscal 2002 or will expire in fiscal 2003. Although it is possible
that the Company will face new competition in the markets for the products to
which these patents relate, based on information currently available to it, the
Company does not presently believe that any such new competition will have a
material adverse effect on the Company's business, financial condition or
results of operations for the foreseeable future. All other existing patents
owned by or licensed to the Company relating to any of its major products expire
after fiscal 2003.

From time to time, the Company is subject to legal actions involving patent
and other intellectual property claims. The Company is currently a defendant in
two related lawsuits alleging that certain of its hemodialysis catheter products
infringe patents owned by or licensed to the plaintiffs. No trial dates have
been set in these actions. Based on information presently available to the
Company and the advice of its patent counsel, the Company believes that its
products do not infringe any valid claim of the plaintiffs' patents and that,
consequently, it has adequate legal defenses with respect to these actions.
Although the ultimate outcome of these actions is not expected to have a
material adverse effect on the Company's business or financial condition,
whether an adverse outcome in these actions would materially adversely affect
the Company's reported results of operations in any future period cannot be
predicted with certainty.

Arrow owns a number of registered trademarks in the United States and, in
addition, has obtained registration in many of its major foreign markets for the
trademark ARROW(R) and certain other trademarks.

(8)

ITEM 1. BUSINESS (CONTINUED)

GOVERNMENT REGULATION

As a developer, manufacturer and marketer of medical devices, the Company
is subject to extensive regulation by, among other governmental entities, the
FDA and the corresponding state, local and foreign regulatory agencies in
jurisdictions in which the Company sells its products. These regulations govern
the introduction of new medical devices, the observance of certain standards
with respect to the manufacture, testing and labeling of such devices, the
maintenance of certain records, the tracking of such devices and other matters.
Failure to comply with applicable federal, state, local or foreign laws or
regulations could subject the Company to enforcement action, including product
seizures, recalls, withdrawal of marketing clearances or approvals, and civil
and criminal penalties, any one or more of which could have a material adverse
effect on the Company. In recent years, the FDA has pursued a more rigorous
enforcement program to ensure that regulated businesses, like the Company's,
comply with applicable laws and regulations. The Company believes that it is in
substantial compliance with such governmental regulations. However, federal,
state, local and foreign laws and regulations regarding the manufacture and sale
of medical devices are subject to future changes. No assurance can be given that
such changes will not have a material adverse effect on the Company.

On occasion, the Company has received notifications, including warning
letters, from the FDA of alleged deficiencies in the Company's compliance with
FDA requirements. The Company believes that it has been able to address or
correct such deficiencies. In addition, from time to time the Company has
recalled, or issued safety alerts on, certain of its products. No such warning
letter, recall or safety alert has had a material adverse effect on the Company,
but there can be no assurance that a warning letter, recall or safety alert
would not have such an effect in the future.

In the early to mid 1990's, the review time by the FDA to clear medical
devices for commercial release lengthened and the number of marketing clearances
and approvals decreased. In response to public and congressional concern, the
FDA Modernization Act of 1997 was adopted with the intent of bringing better
definition to the clearance process for new medical products. While FDA review
times have improved since passage of the 1997 Act, there can be no assurance
that the FDA review process will not continue to delay the Company's
introduction of new products in the U.S. in the future. In addition, many
foreign countries have adopted more stringent regulatory requirements which also
have added to the delays and uncertainties associated with the release of new
products, as well as the clinical and regulatory costs of supporting such
releases. It is possible that delays in receipt of, or failure to receive, any
necessary clearance or approval for the Company's new product offerings could
have a material adverse effect on the Company's business, financial condition or
results of operations.

COMPETITION

Arrow faces substantial competition from a number of other companies in the
market for catheters and related medical devices and equipment, including
companies with greater financial and other resources. In addition, in response
to increased concern about the rising costs of health care, U.S. hospitals and
physicians are placing increasing emphasis on cost-effectiveness in the
selection of products to perform medical procedures. The Company believes that
its products are competing primarily on the basis of product differentiation,
product quality and cost-effectiveness, and that its comprehensive manufacturing
capability enables it to expedite the development and market introduction of new
products and to reduce manufacturing costs, thereby permitting the Company to
respond more effectively to competitive pricing in an environment where its
ability to increase prices is limited.

(9)

ITEM 1. BUSINESS (CONTINUED)

ENVIRONMENTAL COMPLIANCE

The Company is subject to various federal, state and local laws and
regulations relating to the protection of the environment. In the course of its
business, the Company is involved in the handling, storing and disposal of
materials, which are classified as hazardous. In 1989, the Company was notified
that it was among the potentially responsible parties under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, as amended, for
the costs of investigating or remediating contamination at a waste recycling,
treatment and disposal facility located in Maryland. In August 2001, the Company
was invited by the Environmental Protection Agency to enter into a proposed
global consent decree for DE MINIMIS parties with the United States District
Court for the District of Maryland, which, if approved, would resolve the
Company's potential liability with respect to the facility on a DE MINIMIS
basis. The Company has indicated its interest in entering into such a DE MINIMIS
settlement, but currently has no knowledge as to when the proposed consent
decree will be presented to the court or when it may be approved.

The Company believes that its operations comply in all material respects
with applicable environmental laws and regulations. While the Company continues
to make capital and operational expenditures for protection of the environment,
it does not anticipate that these expenditures will have a material adverse
effect on its business, financial condition or results of operations.

PRODUCT LIABILITY AND INSURANCE

The design, manufacture and marketing of medical devices of the types
produced by the Company entail an inherent risk of product liability. The
Company's products are often used in surgical and intensive care settings with
seriously ill patients. While the Company believes that, based on claims made
against the Company in the past, the amount of product liability insurance
maintained by the Company has been adequate, there can be no assurance that such
insurance will be available or in an amount sufficient to satisfy claims made
against the Company in the future or that the Company will be able to obtain
insurance in the future at satisfactory rates or in adequate amounts. Product
liability claims in the future, regardless of their ultimate outcome, could
result in costly litigation and could have a material adverse effect on the
Company's business, reputation, its ability to attract and retain customers for
its products and its results of operations.

A product liability lawsuit against the Company tried before a jury in
Arkansas state court resulted in a judgment against the Company in May 2001 of
$175,000 in compensatory damages and $4.0 million in punitive damages. Notice of
appeal from that judgment to the Arkansas Supreme Court was filed and the
Company is pursuing vigorously the appeal. Based on information presently
available to the Company and the advice of its product liability counsel, the
Company believes that it is more likely than not that the Company will obtain a
reversal of this judgment and a remand for a new trial. In addition, the Company
believes that any damage award, whether punitive or compensatory, that may
ultimately be upheld in this case will be covered by its product liability
insurance policy. The Company's insurer has commenced an action seeking a
judicial declaration that it is not obligated to indemnify the Company for
punitive damages. Based on information presently available to the Company and
the opinion of its insurance litigation counsel, the Company believes that any
award of punitive damages resulting from the product liability lawsuit would be
covered by its insurance. Although the ultimate outcome of these actions is not
expected to have a material adverse effect on the Company's business or
financial condition, whether an adverse outcome in these actions would
materially adversely affect the Company's reported results of operations in any
future period cannot be predicted with certainty.

EMPLOYEES

As of November 1, 2002, Arrow had 3,005 full-time employees. All of the
Company's hourly-paid manufacturing employees at the Company's Reading and
Wyomissing, Pennsylvania facilities are represented by the United Steelworkers
of America AFL-CIO, Local 8467 (the "Union"). The Company and the Union are
currently operating under a three-year agreement that expires in September 2003.
The Company has never experienced an organized work stoppage or strike and
considers its relations with its employees to be good.

(10)

ITEM 1. BUSINESS (CONTINUED)

EXECUTIVE OFFICERS

The executive officers of the Company and their ages and positions as of
November 1, 2002 are listed below. All executive officers are elected or
appointed annually and serve at the discretion of the Board of Directors. There
are no family relationships among the executive officers of the Company.

Mr. Miller has served as Chief Executive Officer and a Director of the
Company since it was founded in 1975, and as Chairman of the Board of the
Company since January 1999. He served as President from 1975 to January 1999.
Mr. Miller also served as President and a director of Arrow Precision Products,
Inc. ("Precision"), a corporation controlled by principal shareholders of the
Company, until Precision's dissolution on May 1, 2002. During fiscal 2002, Mr.
Miller devoted none of his time to Precision. On October 28, 2002, Mr. Miller
retired as a director of Carpenter Technology Corporation, a manufacturer of
specialty steel.

Mr. Anderson has served as Vice Chairman of the Board and General Manager
of the Company's Critical Care Division since January 2002, with responsibility
for worldwide sales, marketing, research and development of the Company's
critical care products. Mr. Anderson has served as a director of Arrow since
January 1998 and, prior to his employment by the Company, served as President
and Chief Executive Officer of ABC School Supply, Inc., a producer of materials
and equipment for public and private schools, from May 1997 to December 2001.
Mr. Anderson served as Principal with the New England Consulting Group, a
general management and marketing consulting company, from May 1996 to May 1997,
as Vice President, General Manager, Retail Consumer Products of James River
Corporation, a multinational company engaged in the development, manufacture and
marketing of paper-based consumer products ("James River"), from August 1994 to
March 1996, and as Vice President, Marketing, Consumer Brands of James River
from May 1992 to August 1994, and in various capacities with Nestle Foods
Corporation, the latest as Vice President, Division General Manager,
Confections, from 1984 to May 1992. Prior thereto, Mr. Anderson served in
several marketing capacities with Procter & Gamble.

Mr. Fleck has served as President of the Company since January 1999. From
June 1994 to January 1999, he served as Vice President - Research and
Manufacturing of the Company. From 1986 to June 1994, Mr. Fleck served as Vice
President - Research and Engineering of the Company. From 1975 to 1986, Mr.
Fleck served as Engineering Manager of the Company.

(11)

ITEM 1. BUSINESS (CONTINUED)

EXECUTIVE OFFICERS (CONTINUED)

Mr. Frankhouser has served as Executive Vice President - Global Business
Development of the Company since January 2002, with responsibility for worldwide
evaluation and acquisition of new business opportunities. From January 1999 to
January 2002, Mr. Frankhouser served as Executive Vice President of the Company,
with responsibility for worldwide sales and marketing. He served as Vice
President-Marketing of the Company from 1986 until January 1999. From 1980 to
1986, Mr. Frankhouser served as Manager of Marketing of the Company.

Mr. Hirt has served as Vice President - Finance, Chief Financial Officer
and Treasurer of the Company since August 1998. Prior to joining the Company,
from 1980 to 1998, Mr. Hirt served in various capacities with Pharmacia &
Upjohn, Inc., the latest as Vice President, Accounting and Reporting.

Mr. Holleran has served as Secretary and a director of the Company since
its founding in 1975 and, until September 1997, also served as a Vice President.
From July 1996, Mr. Holleran served as President and Chief Executive Officer of
Precision Medical Products, Inc. ("PMP"), a former subsidiary of Precision,
which manufactures and markets certain non-catheter medical products and was
sold on August 29, 1997 to certain employees of Precision, including Mr.
Holleran. He is now the Chairman of PMP. From February 1986 to September 1997,
Mr. Holleran was also Vice President, Chief Operating Officer and a director of
Precision. From 1991 to 1996, Mr. Holleran served as President of Endovations,
Inc., a subsidiary of Precision that manufactured and marketed certain
gastroenterological medical products, until the sale in June 1996 of a portion
of the Endovations business to the Company and the remainder to an unrelated
third party.

Mr. Botterbusch has served as Vice President and General Manager of the
Company's Cardiac Assist Division since March 2001. From January 1999 to March
2001, Mr. Botterbusch served as Vice President, Research and Engineering of the
Company. He served as Manager, Product Development, Research and Engineering
from 1993 to January 1999, as Group Leader, Research and Development from 1987
to 1993 and, from 1985, when he joined the Company, to 1987, as a Project
Engineer of the Company.

Mr. Nickel has served as Vice President-Regulatory Affairs and Quality
Assurance of the Company since 1991. From 1986 to 1991, Mr. Nickel served as
Director of Regulatory Affairs and Quality Assurance of the Company.

Mr. Hurley has served as Controller of the Company since April 1998. Prior
to joining the Company, from 1990 to 1998, he served in various capacities with
Rhone-Poulenc Rorer, the latest as a Director of Finance.

ITEM 2. PROPERTIES

The Company's corporate headquarters and principal research center are
located in a 165,000 square foot facility in Reading, Pennsylvania. This
facility, which also includes manufacturing space, is located on 126 acres.

Other major properties owned by the Company include a 165,000 square foot
manufacturing and warehousing facility in Asheboro, North Carolina; a 145,000
square foot manufacturing facility in Wyomissing, Pennsylvania; a 40,000 square
foot manufacturing facility in Chihuahua, Mexico; a 49,000 square foot
manufacturing and warehouse facility in Mount Holly, New Jersey; and an 88,000
square foot manufacturing and research facility in the Czech Republic.

In addition, the Company leases a 55,000 square foot manufacturing facility
in Everett, Massachusetts, a 7,700 square foot sales office and distribution
center in Woburn, Massachusetts, and a 22,500 square foot manufacturing facility
in Camargo, Mexico. The Company also leases sales offices and warehouse space in
Canada, France, Germany, Japan, South Africa, the Netherlands, Spain and Greece,
sales office space in Mexico and warehouse space in California.

The Company considers all of its facilities to be in good condition and
adequate to meet the present and reasonably foreseeable needs of the Company.
The Company believes that it will be able to renew all leases on commercially
reasonable terms as they become due, or, if it is unable to renew them, that
suitable replacement space would be available on commercially reasonable terms.

(12)

ITEM 3. LEGAL PROCEEDINGS

The Company is a party to certain legal actions, including product
liability matters, arising in the ordinary course of its business. The Company
is also subject to legal actions involving patent and other intellectual
property claims. Based upon information presently available to the Company, the
Company believes it has adequate legal defenses or insurance coverage for these
actions and, except as set forth under Item 1 - Business - Patents, Trademarks,
Regulatory Rights and Licenses and - Product Liability and Insurance, that the
ultimate outcome of these actions would not have a material adverse effect on
the Company's business, financial condition or results of operations.

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

No matter was submitted to a vote of security holders during the fourth
quarter of fiscal 2002 through the solicitations of proxies or otherwise.

PART II

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

The Company's common stock has traded publicly on The Nasdaq Stock Market
under the symbol "ARRO" since June 9, 1992, the date that its common stock was
initially offered to the public. The table below sets forth the high and low
sale prices of the Company's common stock as reported by the Nasdaq Stock Market
and the quarterly dividends per share declared by the Company during the last
eight fiscal quarters:

As of November 1, 2002, there were approximately 559 registered
shareholders of the Company's common stock.

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data for the years ended
August 31, 2002, 2001, 2000, 1999 and 1998 have been derived from the Company's
audited consolidated financial statements. The consolidated financial statements
of the Company as of August 31, 2002 and 2001 and for each of the three years in
the period ended August 31, 2002, together with the notes thereto and the
related report of PricewaterhouseCoopers LLP, independent accountants, are
included in Item 8 of this report. The following data should be read in
conjunction with the Company's audited consolidated financial statements, the
notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations, which are included in Items 7 and 8 of this report.

(13)

ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)

(14)

ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)

Certain prior period amounts in the table above have been reclassified to
conform to the fiscal 2002 presentation (see Item 8. Notes to Consolidated
Financial Statements - Note 1).

* See Item 8. Notes to Consolidated Financial Statements - Note 2 for a
description of the special charges recorded in fiscal 2002 and 2000. In the
second quarter of fiscal 1999, the Company recorded a non-cash pre-tax
special charge of $4,139 ($2,670 after tax or $0.12 per basic and diluted
common share) related to the purchase of in-process IAB pump research and
development as part of the Company's acquisition of the assets of the
cardiac assist division of C.R. Bard, Inc. In accordance with Financial
Accounting Standard (FAS) No. 2 "Accounting for Research and Development
Costs" and Financial Accounting Standard Board (FASB) Interpretation (FIN)
No. 4, "Applicability of FAS No. 2 to Business Combinations Accounted for
by the Purchase Method", these costs were charged to expense at the
consummation of the acquisition. In accordance with FAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," and
consistent with the Company's accounting policy for marketable equity
securities, in the fourth quarter of fiscal 1999, the Company determined
that the decline in the fair value of its investment in Cardiac Pathways
Corporation was other than temporary. Accordingly, the Company established
a new basis in the investment of $440, equivalent to its fair market value.
As a result, the Company realized a special charge of $8,680 before tax,
$5,598 after tax or $0.24 per basic and diluted common share. In the fourth
quarter of fiscal 1998, in accordance with FAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of", the Company recorded a non-cash pre-tax special charge of $36,249
($31,960 after tax or $1.38 per basic and diluted common share) to write
down to fair value certain goodwill and intangible assets.

(15)

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

THE FOLLOWING DISCUSSION INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS. SUCH
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF FACTORS, INCLUDING
MATERIAL RISKS, UNCERTAINTIES AND CONTINGENCIES, WHICH COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS. FOR A
DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, SEE EXHIBIT 99.1 TO THIS REPORT
AND THE COMPANY'S PERIODIC REPORTS AND OTHER DOCUMENTS FILED WITH THE
COMMISSION.

RESULTS OF OPERATIONS

The following table presents for the three years ended August 31, 2002
Consolidated Statements of Income expressed as a percentage of net sales and the
period-to-period percentage changes in the dollar amounts of the respective line
items.

* Not a meaningful comparison

(16)

FISCAL 2002 COMPARED TO FISCAL 2001

Net sales increased by $6.8 million, or 2.0%, to $340.8 million in fiscal 2002
from $334.0 million in fiscal 2001. Net sales represent gross sales invoiced to
customers, less certain related charges, including discounts, returns, rebates,
and other allowances. Revenue from sales is recognized at the time products are
shipped and title is passed to the customer. Sales of critical care products
increased 2.9% to $284.0 million from $276.1 million in fiscal 2001, due
primarily to increased sales of central venous and special catheters. Sales were
adversely impacted by a $1.8 million charge for increased rebate reserves
related to the Company's acquisition of the net assets of its former New York
City distributor, Stepic Medical, on September 3, 2002, as further described
above in Item 1. Business - Sales and Marketing. Sales of cardiac care products
decreased 1.9% to $56.8 million from $57.9 million in fiscal 2001, due primarily
to decreased sales of IAB pump and diagnostic products. International sales
increased by $3.5 million, and represented 34.5% of net sales in fiscal 2002,
compared to 34.1% in the prior year, despite the offsetting negative impact of
the strength of the U.S. dollar relative to currencies in countries where the
Company operates direct sales subsidiaries, which reduced sales by $2.1 million
for fiscal 2002 when compared to the prior fiscal year.

As discussed in Item 8. Notes to Consolidated Financial Statements - Note 19, on
April 1, 2002, the Company completed the sale of substantially all of the assets
of its implantable drug infusion pump business pursuant to an asset purchase
agreement dated as of March 1, 2002. As a result of this sale, the Company
reported no sales of implantable drug infusion pump products from April 1, 2002
through August 31, 2002, compared to $3.2 million of such sales in the same five
month period of fiscal 2001.

Gross profit decreased 2.5% to $171.1 million in fiscal 2002 from $175.5 million
in fiscal 2001. As a percentage of net sales, gross profit decreased to 50.2% in
fiscal 2002 compared to 52.5% in fiscal 2001. These decreases were primarily the
result of increased manufacturing variances caused by manufacturing of products
at a rate below the actual sales rate in order to bring inventories more in line
with requirements following manufacturing shifts to expanded international
plants, a less profitable product sales mix and pricing pressures. Gross profit
also decreased, as discussed above, due to a $1.8 million charge against sales
related to the Company's acquisition of its former New York City distributor to
reflect an increase in the reserve for dealer rebates as a result of obtaining
additional information regarding the distributor's rebates (see Item 8. Notes to
Consolidated Financial Statements - Notes 2 and 22). The Company anticipates
that its gross profit in the first two quarters of fiscal 2003 will continue to
be affected by manufacturing variances associated with past inventory reductions
as well as by sales of inventory purchased from Stepic Medical at reduced dealer
margins.

The Japanese Ministry of Health and Welfare adopted new reimbursement pricing
for central venous catheters effective as of April 1, 2002. The impact of this
reduced pricing on the Company's earnings for fiscal 2002 was not material and
the Company does not anticipate that it will have a material impact on its
future earnings.

In addition, effective as of March 1, 2002, the Company entered into an
agreement with a group purchasing organization resulting in reduced pricing to
the hospitals participating in this organization. The impact of the reduced
pricing under this arrangement on the Company's earnings in fiscal 2002 was not
material. The Company presently anticipates that the effect of these pricing
concessions on its future earnings will be more than offset by increased sales
volumes under this arrangement.

The increased emphasis on health care cost containment has resulted in reduced
growth in demand for certain of the Company's products in markets in the U.S.
where Arrow has 80% or greater market shares, and protecting that market share
has affected the Company's pricing in some instances. The Company also continues
to face pricing pressures in certain product lines in European markets as
governments strive to curtail increases in health care costs.

Research, development and engineering expenses in fiscal 2002 increased by 4.0%
to $26.2 million from $25.2 million in fiscal 2001. As a percentage of net
sales, these expenses increased to 7.7% in fiscal 2002, compared to 7.5% in
fiscal 2001. This increase was primarily a result of increased research and
development spending on the Arrow LionHeart(TM), the Company's Left Ventricular
Assist System, and CorAide(TM), the Company's joint research and development
program with The Cleveland Clinic Foundation ("CCF"), which was offset in part
by less research and development spending on the Company's implantable drug
infusion pump business due to its divestiture of this business on April 1, 2002
(see Item 8. Notes to Consolidated Financial Statements - Note 19). For further

(17)

FISCAL 2002 COMPARED TO FISCAL 2001 (CONTINUED)

information regarding the Company's research and product development projects,
see Item 1. Business - Research and Product Development.

Selling, general and administrative expenses were $78.4 million during fiscal
2002 compared to $78.5 million in the previous year, and were 23.0% of net sales
in fiscal 2002 compared to 23.5% in fiscal 2001. This decrease was due primarily
to several offsetting factors, including: decreased legal expenses relating to
patent litigation matters, although the Company continued to incur legal costs
in connection with a patent dispute relating to certain of its hemodialysis
catheter products (see Item 1. Business - Patents, Trademarks, Proprietary
Rights and Licenses); reduced goodwill amortization expense of $3.0 million
related to the Company's adoption in the first quarter of fiscal 2002 of SFAS
142 (see Item 8. Notes to Consolidated Financial Statements - Note 16); less
selling, general and administrative expenses related to the Company's
implantable drug infusion pump business, which was sold in April 2002 (see Item
8. Notes to Consoldated Financial Statements - Note 19); and increased expenses
related to the Company's defined benefit pension plans (see Item 8. Notes to
Consolidated Financial Statements - Note 12). In addition, during fiscal 2002,
the Company recorded a $2.1 million charge for additional product liability
insurance to maintain deductibles at existing levels for five years for claims
incurred but not reported occurring prior to September 1, 2002 and for
additional reserves for product liability claims and workers' compensation
exposures.

Net periodic pension cost is recorded in operating expenses in amounts
determined by the Company's actuaries and is based on management's estimates of
expected interest rates, expected rates of return on plan assets and expected
compensation increases. These estimates reflect management's best judgements in
the current circumstances. Actual results may differ from the estimates.
Interest rates assumptions are based on market rates at the beginning of the
Company's fiscal year. Expected rates of return on plan assets are based in part
on the Company's historical asset portfolio performance over the prior ten year
period and also the estimated rate of return on plan assets in the future. The
Company's rate of compensation increase assumption is based on its historical
compensation percentage increases as well as its expected rate increases in
future periods.

As discussed in Note 19 of Notes to Consolidated Financial Statements in Item 8
of this report, during fiscal 2002, the Company recorded an estimated loss of
$1.2 million ($0.8 million after tax, or $0.04 per basic and diluted common
share) on the sale of its implantable drug infusion pump business. As discussed
in Note 18 of Notes to Consolidated Financial Statements in Item 8 of this
report, the Company also recorded a gain of $1.7 million on the sale of
securities available for sale. The net impact of these transactions was not
material to the Company's results of operations for fiscal 2002.

The Company recorded special charges in the fourth quarter of fiscal 2002
amounting to a total of $8.0 million ($5.4 million after tax, or $0.25 and $0.24
per basic and diluted common share, respectively) relating to the matters
described below. Intangible assets in the aggregate amount of $4.7 million ($3.2
million after tax, or $0.15 and $0.14 per basic and diluted common share,
respectively) were written off relating to purchased technologies the Company
has decided not to support for (1) Pullback Atherectomy Catheterization (PAC)
($2.6 million, $1.8 million after tax, or $0.08 per basic and diluted common
share), (2) IAB pumping software ($1.5 million, $1.0 million after tax, or $0.05
and $0.04 per basic and diluted common share, respectively), and (3) microwave
ablation technology ($0.6 million, $0.4 million after tax, or $0.02 per basic
and diluted common share). As discussed above in Item 1. Business - Research and
Product Development, the Company's special charge relating to the PAC resulted
from its discontinuation of support for this development project due to changes
in the market outlook for this device. The special charge relating to the IAB
pumping software resulted from the Company's decision to evaluate a new pump
which will not utilize this software. As discussed above in Item 1. Business -
Research and Product Development, the special charge relating to microwave
ablation resulted from the Company's decision to discontinue its efforts to
further develop this technology for treating liver ablation. Also included in
the special charge is the write-off of an investment of $2.0 million ($1.3
million after tax, or $0.06 per basic and diluted common share) in a developer
and manufacturer of systems to measure certain cardiac functions due to the
developer's uncertain access to future financing and unfavorable financial
condition. Finally, as discussed above in Item 1. Business - Research and
Product Development, due to delay in CE mark approval for the Arrow
LionHeart(TM), the Company's fully implantable LVAS in Europe, the Company
incurred $1.3 million ($0.9 million after tax, or $0.04 per basic and diluted
common share) of manufacturing variances related to systems being produced for
market introduction.

(18)

FISCAL 2002 COMPARED TO FISCAL 2001 (CONTINUED)

Principally due to the above factors, operating income decreased 18.4% to $58.6
million in fiscal 2002 from $71.8 million in fiscal 2001.

Other expenses (income), net, decreased to $0.8 million of expense in fiscal
2002 from $2.3 million in fiscal 2001, principally due to lower interest expense
on the Company's revolving credit facility. Other expenses (income) net,
consists principally of interest expense and foreign exchange gains and losses
associated with the Company's direct sales subsidiaries. Aggregate foreign
exchange losses were $0.2 million and $0.4 million in fiscal 2002 and 2001,
respectively. Gains relating to foreign currency contracts were $0.1 million in
fiscal 2002 and $0.4 million in fiscal 2001.

As a result of the factors discussed above, income before income taxes decreased
in fiscal 2002 by 16.8% to $57.8 million from $69.5 million in fiscal 2001. The
Company's effective income tax rate decreased to 32.5% from 33.0% in fiscal
2001, principally as a result of the Company's adoption of SFAS 142 and the
elimination of nondeductible goodwill (see Item 8. Notes to Consolidated
Financial Statements - Note 16) in the first quarter of fiscal 2002 and
anticipated research and development tax credits currently under audit.

Net income in fiscal 2002 decreased 16.1% to $39.0 million from $46.5 million in
fiscal 2001. As a percentage of net sales, net income represented 11.4% in
fiscal 2002 compared to 13.9% in fiscal 2001. As a result of the Company's
adoption of SFAS 142 and the discontinuation of amortization of goodwill, net
income in fiscal 2002 increased by $2.1 million after tax from fiscal 2001
($0.10 and $0.09 per basic and diluted common share, respectively).

Basic earnings per common share were $1.78 in fiscal 2002, down 16.0%, or $0.34
per share, from $2.12 in fiscal 2001. Diluted earnings per common share were
$1.76 in fiscal 2002, down 16.2%, or $0.34 per share, from $2.10 in fiscal 2001.
Weighted average shares of common stock outstanding used in computing basic
earnings per common share decreased to 21,912,928 in fiscal 2002 from 21,995,394
in fiscal 2001. Weighted average shares of common stock outstanding used in
computing diluted earnings per common share decreased to 22,105,541 in fiscal
2002 from 22,120,367 in fiscal 2001. These decreases were primarily a result of
the Company's share repurchase program, which, as discussed below, remains in
effect, partially offset by the Company's issuance during fiscal 2002 of 10,000
shares from treasury to CCF as an additional royalty for CCF's completion of
certain research and development milestones under the Company's license
agreement with CCF (see Item 1. Business - Research and Development).

FISCAL 2001 COMPARED TO FISCAL 2000

Net sales increased by $8.3 million, or 2.6%, to $334.0 million in fiscal 2001
from $325.7 million in fiscal 2000. Sales of critical care products increased
2.8% to $276.1 million from $268.7 million in fiscal 2000, due primarily to
increased shipments of central venous and special catheters. Sales of cardiac
care products increased 1.6% to $57.9 million from $57.0 million in fiscal 2000,
due primarily to increased shipments of IAB pump products. International sales
decreased by $3.0 million, and represented 34.1% of net sales in fiscal 2001,
compared to 35.9% in the prior year, principally as a result of the increased
strength of the U.S. dollar, which reduced sales by $7.3 million for fiscal 2001
when compared to the prior fiscal year.

For the fiscal year ended August 31, 2001, the Company adopted the provisions of
Emerging Issues Task Force ("EITF") 00-10 which requires that freight expense be
classified in the Company's income statement as a cost of sales. Previously, the
Company had accounted for freight charges as primarily a reduction of net sales
and in some cases as marketing expense.

Gross profit increased 3.5% to $175.5 million in fiscal 2001 from $169.6 million
in fiscal 2000 due primarily to increased sales volume. As a percentage of net
sales, gross profit was 52.5% in fiscal 2001 compared to 52.1% in fiscal 2000,
due primarily to more efficient manufacturing during the periods in which the
inventory sold was produced and higher margins on special catheters.

(19)

FISCAL 2001 COMPARED TO FISCAL 2000 (CONTINUED)

Research, development and engineering expenses in fiscal 2001 increased by 27.5%
to $25.2 million from $19.8 million in fiscal 2000. As a percentage of net
sales, these expenses increased to 7.5% in fiscal 2001, compared to 6.1% in
fiscal 2000, due primarily to $5.6 million of incremental research and
development spending on the Arrow LionHeart(TM) LVAS and CorAide(TM), the
Company's joint research and development program with CCF. See Item 1. Business
- - Research and Product Development.

Selling, general and administrative expenses increased by 4.8% to $78.5 million
during fiscal 2001 from $74.9 million in the previous year, and were 23.5% of
net sales in fiscal 2001 compared to 23.0% in fiscal 2000. The increase was due
primarily to increased legal expenses relating to patent litigation matters.

In the first quarter of fiscal 2000, the Company recorded a non-cash pre-tax
special charge of $3.3 million ($2.2 million after-tax or $.10 per basic and
diluted common share) related primarily to a write-down for the in-process
research and development acquired in connection with the Company's acquisition
of Sometec, S.A. (see Notes 2 and 3 of Notes to Consolidated Financial
Statements in Item 8 of this report). The technology acquired is a compact
monitoring device that measures and monitors the descending aortic blood flow
during anesthesia and intensive care. The device provides real-time aortic blood
flow (a measurement of cardiac output) by using both pulsed Doppler for
measuring blood velocity and M-mode ultrasound to accurately measure the aortic
diameter. The monitoring system consists of four main components: the main
console (monitor), a transesophageal probe, a disposable jacket and an
articulated probe holder. The monitor provides the physician with a continuous
display of a patient's hemodynamic profile, including aortic blood flow, heart
rate, stroke volume, peak velocity, acceleration, left ventricular ejection time
and systemic vascular resistance. To facilitate use of this device, a disposable
jacket, containing an acoustic gel, is placed over the probe utilizing a special
vacuum mounting tool supplied with the jacket. The Company believes that the
speed and ease of use of this new noninvasive measurement technique has the
potential of establishing cardiac output as a frequently used physician tool
with value similar to blood pressure, EKG and pulse oximetry measurements. In
accordance with SFAS No. 2, "Accounting for Research and Development Costs" and
FIN No. 4, "Applicability of SFAS No. 2 to Business Combinations Accounted for
by the Purchase Method", these costs related to the special charge were charged
to expense at the date of consummation of the acquisition. The value assigned to
purchase Sometec in-process technology was based on a valuation prepared by an
independent third-party appraisal company. Each of the technologies under
development at the date of acquisition was reviewed for technological
feasibility, stage of completeness at the acquisition date, and scheduled
release dates of products employing the technology to determine whether the
technology was complete or under development. At the acquisition date, the
research and development project was estimated to be 75% complete. Incomplete
development efforts at the time of acquisition included improved portability,
software development and development of the disposable sheath. The valuation was
based on the estimated cash flows resulting from commercially viable products
discounted to present value using a risk-adjusted after-tax discount rate of
22%. The research and development costs from these projects have commenced. Some
cash inflows from these projects have commenced. However, while the Company
believes these projects will be completed as planned, the Company cannot assure
that they will be completed on schedule or, once completed, that the new
products resulting from these projects will be successfully introduced into the
marketplace. The Company does not anticipate material adverse changes from
historical pricing, margins and expense levels as a result of the introduction
of the new technologies related to the projects.

Principally due to the above factors, operating income increased 0.2% to $71.8
million in fiscal 2001 from $71.6 million in fiscal 2000.

Other expenses (income), net, increased to $2.3 million of expense in fiscal
2001 from $2.1 million of expense in fiscal 2000. Other expenses (income), net,
consists principally of interest expense and foreign exchange gains and losses
associated with the Company's direct sales subsidiaries. Aggregate foreign
exchange losses in fiscal 2001 were $0.4 million and in fiscal 2000 aggregate
foreign exchange gains were $0.1 million, including gains relating to foreign
currency contracts of $0.4 million in fiscal 2001 and losses of less than $0.1
million in fiscal 2000.

(20)

FISCAL 2001 COMPARED TO FISCAL 2000 (CONTINUED)

As a result of the factors discussed above, income before income taxes was $69.5
million for both fiscal 2001 and 2000. In fiscal 2001, the Company reduced its
annual effective tax rate to 33.0% from 33.5% in fiscal 2000 due to anticipated
research and development tax credits.

Net income in fiscal 2001 increased by 0.8% to $46.5 million from $46.2 million
in fiscal 2000. As a percentage of net sales, net income represented 13.9% in
fiscal 2001 compared to 14.2% in the previous year.

Basic earnings per common share were $2.12 and diluted earnings per common share
were $2.10 in fiscal 2001. Basic earnings per common share increased 2.9% in
fiscal 2001, or $.06 per share, from $2.06 per common share in fiscal 2000.
Diluted earnings per common share increased 2.4% in fiscal 2001, or $.05 per
share, from $2.05 per share in the prior year primarily as a result of the above
factors. Weighted average shares of common stock outstanding used in computing
basic earnings per common share decreased to 21,995,394 in fiscal 2001 from
22,450,581 in the prior year. Weighted average shares of common stock
outstanding used in computing diluted earnings per common share decreased to
22,120,367 in fiscal 2001 from 22,518,928 in the prior year. These decreases are
a result of the Company's share repurchase program, which remains in effect,
partially offset by the Company's issuance during fiscal 2001 of 25,000 shares
from treasury to CCF for the rights granted to the Company by CCF under the
Company's license agreement with CCF (see Item 1. Business - Research and
Product Development).

LIQUIDITY AND CAPITAL RESOURCES

Arrow's primary source of funds continues to be cash generated from operations,
as shown in the Company's Consolidated Statement of Cash Flows included in Item
8 of this report. For fiscal 2002, net cash provided by operations was $77.8
million, an increase of $36.0 million, or 86.1% from the prior year, due
primarily to increased collections of accounts receivable, decreased inventory
levels and less cash used for prepaid expenses. Accounts receivable, measured in
days sales outstanding during the period, decreased to 80 days at August 31,
2002 from 86 days at August 31, 2001, due to improved collection efforts of the
Company.

The parent company of one of the Company's major U.S. distributors had been
experiencing declining net sales and significant net losses. This parent company
recently completed a major recapitalization and, in May 2002, it reported first
quarter earnings and a substantial reduction in debt related to its
recapitalization. The Company had accounts receivable due from this distributor
in the amount of $5.5 million as of August 31, 2002. As discussed above in Item
1. Business - Sales and Marketing, on September 3, 2002, the Company purchased
the net assets of this distributor in consideration for $12.7 million in cash
and forgiveness of the entire accounts receivable balance due from this
distributor, subject to post-closing adjustments (see also Item 8. Notes to
Consolidated Financial Statements - Note 22).

Inventories decreased $8.5 million in fiscal 2002 compared to an $11.6 million
increase in fiscal 2001 due to an inventory reduction program adopted by the
Company in fiscal 2002 as well as to the sale of inventory of $5.7 million
included as part of the Company's sale of substantially all of the assets of its
implantable drug infusion pump business on April 1, 2002 (see Item 8. Notes to
Consolidated Financial Statements - Note 19). Prepaid expenses increased $0.6
million in fiscal 2002 due primarily to an increase in prepaid pension costs
offset by a decrease in prepaid taxes.

Net cash used in the Company's investing activities decreased to $5.5 million in
fiscal 2002 from $27.4 million in fiscal 2001, due primarily to the Company's
receipt of proceeds from its sale of securities available for sale and from its
sale of its implantable drug infusion pump business in fiscal 2002 (see Item 8.
Notes to Consolidated Financial Statements - Notes 18 and 19).

In fiscal 2001, the Company's Board of Directors approved spending of up to
$10.0 million for the construction of additional manufacturing capacity,
including related equipment, at its existing manufacturing and research facility
in the Czech Republic. Construction of the additional space at this facility was
completed in December 2001. As of August 31, 2002, the Company had spent $8.8
million on this construction, including $5.3 million in fiscal 2002, and
anticipates spending up to the authorized amount to bring such additional
manufacturing capacity on-line, which entails the purchase of related equipment.

(21)

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

Financing activities used $42.6 million of net cash in fiscal 2002, compared to
$15.3 million in fiscal 2001, primarily as a result of an increase in fiscal
2002 in the Company's repayment of borrowings under its U.S. revolving credit
facility and an increase in the Company's use of cash to purchase shares of its
common stock in the open market in connection with its share repurchase program,
partially offset by a decrease in the repayment of the Company's current portion
of its long-term debt. The Company's Board of Directors has authorized the
repurchase of up to a maximum of 2,000,000 shares under the share repurchase
program. During fiscal 2002, the Company purchased 158,500 shares of its common
stock under this program for $5.8 million. As of August 31, 2002, the Company
had repurchased a total of 1,418,800 shares under this program for approximately
$43.7 million since the program's inception in March 1999.

To provide additional liquidity and flexibility in funding its operations, the
Company from time to time also borrows amounts under credit facilities and other
external sources of financing. The Company has a revolving credit facility
providing a total of $65.0 million in available revolving credit for general
business purposes, of which $6.2 and $40.6 million were outstanding at August
31, 2002 and 2001, respectively. Under this credit facility, the Company is
required to comply with the following financial covenants: maintain a ratio of
total liabilities to tangible net worth (total assets less total liabilities and
intangible assets) of no more than 1.5 to 1 and a cash flow coverage ratio of
1.25 to 1 or greater; a limitation on certain mergers, consolidations and sales
of assets by the Company or its subsidiaries; a limitation on its and its
subsidiaries' incurrence of liens; and a requirement that the lender approve the
incurrence of additional indebtedness unrelated to the revolving credit facility
when the aggregate principal amount of such new additional indebtedness exceeds
$50.0 million. At August 31, 2002 and 2001, the Company was in compliance with
all such covenants. Failure to remain in compliance with these covenants could
trigger an acceleration of the Company's obligation to repay all outstanding
borrowings under this credit facility. In addition, certain subsidiaries of the
Company had revolving credit facilities totaling the U.S. dollar equivalent of
$20.7 and $20.3 million, of which $9.9 and $9.8 million were outstanding as of
August 31, 2002 and 2001, respectively. Interest rate terms for both U.S. and
foreign bank credit facilities are based on either bids provided by the lender
or the prime rate, London Interbank Offered Rates (LIBOR) or Certificate of
Deposit Rates, plus applicable margins. Certain of these borrowings, primarily
those with U.S. banks, are due on demand. Interest is payable monthly during the
revolving credit period. At August 31, 2002, the weighted average interest rate
on short-term borrowings was 2.2% per annum. Combined borrowings under these
facilities decreased $34.3 million during fiscal year 2002.

A summary of all of the Company's contractual obligations and commercial
commitments as of August 31, 2002 were as follows:

*Includes short-term indebtedness of the Company and its subsidiaries under
various revolving credit facilities, as discussed above in this Item 7.

(22)

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

During fiscal 2002, 2001 and 2000, the percentage of the Company's sales
invoiced in currencies other than the U.S. dollar was 21.6%, 21.9% and 23.9%,
respectively. In addition, a small part of the Company's cost of goods sold is
denominated in foreign currencies. The Company enters into foreign currency
exchange and foreign currency option contracts, which are derivative financial
instruments, with major financial institutions to reduce the effect of these
foreign currency risks, primarily on U.S. dollar cash inflows resulting from the
collection of intercompany receivables denominated in foreign currencies and to
hedge anticipated sales in foreign currencies to foreign subsidiaries. Such
transactions occur throughout the year and are probable, but not firmly
committed. Forward contracts are marked to market each accounting period, and
the resulting gains or losses on these contracts are recorded in Other Income /
Expense of the Company's consolidated statements of income. Realized gains and
losses on these contracts are offset by changes in the U.S. dollar value of the
foreign denominated assets, liabilities and transactions being hedged. The
premiums paid on the foreign currency option contracts are recorded as assets
and amortized over the life of the option. Other than the risk associated with
the financial condition of the counterparties, the Company's maximum exposure
related to foreign currency options is limited to the premiums paid. The total
premiums authorized to be paid in any fiscal year cannot exceed $1.0 million per
the terms of the Foreign Currency Management Policy Statement approved by the
Company's Board of Directors in fiscal 2001. Gains and losses on purchased
option contracts result from changes in intrinsic or time value. Both time value
and intrinsic value gains and losses are recorded in shareholders' equity (as a
component of comprehensive income) until the period in which the underlying sale
by the foreign subsidiary to an unrelated third party is recognized, at which
point those deferred gains and losses are recognized in net sales. By their
nature, all such contracts involve risk, including the risk of nonperformance by
counterparties. Accordingly, losses relating to these contracts could have a
material adverse effect upon the Company's business, financial condition and
results of operations. Based upon the Company's knowledge of the financial
condition of the counterparties to its existing forward contracts, the Company
believes that it does not have any material exposure to any individual
counterparty. The Company's policy prohibits the use of derivative instruments
for speculative purposes. As of November 1, 2002, outstanding foreign currency
exchange contracts totaling the U.S. dollar equivalent of $10.5 million mature
at various dates through November 2002 and foreign currency option contracts
with a fair market value of less than $0.1 million mature at various dates
through February 2003. The Company expects to continue to utilize foreign
currency exchange and foreign currency option contracts to manage its exposure,
although there can be no assurance that the Company's efforts in this regard
will be successful.

The Company's exposure to credit risk consists principally of trade receivables.
Hospitals and international dealers account for a substantial portion of trade
receivables and collateral is generally not required. The Company believes that
its risk associated with this concentration is limited due to the Company's
on-going credit review procedures.

As part of the Company's 1998 purchase of assets of the cardiac assist division
of C.R. Bard, Inc., the Company also agreed to acquire specified assets and
assume specified liabilities of the Belmont Instruments Corporation for $7.3
million based on the achievement of certain milestones. The Company paid $2.3
million in fiscal 2000 and $3.5 million in fiscal 2001 for achievement of
milestones during those periods. During fiscal 2002, the Company paid $1.0
million to Belmont for achievement of additional milestones. Included in the
fiscal 2002 payments were the third, fourth, fifth and sixth of eight quarterly
installments of $250,000 payable by the Company (which payments commenced in
April 2001), leaving $0.5 million remaining to be paid as of August 31, 2002.
The acquisition was accounted for using the purchase method of accounting. The
excess of the purchase price over the estimated fair value of the net assets
acquired was approximately $7.1 million. The results of operations of this
business are included in the Company's consolidated financial statements from
the date of acquisition.

Based upon its present plans, the Company believes that cash generated from its
operations and available credit resources will be adequate to repay current
portions of long-term debt, to finance currently planned capital expenditures
and repurchases of the Company's stock in the open market, and to meet the
currently foreseeable liquidity needs of the Company.

During the periods discussed above, the overall effects of inflation and
seasonality on the Company's business were not significant.

(23)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company has disclosed in Note 1 to its consolidated financial statements
included in Item 8 of this report those accounting policies that it considers to
be significant in determining its results of operations and financial position.
In all material respects, the accounting principles utilized by the Company in
preparing its consolidated financial statements are in conformity with generally
accepted accounting principles in the United States of America.

The preparation of these consolidated financial statements requires the
Company's management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, as well as the disclosure
of contingent assets and liabilities at the date of its financial statements.
The Company bases its estimates on historical experience, actuarial valuations
and various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying value of assets and liabilities that are not readily apparent from
other sources. Some of those judgments can be subjective and complex and,
consequently, actual results may differ from these estimates under different
assumptions or conditions. While for any given estimate or assumption made by
the Company's management there may be other estimates or assumptions that are
reasonable, the Company believes that, given the current facts and
circumstances, it is unlikely that applying any such other reasonable estimate
or assumption would materially impact the financial statements.

The Company's management believes the following critical accounting policies
affect its more significant estimates and judgments used in the preparation of
the Company's consolidated financial statements.

Revenue Recognition:

Revenue is recognized by the Company at the time its products are shipped and
title has passed to its customer. The Company's net sales represent gross sales
invoiced to customers, less certain related charges, including discounts,
returns, rebates and other allowances. Such charges are recognized against
revenue on an accrual basis, at the point in which these costs are incurred.
Product returns are permitted. The accrual for product returns is based on the
Company's history of actual product returns. To date, product returns have not
been material. The Company grants sales rebates to certain distributors upon
achievement of agreed upon pricing for sales of the Company's products to
hospitals. Incurred but unpaid rebates are accrued by the Company in the period
in which they are incurred. The Company's rebate accrual is based on its history
of actual rebates paid. The Company's reserves for rebates are reviewed at each
reporting period and adjusted to reflect data available at that time. To the
extent these estimates prove inaccurate, the Company will adjust the reserves,
which will impact the amount of net product sales revenue recognized by the
Company in the period of the adjustments.

Inventory:

The Company values its inventories at the lower of cost or market. Cost is
determined by the "first-in, first-out" (FIFO) method. Inventory reserves are
recorded to writedown the value of inventory to its fair market value. The
Company uses a materials management program for identifying, redeploying and/or
destroying slow-moving, inactive or potentially obsolete inventory. A reserve is
recorded for all inventory specifically identified as slow-moving, inactive or
potentially obsolete. For certain new products, the Company manufactures
inventory in anticipation of product launch. As of August 31, 2002, the Company
had recorded $7.3 million of inventory related to its HemoSonic(TM) 100
hemodynamic monitoring device, which is significantly greater than the net sales
of this product in fiscal 2002. The Company is currently developing changes to
this product which it believes will enhance the demand for the product in the
marketplace. Accordingly, the Company has not recorded additional reserves
related to this product. The Company's inventory reserves are evaluated on an
ongoing basis and are adjusted as necessary to accurately reflect current
conditions.

(24)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

Impairment of Goodwill:

Goodwill represents the excess of the cost over the fair value of net assets
acquired in business combinations. Currently, the Company operates as a single
reporting unit. Goodwill and other "indefinite-lived" assets are not amortized
and are subject to the impairment rules of Statement of Financial Accounting
Standards No. 142 (SFAS 142), which the Company adopted effective as of
September 1, 2001. Goodwill is tested for impairment on an annual basis or upon
the occurrence of certain circumstances or events. The Company determines the
fair market value of its reporting unit using quoted market rates and cash flow
techniques. The fair market value of the reporting unit is compared to the
carrying value of the reporting unit to determine if an impairment loss should
be calculated. If the book value of the reporting unit exceeds the fair value of
the reporting unit, an impairment loss is indicated. The loss is calculated by
comparing the fair value of the goodwill to the book value of the goodwill. If
the book value of the goodwill exceeds the fair value of goodwill, an impairment
loss is recorded. Fair value of goodwill is determined by subtracting the fair
value of the identifiable assets of a reporting unit from the fair value of the
reporting unit.

Research and Development:

Research and development costs are expensed as incurred. Research and
development costs consist of direct and indirect internal costs related to
specific projects as well as fees paid to other entities which conduct certain
research activities on behalf of the Company. The costs of materials (whether
from the Company's normal inventory or acquired specially for research and
development activities) and equipment or facilities that are acquired or
constructed for research and development activities and that have alternative
future uses (in research and development projects or otherwise) are capitalized
as tangible assets when acquired or constructed. The cost of such materials
consumed in research and development activities and the depreciation of such
equipment or facilities used in those activities are recorded as research and
development costs. As of August 31, 2002, the Company had $8.5 million of
capitalized costs related to the Arrow Lionheart(TM), the Company's LVAS.

Product Liability:

Costs for attorney's fees and indemnification associated with injuries resulting
from the use of the Company's products are provided for in setting reserves. The
Company provides reserves for product liability by utilizing loss estimates
prepared by the primary product liability insurance carrier with adjustments, as
appropriate, based upon management's perspective on the ultimate projected claim
giving consideration to the perspective of outside counsel and other relevant
factors. The Company records a reserve regarding a particular claim when a loss
is known or considered probable and the amount can be reasonably estimated. If a
loss is not probable or a probable loss cannot be reasonably estimated, a
reserve is not recorded. The Company's primary global product liability
insurance policy is on a claims made basis with deductibles of $0.3 million and
$0.1 million for domestic and foreign product liability claims, respectively.
The policy year runs from September 1 to August 31 and has a $10.0 million
aggregate limit. The Company also has additional layers of coverage insuring up
to $35.0 million in annual aggregate losses arising from claims that exceed the
primary product liability insurance policy limits. Because deductibles were due
to increase when the Company renewed its product liability insurance policy in
September 2002, the Company elected to exercise a provision in its current
policy that maintains deductibles and limits for unreported claims occurring
prior to September 1, 2002 at existing levels for five years.

(25)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

Employee Benefit Plans:

The Company sponsors pension, post-retirement, medical and life insurance plans
covering substantially all of its employees who meet the applicable eligibility
requirements. The Company uses several actuarial and other statistical factors
which attempt to anticipate future events in calculating its expense and
liability related to these plans. These factors include assumptions about
discount rate, expected return on plan assets and rate of future compensation
increases, as determined by the Company within specified guidelines. In
addition, the Company's actuarial consultants also utilize subjective
assumptions, such as withdrawal and mortality rates, to estimate these factors.
The actuarial assumptions used by the Company may differ materially from actual
results due to changing market and economic conditions, higher or lower
withdrawal rates or longer or shorter life spans of participants. These
differences, depending on their magnitude, could have a significant impact on
the amount of pension expense recorded by the Company in any particular period.

Income Taxes:

The Company's effective tax rate differs from the statutory rate primarily as a
result of research and development tax credits, the foreign sales corporation
deduction and the extraterritorial income tax regime. Because the Company
operates in a number of domestic and foreign tax jurisdictions, the statutory
rates within these various jurisdictions are considered in determining the
Company's overall effective tax rate. Management judgment is required to
determine the Company's consolidated provision for income tax expense, deferred
income tax balances and any valuation allowances associated with deferred tax
assets. The Company's management also considers open statutory periods, current
and anticipated audits, and the impact that any adverse adjustments would have
on the Company's current and prospective overall effective tax rate.

Deferred tax assets and liabilities are recorded when material differences exist
between the financial statement carrying amounts and the tax bases of assets or
liabilities. The Company regularly reviews its deferred tax assets for
recoverability and to date has not established valuation allowances. The Company
deems all undistributed earnings of foreign subsidiaries permanently invested
and, accordingly, has not established a tax provision for any repatriation of
retained earnings in these entities. Undistributed earnings of the Company's
foreign subsidiaries amounted to $20.2 million and $17.2 million at August 31,
2002 and 2001, respectively.

NEW ACCOUNTING STANDARDS

Financial Accounting Standard No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. The provisions of this
statement are effective for financial statements issued for fiscal years
beginning after December 15, 2001. The Company will adopt the provisions of this
statement as of September 1, 2002.

Financial Accounting Standard No. 145, "Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections", was
issued in April 2002. A principal provision of this statement is the reporting
of gains and losses associated with extinguishments of debt. The Company is
studying the provisions of this statement and has not determined the impact, if
any, that this statement may have on its financial statements.

Financial Accounting Standard No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities", was issued in June 2002. This statement requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. The statement is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company is studying the
provisions of this statement and has not determined the impact, if any, that
this statement may have on its financial statements.

(26)

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK

Due to the global nature of its operations, the Company is subject to the
exposures that arise from foreign exchange rate fluctuations. Such exposures
arise from transactions denominated in foreign currencies, primarily from
translation of results of operations from outside the United States,
intercompany loans, and intercompany purchases of inventory. The Company is also
exposed to interest rate changes.

The Company's objective in managing its exposure to foreign currency
fluctuations is to minimize earnings and cash flow volatility associated with
foreign exchange rate changes. The Company enters into various contracts that
change in value as foreign exchange rates change to protect the value of its
existing foreign currency assets, liabilities, commitments, and anticipated
foreign currency revenues to meet these objectives. The contracts involve
Japanese yen and other foreign currencies. The gains and losses on these
contracts are offset by changes in the value of the related exposures in the
Company's income statement. It is the Company's policy to enter into foreign
currency transactions only to the extent exposures exist. The Company does not
enter into foreign currency transactions for speculative purposes.

The fair value of all the Company's foreign currency forward exchange
contracts outstanding at August 31, 2002 was less than $0.1 million. The
following analysis estimates the sensitivity of the fair value of all foreign
currency forward exchange contracts to hypothetical 10% favorable and
unfavorable changes in spot exchange rates at August 31, 2002 and 2001:

Fair Value of Foreign Currency
Forward Exchange Contracts
--------------------------
(in millions)
August 31, 2002 August 31, 2001
--------------- ---------------
10% adverse rate movement $ (0.2) $ (0.9)
At August 31st rates - -
10% favorable rate movement 0.3 0.6

In addition, the fair value of all the Company's foreign currency option
contracts outstanding at August 31, 2002 was less than $0.1 million. The
following analysis estimates the sensitivity of the fair value of all foreign
currency option contracts to hypothetical 10% favorable and unfavorable changes
in spot exchange rates at August 31, 2002 and 2001:

Fair Value of Foreign Currency
Option Contracts
----------------
(in millions)
August 31, 2002 August 31, 2001
--------------- ---------------
10% adverse rate movement $ - $ -
At August 31st rates - -
10% favorable rate movement 0.1 0.5

Any gains and losses on the fair value of forward and option contracts
would be largely offset by losses and gains on the underlying transactions or
anticipated transactions. These offsetting gains and losses are not reflected in
the above analysis.

Additional Quantitative and Qualitative disclosures about market risk
(e.g., interest rate and foreign currency exchange risk) are set forth in Note
14 of the Notes to Consolidated Financial Statements included in Item 8 of this
report.

(27)

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
----

Report of Independent Accountants 29

Consolidated Balance Sheets at
August 31, 2002 and 2001 30, 31

Consolidated Statements of Income
for the years ended August 31, 2002,
2001 and 2000 32

Consolidated Statements of Comprehensive
Income for the years ended August 31, 2002,
2001 and 2000 33

Consolidated Statements of Cash Flows
for the years ended August 31, 2002,
2001 and 2000 34, 35

Consolidated Statements of Changes in
Shareholders' Equity for the years ended
August 31, 2002, 2001, and 2000 36 - 38

Notes to Consolidated Financial Statements 39 - 66

Schedule II - Valuation and Qualifying Accounts 67

(28)

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Shareholders of Arrow International, Inc.:

In our opinion, the consolidated financial statements listed in the index
appearing under Item 8 on page 28 present fairly, in all material respects, the
financial position of Arrow International, Inc. and its subsidiaries (the
"Company") at August 31, 2002 and 2001, and the results of their operations and
their cash flows for each of the three years in the period ended August 31, 2002
in conformity with accounting principles generally accepted in the United States
of America. In addition, in our opinion, the financial statement schedule listed
in the index appearing under Item 8 on page 28 presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Philadelphia, Pennsylvania
October 2, 2002

(29)