Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .

Overview

The company is a global provider of products, services, and solutions to industrial and commercial users of electronic components and enterprise computing solutions.  The company provides one of the broadest product offerings in the electronic components and enterprise computing solutions distribution industries and a wide range of value-added services to help customers reduce time to market, introduce innovative products through demand creation opportunities, lower their total cost of ownership, and enhance their overall competitiveness. The company has two business segments, the global components business segment and the global ECS business segment.  The company distributes electronic components to OEMs and CMs through its global components business segment and provides enterprise computing solutions to VARs through its global ECS business segment.   For 2011 , approximately 69% of the company's sales were from the global components business segment, and approximately 31% of the company's sales were from the global ECS business segment.

The company's financial objectives are to grow sales faster than the market, increase the markets served, grow profits faster than sales, and increase return on invested capital. To achieve its objectives, the company seeks to capture significant opportunities to grow across products, markets, and geographies. To supplement its organic growth strategy, the company continually evaluates strategic acquisitions to broaden its product offerings, increase its market penetration, and/or expand its geographic reach. Cash flow needed to fund this growth is primarily expected to be generated through continuous corporate-wide initiatives to improve profitability and increase effective asset utilization.

On March 1, 2011, the company acquired all of the assets and operations of Richardson RFPD for a purchase price of $236.0 million . On January 3, 2011, the company acquired Nu Horizons for a purchase price of $161.1 million , which included cash acquired of $18.1 million and $26.4 million of debt paid at closing. On December 16, 2010, the company acquired all of the assets and operations of Intechra for a purchase price of $101.1 million , which included $.1 million of cash acquired. On September 8, 2010, the company acquired Shared for a purchase price of $252.8 million , which included $61.9 million of debt paid at closing. On June 1, 2010, the company acquired Converge for a purchase price of $138.4 million , which included cash acquired of $4.8 million and $27.5 million of debt paid at closing. On December 20, 2009, the company acquired Petsche for a purchase price of $174.1 million , which included $4.0 million of cash acquired.

During 2011 and 2010, the company also acquired Pansystem, Cross, InScope, LWP, C1S, Flection, Verical, Sphinx, Transim, ETG, and Diasa. The impacts of these acquisitions were not individually significant to the company's consolidated financial position and results of operations.

Results of operations of Richardson RFPD, Nu Horizons, Pansystem, C1S, Flection, Intechra, Converge, Verical, Transim, ETG, and Petsche are included within the company's global components business segment, and the results of operations of Shared, Cross, InScope, LWP, Sphinx, and Diasa are included within the company's global ECS business segment.

Consolidated sales for 2011 increased by 14.1% , compared with the year-earlier period, due to a 12.8% increase in the global components business segment sales and a 17.2% increase in the global ECS business segment sales.   The translation of the company's international financial statements into U.S. dollars resulted in an increase in consolidated sales of $486.1 million for 2011 , compared with the year-earlier period, due to a weaker U.S. dollar. Excluding the impact of foreign currency and pro forma for acquisitions, the company's consolidated sales increased by 2.0% in 2011 .

Net income attributable to shareholders increased to $598.8 million in 2011 , compared with net income attributable to shareholders of $479.6 million in the year-earlier period.  The following items impacted the comparability of the company's results for the years ended December 31, 2011 and 2010 :

Excluding the above-mentioned items, the increase in net income attributable to shareholders for 2011 was primarily the result of the sales increases in both the global components business segment and the global ECS business segment and increased gross profit margins. This was offset, in part, by increased selling, general and administrative expenses primarily attributable to acquisitions and the increase in sales, increased interest expense due to higher average debt outstanding primarily to fund acquisitions, and increased depreciation and amortization expense due primarily to increased acquisition activity.

Substantially all of the company's sales are made on an order-by-order basis, rather than through long-term sales contracts.  As such, the nature of the company's business does not provide for the visibility of material forward-looking information from its customers and suppliers beyond a few months.

Consolidated sales for 2011 increased by $2.65 billion , or 14.1% , compared with the year-earlier period. The increase in 2011 was driven by an increase in global components business segment sales of $1.69 billion , or 12.8% , and an increase in global ECS business segment sales of $960.1 million , or 17.2% , compared with the year-earlier period. The translation of the company's international financial statements into U.S. dollars resulted in an increase in consolidated sales of $486.1 million in 2011 , compared with the year-earlier period, due to a weaker U.S. dollar. Excluding the impact of foreign currency and pro forma for acquisitions, the company's consolidated sales increased by 2.0% in 2011 .

The growth in the global components business segment for 2011 was primarily driven by increased demand for the company's products in the EMEA region and the Americas region, as well as the impact of acquisitions. Pro forma for acquisitions, the sales increase for 2011 in EMEA and the Americas was 15.5% and 3.0% , respectively, offset by a sales decrease in the Asia Pacific region of 10.0% . The decline in sales in Asia Pacific was primarily due to weakness in low-end mobile handset components offset, in part, by increased demand in the vertical markets led by lighting and transportation. Excluding the impact of foreign currency and pro forma for acquisitions, the company's global components business segment sales remained flat in 2011 , compared with the year-earlier period.

In the global ECS business segment, the sales for 2011 increased due to higher demand for products in both North America and EMEA.  The increase in sales for 2011 was due to growth in storage, software, services, industry standard servers, and proprietary servers. Excluding the impact of foreign currency and pro forma for acquisitions, the company's global ECS business segment sales increased by 6.9% for 2011 .

Following is an analysis of net sales (in millions) by reportable segment for the years ended December 31:

Consolidated sales for 2010 increased by $4.06 billion , or 27.7% , compared with the year-earlier period. The increase was driven by an increase in global components business segment sales of $3.42 billion , or 35.0% , and an increase in global ECS business segment sales of $643.5 million , or 13.0% . The translation of the company's international financial statements into U.S. dollars resulted in a reduction in consolidated sales of $127.1 million for 2010 , compared with the year-earlier period, due to a stronger U.S. dollar. Excluding the impact of foreign currency and pro forma for acquisitions, the company's consolidated sales increased by 24.7% in 2010 .

In the global components business segment, sales for 2010 increased primarily as a result of strengthening in the world's economies and to average lead times for components extending beyond traditional levels during part of 2010 . Average lead times exiting 2010 were near normal levels. The growth in the global components business segment for 2010 was primarily driven by the sales increase in EMEA of 42.9% , the sales increase in the Americas of 34.2% , the sales increase in the Asia Pacific region of 18.4% , and, to a

lesser extent, the impact of acquisitions. Excluding the impact of foreign currency and pro forma for acquisitions, the company's global components business segment sales increased by 30.9% in 2010 .

In the global ECS business segment, sales for 2010 increased primarily due to higher demand for products. The increase in sales for 2010 was due to growth in storage, software, services, and industry standard servers, offset, in part, by declines principally in proprietary servers. Excluding the impact of foreign currency and pro forma for acquisitions, the company's global ECS business segment sales increased by 12.1% in 2010 .

Gross Profit

The company recorded gross profit of $2.95 billion and $2.42 billion for 2011 and 2010 , respectively.  The increase in gross profit was primarily due to the aforementioned 14.1% increase in sales during 2011 and an increase in the gross profit margin of approximately 90 basis points, compared with the year-earlier period, primarily due to higher margins attributable to recent acquisitions, improved pricing, and a favorable mix towards higher profit margin products in both the global components and global ECS businesses. Excluding the impact of foreign currency and pro forma for acquisitions, gross profit margin increased approximately 20 basis points for 2011 , compared with the year-earlier period.

The company recorded gross profit of $2.42 billion and $1.75 billion for 2010 and 2009 , respectively. The increase in gross profit was primarily due to the aforementioned 27.7% increase in sales during 2010 . The gross profit margin for 2010 increased by approximately 100 basis points, compared with the year-earlier period, due primarily to a lessening of pricing pressure in the global components business segment and a change in geographic mix, with the Americas and EMEA components businesses being a larger percentage of the company's consolidated sales for 2010 compared with the year-earlier period. The gross profit margin for the global ECS business segment was flat, compared with the year-earlier period. The gross profit margins of products sold in the global components business segment are typically higher than the gross profit margins of products in the global ECS business segment and the gross profit margins of the components sold in the Americas and EMEA tend to be higher than the gross profit margins of products in the Asia Pacific region. The financial impact of the lower gross profit margins in the global ECS business segment and the Asia Pacific region were offset, in part, by the lower operating costs and lower working capital requirements in these businesses relative to the company's other businesses.

Selling, General and Administrative Expenses and Depreciation and Amortization

Selling, general and administrative expenses increased $335.6 million , or 21.6% , in 2011 , compared with 2010 , on a sales increase of 14.1% . Selling, general and administrative expenses, as a percentage of sales, was 8.8% and 8.3% for 2011 and 2010 , respectively. The increase in selling, general and administrative expenses in excess of the sales increase was driven by certain recent acquisitions which have a higher operating cost structure relative to the company's other businesses and was offset by higher profit margins for those businesses. For the year ended December 31, 2011, the dollar increase in selling, general and administrative expenses attributable to acquisitions was approximately $285 million .

Depreciation and amortization expense for 2011 increased by $26.1 million , or 33.8% , compared with the year-earlier period, primarily due to acquisitions.  

Excluding the impact of foreign currency and pro forma for acquisitions, operating expenses (which include both selling, general and administrative expenses and depreciation and amortization expense) remained flat on a sales increase of 2.0% in 2011 , as compared with 2010 , due to the company's ability to efficiently manage operating costs.

Selling, general and administrative expenses increased $251.4 million , or 19.3% , in 2010 , compared with 2009 , on a sales increase of 27.7% . The dollar increase in selling, general and administrative expenses was primarily due to higher selling, general and administrative expenses to support the increased sales, the reinstatement of certain employee-related costs that were temporarily suspended during the global economic downturn, and higher selling, general and administrative expenses as a result of acquisitions. These increases were offset, in part, by the impact of a stronger U.S. dollar on the translation of the company's international financial statements for 2010 compared with the year-earlier period. Selling, general and administrative expenses, as a percentage of sales, was 8.3% and 8.9% , for 2010 and 2009 , respectively. This decrease was primarily due to the company's continuing efforts to streamline and simplify processes and the company's ability to better leverage its existing cost structure to manage the increased level of sales relative to the year-earlier period.

Depreciation and amortization expense for 2010 increased by $10.3 million , or 15.4% , compared with the year-earlier period, primarily due to acquisitions.

Excluding the impact of foreign currency and pro forma for acquisitions, operating expenses increased 9.2% on a sales increase of 24.7% in 2010 , as compared with 2009 , due to the company's ability to efficiently manage operating costs.

Restructuring, Integration, and Other Charges

2011 Charges

In 2011 , the company recorded restructuring, integration, and other charges of $37.8 million ( $28.1 million net of related taxes or $.25 and $.24 per share on a basic and diluted basis, respectively). Included in the restructuring, integration, and other charges for 2011 is a restructuring charge of $23.8 million related to initiatives taken by the company to improve operating efficiencies, primarily due to the integration of recently acquired businesses. Also included in the restructuring, integration, and other charges for 2011 is a credit of $.7 million related to restructuring and integration actions taken in prior periods and acquisition-related expenses of $14.7 million .

The restructuring charge of $23.8 million in 2011 primarily includes personnel costs of $17.5 million and facilities costs of $5.4 million . The personnel costs are related to the elimination of approximately 280 positions within the global components business segment and approximately 240 positions within the global ECS business segment.  The facilities costs are related to exit activities for 18 vacated facilities in the Americas and EMEA due to the company's continued efforts to streamline its operations and reduce real estate costs. These initiatives are due to the company's continued efforts to lower cost and drive operational efficiency.  

 

2010 Charges

In 2010 , the company recorded restructuring, integration, and other charges of $33.5 million ( $24.6 million net of related taxes or $.21 per share on both a basic and diluted basis). Included in the restructuring, integration, and other charges for 2010 is a restructuring charge of $21.6 million related to initiatives taken by the company to improve operating efficiencies. Also included in the restructuring, integration, and other charges for 2010 is a credit of $.6 million related to restructuring and integration actions taken in prior periods and acquisition-related expenses of $12.4 million .

The restructuring charge of $21.6 million in 2010 primarily includes personnel costs of $14.7 million and facilities costs of $2.3 million . The personnel costs are related to the elimination of approximately 180 positions within the global ECS business segment and approximately 100 positions within the global components business segment. The facilities costs are related to exit activities for 7 vacated facilities in the Americas and EMEA due to the company's continued efforts to streamline its operations and reduce real estate costs. These initiatives are due to the company's continued efforts to lower cost and drive operational efficiency.

2009 Charges

In 2009 , the company recorded restructuring, integration, and other charges of $105.5 million ( $75.7 million net of related taxes or $.63 per share on both a basic and diluted basis). Included in the restructuring, integration, and other charges for 2009 is a restructuring charge of $100.3 million related to initiatives taken by the company to improve operating efficiencies. Also included in the restructuring, integration, and other charges for 2009 are charges of $1.4 million related to restructuring and integration actions taken in prior periods and acquisition-related expenses of $3.9 million .

The restructuring charge of $100.3 million in 2009 primarily includes personnel costs of $90.9 million and facilities costs of $8.0 million . The personnel costs are related to the elimination of approximately 1,605 positions within the global components business segment and approximately 320 positions within the global ECS business segment. The facilities costs are related to exit activities for 28 vacated facilities worldwide due to the company's continued efforts to streamline its operations and reduce real estate costs. These initiatives are due to the company's continued efforts to lower cost and drive operational efficiency.

As of December 31, 2011 , the company does not anticipate there will be any material adjustments relating to the aforementioned restructuring plans. Refer to Note 9, "Restructuring, Integration, and Other Charges," of the Notes to the Consolidated Financial Statements for further discussion of the company's restructuring and integration activities.

Settlement of Legal Matter

During 2011 , the company recorded a charge of $5.9 million ( $3.6 million net of related taxes or $.03 per share on both a basic and diluted basis) in connection with the settlement of a legal matter, inclusive of related legal costs. This matter related to a customer dispute that originated in 1997. The company had successfully defended itself in a trial, but the verdict was subsequently overturned, in part, by an appellate court and remanded for a new trial. The company ultimately decided to settle this matter to avoid further legal expense and the burden on management's time that such a trial would entail.

Operating Income

The company recorded operating income of $908.8 million , or 4.2% of sales, in 2011 compared with operating income of $750.8 million , or 4.0% of sales, in 2010 .  Included in operating income for 2011 and 2010 were the previously discussed restructuring, integration, and other charges of $37.8 million and $33.5 million , respectively.  Also included in operating income for 2011 was the previously discussed charge of $5.9 million related to the settlement of a legal matter.

The company recorded operating income of $750.8 million , or 4.0% of sales, in 2010 compared with operating income of $272.8 million , or 1.9% of sales, in 2009 . Included in operating income for 2010 and 2009 were the previously discussed restructuring, integration, and other charges of $33.5 million and $105.5 million , respectively.

Gain on Bargain Purchase

During 2011 , the company acquired Nu Horizons for less than the fair value of its net assets due to Nu Horizons' stock trading below its book value for an extended period of time prior to the announcement of the acquisition. The company offered a purchase price per share for Nu Horizons that was above the prevailing stock price thereby representing a premium to the shareholders. The acquisition of Nu Horizons by Arrow was approved by Nu Horizons' shareholders. The excess of the fair value of the net assets acquired over the purchase price paid of $1.1 million ( $.7 million net of related taxes or $.01 per share on both a basic and diluted basis) was recognized as a gain on bargain purchase.

Loss on Prepayment of Debt

During the fourth quarter of 2011, the company recorded a loss on prepayment of debt of $.9 million ( $.5 million net of related taxes), related to the repurchase of $17.9 million principal amount of its 6.875% senior notes due in 2013.

During 2010 , the company recorded a loss on prepayment of debt of $1.6 million ( $1.0 million net of related taxes or $.01 per share on both a basic and diluted basis), related to a property the company sold and was required to pay the related collateralized debt with a face amount of $9.0 million . The loss on prepayment of debt was offset by a gain on the sale of this property of $1.7 million , which is included in restructuring, integration, and other charges in 2010.

During 2009, the company recorded a loss on prepayment of debt of $5.3 million ($3.2 million net of related taxes or $.03 per share on both a basic and diluted basis), related to the repurchase of $130.5 million principal amount of its 9.15% senior notes due in 2010. The loss on prepayment of debt includes the premium paid and write-off of the related deferred financing costs, offset by the gain for terminating the related interest rate swaps.

Interest and Other Financing Expense, Net

Net interest and other financing expense increased by 38.4% in 2011 to $106.0 million , compared with $76.6 million in 2010 , due to higher average debt outstanding primarily to fund acquisitions.

Net interest and other financing expense decreased by 8.1% in 2010 to $76.6 million , compared with $83.3 million in 2009 , primarily due to lower interest rates on the company's variable rate debt and a reduction in interest expense of $3.8 million ( $2.3 million net of related taxes or $.02 per share on both a basic and diluted basis) primarily related to the settlement of certain income tax matters (discussed in "Income Taxes" below).

Income Taxes

The company recorded a provision for income taxes of $210.5 million (an effective tax rate of 26.0% ) for 2011 . In the fourth quarter of 2011 , the company recorded a net reduction in the provision for income taxes of $28.9 million ( $.25 per share on both a basic and diluted basis) principally due to a reversal of a valuation allowance on certain international deferred tax assets as a result of a realignment of the company's international business operations. The company's provision and effective tax rate for 2011 were impacted by the previously discussed reversal of a valuation allowance on certain deferred tax assets, restructuring, integration, and other charges, charge related to the settlement of a legal matter, a loss on prepayment of debt, and a gain on bargain purchase. Excluding the impact of the above-mentioned items, the company's effective tax rate was 29.5% for 2011 .

The company recorded a provision for income taxes of $199.4 million (an effective tax rate of 29.4% ) for 2010 . During 2010 , the company recorded a net reduction of the provision of $9.4 million ($.08 per share on both a basic and diluted basis) primarily related to the settlement of certain tax matters covering multiple tax years. The company's provision and effective tax rate for 2010 were impacted by the previously discussed settlement of certain income tax matters, restructuring, integration, and other

charges, and a loss on prepayment of debt. Excluding the impact of the above-mentioned items, the company's effective tax rate was 30.5% for 2010 .

The company recorded a provision for income taxes of $65.4 million (an effective tax rate of 34.6% ) for 2009 . The company's provision and effective tax rate for 2009 were impacted by the previously discussed restructuring, integration, and other charges and a loss on prepayment of debt. Excluding the impact of the above-mentioned items, the company's effective tax rate was 32.5% for 2009 .

The company's provision for income taxes and effective tax rate are impacted by, among other factors, the statutory tax rates in the countries in which it operates and the related level of income generated by these operations.

 

Net Income Attributable to Shareholders

 

The company recorded net income attributable to shareholders of $598.8 million in 2011 compared with net income attributable to shareholders of $479.6 million in the year-earlier period.  Included in net income attributable to shareholders for 2011 were the previously discussed restructuring, integration, and other charges of $28.1 million , a charge of $3.6 million related to the settlement of a legal matter, a gain on bargain purchase of $.7 million , a loss on prepayment of debt of $.5 million , and a net reduction of the provision for income taxes of $28.9 million principally due to a reversal of a valuation allowance on certain international deferred tax assets.  Included in net income attributable to shareholders for 2010 were the previously discussed restructuring, integration, and other charges of $24.6 million , and a loss on prepayment of debt of $1.0 million , as well as a net reduction of the provision for income taxes of $9.4 million and a reduction of interest expense, net of related taxes, of $2.3 million primarily related to the settlement of certain income tax matters covering multiple years. Excluding the above-mentioned items, the increase in net income attributable to shareholders for 2011 was primarily the result of the sales increases in both the global components business segment and the global ECS business segment and increased gross profit margins. This was offset, in part, by increased selling, general and administrative expenses primarily attributable to acquisitions and the increase in sales, increased interest expense due to higher average debt outstanding primarily to fund acquisitions, and increased depreciation and amortization expense due primarily to increased acquisition activity.

The company recorded net income attributable to shareholders of $479.6 million for 2010 , compared with net income attributable to shareholders of $123.5 million in the year-earlier period. Included in net income attributable to shareholders for 2010 were the previously discussed restructuring, integration, and other charges of $24.6 million , and a loss on prepayment of debt of $1.0 million , as well as a net reduction of the provision for income taxes of $9.4 million and a reduction of interest expense, net of related taxes, of $2.3 million primarily related to the settlement of certain income tax matters covering multiple years. Included in net income attributable to shareholders for 2009 were the previously discussed restructuring, integration, and other charges of $75.7 million and a loss on prepayment of debt of $3.2 million . Excluding the above-mentioned items, the increase in net income attributable to shareholders was primarily the result of the sales increases in both the global components business segment and the global ECS business segment, increased gross profit margins, reduced selling, general and administrative expenses as a percentage of sales due to the company's continuing efforts to streamline and simplify processes, and a lower effective income tax rate. This was offset, in part, by increased depreciation and amortization expense due primarily to increased acquisition activity.