UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2005

OR

For the transition period from       to      

Commission file number 1-4482

ARROW ELECTRONICS, INC.

Registrant’s telephone number, including area code (631) 847-2000

Securities registered pursuant to Section 12(b) of the Act:

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

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

Indicate by a check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act.
Yes [   ] No [X]

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 the 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. [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer [X] Accelerated filer [   ] Non-accelerated filer [   ]

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

The aggregate market value of voting stock held by non-affiliates of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter was $3,153,776,838.

There were 120,635,812 shares of Common Stock outstanding as of February 10, 2006.

The following documents are incorporated herein by reference:

1. Proxy Statement to be filed in connection with the Annual Meeting of Shareholders to be held May 2, 2006 (incorporated in Part III).

TABLE OF CONTENTS

PART I

Item 1. Business.

Arrow Electronics, Inc. (the “company” or “Arrow”) is a major global provider of products, services, and solutions to industrial and commercial users of electronic components and computer products. The company believes it is one of the electronics distribution industry’s leaders in operating systems, employee productivity, value-added programs, and total quality assurance. Arrow, which was incorporated in New York in 1946, serves as a supply channel partner for nearly 600 suppliers and more than 130,000 original equipment manufacturers (“OEMs”), contract manufacturers (“CMs”), and commercial customers.

Serving its industrial and commercial customers as a supply channel partner, the company offers both a wide spectrum of products and a broad range of services and solutions, including materials planning, design services, programming and assembly services, inventory management, and a comprehensive suite of online supply chain tools.

Arrow’s diverse worldwide customer base consists of OEMs, CMs, and commercial customers. Customers include manufacturers of industrial equipment (including machine tools, factory automation, and robotic equipment), telecommunications products, automotive and transportation, aircraft and aerospace equipment, scientific and medical devices, and computer and office products. Customers also include value-added resellers (“VARs”) of computer products.

The company maintains nearly 250 sales facilities and 19 distribution and value-added centers in 53 countries and territories. Through this network, Arrow provides one of the broadest product offerings in the electronics distribution industry and a wide range of value-added services to help customers reduce their time to market, lower their total cost of ownership, and enhance their overall competitiveness.

The company’s has two business segments: electronic components and computer products. The financial information about the company’s business segments and geographic operations can be found in Note 16 of the Notes to Consolidated Financial Statements.

The company’s global electronic components business, one of the largest distributors of electronic components and related services in the world, spans the world’s three largest electronics markets — the Americas, EMEASA (Europe, Middle East, Africa, and South America), and the Asia/Pacific region. The Americas components group includes five sales and marketing organizations in the United States and Canada, as well as an operation in Mexico. The EMEASA components group is divided into the following three regions and also has operations in the Republic of South Africa, Argentina, and Brazil:

-		Northern Europe, which includes Denmark, England, Estonia, Finland, Ireland, Latvia, Lithuania, Norway, Scotland, and Sweden.
-		Central Europe, which includes Austria, Belarus, Belgium, the Czech Republic, Germany, Hungary, the Netherlands, Poland, Russian Federation, Slovakia, Switzerland, and Ukraine.
-		Southern Europe, which includes Bosnia and Herzegovina, Bulgaria, Croatia, Egypt, France, Greece, Israel, Italy, Portugal, Romania, Serbia and Montenegro, Slovenia, Spain, and Turkey.

In the Asia/Pacific region, Arrow operates in Australia, China, Hong Kong, India, Korea, Malaysia, New Zealand, the Philippines, Singapore, Taiwan, and Thailand.

The company’s global computer products business includes Arrow’s Enterprise Computing Solutions (“ECS”), formerly North American Computer Products, which is a leading distributor of enterprise and embedded computing systems, and storage and software, to resellers and OEM customers in North America, as well as Central, Northern, and Eastern Europe. The company also has dedicated computer product businesses in France, Spain, and the United Kingdom.

The company distributes a broad range of electronic components, computer products, and related equipment. Approximately 53% of the company’s sales consist of semiconductor products and related services. Industrial and commercial computer products and related services, including servers, workstations, storage products, microcomputer boards and systems, design systems, desktop computer systems, software, monitors, printers, flat panel displays, system chassis and enclosures, controllers, and communication control equipment, account for approximately 29% of sales. The remaining 18% of the company’s sales, included within electronic

3

components, are of passive, electromechanical, and interconnect products, primarily capacitors, resistors, potentiometers, power supplies, relays, switches, and connectors.

Most manufacturers of electronic components and computer products rely on authorized distributors, such as the company, to augment their sales and marketing operations. As a marketing, stocking, and financial intermediary, the distributor relieves manufacturers of a portion of the costs and personnel associated with selling and stocking their products (including otherwise sizable investments in finished goods inventories, accounts receivable systems, and distribution networks), while providing geographically dispersed selling, order processing, and delivery capabilities. At the same time, the distributor offers a broad range of customers the convenience of accessing, from a single source, multiple products from multiple suppliers and rapid or scheduled deliveries, as well as other value-added services such as materials management and memory programming capabilities. The growth of the electronics distribution industry has been fostered by the many manufacturers who recognize their authorized distributors as essential extensions of their marketing organizations.

The company and its affiliates serve more than 130,000 industrial and commercial customers. Industrial customers range from major OEMs and CMs to small engineering firms, while commercial customers include primarily VARs and OEMs. No single customer accounted for more than 3% of the company’s 2005 consolidated sales.

Most of the company’s customers require delivery of the products they have ordered on schedules that are generally not available on direct purchases from manufacturers, and frequently their orders are of insufficient size to be placed directly with manufacturers.

The electronic components and other products offered by the company are sold by both field sales representatives, who regularly call on customers in assigned market areas, and by inside sales personnel, who call on customers by telephone from the company’s selling locations. Each of the company’s North American selling locations, warehouses, and primary distribution centers are electronically linked to the company’s central computer system, which provides fully integrated, online, real-time data with respect to nationwide inventory levels and facilitates control of purchasing, shipping, and billing. The company’s international operations have similar online, real-time computer systems, and they can also access the company’s Worldwide Stock Check System, which provides access to the company’s online, real-time inventory system.

The company sells the products of nearly 600 manufacturers. No single supplier accounted for more than 8% of the company’s 2005 consolidated sales. The company does not regard any one supplier of products to be essential to its operations and believes that many of the products currently sold by the company are available from other sources at competitive prices. Most of the company’s purchases are pursuant to authorized distributor agreements, which are typically cancelable by either party at any time or on short notice.

Approximately 60% of the company’s inventory consists of semiconductors. It is the policy of most manufacturers to protect authorized distributors, such as the company, against the potential write-down of such inventories due to technological change or manufacturers’ price reductions. Write-downs of inventories to market value are based upon contractual provisions which typically provide certain protections to the company for product obsolescence and price erosion in the form of return privileges and price protection. Under the terms of the related distributor agreements, and assuming the distributor complies with certain conditions, such suppliers are required to credit the distributor for inventory losses incurred through reductions in manufacturers’ list prices of the items. In addition, under the terms of many such agreements, the distributor has the right to return to the manufacturer for credit a defined portion of those inventory items purchased within a designated period of time.

A manufacturer which elects to terminate a distribution agreement is generally required to purchase from the distributor the total amount of its products carried in inventory. As of December 31, 2005, this type of repurchase arrangement covered approximately 85% of the company’s consolidated inventories. While these industry practices do not wholly protect the company from inventory losses, the company believes that they currently provide substantial protection from such losses.

The company’s business is extremely competitive, particularly with respect to prices, franchises, and, in certain instances, product availability. The company competes with several other large multinational and national distributors as well as numerous regional and local distributors. As one of the world’s largest electronics distributors, the company’s financial resources and sales are greater than most of its competitors.

The company and its affiliates employed more than 11,400 employees worldwide as of December 31, 2005.

4

Available Information

The company makes the annual report on Form 10-K, quarterly reports on Form 10-Q, and any current reports on Form 8-K, and amendments to any of these reports available through its website (http://www.arrow.com) as soon as reasonably practicable after the company files such material with the Securities and Exchange Commission (“SEC”). The information posted on the company’s website is not incorporated into this annual report on Form 10-K. In addition, the SEC maintains a website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The annual report on Form 10-K, for the year ended December 31, 2005, includes the certifications of the company’s Chief Executive Officer and Chief Financial Officer as Exhibits 31 (i) and 31 (ii), respectively, which were filed with the SEC as required under Section 302 of the Sarbanes-Oxley Act of 2002 and certify the quality of the company’s public disclosure. The company’s Chief Executive Officer has also submitted a certification to the New York Stock Exchange (“NYSE”) certifying that he is not aware of any violations by the company of NYSE corporate governance listing standards.

5

Executive Officers

The following table sets forth the names, ages, and the positions and offices with the company held by each of the executive officers of the company as of February 27, 2006:

Set forth below is a brief account of the business experience during the past five years of each executive officer of the company.

William E. Mitchell has been President and Chief Executive Officer of the company since February 2003. Prior thereto, he served as Executive Vice President of Solectron Corporation and President of Solectron Global Services, Inc. since March 1999.

Peter S. Brown has been Senior Vice President, General Counsel and Secretary of the company since September 2001. Prior to joining the company, he served as the managing partner of the London office of the law firm of Pillsbury Winthrop LLP (formerly, Winthrop, Stimson, Putnam, & Roberts) for more than five years.

J. Edward Coleman was appointed Senior Vice President and President of Arrow Enterprise Computing Solutions (formerly North American Computer Products) in September 2005. Prior thereto, he served as Chief Executive Officer of CompuCom Systems, Inc. (“CompuCom”) from December 1999 until November 2004 and as Chairman of the Board of CompuCom from October 2001 until October 2004, when CompuCom was taken private.

Bhawnesh Mathur was appointed Senior Vice President and Chief Supply Chain Officer in September 2005. Prior thereto, he served as Executive Vice President of Sanmina-SCI’s (SSCI) Global Logistics and Services since October 2003 and Executive Vice President of SSCI’s Global Supply Chain Management from April 2000 to September 2003.

Paul J. Reilly was appointed Senior Vice President of the company in May 2005 and has been Chief Financial Officer since October 2001. Prior thereto, he served as a Vice President of the company for more than five years.

Germano Fanelli has been President of Arrow EMEASA since January 2004. Prior thereto, he served as Managing Director of Southern Europe and has been a Vice President of the company for more than five years.

Michael J. Long was appointed President of North America and Asia/Pacific Components in January 2006. Prior thereto, he served as President and Chief Operating Officer of Arrow Enterprise Computing Solutions (formerly North American Computer Products) from July 1999 to April 2005 and, most recently, President of North America from May 2005 to December 2005. In addition, he has been a Vice President of the company for more than five years.

Brian P. McNally has been President of North American Components since March 2004 and has been a Vice President of the company since June 2002. Prior thereto, he served in several executive positions including Managing Director of Northern Europe and President of the company’s Contract Manufacturing Services Distribution group.

6

Jan M. Salsgiver was appointed Executive Vice President of Arrow EMEASA in September 2005. Prior thereto, she served in several executive positions, including President of the Americas Components group from July 1999 to February 2004 and, most recently, Vice President of Global Strategy and Operations from March 2004 to August 2005. In addition, she has been a Vice President of the company for more than five years.

Mark Settle has been a Vice President of the company and Chief Information Officer since November 2001. Prior to joining the company, he served as Executive Vice President, Systems and Processing at Visa International since April 1999.

Susan M. Suver has been Vice President of Global Human Resources since March 2004. Prior thereto, she served as Vice President of Global Organizational Development. Prior to joining the company in October 2001, she held the position of Vice President, Organizational Effectiveness and Communications at Phelps Dodge Corporation.

7

Item 1A. Risk Factors.

Described below and throughout this report are certain risks that the company’s management believes are applicable to the company’s business and the industry in which it operates. There may be additional risks that are not presently material or known. There are also risks within the economy, the industry and the capital markets that affect business generally, and the company as well, which have not been described.

If any of the described events occur, the company’s business, results of operations, financial condition, liquidity or access to the capital markets could be materially adversely affected. When stated below that a risk may have a material adverse effect on the company’s business, it means that such risk may have one or more of these effects.

A large portion of the company’s revenues come from the sale of semiconductors, which is a highly cyclical industry, and an industry down-cycle could have a material adverse effect on the company’s business.

The semiconductor industry historically has experienced fluctuations in product supply and demand, often associated with changes in technology and manufacturing capacity, and is generally considered to be highly cyclical. During the last three fiscal years, sales of semiconductor products and related services represented approximately 53% of the company’s consolidated sales, and the company’s revenues, particularly in its electronic components group, tend to closely follow the strength or weakness of the semiconductor market. For example, as a result of the semiconductor industry downturn in 2001 and 2002, the company’s revenues fell from $12.0 billion in 2000 to $9.4 billion in 2001 and $7.3 billion in 2002. The company also generated a net loss in 2001 and 2002. While the semiconductor industry has strengthened in recent years, it is uncertain whether this improvement will continue, and future downturns in the technology industry, particularly in the semiconductor sector, could have a material adverse effect on the company’s business and negatively impact its ability to maintain current profitability levels.

If the company is unable to maintain its relationships with its suppliers, its business could be materially adversely affected.

Substantially all of the company’s inventory has been and will be purchased from suppliers with which the company has entered into non-exclusive distribution agreements. These agreements are typically cancelable on short notice (generally 30 to 90 days). There are also certain parts of the company’s business that rely on a limited number of suppliers. For a significant portion of the company’s Arrow Enterprise Computing Solutions business, the company relies on three suppliers. To the extent that the company’s significant suppliers are unwilling to do business with the company, the company’s business could be materially adversely affected. In addition, to the extent that the company’s suppliers modify the terms of their contracts with the company (including, without limitation, the terms regarding price protection, rights of return, rebates or other terms that are favorable to the company), or extend lead times, limit supplies due to capacity constraints or other factors, there could a material adverse affect on the company’s business.

The company operates in a competitive industry and continues to be under the pressure of eroding gross profit margins, which could have a material adverse effect on the company’s business.

The market for the company’s products and services is very competitive and subject to rapid technological change. Not only does the company compete with other distributors, it also competes for customers with many of its own suppliers. This is particularly true of the company’s larger customers whose volumes of purchases make them more attractive to suppliers for direct sales. Additional competition has emerged from third party logistics providers, fulfillment companies, catalogue distributors and on-line distributors and brokers.

Additionally, prices for the company’s products tend to decrease over their life cycle. Such decreases often result in decreased gross profit margins for the company. There is also substantial and continuing pressure from customers to reduce their total cost for products. Suppliers may also seek to reduce the company’s margins on the sale of their products in order to increase their own profitability. The company expends substantial amounts on the value creation services required to remain competitive, retain existing business and gain new customers, and the company must evaluate the expense of those efforts against the impact of price and margin reductions.

8

Further, the manufacturing of electronic components and computer products is increasingly shifting to lower-cost production facilities in Asia, most notably China. Suppliers in Asia have traditionally had lower gross profit margins than those in the United States and Europe, and typically charge lower prices in the Asian markets for their products, which places pressure on the company to lower its prices to meet competition. Thus, the company’s consolidated gross profit margins have eroded over time, from 16.7% in 2003, to 16.2% in 2004, and 15.6% in 2005. If the company is unable to effectively compete in its industry or is unable to maintain acceptable gross profit margins, its business could be materially adversely affected.

Products sold by the company may be found to be defective and, as a result, warranty and/or product liability claims may be asserted against the company which may have a material adverse effect on the company.

Products sold by the company are at prices that are significantly lower than the cost of the equipment or other goods in which they are incorporated. Since a defect or failure in a product could give rise to failures in the end products that incorporate them (and claims for consequential damages against the company from its customers), the company may face claims for damages that are disproportionate to the sales and profits it receives from the products involved. While the company and its suppliers specifically exclude consequential damages in their standard terms and conditions, the company’s ability to avoid such liabilities may be limited by the laws of some of the countries where it does business. The company’s business could be materially adversely affected as a result of a significant quality or performance issue in the products sold by the company, if it is required to pay for the damages that result. Although the company currently has product liability insurance, such insurance is limited in coverage and amount.

Declines in value and other factors pertaining to the company’s inventory could materially adversely affect its business.

The electronic components and computer products industries are subject to rapid technological change, evolving industry standards, changes in end-market demand and regulatory requirements, which can contribute to the decline in value or obsolescence of inventory. During an economic downturn, it is possible that prices will decline due to an oversupply of product and, therefore, there may be greater risk of declines in inventory value. Although it is the policy of most of the company’s suppliers to provide distributors with certain protections from the loss in value of inventory (such as price protection, certain rights of return and rebates), the company cannot be sure that such protections will fully compensate it for the loss in value, or that the suppliers will choose to, or be able to, honor such agreements. For example, many of the company’s suppliers will not allow it to return products after they have been held in inventory beyond a certain amount of time and, in most instances, the return rights are limited to a certain percentage of the amount of product the company purchased in a particular time frame. In addition, as discussed below, the company historically has sold products that contain substances that are now or will soon be regulated by various environmental laws. Some of the company’s inventory may become obsolete as a result of these or other existing or new regulations. All of these factors pertaining to inventory could have a material adverse effect on the company’s business.

The company is subject to environmental laws and regulations that could materially adversely affect its business.

The company is subject to a wide and ever-changing variety of U.S. and foreign federal, state, and local laws and regulations, compliance with which may require substantial expense. Of particular note are two recent European Union (“EU”) directives, known as the Restriction of Certain Hazardous Substances Directive (“RoHS”) and the Waste Electrical and Electronic Equipment Directive (“WEEE”). These directives restrict the distribution of products within the EU of certain substances and require a manufacturer or importer to recycle products containing those substances. Failure to comply with these directives could result in fines or suspension of sales. Additionally, RoHS may result in the company having non-compliant inventory that may be less readily salable or have to be written off.

In addition, some environmental laws impose liability, sometimes without fault, for investigating or cleaning up contamination on or emanating from the company’s currently or formerly owned, leased or operated property, as well as for damages to property or natural resources and for personal injury arising out of such contamination. As the distribution business, in general, does not involve the manufacture of products, it is typically not subject to significant liability in this area. However, there may be occasions, including through acquisitions, where environmental liability arises. Such liability may be joint and several, meaning that the company could be held responsible for more than its share of the liability involved, or even the entire share. In addition, the presence of environmental contamination could also interfere with ongoing operations or adversely affect the company’s ability to sell or lease its properties. The discovery of contamination for which

9

the company is responsible, or the enactment of new laws and regulations, or changes in how existing requirements are enforced, could require the company to incur costs for compliance or subject it to unexpected liabilities.

The foregoing matters could materially adversely affect the company’s business.

The company is currently involved in the investigation and remediation of environmental problems at two sites as a result of its Wyle Electronics acquisition, and the company is in litigation related to those sites.

As a result of its acquisition of Wyle Electronics from the VEBA Group (“VEBA”) in 2000, the company assumed Wyle’s outstanding liabilities, including the responsibility for certain environmental contamination at sites formerly owned by Wyle. Two sites are known to have such contamination, one at Norco, California, and the other at Huntsville, Alabama, and the company has thus far borne most of the cost of the investigation and remediation of each, under the direction of the cognizant state agencies. The company has expended more than $13 million to date in connection with these sites. The company has also recently received and is reviewing a demand regarding alleged contamination at a third site related to Wyle, in El Segundo, California.

The agreement pursuant to which the company bought Wyle from VEBA contains an indemnification from VEBA to the company for all of the costs associated with the Wyle environmental obligations. VEBA’s successor-in-interest, E.ON AG, acknowledged liability under the VEBA contractual indemnities with respect to the Norco and Huntsville sites, and made a small initial payment, but has subsequently refused to make further payments. As a result, the company has initiated litigation against E.ON AG and certain others in the United States District Court for the Central District of California and in the Regional Court in Frankfurt am Main, Germany. The company believes strongly in the merits of its case and the probability of recovery from E.ON AG, but there can be no guaranty of the outcome of litigation, and should the company lose on all of its claims in both cases, it would bear all of the cost of the Wyle environmental obligations. Because characterization and remedial design is not yet complete at any of these sites, the future costs in excess of accrued costs associated therewith are as yet undetermined and could have a material adverse effect on the company. The company has accrued the minimum of the estimated range of costs associated with the Wyle environmental obligations and, during the fourth quarter of 2005, has recorded a $10.3 million offset relating to the probable recovery of costs from E.ON AG.

In addition, the company is, along with other parties, a defendant in a suit filed by 91 plaintiff landowners and residents in Riverside County Court in California for personal injury and property damages allegedly caused by the contaminated groundwater and related soil-vapor found in certain residential areas adjacent to the Norco site. Wyle Laboratories, formerly a division of Wyle Electronics, has demanded defense and indemnification from the company in connection with the litigation, and the company has, in turn demanded defense and indemnification from E.ON AG. The claims for indemnification are at issue in the U.S. District Court and Frankfurt Regional Court proceedings.

While the company believes strongly in the merits of its claim for indemnification against E.ON AG, and has no reason to believe that the plaintiff’s allegations of damages in the Norco matter pending in Riverside County have merit, there can be no guaranty regarding the outcome of either matter, and should the company be found to be liable for damages to the Riverside plaintiffs and E.ON AG found not to be liable to indemnify the company for those damages, it could have a material adverse effect on the company.

The company may not have adequate or cost-effective liquidity or capital resources.

The company needs cash to make interest payments on and to refinance indebtedness, and for general corporate purposes, such as funding its ongoing working capital and capital expenditure needs. At December 31, 2005, the company had cash, cash equivalents, and short-term investments of $580.7 million. In addition, the company currently has access to credit lines in excess of $1.1 billion. The company’s ability to satisfy its cash needs depends on its ability to generate cash from operations and to access the financial markets, both of which are subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control.

The company may in the future need to access the financial markets to satisfy its cash needs. The company’s ability to obtain external financing is affected by its debt ratings. Any increase in the company’s level of debt, change in status of its debt from unsecured to secured debt, or deterioration of its operating results may cause a reduction in its current debt ratings. Any downgrade in the company’s current debt rating could impair the company’s ability to obtain additional financing on acceptable terms. Under the terms of any external financing, the company may incur higher than expected financing expenses and become subject to additional

10

restrictions and covenants. For example, the company’s existing debt agreements contain restrictive covenants, including covenants requiring compliance with specified financial ratios and a failure to comply with these or any other covenants may result in an event of default. An increase in the company’s financing costs or a breach of debt instrument covenants could have a material adverse effect on the company.

The agreements governing some of the company’s financing arrangements contain various covenants and restrictions that limit the discretion of management in operating the business and could prevent the company from engaging in some activities that may be beneficial to its business.

The agreements governing the company’s financings contain various covenants and restrictions that, in certain circumstances, could limit its ability to:

	•		grant liens on assets;
	•		make restricted payments (including paying dividends on capital stock or redeeming or repurchasing capital stock);
	•		make investments;
	•		merge, consolidate or transfer all or substantially all of its assets;
	•		incur additional debt; or
	•		engage in certain transactions with affiliates.

As a result of these covenants and restrictions, the company may be limited in how it conducts its business and may be unable to raise additional debt, compete effectively or make investments.

The company’s failure to have long-term sales contracts may have a material adverse effect on its business.

Most of the company’s sales are made on an order-by-order basis, rather than through long-term sales contracts. The company generally works with its customers to develop non-binding forecasts for future volume of orders. Based on such nonbinding forecasts, the company makes commitments regarding the level of business that it will seek and accept, the inventory that it purchases, the timing of production schedules, and the levels of utilization of personnel and other resources. A variety of conditions, both specific to each customer and generally affecting each customer’s industry, may cause customers to cancel, reduce or delay orders that were either previously made or anticipated. Generally, customers cancel, reduce or delay purchase orders and commitments without penalty. The company seeks to mitigate these risks, in some cases, by entering into noncancelable/nonreturnable sales agreements, but there is no guaranty that such agreements will adequately protect the company. Significant or numerous cancellations, reductions or delays in orders by customers could materially adversely affect the company’s business.

The company’s non-U.S. locations, particularly Asia, represent a significant and growing portion of its sales, and consequently, the company is increasingly exposed to risks associated with operating internationally.

In 2005, approximately 47% of the company’s sales came from its operations outside the United States. During 2004 and 2003, approximately 46% of sales were from locations outside the United States. As a result of the company’s foreign sales and locations, its operations are subject to a variety of risks that are specific to international operations, including the following:

	•		import and export regulations that could erode profit margins or restrict exports;
	•		the burden and cost of compliance with foreign laws, treaties and technical standards and changes in those regulations;
	•		potential restrictions on transfers of funds;
	•		foreign currency fluctuations;
	•		import and export duties and value added taxes;
	•		transportation delays and interruptions;
	•		uncertainties arising from local business practices and cultural considerations; and
	•		potential military conflicts and political risks.

While the company has and will continue to adopt measures to reduce the potential impact of losses resulting from the risks of doing business abroad, it cannot ensure that such measures will be adequate.

11

In the event the company makes acquisitions, it may not be able to successfully integrate such acquisitions or attain the anticipated benefits.

While acquisitions no longer represent a major part of the company’s core growth strategy, the company will continue to consider financially attractive and strategic acquisitions as opportunities arise. If the company is unsuccessful in integrating the acquisitions it does make, or if integration is more difficult than anticipated, the company may experience disruptions that could have a material adverse effect on its business. In addition, the company may not realize all of the benefits it anticipates from such acquisitions. For example, a certain portion of the purchase price for most acquisitions is considered goodwill, an asset. In the event that an acquired company does not perform as anticipated, the value of the goodwill may have to be written down, which could have a material adverse effect on the company.

If the company fails to maintain an effective system of internal controls or discovers material weaknesses in its internal controls over financial reporting, it may not be able to report its financial results accurately or timely or detect fraud, which could have a material adverse effect on its business.

An effective internal control environment is necessary for the company to produce reliable financial reports and is important in its effort to prevent financial fraud. The company is required to periodically evaluate the effectiveness of the design and operation of its internal controls over financial reporting. These evaluations may result in the conclusion that enhancements, modifications or changes to internal controls are necessary or desirable. While management evaluates the effectiveness of the company’s internal controls on a regular basis, these controls may not always be effective. There are inherent limitations on the effectiveness of internal controls including collusion, management override, and failure of human judgment. In addition, control procedures are designed to reduce rather than eliminate business risks. If the company fails to maintain an effective system of internal controls or if management or the company’s independent registered public accounting firm was to discover material weaknesses in the company’s internal controls, it may be unable to produce reliable financial reports or prevent fraud and it could have a material adverse effect on the company’s business. In addition, the company may be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission or The New York Stock Exchange. Any such actions could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of the company’s financial statements, which could cause the market price of its common stock to decline or limit the company’s access to other forms of capital.

The Commerce Department may levy substantial fines on the company or may limit its ability to export products.

Under U.S. Export Administration Regulations (“EAR”), administered by the Bureau of Industry and Security of the Department of Commerce (“BIS”), licenses or proper license exceptions are required for the shipment of certain U.S. goods and technology to certain countries, including China, India, Russia and other countries in which the company operates. Non-compliance with the Export Administration Regulations can result in a wide range of penalties including the denial of export privileges, fines, criminal penalties, and the seizure of commodities. In September 2004, the company made a preliminary, voluntary disclosure to the BIS advising them that it suspected that its Hong Kong subsidiary, Arrow Asia Pac, Ltd., may have exported or re-exported certain products without the required licenses. The company performed a review of its historical shipments from North America and the Asia/Pacific region to determine the number and nature of any violations. In March 2005, the company advised the BIS that it had identified 28 export or re-export shipments, over a five-year period, that may constitute violations of the EAR. The statutory maximum civil penalty for each violation of the EAR identified is $11,000 for all but two of the shipments in question, which are subject to a higher statutory maximum civil penalty of $120,000 per violation. However, because it is not known whether the BIS will agree with the company’s count or characterization of the violations, and because penalties for such violations may also include export prohibitions or restrictions, it is not possible at this time to determine the extent of the penalties the company may incur. In the event that BIS views these shipments as violations of the EAR, the company could be fined significant sums and/or its export capabilities could be restricted. Such results could have a material adverse effect on the company.

The company relies heavily on its internal information systems which, if not properly functioning, could materially adversely affect the company’s business.

The company’s current global operations reside on four separate technology platforms. Any of these systems are subject to electrical or telecommunications outages, computer hacking or other general system failure. Moreover, the company recently initiated the design of a new global financial system. The implementation and

12

installation of this system will be complicated and will take more than a year to finalize. There is no guarantee that the implementation will be successful or that there will not be integration difficulties that will adversely affect the company’s operations or the accurate recording and reporting of financial data. Failure of its internal information systems or material difficulties in upgrading its global financial system could have material adverse effects on the company’s business.

Item 1B. Unresolved Staff Comments.

None.

13

Item 2. Properties.

The company owns and leases sales offices, distribution centers, and administrative facilities worldwide. The company’s executive office is located in Melville, New York and occupies a 163,000 square foot facility under a long-term lease. The company owns 14 locations throughout the Americas, EMEASA, and the Asia/Pacific region. The company occupies over 270 additional locations under leases due to expire on various dates through 2053. The company believes its facilities are well maintained and suitable for company operations.

Item 3. Legal Proceedings.

Wyle Matters

As is discussed in Note 15 of the Notes to Consolidated Financial Statements, in 2000, when the company purchased Wyle Electronics (“Wyle”) from the VEBA Group (“VEBA”), the company assumed Wyle’s then outstanding obligations. Among the obligations the company assumed was Wyle’s 1994 indemnification of the purchasers of one of its divisions, Wyle Laboratories, for costs associated with then existing contamination or violation of environmental regulations. Under the terms of the company’s purchase of Wyle, VEBA agreed to indemnify the company for, among other things, costs related to environmental pollution associated with Wyle, including those associated with its prior sale of Wyle Laboratories. VEBA has since merged with E.ON AG, a large German-based multinational conglomerate.

The company is aware of two Wyle Laboratories facilities (in Huntsville, Alabama and Norco, California) at which contaminated groundwater has been identified. Each site will require remediation, the final form and cost of which is as yet undetermined. As is further discussed at Note 15, the Alabama site is being investigated by the company under the supervision of the Alabama Department of Environmental Management. The company is party to a consent decree, entered in October 2003, with the California Department of Toxic Substance Control regarding the Norco site. In addition, the company has recently received from the owner of a third site related to Wyle, in El Segundo, California, a demand regarding alleged contamination at such site. To date, the company has neither accepted nor rejected responsibility in connection with the site and has no actual knowledge of the nature or scope of any contamination or possible remediation. Investigation at the site is currently under the direction of the Los Angeles Regional Water Quality Board of the California Environmental Protection Agency.

Arrow has been named as a defendant in a suit filed in January 2005 in the California Superior Court in Riverside County, California (Gloria Austin, et al. v. Wyle Laboratories, Inc. et al.) in which 91 plaintiff landowners and residents have sued a number of defendants (including Wyle Laboratories and E.ON AG) under a variety of theories for unquantified damages allegedly caused by environmental contamination at and around the Wyle Laboratories’ Norco site. Contaminated groundwater and related soil-vapor have been found in certain residential areas adjacent to the site. Characterization of the on- and off-site scope and impact of the contamination, and the design of remedial measures, are on-going. Wyle Laboratories has demanded indemnification from the company in connection with the litigation.

As with the costs of the ongoing investigation and remediation of the Norco and Huntsville, Alabama sites discussed in Note 15 of the Notes to Consolidated Financial Statements, the company believes that any cost or liability which it may incur in connection with the Austin v. Wyle matter, including the defense of the case, is covered by the VEBA indemnifications (except, under the terms of the environmental indemnification, for the first $450,000).

Despite E.ON AG’s acknowledgment of liability under the VEBA contractual indemnities, and a single, partial payment, neither the company’s demand for defense and indemnification in the Austin v. Wyle matter, nor its demand for further indemnification payments have been met. In September 2004, the company filed suit against E.ON AG and certain of its U.S. subsidiaries in the United States District Court for the Northern District of Alabama seeking further payments of indemnified amounts and additional related damages. The case has since been transferred to the United States District Court for the Central District of California, where a motion to reconsider the dismissal of the first complaint has been made and it has been consolidated with a case commenced by the company and Wyle Laboratories in May 2005 against E.ON AG seeking indemnification, contribution, and a declaration of the parties’ respective rights and obligations in connection with the Riverside County litigation and other costs associated with the Norco site. In October 2005, the company filed a related action against E.ON AG in the Frankfurt am Main Regional Court in Germany.

14

Based on the opinion of counsel in the fourth quarter of 2005, that recovery from E.ON AG of costs incurred to date which are covered under the contractual indemnifications associated with the environmental clean-up costs related to the Wyle sites is deemed probable, the company recorded a $10,338,000 receivable from E.ON AG. The company’s net costs for such indemnified matters may vary from period to period as estimates of recoveries are not always recognized in the same period as the accrual of estimated expenses. To date, the cumulative estimate of recoveries have offset estimates of expense.

In connection with the acquisition of Wyle, the company acquired a $4,495,000 tax receivable due from E.ON AG (as successor to VEBA) in respect of certain tax payments made by Wyle prior to the effective date of the acquisition, the recovery of which the company also believes is probable.

Export and Re-Export Regulations

Due to the international nature of its business, the company and its subsidiaries are subject to the import and export laws of the United States and other countries in which they operate or to which they export.

Under U.S. Export Administration Regulations (“EAR”), administered by the Bureau of Industry and Security (“BIS”) of the Department of Commerce, licenses or proper license exceptions are required for the shipment of certain U.S. goods and technology to certain countries in which the company operates. Non-compliance with the regulations can result in a wide range of penalties including the denial of export privileges, fines, criminal penalties, and seizure of commodities.

In September 2004, the company made a preliminary, voluntary disclosure to the BIS advising them that the company suspected that its Hong Kong subsidiary, Arrow Asia Pac, Ltd., may have exported or re-exported certain products without the required licenses.

The company has since undertaken a review of its historical shipments from North America and the Asia/Pacific region to determine the number and nature of any violations. In March 2005, the company advised the BIS that it had identified 28 export or re-export shipments, over a five-year period, that may constitute violations of the EAR. The statutory maximum civil penalty for each violation of the EAR identified by the company is $11,000 for all but two of the shipments in question, which are subject to a higher statutory maximum civil penalty of $120,000 per violation. However, because it is not known whether the BIS will agree with the company’s count or characterization of the violations, and because penalties for such violations may also include export prohibitions or restrictions, it is not possible at this time to determine the extent of the penalties the company may incur.

The company’s submission is currently under review by BIS. The company understands that it is BIS practice following such a review to attempt to achieve a negotiated settlement without formal proceedings, but such negotiations have not yet begun. Nevertheless, based on the information available to the company at this time, the company does not believe that the ultimate resolution of this matter will have a material adverse impact on the company’s financial position, liquidity, or results of operations.

Other

From time to time, in the normal course of business, the company may become liable with respect to other pending and threatened litigation, environmental, regulatory, and tax matters. While such matters are subject to inherent uncertainties, it is not currently anticipated that any such matters will have a material adverse impact on the company’s financial position, liquidity, or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

15

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Market Information

The company’s common stock is listed on the New York Stock Exchange (trading symbol: “ARW”). The high and low sales prices during each quarter of 2005 and 2004 were as follows:

Holders

On February 10, 2006, there were approximately 2,500 shareholders of record of the company’s common stock.

Dividend History

The company did not pay cash dividends on its common stock during 2005 or 2004. While the board of directors considers the payment of dividends on the common stock from time to time, the declaration of future dividends will be dependent upon the company’s earnings, financial condition, and other relevant factors, including debt covenants.

16

Item 6. Selected Financial Data.

The following table sets forth certain selected consolidated financial data and should be read in conjunction with the company’s consolidated financial statements and related notes appearing elsewhere in this annual report on Form 10-K (in thousands except per share data):

17

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

For an understanding of the significant factors that influenced the company’s performance during the past three years, the following discussion should be read in conjunction with the consolidated financial statements and other information appearing elsewhere in this annual report on Form 10-K.

Overview

The company has two business segments: electronic components and computer products. Consolidated sales grew by 4.9% in 2005, compared with the year-earlier period, primarily as a result of continued sales growth in the worldwide components businesses and increased sales in Arrow Enterprise Computing Solutions (“ECS”). The sales growth in the EMEASA (Europe, Middle East, Africa, and South America) components businesses is primarily due to the acquisition of Disway AG (“Disway”) during the third quarter of 2004. The sales growth in the Asia/Pacific components businesses is a result of the region’s strong market growth coupled with the company’s initiative to expand its product offering and customer base. Sales in the North American Components (“NAC”) businesses remained flat, compared to the year-earlier period. End market demand in North America remained stable throughout 2005 while in Europe the market experienced a relatively small decline. The sales growth in ECS is primarily due to a company initiative to grow certain strategic products such as software, services, and storage in its Enterprise Computing Solutions business.

In December 2005, the company acquired DNSint.com AG (“DNS”). DNS, which is headquartered in Munich, Germany, is a distributor of mid-range computer products in Central, Northern, and Eastern Europe and is one of the largest suppliers of Sun Microsystems, Inc. products in Europe. In 2005, DNS had sales in excess of $400.0 million. The company anticipates that the DNS acquisition will provide additional opportunities to expand its business in this region as the demand for enterprise computing solutions grows globally.

Also in December 2005, the company acquired 70.7% of the common shares of Ultra Source Technology Corp. (“Ultra Source”). Ultra Source, which is headquartered in Taipei, Taiwan, is one of the leading electronic components distributors in Taiwan, and a provider of consumer digital technology with sales offices and distribution centers in Taiwan, Hong Kong, and the People’s Republic of China. In 2005, Ultra Source had sales in excess of $500.0 million. The company anticipates that the Ultra Source acquisition will strengthen its position in Taiwan, which is considered to be an important gateway to the Greater China market.

Net income increased to $253.6 million in 2005, compared with net income of $207.5 million in 2004. The increase in net income is due to the impact of efficiency initiatives reducing operating expenses and lower interest costs as a result of the prepayment of debt. The following items impact the comparability of the company’s results for the years ended December 31, 2005 and 2004:

	•		an acquisition indemnification credit of $1.7 million ($1.3 million net of related taxes) in 2005 and $9.7 million in 2004;
	•		restructuring charges of $12.7 million ($7.3 million net of related taxes) in 2005 and $11.4 million ($6.9 million net of related taxes) in 2004;
	•		an integration credit of $2.3 million ($1.4 million net of related taxes) in 2004;
	•		an impairment charge of $10.0 million in 2004;
	•		a loss on the prepayment of debt of $4.3 million ($2.6 million net of related taxes) in 2005 and $33.9 million ($20.3 million net of related taxes) in 2004; and
	•		a loss of $3.0 million and $1.3 million on the write-down of investments in 2005 and 2004, respectively.

Sales

Consolidated sales for 2005 increased $518.1 million or 4.9% compared with 2004. The increase in consolidated sales was driven by an increase of $389.7 million, or 4.8%, in the worldwide electronic components business and an increase of $128.4 million, or 5.0%, in the worldwide computer products business, compared with the year-earlier period.

The growth in the worldwide electronic components business for 2005 was primarily driven by the sales increase in Asia/Pacific of 25.3% and the sales increase in the EMEASA components business of 2.0%, compared to the year-earlier period. The increase in Asia/Pacific sales for 2005, compared with the year-earlier period, was due to the region’s strong market growth coupled with the company’s initiative to expand its product offering and customer base. The sales increase in the EMEASA components businesses for 2005 was primarily due to the acquisition of Disway during 2004. Sales in the NAC businesses remained flat in

18

2005, when compared with the year-earlier period. End market demand in North America remained stable throughout 2005 while in Europe the market experienced a relatively small decline.

Sales of worldwide computer products increased $128.4 million or 5.0% for 2005, compared with the year-earlier period primarily due to increased sales in North America’s server, storage, software, and manufacturer services group of 12.6% for 2005, compared with the year-earlier period. The increase in sales was partially offset by a decrease in sales of industrial related computer products to original equipment manufacturers (“OEMs”) in North America of 9.9% for 2005, compared with the year-earlier period, primarily due to the company’s decision in early 2005 to terminate certain low-margin customer engagements and lower computer product sales in France.

The translation of the company’s international financial statements into U.S. dollars resulted in increased sales of $6.8 million for 2005, compared with the year-earlier period, due to a weaker U.S. dollar. The increase in consolidated sales, giving effect to the impact of the U.S. dollar, was 4.8% in 2005.

Consolidated sales for 2004 increased $2.1 billion, or 24.8%, compared with 2003. The increase in consolidated sales was driven by an increase of $1.6 billion, or 25.5%, in the worldwide electronic components business and an increase of $478.8 million, or 22.7%, in the worldwide computer products business, compared with the year earlier period.

The growth in the worldwide electronic components business for 2004 was due to increased sales of electronic components in North America, Europe, and the Asia/Pacific region. The growth in the NAC businesses was driven by the strength of demand from the company’s broad customer base, as well as the cyclical upturn that began during 2003 and continued through mid-2004. The second half of 2004 was marked by rational demand and continued cautiousness on the part of customers as product remained readily available. Sales in the EMEASA components businesses for 2004 increased by $619.3 million or 26.1%, compared with the year-earlier period, primarily due to improved customer order patterns, the impact of a weaker U.S. dollar on the translation of the company’s European financial statements, and the completion, during the third quarter of 2004, of the acquisition of Disway. Asia/Pacific sales for 2004 increased by $349.8 million or 42.6%, compared with the year-earlier period, as a result of improved market conditions as well as the company’s initiatives to expand its product offering and customer base.

Sales of worldwide computer products increased by $478.8 million or 22.7% for 2004, compared with the year-earlier period. An estimated $196.6 million of the increase was the result of a change in the business model with the Hewlett Packard Company (“HP”) during February 2004. HP modified its agreement with distributors transforming the relationship from that of an agent to that of a distributor and thereby changing the method of recognizing revenue. Excluding the change related to HP, computer product sales would have increased by 13.4% for 2004. Sales in ECS’ server, storage, software, and manufacturer services group increased by 34.0% for 2004, compared with the year-earlier period, due to a company initiative to grow sales of certain strategic product segments, increased sales of storage and software, as well as increases in the size of the market served by Arrow. Sales of industrial related computer products to OEMs increased by 17.1% for 2004, compared with the year-earlier period. These increases were reduced, in part, by the elimination of sales in the Nordic commodity computer products business, which the company exited during 2003.

The increase in consolidated sales was impacted by the translation of the company’s international financial statements into U.S. dollars which resulted in increased sales of $246.3 million for 2004, compared with the year-earlier period, due to a weaker U.S. dollar. The increase in consolidated sales, giving effect to the impact of the U.S. dollar, was 21.3% for 2004.

Gross Profit

The company recorded gross profit of $1.7 billion for 2005 and 2004. The gross profit margin for 2005 decreased by approximately 60 basis points when compared with the year-earlier period. The decrease in gross profit margin is primarily the result of pricing pressures in the marketplace relating to the worldwide electronic components business, and a larger portion of sales mix from Asia/Pacific and the ECS businesses that have lower margins.

The company recorded gross profit of $1.7 billion for 2004, compared with $1.4 billion in the year-earlier period. The increase in gross profit was primarily due to the 24.8% increase in sales in 2004. The gross profit margin for 2004 decreased by approximately 50 basis points when compared with the year-earlier period. The decrease in gross profit margin was primarily the result of pricing pressures in the marketplace relating to the worldwide electronic components business, and a larger portion of sales mix from Asia/Pacific and the ECS businesses that had lower margins. The change in the business model used for the sale of HP products,

19

beginning in the first quarter of 2004, reduced the gross profit margin by approximately 30 basis points but had no impact on gross profit.

Restructuring, Integration, and Other Charges (Credits)

The company recorded total restructuring charges of $12.7 million ($7.3 million net of related taxes or $.06 and $.05 per share on a basic and diluted basis, respectively), $11.4 million ($6.9 million net of related taxes or $.07 and $.06 per share on a basic and diluted basis, respectively), and $38.0 million ($27.1 million net of related taxes or $.27 per share) in 2005, 2004, and 2003, respectively. These items are discussed in greater detail below.

Restructurings

In the first quarter of 2005, the company announced that it would take additional actions to better optimize the use of its mainframe, reduce real estate costs, be more efficient in its distribution centers, and to be more productive. These actions are expected to further reduce costs by approximately $50.0 million per annum with $40.0 million realized in 2005. The restructuring charges associated with these 2005 actions total $12.9 million for 2005 and consisted primarily of personnel costs relating to the elimination of approximately 425 positions, or 4% of the prior year-end worldwide total of 11,500 positions, across multiple locations, primarily within the company’s electronic components business segment and shared services function. The majority of the total charge was spent in cash.

The company, during 2004 and 2003, announced a series of steps to make its organizational structure more efficient resulting in annualized savings in excess of $100.0 million. The restructuring charges associated with these 2004 and 2003 actions total approximately $48.6 million, of which approximately $.8 million, $9.8 million, and $38.0 million were recorded in 2005, 2004, and 2003, respectively. Approximately 85% of the total charge was spent in cash.

As of December 31, 2005, $6.9 million of the previously discussed charges were accrued but unused of which $4.6 million are for personnel costs, $1.9 million are to address remaining facilities commitments, and approximately $.4 million are for other remaining contractual obligations.

Also during 2005, the company recorded a restructuring credit against the accrual related to the 2001 restructuring of $1.0 million. During 2004, the company recorded a restructuring charge of $1.6 million related to the 2001 restructuring. As of December 31, 2005, $7.1 million related to the 2001 restructuring was accrued but unused of which $3.6 million is to address remaining real estate lease commitments and $3.5 million primarily relates to the termination of certain customer programs.

Integration

During 2004, the company recorded an integration credit, due to a change in estimate, of $2.3 million ($1.4 million net of related taxes or $.01 per share), which primarily related to the final negotiation of facilities related obligations for numerous acquisitions made prior to 2001.

During 2003, the company incurred integration costs of $18.4 million related to the acquisition of the Industrial Electronics Division (“IED”) of Agilysys, Inc. in 2003. Of the total amount recorded, $6.9 million ($4.8 million net of related taxes or $.05 per share), relating primarily to severance costs for the company’s employees, was expensed and $11.5 million, relating primarily to severance costs for IED employees and professional fees, was recorded as additional cost in excess of net assets of companies acquired.

The integration accrual of $5.8 million, as of December 31, 2005, relates to the acquisition of Disway in 2004 and IED in 2003, as well as numerous acquisitions made prior to 2001, is for remaining contractual obligations.

Restructuring and Integration Summary

The remaining balances of the restructuring and integration accruals aggregate $19.8 million as of December 31, 2005, of which $16.0 million is expected to be spent in cash, and will be utilized as follows:

-

The personnel costs accruals of $4.7 million will be utilized to cover costs associated with the termination of personnel, which are primarily expected to be spent during 2006.

20

-		The facilities accruals totaling $9.9 million relate to terminated leases with expiration dates through 2010, of which $4.2 million will be paid in 2006. The minimum lease payments for these leases are approximately $2.4 million in 2007, $1.6 million in 2008, $1.0 million in 2009, and $.7 million thereafter.
-		The customer termination accrual of $3.5 million relates to costs associated with the termination of certain customer programs primarily related to services not traditionally provided by the company and is expected to be utilized over several years.
-		Other of $1.7 million primarily relates to certain terminated contracts, the majority of which are expected to be utilized over several years.

Acquisition Indemnification

During the first quarter of 2005, Tekelec Europe SA (“Tekelec”), a French subsidiary of the company, entered into a settlement agreement with Tekelec Airtronic SA (“Airtronic”) pursuant to which Airtronic paid €1.5 million (approximately $2.0 million) to Tekelec in full settlement of all of Tekelec’s claims for indemnification under the purchase agreement. The company recorded the net amount of the settlement of $1.7 million ($1.3 million net of related taxes or $.01 per share on a basic basis) as an acquisition indemnification credit.

In the third quarter of 2003, the company recognized a liability which was recorded as an acquisition indemnification charge, due to a change in estimate, of €11.3 million ($13.0 million or $.13 per share at the 2003 third quarter-end exchange rate) for the full amount of a claim asserted by the French tax authorities relating to alleged fraudulent activities concerning value-added tax by Tekelec. The alleged activities occurred prior to the company’s purchase of Tekelec from Airtronic in 2000. In August 2004, an agreement was reached with the French tax authorities pursuant to which Tekelec agreed to pay €3.4 million in full settlement of this claim. The company recorded an acquisition indemnification credit, due to a change in estimate, of €7.9 million ($9.7 million at the exchange rate prevailing on August 12, 2004 or $.09 and $.08 per share on a basic and diluted basis, respectively) in the third quarter of 2004 to reduce the liability previously recorded (€11.3 million) to the required level (€3.4 million). In December 2004, Tekelec paid €3.4 million ($4.6 million at the exchange rate prevailing at year-end) in full settlement of this claim.

Impairment

In the fourth quarter of 2004, the company recorded an impairment charge related to costs in excess of net assets of companies acquired of $10.0 million ($.09 and $.08 per share on a basic and diluted basis, respectively). This non-cash charge principally related to the company’s electronic components operations in Latin America. In calculating the impairment charge, the fair value of the reporting units was estimated using a weighted average multiple of earnings before interest and taxes from comparable businesses.

Operating Income

The company recorded operating income of $480.3 million in 2005 as compared with operating income of $439.3 million in 2004. The increase in operating income of $40.9 million is primarily a result of the cost savings realized from restructuring activities and the impact of the impairment charge which only occurred in 2004.

Operating expenses decreased in 2005, compared with 2004, by $24.5 million or 1.9%. This decrease is primarily due to the cost savings resulting from the company’s initiatives to be more efficiently organized, offset, in part, by the impact of the acquisition of Disway in 2004.

The company recorded operating income of $439.3 million in 2004 as compared with operating income of $184.0 million in 2003. The increase in operating income of $255.3 million was primarily a result of higher absolute gross profit dollars due to increased sales in 2004, the cost savings realized from restructuring activities, and the impact of the lower overall acquisition indemnification, restructuring, and integration charges in 2004 compared to 2003 offset, in part, by the impairment charge in 2004.

Operating expenses increased in 2004, compared with 2003, by $46.9 million or 3.8%. This increase was primarily due to the increase in the foreign exchange rates. Variable expenses related to incremental sales were partially offset by the cost savings resulting from the company’s restructuring activities.

21

Loss on Prepayment of Debt

The company recorded a loss on prepayment of debt of $4.3 million ($2.6 million net of related taxes or $.02 and $.01 per share on a basic and diluted basis, respectively), $33.9 million ($20.3 million net of related taxes or $.18 and $.16 per share on a basic and diluted basis, respectively), and $6.6 million ($3.9 million net of related taxes or $.04 per share) in 2005, 2004, and 2003, respectively. These items are discussed in greater detail below.

During 2005, the company repurchased, through a series of transactions, $151.8 million accreted value of its zero coupon convertible debentures due in 2021, which could have been initially put to the company in February 2006 (“convertible debentures”). The related loss on the repurchase, including the premium paid and the write-off of related deferred financing costs, aggregated $3.2 million ($1.9 million net of related taxes or $.02 and $.01 per share on a basic and diluted basis, respectively). Also during 2005, the company repurchased, through a series of transactions, $26.8 million principal amount of its 7% senior notes due in January 2007. The premium paid, the related deferred financing costs written-off upon the repurchase of this debt, and the loss for terminating the related interest rate swaps, aggregated $1.1 million ($.7 million net of related taxes). The aggregate of these charges, including $1.7 million in cash, are recognized as a loss on prepayment of debt. As a result of these transactions, net interest expense will be reduced by approximately $2.4 million from the dates of repurchase and/or redemption through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

During 2004, the company repurchased, through a series of transactions, $319.8 million accreted value of its convertible debentures. The related loss on the repurchase, including the premium paid and the write-off of related deferred financing costs, aggregated $15.0 million ($9.0 million net of related taxes or $.08 and $.07 per share on a basic and diluted basis, respectively). Also during 2004, the company repurchased and/or redeemed, through a series of transactions, $250.0 million principal amount of its 8.7% senior notes due in October 2005. The premium paid and the related deferred financing costs written-off upon the repurchase and/or redemption of this debt, net of the gain recognized by terminating the related interest rate swaps, aggregated $18.9 million ($11.3 million net of related taxes or $.10 and $.09 per share on a basic and diluted basis, respectively). The aggregate of these charges, including $28.2 million in cash, were recognized as a loss on prepayment of debt. As a result of these transactions, net interest expense will be reduced by approximately $36.2 million from the dates of repurchase and/or redemption through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

During 2003, the company repurchased, through a series of transactions, $169.0 million accreted value of its convertible debentures. The related loss on the repurchase, including the write-off of related deferred financing costs offset, in part, by the discount on the repurchase, aggregated $3.6 million ($2.2 million net of related taxes or $.02 per share). Also during 2003, the company repurchased, through a series of transactions, prior to maturity, $84.8 million principal amount of its 8.2% senior notes due in October 2003. The premium paid and the related deferred financing costs written-off upon the repurchase of this debt aggregated $2.9 million ($1.8 million net of related taxes or $.02 per share). The aggregate of these charges, including $2.3 million in cash, were recognized as a loss on prepayment of debt. As a result of these transactions, net interest expense was reduced by approximately $15.4 million from the dates of the repurchases through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

Write-Down of Investments

During 2005, the company recorded a loss of $3.0 million ($.03 per share) for an other-than-temporary decline in the fair value of its investment of Marubun Corporation. During 2004, the company recorded a loss of $1.3 million ($.01 per share) on the write-down of an investment.

Interest Expense

Net interest expense decreased 11.0% in 2005 to $91.8 million, compared with $103.2 million in 2004, primarily as a result of lower debt balances. During 2005, the company prepaid $178.6 million of debt primarily as a result of the generation of cash flow from operations of $402.5 million.

Net interest expense decreased 23.5% in 2004 to $103.2 million, compared with $135.0 million in 2003, primarily as a result of lower debt balances. The company took advantage of its strong liquidity and utilized the cash proceeds from the sale of 13.8 million shares (net proceeds of $312.5 million) of common stock in February 2004, existing cash balances, and cash flow from operations of $187.5 million to prepay $569.8 million of debt in 2004.

22

Income Taxes

The company recorded an income tax provision of $131.2 million on income before income taxes and minority interest of $385.6 million for 2005 (an effective tax rate of 34.0%) compared with an income tax provision of $96.4 million on income before income taxes and minority interest of $305.0 million (an effective tax rate of 31.6%) for 2004. The income taxes recorded in 2005 are impacted by the previously discussed restructuring charges, acquisition indemnification credit, and write-down of an investment. The income taxes recorded in 2004 were impacted by the previously discussed restructuring charges, integration credit, impairment charge, and write-down of an investment. The acquisition indemnification credit in 2004 did not result in a tax charge. There was no tax benefit provided on the aforementioned write-down of investments in 2005 and 2004 as these capital losses are not currently deductible for tax purposes. The company’s income tax provision and effective tax rate is primarily 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.

The company recorded an income tax provision of $96.4 million on income before income taxes and minority interest of $305.0 million for 2004 (an effective tax rate of 31.6%) compared with an income tax provision of $21.2 million on income before income taxes and minority interest of $47.3 million (an effective tax rate of 44.8%) for 2003. The income taxes recorded in 2004 were impacted by the previously discussed items. The income taxes recorded in 2003 were impacted by the previously discussed restructuring charges, integration charge, and the acquisition indemnification charge was not deductible for tax purposes. The company’s income tax provision and effective tax rate was primarily 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

The company recorded net income of $253.6 million for 2005, compared with $207.5 million in the year-earlier period. Included in the results for 2005 are the previously discussed acquisition indemnification credit of $1.3 million, restructuring charges of $7.3 million, loss on prepayment of debt of $2.6 million, and loss of $3.0 million on the write-down of an investment. Included in the results for 2004 are the previously discussed acquisition indemnification credit of $9.7 million, restructuring charges of $6.9 million, integration credit of $1.4 million, impairment charge of $10.0 million, loss on prepayment of debt of $20.3 million, and loss of $1.3 million on the write-down of an investment.

The company recorded net income of $207.5 million for 2004, compared with $25.7 million in the year-earlier period. Included in the results for 2004 are the previously discussed acquisition indemnification credit of $9.7 million, restructuring charges of $6.9 million, integration credit of $1.4 million, impairment charge of $10.0 million, loss on prepayment of debt of $20.3 million, and loss of $1.3 million on the write-down of an investment. Included in the results for 2003 are the previously discussed acquisition indemnification charge of $13.0 million, restructuring charges of $27.1 million, integration charge of $4.8 million, and loss on prepayment of debt of $3.9 million.

Liquidity and Capital Resources

At December 31, 2005, the company had cash and cash equivalents of $580.7 million. The net amount of cash generated by the company’s operating activities during 2005 was $402.5 million primarily from earnings from operations, adjusted for non-cash items, and the company’s ability to reduce the amount of net working capital required to support sales. The net amount of cash used for investing activities during 2005 was $32.8 million, including $179.0 million for consideration paid for acquired businesses, $33.2 million for various capital expenditures offset, in part, by $158.6 million for net proceeds from the sale of short-term investments and $18.4 million from the sale of facilities. The net amount of cash used for financing activities during 2005 was $88.4 million, primarily reflecting $152.4 million used to repurchase convertible debentures and $27.8 million used to repay 7% senior notes offset by $82.2 million for proceeds from the exercise of stock options and a change in short-term borrowings of $12.0 million. The effect of exchange rate changes on cash was a decrease of $5.9 million.

The net amount of cash provided by operating activities in 2004 was $187.5 million, primarily a result of earnings from operations, adjusted for non-cash items and the net impact of the charges, credits, and losses, partially offset by investments in working capital to support increased sales. The net amount of cash used for investing activities during 2004 was $196.4 million, including $158.6 million for net purchases of short-term investments, $35.0 million for consideration paid for acquired businesses and $23.5 million for various capital expenditures offset, in part, by proceeds of $9.6 million from notes receivable and $10.5 million from the sale

23

of facilities. The net amount of cash used for financing activities during 2004 was $300.6 million, primarily reflecting $329.6 million used to repurchase convertible debentures, $268.4 million used to repay 8.7% senior notes, and a change in short-term borrowings of $40.0 million offset by the net proceeds of $312.5 million from the sale of common stock in February 2004 and $27.9 million from the exercise of stock options. The effect of exchange rate changes on cash was an increase of $2.4 million.

The net amount of cash provided by operating activities in 2003 was $291.6 million, primarily a result of earnings from operations, adjusted for non-cash items and the net impact of the charges, and lower working capital requirements. The net amount of cash used for investing activities in 2003 was $261.5 million, primarily including $231.3 million for consideration paid for acquired businesses and $32.0 million for various capital expenditures. The net amount of cash used for financing activities in 2003 was $96.7 million, primarily reflecting $282.2 million used to repay senior notes and $168.4 million used to repurchase convertible debentures, offset, in part, by the net proceeds of $346.3 million from the June 2003 senior note offering. The effect of exchange rate changes on cash was a decrease of $15.0 million.

Cash Flows from Operating Activities

The company historically has maintained a significant investment in accounts receivable and inventories. As a percentage of total assets, accounts receivable and inventories were approximately 63.1% and 63.0% at December 31, 2005 and 2004, respectively.

Net cash provided by operating activities increased by $215.0 million in 2005, as compared with the year-earlier period, primarily reflecting the company’s initiatives to manage working capital more efficiently and earnings from operations. Working capital as a percentage of sales was 19.6% in 2005 compared with 20.7% in 2004.

Net cash provided by operating activities decreased by $104.1 million in 2004, as compared with the year-earlier period, primarily due to investments in working capital to support increased sales, partially offset by earnings from operations, adjusted for non-cash items and the net impact of the charges, credits, and losses.

Cash Flows from Investing Activities

On December 30, 2005, the company acquired DNS, a distributor of mid-range computer products in Central, Northern, and Eastern Europe, for a purchase price of $116.2 million. In addition, there was the assumption of $30.6 million in debt. Additional cash purchase consideration may be due if DNS achieves certain specified financial performance targets over the two-year period from January 1, 2006 through December 31, 2007. Such amount is not expected to exceed €12.8 million (approximately $15.2 million at the December 31, 2005 exchange rate). The cash consideration paid, net of cash acquired of $7.5 million, was $108.7 million.

In December 2005, through a series of transactions, the company acquired 70.7% of the common shares of Ultra Source, one of the leading electronic components distributors in Taiwan, for a purchase price of $64.6 million. In addition, Ultra Source had $78.9 million in debt and approximately $19.4 million in cash. The cash consideration paid, net of cash acquired, was $45.2 million.

On July 1, 2005, the company acquired the component distribution business of Connektron Pty. Ltd (“Connektron”), a passive, electromechanical, and connectors distributor in Australia and New Zealand. The cash consideration paid was $2.5 million. The impact of the Connektron acquisition was not deemed to be material to the company’s consolidated financial position and consolidated results of operations.

In July 2004, the company acquired Disway, an electronic components distributor operating in Italy, Germany, Austria, and Switzerland. The company made a final payment of $20.1 million during 2005 relating to this acquisition. The impact of the Disway acquisition was not deemed to be material to the company’s consolidated financial position and consolidated results of operations.

In February 2003, the company acquired substantially all the assets of the IED business. The net consideration paid for this acquisition was $238.1 million, of which approximately $225.9 million was paid during 2003 and $12.2 million was paid during 2004.

As a result of certain acquisitions, the company may be contractually required to purchase the shareholder interest held by others in its majority (but less than 100%) owned subsidiaries. During 2005, the company made payments aggregating $2.5 million to increase its ownership interest in Arrow/Rapac Ltd. from 51% to 74% and in Dicopel US and Dicopel SA (collectively “Dicopel”) to 100%. During 2004, the company made a payment of $.8 million to increase its ownership interest in Dicopel from 70% to 80%. During 2003, the

24

company made payments which aggregated $5.4 million to purchase additional interests in certain of its majority (but less than 100%) owned subsidiaries. If the put or call options on outstanding agreements were exercised at December 31, 2005, such payments would be approximately $.3 million, excluding the payment noted below for the remaining 26% minority interest in Arrow/Rapac Ltd., ($11.0 million at December 31, 2004). As these payments are based on the future earnings of the acquired companies, the amounts will change as the performance of these subsidiaries changes.

During the second quarter of 2005, the company closed on the sale of its Cable Assembly business, a business unit within the company’s NAC group that supplies custom cable assembly and associated contract manufacturing services. The $1.3 million loss resulting from this sale was reflected as a component of restructuring charges. The impact of this disposition was not deemed to be material to the company’s financial position and consolidated results of operations.

The company received proceeds of $18.4 million and $10.5 million during 2005 and 2004, respectively, on the sale of facilities. The company also received proceeds of $9.6 million from notes receivable in 2004.

Capital expenditures were $33.2 million, $23.5 million, and $32.0 million in 2005, 2004, and 2003, respectively.

In January 2006, the company acquired the remaining 26% minority interest in Arrow/Rapac Ltd. for approximately $3.4 million. This transaction resulted in Arrow/Rapac Ltd. becoming a wholly-owned subsidiary of the company.

On February 15, 2006, the company announced that it signed a definitive agreement to acquire SKYDATA Corporation (“SKYDATA”), a value-added distributor of data storage solutions based in Mississauga, Canada. SKYDATA maintains sales offices in Mississauga, Ottawa, and Calgary, as well as Laval, Quebec. Total SKYDATA sales for 2005 were approximately CDN $50.0 million (U.S. $43.0 million). This transaction is subject to customary closing conditions and is expected to be completed during the first quarter of 2006.

Cash Flows from Financing Activities

During 2005, the company repurchased, through a series of transactions, $151.8 million accreted value of its convertible debentures. The related loss on the repurchase, including the premium paid and the write-off of related deferred financing costs, aggregated $3.2 million ($1.9 million net of related taxes or $.02 and $.01 per share on a basic and diluted basis, respectively). Also during 2005, the company repurchased, through a series of transactions, $26.8 million principal amount of its 7% senior notes due in January 2007. The premium paid, the related deferred financing costs written-off upon the repurchase of this debt, and the loss for terminating the related interest rate swaps, aggregated $1.1 million ($.7 million net of related taxes). These charges total $4.3 million ($2.6 million net of related taxes or $.02 and $.01 per share on a basic and diluted basis, respectively), including $1.7 million in cash. As a result of these transactions, net interest expense will be reduced by approximately $2.4 million from the dates of repurchase and/or redemption through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

During 2004, the company repurchased, through a series of transactions, $319.8 million accreted value of its convertible debentures. The related loss on the repurchase, including the premium paid and the write-off of related deferred financing costs, aggregated $15.0 million ($9.0 million net of related taxes or $.08 and $.07 per share on a basic and diluted basis, respectively). Also during 2004, the company repurchased and/or redeemed, through a series of transactions, $250.0 million principal amount of its 8.7% senior notes due in October 2005. The premium paid and the related deferred financing costs written-off upon the repurchase and/or redemption of this debt, net of the gain recognized by terminating the related interest rate swaps, aggregated $18.9 million ($11.3 million net of related taxes or $.10 and $.09 per share on a basic and diluted basis, respectively). These charges total $33.9 million ($20.3 million net of related taxes or $.18 and $.16 per share on a basic and diluted basis, respectively), including $28.2 million in cash. As a result of these transactions, net interest expense will be reduced by approximately $36.2 million from the dates of repurchase and/or redemption through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

During 2003, the company repurchased, through a series of transactions, $169.0 million accreted value of its convertible debentures. The related loss on the repurchase, including the write-off of related deferred financing costs offset, in part, by the discount on the repurchase, aggregated $3.6 million ($2.2 million net of related taxes or $.02 per share). Also during 2003, the company repurchased, through a series of transactions, prior to maturity, $84.8 million principal amount of its 8.2% senior notes due in October 2003. The premium paid and the related deferred financing costs written-off upon the repurchase of this debt aggregated $2.9 million ($1.8 million net of related taxes or $.02 per share). These charges total $6.6 million

25

($3.9 million net of related taxes or $.04 per share), including $2.3 million in cash. As a result of these transactions, net interest expense was reduced by approximately $15.4 million from the dates of the repurchases through the earliest maturity date, based on interest rates in effect at the time of the repurchases.

In October 2005, the company entered into a cross-currency interest rate swap, which has a maturity date of October 2010, for approximately $200.0 million or €168.4 million (“cross-currency swap”) to hedge a portion of its net investment in euro denominated net assets and which has been designated as a net investment hedge. The cross-currency swap will also effectively convert the interest expense on $200.0 million of long-term debt from U.S. dollars to euros. Based on the foreign exchange rate at December 31, 2005, the company would expect reduced interest expense of approximately $2.0 million for the period from October 2005 through April 2006 (date that interest will reset). As the notional amount of the cross-currency swap is expected to equal a comparable amount of hedged net assets, no ineffectiveness is expected. The cross-currency swap had a fair value of $.5 million at December 31, 2005 and the related unrealized gain on the net investment hedge was recorded in the “Foreign currency translation adjustment”, which is included in the shareholders’ equity section in the accompanying consolidated balance sheet.

In June 2004, the company entered into a series of interest rate swaps (the “2004 swaps”), with an aggregate notional amount of $300.0 million. The 2004 swaps modify the company’s interest rate exposure by effectively converting the fixed 9.15% senior notes to a floating rate based on the six-month U.S. dollar LIBOR plus a spread (an effective rate of 8.57% and 6.53% at December 31, 2005 and 2004, respectively), and a portion of the fixed 6.875% senior notes to a floating rate also based on the six-month U.S. dollar LIBOR plus a spread (an effective rate of 5.55% and 3.80% at December 31, 2005 and 2004, respectively), through their maturities. The 2004 swaps are classified as fair value hedges and had a fair value of $.4 million and $12.7 million at December 31, 2005 and 2004, respectively.

In November 2003, the company entered into a series of interest rate swaps (the “2003 swaps”), with an aggregate notional amount of $200.0 million. The 2003 swaps modify the company’s interest rate exposure by effectively converting the fixed 7% senior notes to a floating rate based on the six-month U.S. dollar LIBOR plus a spread (an effective rate of 7.77% and 5.81% at December 31, 2005 and 2004, respectively) through their maturities. The 2003 swaps are classified as fair value hedges and had a negative fair value of $4.1 million and $.7 million at December 31, 2005 and 2004, respectively.

In June 2005, the company amended and restated its revolving credit agreement and, among other things, increased the facility size from $450.0 million to $600.0 million. The company had no outstanding borrowings under the revolving credit facility at December 31, 2005 and 2004. The facility fee related to the revolving credit agreement, which matures in June 2010, is .175% per annum.

The company has a $550.0 million asset securitization program (the “program”). At December 31, 2005 and 2004, there were no receivables sold to and held by third parties under the program, and as such, the company had no obligations outstanding under the program. The company has not utilized the program since June 2001. The program agreement, which requires annual renewals of the banks’ underlying liquidity facilities, expires in February 2008. In February 2006, the program was renewed with the facility fee reduced to .175%.

In February 2004, the company issued 13.8 million shares of common stock with net proceeds of $312.5 million. The proceeds were used to redeem $208.5 million of the company’s outstanding 8.7% senior notes due in October 2005, as described above, and for the repurchase of a portion of the company’s outstanding convertible debentures ($91.9 million accreted value).

In June 2003, the company completed the sale of $350.0 million principal amount of 6.875% senior notes due in 2013. The net proceeds of the offering of $346.3 million were used to repay the previously discussed 8.2% senior notes and for general corporate purposes. The additional debt the company carried during the period between the sale of the 6.875% senior notes in June 2003 and the repayment of the 8.2% senior notes in October 2003 negatively impacted income by $4.7 million ($2.9 million net of related taxes).

In February 2006, the company redeemed the total amount outstanding of $283.2 million principal amount ($156.3 million accreted value) of its convertible debentures. The pre-tax loss on the redemption aggregated $2.5 million, relating to the write-off of deferred financing costs, and will be recorded as a loss on prepayment of debt in the consolidated statement of operations during the first quarter of 2006.

26

Restructuring and Integration Activities

Based on the previously discussed restructuring and integration charges, at December 31, 2005, the company has a remaining accrual of $19.8 million, of which $16.0 million is expected to be spent in cash. The expected cash payments are approximately $9.3 million in 2006, $3.2 million in 2007, $1.7 million in 2008, $1.1 million in 2009, and $.7 million thereafter.

Impact of Governmental Regulation

There are two European Union (“EU”) directives that could have a material impact on the company’s business. The first directive is the Restriction of Certain Hazardous Substances Directive (“RoHs”). Effective July 1, 2006, this directive restricts the distribution of products within the EU containing certain substances, including lead. While the enabling legislation of some EU member countries has not yet been adopted, it is clear that the company will not be able to sell non-RoHS compliant product to most customers who intend to sell their finished goods in the EU after the effective date. Complying with this directive may impose some additional costs and administrative burdens on the company. If the company fails to achieve compliance, including by reason of a delay or failure of its suppliers to comply, the company may be restricted from conducting certain business in the EU, which could adversely affect its results of operations. In addition, some of the company’s inventory contains substances prohibited by the RoHS directive. Upon effectiveness of the RoHS legislation, should the company be unable to sell such inventory to locations which do not have such restrictions, or return it to suppliers, some of that inventory may become unsaleable and, as a result, have to be written off.

The second directive is the Waste Electrical and Electronic Equipment Directive (“WEEE”) which was effective August 13, 2005 in certain EU Member countries. A number of member countries, however, have not yet enacted legislation or delayed their legislation’s effective date. Under WEEE, a manufacturer or importer will be required, at its own cost, to take back and recycle all of the products it manufactured in or imported into the EU. To date, there has not been a material impact to the company’s business due to the implementation of WEEE. Since WEEE has only recently been implemented in certain EU member countries and not yet implemented in others, it is unclear what business impact it will have on the company’s operations. Thus, it is difficult to quantify the impact, if any, of WEEE on the company’s financial performance.

Both directives will affect the worldwide electronics and electronic components industries, and collaborative efforts among suppliers, distributors and customers to develop compliant processes are continuing. Pending those developments, the full implementation of existing regulations, and the final enactment of enabling legislation for the remaining EU member countries, it is not possible to estimate the cost of compliance or the costs associated with inventory that could become unsaleable. Also under consideration are similar regulations in other jurisdictions, such as China. The promulgation of policies and procedures geared to comply with these regulations and those described above with regard to the EU, may result in significant costs to the company.

Contractual Obligations

Payments due under contractual obligations at December 31, 2005 were as follows (in thousands):

(a)

Includes convertible debentures of $155.5 million. The company subsequently redeemed these convertible debentures in February 2006.

(b)

Amounts represent an estimate of non-cancelable inventory purchase orders and other contractual obligations related to information technology and facilities as of December 31, 2005. Most of the

27

		company’s inventory purchases are pursuant to authorized distributor agreements, which are typically cancelable by either party at any time or on short notice, usually within a few months.
(c)		Includes estimates of contributions required to meet the requirements of several defined benefit plans. Amounts are subject to change based upon the performance of plan assets, as well as the discount rate

used to determine the obligation. The company is unable to estimate the projected contributions beyond 2010. Also included are amounts relating to personnel, customer termination, and certain other costs resulting from restructuring and integration activities. Amounts relating to facilities are included in operating leases.

Under the terms of various joint venture agreements, the company would be required to pay its pro-rata share, based upon its ownership interests, of the third party debt of the joint ventures in the event that the joint ventures were unable to meet their obligations. At December 31, 2005, the company’s pro-rata share of this debt was $2.5 million. The company believes there is sufficient equity in the joint ventures to cover this potential liability.

Off-Balance Sheet Arrangements

An off-balance sheet arrangement is any contractual arrangement involving an unconsolidated entity under which a company has (a) made guarantees, (b) a retained or a contingent interest in transferred assets, (c) any obligation under certain derivative instruments or (d) any obligation under a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the company, or engages in leasing, hedging, or research and development services within the company.

The company does not have any off-balance sheet financing or unconsolidated special purpose entities.

Critical Accounting Policies and Estimates

The company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires the company to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. The company evaluates its estimates, including those related to uncollectible receivables, inventories, intangible assets, income taxes, restructuring and integration costs, and contingencies and litigation, on an ongoing basis. The company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The company believes the following critical accounting policies, among others, involve the more significant judgments and estimates used in the preparation of its consolidated financial statements:

-		The company recognizes revenue in accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectibility is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates, and returns.
		A portion of the company’s business involves shipments directly from its suppliers to its customers. In these transactions, the company is responsible for negotiating price both with the supplier and customer, payment to the supplier, establishing payment terms with the customer, product returns, and has risk of loss if the customer does not make payment. As the principal with the customer, the company recognizes the sale and cost of sale of the product upon receiving notification from the supplier that the product has been shipped.
		In addition, the company has certain business with select customers and suppliers that is accounted for on an agency basis (that is, the company recognizes the fees associated with serving as an agent in sales with no associated cost of sales) in accordance with Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”.
		In the fourth quarter of 2004, based upon an evaluation of its business and accounting practices, the company determined that revenue related to the sale of service contracts should more appropriately be classified on an agency basis rather than a gross basis. While this change reduced reported sales

28

and cost of sales, it had no impact on gross profit, operating income, net income, cash flow, or the balance sheet. All prior period sales and cost of sales were reclassified to present the revenue related to the sale of service contracts on an agency basis. Sales and cost of sales were reduced by $171.0 million for the nine months ended September 30, 2004 and $151.0 million for the full year 2003.

-		The company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowances for doubtful accounts are determined using a combination of factors, including the length of time the receivables are outstanding, the current business environment, and historical experience. In addition, if the financial condition of the company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.
-		Inventories are recorded at the lower of cost or market. Write-downs of inventories to market value are based upon contractual provisions governing price protection, stock rotation, and obsolescence, as well as assumptions about future demand and market conditions. If assumptions about future demand change and/or actual market conditions are less favorable than those projected by the company, additional write-downs of inventories may be required. Due to the large number of transactions and the complexity of managing the process around price protections and stock rotations, estimates are made regarding adjustments to the book cost of inventories. Actual amounts could be different from those estimated.
-		The company assesses its investments accounted for as available-for-sale on a quarterly basis to determine whether declines in market value below cost are other-than-temporary. When the decline is determined to be other-than-temporary, the cost basis for the individual security is reduced and a loss is realized in the period in which it occurs. The company makes such determination based upon the quoted market price, financial condition, operating results of the investee, and the company’s intent and ability to retain the investment over a period of time which would be sufficient to allow for any recovery in market value. In addition, the company assesses the following factors:

	-		broad economic factors impacting the investee’s industry,
	-		publicly available forecasts for sales and earnings growth for the industry and investee, and
	-		the cyclical nature of the investee’s industry.

		The company could potentially have an impairment charge in future periods if, among other factors, the investee’s future earnings differ from currently available forecasts.
-		The carrying value of the company’s deferred tax assets is dependent upon the company’s ability to generate sufficient future taxable income in certain tax jurisdictions. Should the company determine that it would not be able to realize all or part of its deferred tax assets in the future, a valuation allowance to the deferred tax assets would be established in the period such determination was made.
-		It is the company’s policy to establish accruals for taxes that may become payable in future years as a result of examinations by tax authorities. The company establishes the accruals based upon management’s assessment of probable contingencies. At December 31, 2005, the company believes it has appropriately accrued for probable contingencies. To the extent the company were to prevail in matters for which accruals have been established or be required to pay amounts in excess of accruals, the company’s effective tax rate in a given financial statement period could be affected.
-		The company uses various financial instruments, including derivative financial instruments, for purposes other than trading. Derivatives used as part of the company’s risk management strategy are designated at inception as hedges and measured for effectiveness both at inception and on an ongoing basis. The company has also entered into interest rate swap transactions that convert certain fixed rate debt to variable rate debt, effectively hedging the change in fair value of the fixed rate debt resulting from fluctuations in interest rates. The fair value hedges and the hedged debt are adjusted to current market values through interest expense.
-		The effective portion of the change in the fair value of the derivative designated as a net investment hedge is recorded in the foreign currency translation adjustment, which is included in the shareholders’ equity section, and any ineffective portion would be recorded in earnings. The company uses the hypothetical derivative method to assess the effectiveness of its net investment hedge on a quarterly basis.
-		The company is subject to proceedings, lawsuits, and other claims related to environmental, labor, product, tax, and other matters. The company assesses the likelihood of an adverse judgment or

29

		outcomes for these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis. The required reserves may change in the future due to new developments impacting the probability of a loss, the estimate of such loss, and the probability of recovery of such loss from third parties.
-		The company has recorded charges in connection with restructuring its businesses, as well as the integration of acquired businesses. These items primarily include employee separation costs and estimates related to the consolidation of facilities (net of sub-lease income), contractual obligations, and the valuation of certain assets including accounts receivable, inventories, and investments. Actual amounts could be different from those estimated.
-		The costs and obligations of the company’s defined benefit pension plan are dependent on actuarial assumptions. The two critical assumptions used which impact the net periodic pension cost (income) and the benefit obligation are the discount rate and expected return on plan assets. The discount rate represents the market rate for a high quality corporate bond and the expected return on plan assets is based on current and expected asset allocations, historical trends, and expected returns on plan assets. These key assumptions are evaluated annually. Changes in these assumptions can result in different expense and liability amounts.
-		The company performs an annual impairment test as of the first day of the fourth quarter, or earlier if indicators of potential impairment exist, to evaluate goodwill. Goodwill is considered impaired if the carrying amount of the reporting unit exceeds its estimated fair value. In assessing the recoverability of goodwill, the company reviews both quantitative as well as qualitative factors to support its assumptions with regard to fair value. The fair value of a reporting unit is estimated using a weighted average multiple of earnings before interest and taxes from comparable companies. In determining the fair value, the company makes certain judgments, including the identification of reporting units and the selection of comparable companies. If these estimates or their related assumptions change in the future as a result of changes in strategy and/or market conditions, the company may be required to record an impairment charge.
-		Shipping and handling costs may be reported as either a component of cost of products sold or selling, general and administrative expenses. The company reports shipping and handling costs, primarily related to outbound freight, in the consolidated statement of operations as a component of selling, general and administrative expenses. If the company included such costs in cost of products sold, gross profit margin as a percentage of sales for 2005 would decrease from 15.6% to 15.1% with no impact on reported earnings.

Impact of Recently Issued Accounting Standards

In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“Statement No. 123R”). Statement No. 123R addresses all forms of share-based payment (“SBP”) awards, including, but not limited to, shares issued under stock options, restricted stock, performance shares, and stock appreciation rights. As required, the company has begun to record compensation expense for SBP awards measured at fair value as of January 1, 2006 and currently estimates compensation expense to be in the range of approximately $8.0 million to $8.5 million (net of related taxes) and $.06 to $.08 per share. Statement No. 123R also requires that the benefits of tax deductions in excess of compensation expense recognized be reported as a financing cash flow rather than as an operating cash flow, as required under previous accounting guidance. This requirement may result in a reduction of net operating cash flows and an increase of net financing cash flows in periods after adoption. The company is not able to estimate the benefits of such tax deductions for future periods as they depend on, among other things, when employees exercise stock options. The company’s estimate may be impacted by certain variables including, but not limited to, stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and related tax impacts. The company has transitioned to Statement No. 123R using the modified prospective application and will continue to utilize the Black-Scholes option-pricing model to value stock options.

Information Relating to Forward-Looking Statements

This report includes forward-looking statements that are subject to numerous assumptions, risks and uncertainties which could cause actual results or facts to differ materially from such statements for a variety of reasons, including, but not limited to: industry conditions, changes in product supply, pricing and customer demand, competition, other vagaries in the electronic components and computer products markets, changes in relationships with key suppliers, increased profit margin pressure, the effects of additional actions taken to become more efficient or lower costs, and the company’s ability to generate additional cash flow. Shareholders

30

and other readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The company undertakes no obligation to update publicly or revise any of the forward-looking statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The company is exposed to market risk from changes in foreign currency exchange rates and interest rates.

Foreign Currency Exchange Rate Risk

The company, as a large global organization, faces exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material impact on the company’s financial results in the future. The company’s primary exposure relates to transactions in which the currency collected from customers is different from the currency utilized to purchase the product sold in Europe, the Asia/Pacific region, Canada, and Latin America. The company’s policy is to hedge substantially all such currency exposures for which natural hedges do not exist. Natural hedges exist when purchases and sales within a specific country are both denominated in the same currency and therefore no exposure exists to hedge with a foreign exchange forward, option, or swap contracts (collectively, the “foreign exchange contracts”). In many regions in Asia, for example, sales and purchases are primarily denominated in U.S. dollars, resulting in a “natural hedge”. Natural hedges exist in most countries in which the company operates, although the percentage of natural offsets, as compared with offsets, which need to be hedged by foreign exchange contracts, will vary from country to country. The company does not enter into foreign exchange contracts for trading purposes. The risk of loss on a foreign exchange contract is the risk of nonperformance by the counterparties, which the company minimizes by limiting its counterparties to major financial institutions. The fair value of the foreign exchange contracts is estimated using market quotes. The notional amount of the foreign exchange contracts at December 31, 2005 and 2004 was $228.4 million and $224.7 million, respectively. The carrying amounts, which are nominal, approximated fair value at December 31, 2005 and 2004.

The translation of the financial statements of the non-North American operations is impacted by fluctuations in foreign currency exchange rates. The increase in consolidated sales and operating income was impacted by the translation of the company’s international financial statements into U.S. dollars which resulted in increased sales of $6.8 million and increased operating income of $2.9 million for 2005, compared with the year-earlier periods, based on 2004 sales at the average rate for 2005. Sales and operating income would have decreased by approximately $333.0 million and $12.8 million, respectively, if average foreign exchange rates had declined by 10% against the U.S. dollar in 2005. This amount was determined by considering the impact of a hypothetical foreign exchange rate on the sales and operating income of the company’s international operations.

The company entered into a cross-currency swap for approximately $200.0 million or €168.4 million to hedge a portion of its net investment in euro denominated net assets. The cross-currency swap will also effectively convert the interest expense on $200.0 million of long-term debt from U.S. dollars to euros. Based on the foreign exchange rate at December 31, 2005, the company would expect reduced interest expense of approximately $2.0 million for the period from October 2005 through April 2006 (date that interest will reset). As the notional amount of the cross-currency swap is expected to equal a comparable amount of hedged net assets, no ineffectiveness is expected. The cross-currency swap had a fair value of $.5 million at December 31, 2005.

Interest Rate Risk

The company’s interest expense, in part, is sensitive to the general level of interest rates in the Americas, Europe, and the Asia/Pacific region. The company historically has managed its exposure to interest rate risk through the proportion of fixed rate and floating rate debt in its total debt portfolio. In addition, the company uses interest rate swaps to manage its targeted mix of fixed and floating rate debt. At December 31, 2005, approximately 57% of the company’s debt was subject to fixed rates and 43% of its debt was subject to floating rates. A one percentage point change in average interest rates would not have a material impact on interest expense, net of interest income, in 2005. This was determined by considering the impact of a hypothetical interest rate on the company’s average floating rate on invested cash and outstanding debt. This analysis does not consider the effect of the level of overall economic activity that could exist. In the event of a change in the level of economic activity, which may adversely impact interest rates, the company could likely take actions to further mitigate any potential negative exposure to the change. However, due to the uncertainty of the specific actions that might be taken and their possible effects, the sensitivity analysis assumes no changes in the company’s financial structure.

31

Item 8. Financial Statements and Supplementary Data.

REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Arrow Electronics, Inc.

We have audited the accompanying consolidated balance sheets of Arrow Electronics, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and the schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arrow Electronics, Inc. at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Arrow Electronics, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2006 expressed an unqualified opinion thereon.

 
/s/ ERNST & YOUNG LLP

 
New York, New York
February 22, 2006

32

ARROW ELECTRONICS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands except per share data)

See accompanying notes.

33

ARROW ELECTRONICS, INC.
CONSOLIDATED BALANCE SHEET
(In thousands)

See accompanying notes.

34

ARROW ELECTRONICS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)

See accompanying notes.

35

ARROW ELECTRONICS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In thousands)

36

ARROW ELECTRONICS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (continued)
(In thousands)

See accompanying notes.

37

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

1. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the company and its majority-owned subsidiaries. All significant intercompany transactions are eliminated.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investments, which are readily convertible into cash and have maturities of three months or less when acquired.

Short-term Investments

Short-term investments, consisting primarily of high-grade debt securities including Auction Rate Securities, are classified as available-for-sale securities. The company classifies as short-term investments those investments with an original maturity of less than one year or those investments it intends to sell within one year. The carrying amount reported in the consolidated balance sheet for short-term investments approximates fair value.

Net Investment Hedge

The effective portion of the change in the fair value of the derivative designated as a net investment hedge is recorded in the foreign currency translation adjustment, which is included in the shareholders’ equity section, and any ineffective portion would be recorded in earnings. The company uses the hypothetical derivative method to assess the effectiveness of its net investment hedge on a quarterly basis.

Financial Instruments

The company uses various financial instruments, including derivative financial instruments, for purposes other than trading. Derivatives used as part of the company’s risk management strategy are designated at inception as hedges and measured for effectiveness both at inception and on an ongoing basis. The company has also entered into interest rate swap transactions that convert certain fixed rate debt to variable rate debt, effectively hedging the change in fair value of the fixed rate debt resulting from fluctuations in interest rates. The fair value hedges and the hedged debt are adjusted to current market values through interest expense.

Inventories

Inventories are stated at the lower of cost or market. Cost approximates the first-in, first-out method.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation is computed on the straight-line method for financial reporting purposes and on accelerated methods for tax reporting purposes. Leasehold improvements are amortized over the shorter of the term of the related lease or the life of the improvement. Long-lived assets are reviewed for impairment whenever changes in circumstances or events may indicate that the carrying amounts may not be recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized for the difference.

38

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

Investments

Investments are accounted for using the equity method of accounting if the investment provides the company the ability to exercise significant influence, but not control, over an investee. Significant influence is generally deemed to exist if the company has an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s Board of Directors, are considered in determining whether the equity method of accounting is appropriate. The company records its investments in equity method investees meeting these characteristics as “Investments in affiliated companies” in the accompanying consolidated balance sheet.

All other equity investments, which consist of investments for which the company does not have the ability to exercise significant influence, are accounted for under the cost method, if private, or as available-for-sale, if public, and are included in “Other assets” in the accompanying consolidated balance sheet. Under the cost method of accounting, investments are carried at cost and are adjusted only for other-than-temporary declines in realizable value, distributions of earnings, and additional investments. If classified as available-for-sale, the company accounts for the changes in the fair value with unrealized gains or losses reflected in the shareholders’ equity section in the accompanying consolidated balance sheet in “Other”. The company assesses its long-term investments accounted for as available-for-sale on a quarterly basis to determine whether declines in market value below cost are other-than-temporary. When the decline is determined to be other-than-temporary, the cost basis for the individual security is reduced and a loss is realized in the period in which it occurs. When the decline is determined to be temporary, the unrealized losses are included in the shareholders’ equity section in the accompanying consolidated balance sheet in “Other”. The company makes such determination based upon the quoted market price, financial condition, operating results of the investee, and the company’s intent and ability to retain the investment over a period of time which would be sufficient to allow for any recovery in market value. In addition, the company assesses the following factors:

	-		broad economic factors impacting the investee’s industry,
	-		publicly available forecasts for sales and earnings growth for the industry and investee, and
	-		the cyclical nature of the investee’s industry.

The company could potentially have an impairment charge in future periods if, among other factors, the investee’s future earnings differ from currently available forecasts.

Cost in Excess of Net Assets of Companies Acquired

The company performs an annual impairment test as of the first day of the fourth quarter, or earlier if indicators of potential impairment exist, to evaluate goodwill. Goodwill is considered impaired if the carrying amount of the reporting unit exceeds its estimated fair value. In assessing the recoverability of goodwill, the company reviews both quantitative as well as qualitative factors to support its assumptions with regard to fair value. The fair value of a reporting unit is estimated using a weighted average multiple of earnings before interest and taxes from comparable companies. In determining the fair value, the company makes certain judgments, including the identification of reporting units and the selection of comparable companies. If these estimates or their related assumptions change in the future as a result of changes in strategy and/or market conditions, the company may be required to record an impairment charge.

Foreign Currency Translation

The assets and liabilities of foreign operations are translated at the exchange rates in effect at the balance sheet date, with the related translation gains or losses reported as a separate component of shareholders’ equity in the accompanying consolidated balance sheet. The results of foreign operations are translated at the monthly average exchange rates.

Income Taxes

Income taxes are accounted for under the liability method. Deferred taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting

39

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

amounts. The carrying value of the company’s deferred tax assets is dependent upon the company’s ability to generate sufficient future taxable income in certain tax jurisdictions. Should the company determine that it would not be able to realize all or part of its deferred tax assets in the future, a valuation allowance to the deferred tax assets would be established in the period such determination was made.

It is the company’s policy to establish accruals for taxes that may become payable in future years as a result of examinations by tax authorities. The company establishes the accruals based upon management’s assessment of probable contingencies. At December 31, 2005, the company believes it has appropriately accrued for probable contingencies. To the extent the company were to prevail in matters for which accruals have been established or be required to pay amounts in excess of accruals, the company’s effective tax rate in a given financial statement period could be affected.

Net Income Per Share

Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock.

Comprehensive Income

Comprehensive income is defined as the aggregate change in shareholders’ equity excluding changes in ownership interests. Comprehensive income consists of foreign currency translation adjustments, unrealized gain on securities, unrealized loss on employee benefit plan assets, unrealized gain (loss) on foreign exchange options, and minimum pension liability adjustments. The unrealized gain on securities are net of any reclassification adjustments for realized loss included in net income. The foreign currency translation adjustments included in comprehensive income have not been tax effected as investments in foreign affiliates are deemed to be permanent.

Stock-based Compensation

The company accounts for stock-based compensation using Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees”. The company adopted the disclosure requirements of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (collectively, “Statement No. 123”) which uses a fair-value based method of accounting for stock-based employee compensation plans.

The company’s current method of accounting utilizes the intrinsic value method whereby stock options are granted at market price and therefore no compensation costs are recognized.

40

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

If compensation expense for the company’s various stock-based compensation plans (“compensation plans”) had been determined utilizing the fair value method of accounting at the grant dates for awards under the compensation plans in accordance with Statement No. 123, the company’s pro forma net income and basic and diluted net income per share would have been as follows:

The estimated weighted average fair value, utilizing the Black-Scholes option-pricing model, at the date of option grant, during 2005, 2004, and 2003 was $11.90, $11.34, and $9.62 per share, respectively. The weighted average fair value was estimated using the following assumptions:

There is no expected dividend yield.

Segment Reporting

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The company’s operations are classified into two reportable business segments, the distribution of electronic components and the distribution of computer products.

Revenue Recognition

The company recognizes revenue in accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectibility is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates, and returns.

A portion of the company’s business involves shipments directly from its suppliers to its customers. In these transactions, the company is responsible for negotiating price both with the supplier and customer, payment to the supplier, establishing payment terms with the customer, product returns, and has risk of loss if the customer does not make payment. As the principal with the customer, the company recognizes the sale and cost of sale of the product upon receiving notification from the supplier that the product has been shipped.

In addition, the company has certain business with select customers and suppliers that is accounted for on an agency basis (that is, the company recognizes the fees associated with serving as an agent in sales

41

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

with no associated cost of sales) in accordance with Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”.

In the fourth quarter of 2004, based upon an evaluation of its business and accounting practices, the company determined that revenue related to the sale of service contracts should more appropriately be classified on an agency basis rather than a gross basis. While this change reduced reported sales and cost of sales, it had no impact on gross profit, operating income, net income, cash flow, or the balance sheet. All prior period sales and cost of sales were reclassified to present the revenue related to the sale of service contracts on an agency basis. Sales and cost of sales were reduced by $171,004 for the nine months ended September 30, 2004 and $150,982 for the full year 2003.

Shipping and Handling Costs

Shipping and handling costs included in selling, general and administrative expenses totaled $56,629, $57,296, and $42,941 in 2005, 2004, and 2003, respectively.

Software Development Costs

The company capitalizes qualifying costs under FASB Statement of Position 98-1, “Accounting for the Costs to Develop or Obtain Software for Internal Use” including certain costs incurred in connection with developing or obtaining software for internal use. Capitalized software costs are amortized on a straight-line basis over the estimated useful life of the software, which is generally three to five years.

Impact of Recently Issued Accounting Standards

In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“Statement No. 123R”). Statement No. 123R addresses all forms of share-based payment (“SBP”) awards, including, but not limited to, shares issued under stock options, restricted stock, performance shares, and stock appreciation rights. As required, the company has begun to record compensation expense for SBP awards measured at fair value as of January 1, 2006 and currently estimates compensation expense to be in the range of approximately $8,000 to $8,500 (net of related taxes) and $.06 to $.08 per share. Statement No. 123R also requires that the benefits of tax deductions in excess of compensation expense recognized be reported as a financing cash flow rather than as an operating cash flow, as required under previous accounting guidance. This requirement may result in a reduction of net operating cash flows and an increase of net financing cash flows in periods after adoption. The company is not able to estimate the benefits of such tax deductions for future periods as they depend on, among other things, when employees exercise stock options. The company’s estimate may be impacted by certain variables including, but not limited to, stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and related tax impacts. The company has transitioned to Statement No. 123R using the modified prospective application and will continue to utilize the Black-Scholes option-pricing model to value stock options.

Reclassification

Certain prior year amounts have been reclassified to conform with current year presentation.

2. Acquisitions/Disposition

The following acquisitions have been accounted for as purchase transactions and, accordingly, results of operations have been included in the consolidated results of the company from the dates of acquisition.

2005

On December 30, 2005, the company acquired DNSint.com AG (“DNS”) for a purchase price of $116,224, which included cash acquired as well as acquisition costs. In addition, there was the assumption of $30,638 in debt. Additional cash purchase consideration may be due if DNS achieves certain specified financial performance targets over the two-year period from January 1, 2006 through December 31, 2007. Such amount is not expected to exceed €12,800 (approximately $15,200 at the December 31, 2005

42

ARROW ELECTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

exchange rate). DNS, which is headquartered in Munich, Germany, is a distributor of mid-range computer products in Central, Northern, and Eastern Europe and is one of the largest suppliers of Sun Microsystems, Inc. products in Europe. In 2005, DNS had sales in excess of $400,000. The cash consideration paid, net of cash acquired of $7,500, was $108,724.

In December 2005, through a series of transactions, the company acquired 70.7% of the common shares of Ultra Source Technology Corp. (“Ultra Source”) for a purchase price of $64,647 which included cash acquired as well as acquisition costs. In addition, Ultra Source had $78,850 in debt and $19,497 in cash. Ultra Source, which is headquartered in Taipei, Taiwan, is one of the leading electronic components distributors in Taiwan with sales offices and distribution centers in Taiwan, Hong Kong, and the People’s Republic of China. In 2005, Ultra Source had sales in excess of $500,000. The cash consideration paid, net of cash acquired, was $45,150.

The following table summarizes the preliminary allocation of the net consideration paid to the fair value of the assets acquired and liabilities assumed for the DNS and Ultra Source acquisitions:

The preliminary allocation is subject to refinement as the company has not yet completed its evaluation of the fair value of the assets acquired and liabilities assumed, including the valuation of any identifiable intangible assets acquired through these acquisitions.