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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2010

or

For the transition period from           to            

Commission File Number:  0-10653

UNITED STATIONERS INC.

(Exact Name of Registrant as Specified in its Charter)

One Parkway North Boulevard
Suite 100
Deerfield, Illinois 60015-2559
(847) 627-7000
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s
Principal Executive Offices)

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

None

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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

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

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

On April 28, 2010, United Stationers Inc. had 24,202,397 shares of common stock outstanding.

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UNITED STATIONERS INC.
FORM 10-Q
For the Quarterly Period Ended March 31, 2010

TABLE OF CONTENTS

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UNITED STATIONERS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)
(Unaudited)

See notes to condensed consolidated financial statements.

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UNITED STATIONERS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)
(Unaudited)

See notes to condensed consolidated financial statements.

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UNITED STATIONERS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)
(Unaudited)

See notes to condensed consolidated financial statements.

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UNITED STATIONERS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying Condensed Consolidated Financial Statements represent United Stationers Inc. (“USI”) with its wholly owned subsidiary United Stationers Supply Co. (“USSC”), and USSC’s subsidiaries (collectively, “United” or the “Company”). The Company is a leading wholesale distributor of business products, with net sales for the trailing 12 months of $4.7 billion. The Company operates in a single reportable segment as a national wholesale distributor of business products. The Company offers more than 100,000 items from over 1,000 manufacturers. These items include a broad spectrum of technology products, traditional business products, office furniture, janitorial and breakroom supplies, and industrial supplies. In addition, the Company also offers private brand products. The Company primarily serves commercial and contract office products dealers. The Company sells its products through a national distribution network of 64 distribution centers to approximately 25,000 resellers, who in turn sell directly to end-consumers.

The accompanying Condensed Consolidated Financial Statements are unaudited, except for the Condensed Consolidated Balance Sheet as of December 31, 2009, which was derived from the December 31, 2009 audited financial statements. The Condensed Consolidated Financial Statements have been prepared in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements, prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted pursuant to such rules and regulations. Accordingly, the reader of this Quarterly Report on Form 10-Q should refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for further information.

In the opinion of the management of the Company, the Condensed Consolidated Financial Statements for the periods presented include all adjustments necessary to fairly present the Company’s results for such periods. Certain interim estimates of a normal, recurring nature are recognized throughout the year, relating to accounts receivable, supplier allowances, inventory, customer rebates, price changes and product mix. The Company evaluates these estimates periodically and makes adjustments where facts and circumstances dictate.

Acquisition of MBS Dev, Inc.

The Company completed the acquisition of all of the capital stock of MBS Dev, Inc. (“MBS Dev”) during the quarter for a purchase price of $15 million and an additional potential $3 million earn-out based upon the achievement of certain financial goals.  The purchase price consisted of $12 million in cash at closing plus $3 million to be paid to the former owners over the course of the next three years, the timing (but not the amount) of which is based upon achievement of certain financial goals.  Net of cash held by MBS Dev at closing, the initial cash outlay was $10.5 million.  MBS Dev is a software solutions provider to business products resellers and allows the Company to accelerate e-business development and enable customers and suppliers to leverage the internet.  As a result of the acquisition the Company recorded $13.9 million of goodwill, $3.7 million in intangible assets, and $4.1 million of liabilities to be paid upon achievement of certain financial metrics agreed to in the purchase agreement.  The $4.1 million liability represents the combined fair value of both earn-outs.

2.              Summary of Significant Accounting Policies

Principles of Consolidation

The Condensed Consolidated Financial Statements include the accounts of the Company. All intercompany accounts and transactions have been eliminated in consolidation. For all acquisitions, account balances and results of operations are included in the Condensed Consolidated Financial Statements as of the date acquired.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results could differ from these estimates.

Various assumptions and other factors underlie the determination of significant accounting estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial techniques. The Company periodically reevaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from estimates.

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Supplier Allowances

Supplier allowances (fixed or variable) are common practice in the business products industry and have a significant impact on the Company’s overall gross margin. Gross margin is determined by, among other items, file margin (determined by reference to invoiced price), as reduced by customer discounts and rebates as discussed below, and increased by supplier allowances and promotional incentives. Receivables related to supplier allowances totaled $58.8 million and $78.2 million as of March 31, 2010 and December 31, 2009, respectively.  These receivables are included in “Accounts receivable” in the Condensed Consolidated Balance Sheets.

In the first quarter of 2010, approximately 14% of the Company’s estimated supplier allowances and incentives were fixed, based on supplier participation in various Company advertising and marketing publications. Fixed allowances and incentives are taken to income through lower cost of goods sold as inventory is sold.

The remaining 86% of the Company’s supplier allowances and incentives in the first quarter of 2010 were variable, based on the volume and mix of the Company’s product purchases from suppliers.  These variable allowances are recorded based on the Company’s annual inventory purchase volumes and product mix and are included in the Company’s financial statements as a reduction to cost of goods sold, thereby reflecting the net inventory purchase cost. Supplier allowances and incentives attributable to unsold inventory are carried as a component of net inventory cost. The potential amount of variable supplier allowances often differs based on purchase volumes by supplier and product category. As a result, changes in the Company’s sales volume (which can increase or reduce inventory purchase requirements) and changes in product sales mix (especially because higher-margin products often benefit from higher supplier allowance rates) can create fluctuations in variable supplier allowances.

Customer Rebates

Customer rebates and discounts are common practice in the business products industry and have a significant impact on the Company’s overall sales and gross margin. Such rebates are reported in the Condensed Consolidated Financial Statements as a reduction of sales. Customer rebates of $39.1 million and $59.5 million as of March 31, 2010 and December 31, 2009, respectively, are included as a component of “Accrued liabilities” in the Condensed Consolidated Balance Sheets.

Customer rebates include volume rebates, sales growth incentives, advertising allowances, participation in promotions and other miscellaneous discount programs. These rebates are paid to customers monthly, quarterly and/or annually. Estimates for volume rebates and growth incentives are based on estimated annual sales volume to the Company’s customers.

The aggregate amount of customer rebates depends on product sales mix and customer mix changes. Reported results reflect management’s current estimate of such rebates. Changes in estimates of sales volumes, product mix, customer mix or sales patterns, or actual results that vary from such estimates, may impact future results.

Revenue Recognition

Revenue is recognized when a service is rendered or when title to the product has transferred to the customer. Management records an estimate for future product returns related to revenue recognized in the current period. This estimate is based on historical product return trends and the gross margin associated with those returns. Management also records customer rebates that are based on estimated annual sales volume to the Company’s customers. Annual rebates earned by customers include growth components, volume hurdle components, and advertising allowances.

Shipping, handling and fuel costs billed to customers are treated as revenues and recognized at the time title to the product has transferred to the customer. Freight costs for inbound and outbound shipments are included in the Company’s financial statements as a component of cost of goods sold and not netted against shipping and handling revenues. Net sales do not include sales tax charged to customers.

Valuation of Accounts Receivable

The Company makes judgments as to the collectability of accounts receivable based on historical trends and future expectations. Management estimates an allowance for doubtful accounts, which addresses the collectability of trade accounts receivable. This allowance adjusts gross trade accounts receivable downward to its estimated collectible or net realizable value. To determine the allowance for doubtful accounts, management reviews specific customer risks and the Company’s accounts receivable aging.  Uncollectible receivable balances are written off against the allowance for doubtful accounts when it is determined that the receivable balance is uncollectible.

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Insured Loss Liability Estimates

The Company is primarily responsible for retained liabilities related to workers’ compensation, vehicle, property and general liability and certain employee health benefits. The Company records expense for paid and open claims and an expense for claims incurred but not reported based on historical trends and on certain assumptions about future events. The Company has an annual per-person maximum cap, provided by a third-party insurance company, on certain employee medical benefits. In addition, the Company has both a per-occurrence maximum loss and an annual aggregate maximum cap on workers’ compensation claims.

Leases

The Company leases real estate and personal property under operating leases. Certain operating leases include incentives from landlords including landlord “build-out” allowances, rent escalation clauses and rent holidays or periods in which rent is not payable for a certain amount of time. The Company accounts for landlord “build-out” allowances as deferred rent at the time of possession and amortizes this deferred rent on a straight-line basis over the term of the lease.

The Company also recognizes leasehold improvements and amortizes these improvements over the shorter of (1) the term of the lease or (2) the expected life of the respective improvements.

The Company accounts for rent escalation and rent holidays as deferred rent at the time of possession and amortizes this deferred rent on a straight-line basis over the term of the lease. As of March 31, 2010, the Company is not a party to any capital leases.

Inventories

Inventory valued under the last-in, first-out (“LIFO”) accounting method constituted approximately 80% and 79% of total inventory as of March 31, 2010 and December 31, 2009, respectively. LIFO results in a better matching of costs and revenues. The remaining inventory is valued under the first-in, first-out (“FIFO”) accounting method. Inventory valued under the FIFO and LIFO accounting methods is recorded at the lower of cost or market. If the Company had valued its entire inventory under the lower of FIFO cost or market, inventory would have been $81.9 million and $80.9 million higher than reported as of March 31, 2010 and December 31, 2009, respectively. The change in the LIFO reserve since December 31, 2009, resulted in a $1.0 million increase in cost of sales.

The Company also records adjustments to inventory for shrinkage. Inventory that is obsolete, damaged, defective or slow moving is recorded to the lower of cost or market. These adjustments are determined using historical trends and are adjusted, if necessary, as new information becomes available.  The Company charges certain warehousing and administrative expenses to inventory each period with $25.6 million and $25.3 million remaining in inventory as of March 31, 2010 and December 31, 2009, respectively.

Cash and Cash Equivalents

An unfunded check balance (payments in-transit) exists for the Company’s primary disbursement accounts.  Under the Company’s cash management system, the Company utilizes available cash and borrowings, on an as-needed basis, to fund the clearing of checks as they are presented for payment.  As of March 31, 2010 and December 31, 2009, outstanding checks totaling $35.7 million and $88.4 million, respectively, were included in “Accounts payable” in the Condensed Consolidated Balance Sheets.

All highly-liquid investments with original maturities of three months or less are considered to be short-term investments.  Short-term investments consist primarily of money market funds rated AAA and are stated at cost, which approximates fair value.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation and amortization are determined by using the straight-line method over the estimated useful lives of the assets. The estimated useful life assigned to fixtures and equipment is from two to 10 years; the estimated useful life assigned to buildings does not exceed 40 years; leasehold improvements are amortized over the lesser of their useful lives or the term of the applicable lease. Repairs and maintenance costs are charged to expense as incurred.

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Software Capitalization

The Company capitalizes internal use software development costs in accordance with accounting guidance on accounting for costs of computer software developed or obtained for internal use. Amortization is recorded on a straight-line basis over the estimated useful life of the software, generally not to exceed seven years. Capitalized software is included in “Property, plant and equipment, at cost” on the Condensed Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009. The total costs are as follows (in thousands):

Derivative Financial Instruments

The Company’s risk management policies allow for the use of derivative financial instruments to prudently manage foreign currency exchange rate and interest rate exposure.  The policies do not allow such derivative financial instruments to be used for speculative purposes.  At this time, the Company primarily uses interest rate swaps, which are subject to the management, direction and control of our financial officers.  Risk management practices, including the use of all derivative financial instruments, are presented to the Board of Directors for approval.

All derivatives are recognized on the balance sheet date at their fair value.  All derivatives in a net receivable position are included in “Other assets”, and those in a net liability position are included in “Other long-term liabilities”.  The interest rate swaps that the Company has entered into are classified as cash flow hedges in accordance with accounting guidance on derivative instruments as they are hedging a forecasted transaction or the variability of cash flow to be paid by the Company.

Changes in the fair value of a derivative that is qualified, designated and highly effective as a cash flow hedge are recorded in other comprehensive income, net of tax, until earnings are affected by the forecasted transaction or the variability of cash flow, and then are reported in current earnings.

The Company formally documents all relationships between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions.  This process includes linking all derivatives designated as cash flow hedges to specific forecasted transactions or variable cash flows.

The Company formally assesses, at both the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items.  When it is determined that a derivative is not highly effective as a hedge then hedge accounting is discontinued prospectively in accordance with accounting guidance on derivative instruments and hedging activities.  At this time, this has not occurred as all cash flow hedges contain no ineffectiveness.  See Note 13, “Derivative Financial Instruments” and Note 14, “Fair Value Measurements”, for further detail.

Income Taxes

The Company accounts for income taxes using the liability method in accordance with accounting guidance on income taxes.  The Company estimates actual current tax expense and assesses temporary differences that exist due to differing treatments for tax and financial statement purposes.  These temporary differences result in the recognition of deferred tax assets and liabilities.  A provision has not been made for deferred U.S. income taxes on the undistributed earnings of the Company’s foreign subsidiaries as these earnings have historically been permanently invested.  It is not practicable to determine the amount of unrecognized deferred tax liability for such unremitted foreign earnings.  The Company accounts for interest and penalties related to uncertain tax positions as a component of income tax expense.

Foreign Currency Translation

The functional currency for the Company’s foreign operations is the local currency. Assets and liabilities of these operations are translated into U.S. currency at the rates of exchange at the balance sheet date. The resulting translation adjustments are included in accumulated other comprehensive loss, a separate component of stockholders’ equity. Income and expense items are translated at average monthly rates of exchange. Realized gains and losses from foreign currency transactions were not material.

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New Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (ASC) Topic 805 “Business Combinations”, which is a revision to previous guidance, originally issued in June 2001.  ASC Topic 805 retains the fundamental requirements of the previous guidance but also defines the acquirer and establishes the acquisition date as the date that the acquirer achieves control. The main features of ASC Topic 805 are that it requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions.  ASC Topic 805 also requires the acquirer to recognize goodwill as of the acquisition date.  Finally, ASC Topic 805 makes a number of other significant amendments to other prior guidance and other authoritative guidance including requiring research and development costs acquired to be capitalized separately from goodwill and requiring the expensing of transaction costs directly related to an acquisition.  ASC Topic 805 is effective for acquisitions on or after the beginning of the first fiscal year beginning on or after December 15, 2008.  The adoption of ASC Topic 805 on January 1, 2009 did not have a material impact on the Company’s financial position and/or its results of operations.

In December 2007, as part of ASC Topic 805 “Business Combinations”, the FASB issued new guidance on non-controlling interests in consolidated financial statements which requires, among other items, that ownership interest in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity.  The new guidance on non-controlling interests also requires that the amount of consolidated net income attributable to the parent and to the non-controlling interest be clearly identified and presented on the face of the consolidated statement of income. Finally, the new guidance requires that entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners.  This new guidance on non-controlling interests is effective for fiscal years beginning on or after December 15, 2008.  The adoption of this new guidance on January 1, 2009 did not have an impact on the Company’s financial position and/or its results of operations.

In December 2008, the FASB issued ASC Topic 715 “Compensation — Retirement Benefits”.  ASC Topic 715 requires enhanced disclosures about the plan assets of a Company’s defined benefit pension and other postretirement plans intended to provide financial users with a greater understanding of: 1) how investment allocations are made ; 2) the major categories of plan assets; 3) the inputs and valuation techniques used to measure the fair value of plan assets; 4) the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and 5) significant concentrations of risk within plan assets.  The Company adopted ASC Topic 715 for the year ending December 31, 2009.  These additional disclosure requirements required by ASC Topic 715 had no impact on the Company’s financial position, results of operations or cash flows.

In May 2009, the FASB issued ASC Topic 855 “Subsequent Events”, intended to improve disclosure of significant events that occur after the interim and/or annual financial statement date as well as to specify a time period through which management has included analysis of such subsequent events.  ASC Topic 855 is effective for all interim and annual periods beginning on or after June 15, 2009. Accordingly, the Company adopted ASC Topic 855 during the second quarter of 2009. The Company has evaluated subsequent events through May 5, 2010.

In June 2009, the FASB issued ASC Topic 810 “Accounting for Transfers of Financial Assets”.  ASC Topic 810 is a revision to prior guidance and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. Also, in June 2009, the FASB issued ASC Topic 810 “Amendments to FASB Interpretation No. 46 (R)” for accounting for variable interest entities (VIEs). This new guidance on VIEs is a revision to prior guidance, and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASC Topic 810 was effective at the start of a company’s first fiscal year beginning after November 15, 2009. The adoption of ASC Topic 810 did not have an impact on the Company’s financial position and/or its results of operations.

In January 2010, the FASB issued ASC Topic 820 “Fair Value Measurements and Disclosures”, which updated and clarified previously issued guidance to improve disclosures about fair value measurements.  These new disclosures include stating separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers.  In addition, it states that a reporting entity should present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASC Topic 820 did not have an impact on the Company’s financial position and/or its results of operations. See Note 14, “Fair Value Measurements”, for information and related disclosures regarding the Company’s fair value measurements.

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3. Share-Based Compensation

Overview

As of March 31, 2010, the Company has two active equity compensation plans under which share-based awards are issued. A description of these plans is as follows:

Amended and Restated 2004 Long-Term Incentive Plan (“LTIP”)

In March 2004, the Company’s Board of Directors adopted the LTIP to, among other things, attract and retain managerial talent, further align the interest of key associates to those of the Company’s stockholders and provide competitive compensation to key associates. Award vehicles include stock options, stock appreciation rights, full value awards, cash incentive awards and performance-based awards. Key associates and non-employee directors of the Company are eligible to become participants in the LTIP, except that non-employee directors may not be granted incentive stock options. The Company granted 11,288 shares of restricted stock and 103,624 restricted stock units (RSUs) under the LTIP during the first three months of 2010. The Company did not grant stock options under the LTIP during 2010.

Nonemployee Directors’ Deferred Stock Compensation Plan

Pursuant to the United Stationers Inc. Nonemployee Directors’ Deferred Stock Compensation Plan, non-employee directors may defer receipt of all or a portion of their retainer and meeting fees. Fees deferred are credited quarterly to each participating director in the form of stock units based on the fair market value of the Company’s common stock on the quarterly deferral date. Each stock unit account generally is distributed and settled in whole shares of the Company’s common stock on a one-for-one basis, with a cash-out of any fractional stock unit interests, after the participant ceases to serve as a Company director.

Accounting For Share-Based Compensation

The Company recorded pre-tax expense of $3.3 million ($2.0 million after-tax), or $0.09 per basic and $0.08 per diluted share, for share-based compensation in the first quarter of 2010. During the first quarter of 2009, the Company recorded $2.9 million ($1.8 million after-tax), or $0.08 per basic and diluted share, for share-based compensation.

The following tables summarize the intrinsic value of options outstanding, exercisable, and exercised for the applicable periods listed below:

Intrinsic Value of Options

(in thousands of dollars)

Intrinsic Value of Options Exercised

(in thousands of dollars)

The following tables summarize the intrinsic value of restricted shares outstanding and vested for the applicable periods listed below:

Value of Restricted Shares Outstanding

(in thousands of dollars)

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Value of Restricted Shares Vested

(in thousands of dollars)

As of March 31, 2010, there was $0.8 million of total unrecognized compensation cost related to non-vested stock option awards granted and $22.1 million of total unrecognized compensation cost related to non-vested restricted stock awards and RSUs granted. These costs are expected to be recognized over a weighted-average period of 1.8 years.

Accounting guidance from the FASB on share-based payments requires that cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) be classified as financing cash flows. For the three months ended March 31, 2010, excess tax benefits of $3.4 million, classified as financing cash inflows on the Consolidated Statement of Cash Flows, would have been classified as operating cash inflows if the Company had not adopted this guidance on share-based payments. For the three months ended March 31, 2009 this amount was not significant.

Stock Options

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses various assumptions including the expected stock price volatility, risk-free interest rate, and expected life of the option.  Stock options generally vest in annual increments over three years and have a term of 10 years. Compensation costs for all stock options are recognized, net of estimated forfeitures, on a straight-line basis as a single award typically over the vesting period. The Company estimates expected volatility based on historical volatility of the price of its common stock. The Company estimates the expected term of share-based awards by using historical data relating to option exercises and employee terminations to estimate the period of time that options granted are expected to be outstanding. The interest rate for periods during the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.  There were no stock options granted during the first three months of 2010 or 2009.

The following table summarizes the transactions relating to stock options under the Company’s equity compensation plans for the three months ended March 31, 2010:

Restricted Stock and Restricted Stock Units

During the first quarter of 2010, the Company granted 11,288 shares of restricted stock and 103,624 RSUs.  During the first three months of 2009, 182,781 shares of restricted stock and 206,474 RSUs were granted.  The restricted stock granted in each period vests in three equal annual installments on the anniversaries of the date of the grant.  The RSUs granted in 2009 vest on December 31, 2012, and the RSUs granted in 2010 vest in these annual installments on the anniversaries of the grant date, in each case to the extent earned based on the Company’s cumulative economic profit performance against target economic profit goals.  A summary of the status of the Company’s restricted stock award and RSU grants and changes during the first three months of 2010 is as follows:

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4. Goodwill and Intangible Assets

Accounting guidance from the FASB on goodwill and intangible assets requires that goodwill be tested for impairment at the reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value.  The Company performs an annual impairment test on goodwill and intangible assets with indefinite lives at December 31st of each year.  Based on this latest test, the Company concluded that the fair value of each of the reporting units was in excess of the carrying value as of December 31, 2009. The Company did not consider there to be any triggering event during the three-month period ended March 31, 2010 that would require an interim impairment assessment.  As a result, none of the goodwill or intangible assets with indefinite lives were tested for impairment during the three-month period ended March 31, 2010.

As of March 31, 2010 and December 31, 2009, the Company’s Condensed Consolidated Balance Sheets reflect $328.3 million and $314.4 million of goodwill, and $65.3 million and $62.9 million in net intangible assets, respectively.

The net intangible assets consist primarily of customer lists and non-compete agreements purchased as part of past acquisitions.  The Company has no intention to renew or extend the terms of acquired intangible assets and accordingly, did not incur any related costs during the first three months of 2010.  Amortization of intangible assets totaled $1.3 million and $1.2 million for the three months ended March 31, 2010 and 2009, respectively.  Accumulated amortization of intangible assets as of March 31, 2010 and December 31, 2009 totaled $17.7 million and $16.4 million, respectively.

5. 2009 Severance Charge

On January 27, 2009, the Company announced a plan to eliminate staff positions through an involuntary separation plan.  The severance charge included workforce reductions of 250 associates. The Company recorded a pre-tax charge of $3.4 million in the first quarter of 2009 for estimated severance pay and benefits, prorated bonuses, and outplacement costs.  This charge is included in “Warehousing, marketing and administrative expenses” on the Company’s Statements of Income. Cash outlays associated with the severance charge in the three months ended March 31, 2009 totaled $1.1 million.  The Company had accrued liabilities for the severance charge of $2.3 million as of March 31, 2009 which were paid throughout the remainder of 2009.  As a result, the Company had no accrued reserves for this workforce reduction as of December 31, 2009.

6.  Comprehensive Income

Comprehensive income is a component of stockholders’ equity and consists of the following components (in thousands):

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7.              Earnings Per Share

Basic earnings per share (“EPS”) are computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if dilutive securities were exercised into common stock. Stock options, non-vested restricted stock and restricted stock units are considered dilutive securities.  Stock options to purchase 0.4 million and 0.1 million shares of common stock were outstanding at March 31, 2010 and March 31, 2009, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive.  The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

Common Stock Repurchase

As of March 31, 2010, the Company had $89.2 million remaining of Board authorizations to repurchase USI common stock.  During the three-month period ended March 31, 2010, the Company repurchased 198,074 shares of common stock at a cost of $11.7 million.  There were no share repurchases in the first three months of 2009. Depending on market and business conditions and other factors, the Company may continue or suspend purchasing its common stock at any time without notice.  Acquired shares are included in the issued shares of the Company and treasury stock, but are not included in average shares outstanding when calculating earnings per share data. During the first quarter of 2010 and 2009, the Company reissued 438,177 and 178,780 shares, respectively, of treasury stock to fulfill its obligations under its equity compensation plans.

8.  Off-Balance Sheet Financing

General

On March 28, 2003, USSC entered into a third-party receivables securitization program with JP Morgan Chase Bank, as trustee (the “Prior Receivables Securitization Program” or the “Prior Program”). On November 10, 2006, the Company entered into an amendment to its revolving credit agreement which, among other things, increased the permitted size of the Prior Receivables Securitization Program to $350 million, a $75 million increase from the $275 million limit under the prior credit agreement.  During the first quarter of 2007, the Company increased its commitments for third party purchases of receivables, and the maximum funding available under the Prior Program became $250 million.  On March 2, 2009, in preparation for entering into a new securitization program (see Note 9, “Debt” for more information on the new program), USI’s subsidiaries United Stationers Financial Services (“USFS”) and USS Receivables Company, Ltd. (“USSRC”) terminated the Prior Program. The Prior Program typically had been the Company’s preferred source of floating rate financing, primarily because it generally carried a lower cost than other traditional borrowings.

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Under the Prior Program, USSC sold, on a revolving basis, its eligible trade accounts receivable (except for certain excluded accounts receivable, which initially included all accounts receivable of Lagasse, Inc. and foreign operations) to USSRC. USSRC, in turn, ultimately transferred the eligible trade accounts receivable to a trust. The trust then sold investment certificates, which represented an undivided interest in the pool of accounts receivable owned by the trust, to third-party investors. Affiliates of J.P. Morgan Chase Bank, PNC Bank and Fifth Third Bank acted as funding agents. The funding agents, or their affiliates, provided standby liquidity funding to support the sale of the accounts receivable by USSRC under 364-day liquidity facilities. The Prior Program provided for the possibility of other liquidity facilities that may have been provided by other commercial banks rated at least A-1/P-1.

Financial Statement Presentation

The Prior Program was accounted for as a sale in accordance with FASB accounting guidance on the accounting for transfers and servicing of financial assets and extinguishments of liabilities. Trade accounts receivable sold under the Prior Program were excluded from accounts receivable in the Consolidated Financial Statements.

The Company recognized certain costs and/or losses related to the Prior Program. Costs related to the Prior Program varied on a daily basis and generally were related to certain short-term interest rates. The annual interest rate on the certificates issued under the Prior Program for the first two months of 2009 ranged between 0.6% and 2.3%. In addition to the interest on the certificates, the Company paid certain bank fees related to the program. Losses recognized on the sale of accounts receivable, which represent the interest and bank fees that are the financial cost of funding under the Prior Program including amortization of previously capitalized bank fees and excluding servicing revenues, totaled $0.2 million for the three months ended March 31, 2009. Proceeds from collections for the first quarter of 2009 totaled $0.6 billion under the Prior Program.  All costs and/or losses related to the Prior Program are included in the Condensed Consolidated Statements of Income under the caption “Other Expense, net.”

The Company maintained responsibility for servicing the sold trade accounts receivable and those transferred to the trust. No servicing asset or liability was recorded because the fees received for servicing the receivables approximated the related costs.

Retained Interest

USSRC determined the level of funding achieved by the sale of trade accounts receivable under the Prior Program, subject to a maximum amount. It retained a residual interest in the eligible receivables transferred to the trust, such that amounts payable in respect of the residual interest would be distributed to USSRC upon payment in full of all amounts owed by USSRC to the trust (and by the trust to its investors).

The Company measured the fair value of its retained interest throughout the term of the Prior Program using a present value model incorporating the following two key economic assumptions: (1) an average collection cycle of approximately 45 days; and (2) an assumed discount rate of 3% per annum, which approximated the Company’s interest cost on the Prior Program. In addition, the Company estimated and recorded an allowance for doubtful accounts related to the Company’s retained interest. Considering the above noted economic factors and estimates of doubtful accounts, the book value of the Company’s retained interest approximated fair value at year-end 2008. A 10% or 20% adverse change in the assumed discount rate or average collection cycle would not have a material impact on the Company’s financial position or results of operations. Accounts receivable sold to the trust and written off during the first quarter of 2009 were not material.

9.              Debt

USI is a holding company and, as a result, its primary sources of funds are cash generated from operating activities of its direct operating subsidiary, USSC, and from borrowings by USSC. The 2007 Credit Agreement (as defined below), the 2007 Master Note Purchase Agreement (as defined below) and the 2009 Receivables Securitization Program (as defined below) contain restrictions on the ability of USSC to transfer cash to USI.

Long-term debt consisted of the following amounts (in thousands):

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As of March 31, 2010, 100% of the Company’s outstanding debt was priced at variable interest rates based primarily on the applicable bank prime rate, the London InterBank Offered Rate (“LIBOR”) or the applicable commercial paper rates related to the 2009 Receivables Securitization Program (the “2009 Program”). While the Company had primarily all of its outstanding debt based on LIBOR at March 31, 2010, the Company had hedged $435.0 million of this debt with three separate interest rate swaps further discussed in Note 2, “Summary of Significant Accounting Policies”; and Note 13, “Derivative Financial Instruments”, to the Consolidated Financial Statements.  As of March 31, 2010, the overall weighted average effective borrowing rate of the Company’s debt was 5.0%.  At March 31, 2010 funding levels, a 50 basis point movement in interest rates would not result in a material increase or decrease in annualized interest expense on a pre-tax basis, nor upon cash flows from operations.

2009 Receivables Securitization Program

On March 3, 2009, USI entered into an accounts receivables securitization program (as amended to date, the 2009 Receivables Securitization Program” or the “2009 Program”) that replaced the securitization program that USI terminated on March 2, 2009 (the “Prior Receivables Securitization Program” or the “Prior Program”). The parties to the 2009 Program are USI, USSC, USFS, and United Stationers Receivables, LLC (“USR”), and Bank of America, National Association (“Bank of America”) and Enterprise Funding Company LLC (“Enterprise” and, together with Bank of America, the “Investors”).  The 2009 Program is governed by the following agreements:

·                  Transfer and Administration Agreement among USSC, USFS, USR, and the Investors;

·                  Receivables Sale Agreement between USSC and USFS;

·                  Receivables Purchase Agreement between USFS and USR; and

·                  Performance Guaranty executed by USI in favor of USR.

Pursuant to the Receivables Sale Agreement, USSC sells to USFS, on an on-going basis, all the customer accounts receivable and related rights originated by USSC.  Pursuant to the Receivables Purchase Agreement, USFS sells to USR, on an on-going basis, all the accounts receivable and related rights purchased from USSC, as well as the accounts receivable and related rights USFS acquired from its then subsidiary, USSRC, upon the termination of the Prior Program.  Pursuant to the Transfer and Administration Agreement, USR then sells the receivables and related rights to Bank of America, as agent on behalf of Enterprise.  The maximum investment to USR at any one time outstanding under the 2009 Program cannot exceed $100 million. USFS retains servicing responsibility over the receivables. USR is a wholly-owned, bankruptcy remote special purpose subsidiary of USFS.

The assets of USR are not available to satisfy the creditors of any other person, including USFS, USSC or USI, until all amounts outstanding under the facility are repaid and the 2009 Program has been terminated.  The maturity date of the 2009 Program is November 23, 2013, subject to the Investors’ renewing their commitments as liquidity providers supporting the 2009 Program, which expire on January 21, 2011.

The receivables sold to Bank of America will remain on USI’s Condensed Consolidated Balance Sheet, and amounts advanced to USR by Enterprise, Bank of America or any successor Investor will be recorded as debt on USI’s Condensed Consolidated Balance Sheet. The cost of such debt will be recorded as interest expense on USI’s income statement.  As of March 31, 2010 and December 31, 2009, $429.5 million and $445.3 million, respectively, of receivables have been sold and no amounts have been advanced to USR.

The Transfer and Administration Agreement prohibits the Company from exceeding a Leverage Ratio of 3.25 to 1.00 and imposes other restrictions on the Company’s ability to incur additional debt. This agreement also contains additional covenants, requirements and events of default that are customary for this type of agreement, including the failure to make any required payments when due.

Credit Agreement and Other Debt

On July 5, 2007, USI and USSC entered into a Second Amended and Restated Five-Year Revolving Credit Agreement with PNC Bank, National Association and U.S. Bank National Association, as Syndication Agents, KeyBank National Association and LaSalle Bank, National Association, as Documentation Agents, and JPMorgan Chase Bank, National Association, as Agent (as amended on December 21, 2007, the “2007 Credit Agreement”).  The 2007 Credit Agreement provides a Revolving Credit Facility with a committed principal amount of $425 million and a Term Loan in the principal amount of $200 million.  Interest on both the Revolving Credit Facility and the Term Loan is based on the three-month LIBOR plus an interest margin based upon the Company’s debt to EBITDA ratio (or “Leverage Ratio”, as defined in the 2007 Credit Agreement).  The Revolving Credit Facility expires on July 5, 2012, which is also the maturity date of the Term Loan.

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On October 15, 2007, USI and USSC entered into a Master Note Purchase Agreement (the “2007 Note Purchase Agreement”) with several purchasers.  The 2007 Note Purchase Agreement allows USSC to issue up to $1 billion of senior secured notes, subject to the debt restrictions contained in the 2007 Credit Agreement.  Pursuant to the 2007 Note Purchase Agreement, USSC issued and sold $135 million of floating rate senior secured notes due October 15, 2014 at par in a private placement (the “Series 2007-A Notes”).  Interest on the Series 2007-A Notes is payable quarterly in arrears at a rate per annum equal to three-month LIBOR plus 1.30%, beginning January 15, 2008.  USSC may issue additional series of senior secured notes from time to time under the 2007 Note Purchase Agreement but has no specific plans to do so at this time.  USSC used the proceeds from the sale of these notes to repay borrowings under the 2007 Credit Agreement.

USSC has entered into several interest rate swap transactions to mitigate its floating rate risk on a portion of its total long-term debt.  See Note 13, “Derivative Financial Instruments” and Note 14, “Fair Value Measurements”, for further details on these swap transactions and their accounting treatment.

The 2007 Credit Agreement also provides for the issuance of letters of credit in an aggregate amount of up to a sublimit of $90 million and provides a sublimit for swingline loans in an aggregate outstanding principal amount not to exceed $30 million at any one time. These amounts, as sublimits, do not increase the maximum aggregate principal amount, and any undrawn issued letters of credit and all outstanding swingline loans under the facility reduce the remaining availability under the 2007 Credit Agreement. As of both March 31, 2010 and December 31, 2009, the Company had outstanding letters of credit under the 2007 Credit Agreement of $17.9 million.  Approximately, $7.0 million of these letters of credit were used to guarantee the industrial development bond. The industrial development bond had $6.8 million outstanding as of March 31, 2010 and carried market-based interest rates.

Obligations of USSC under the 2007 Credit Agreement and the 2007 Note Purchase Agreement are guaranteed by USI and certain of USSC’s domestic subsidiaries.  USSC’s obligations under these agreements and the guarantors’ obligations under the guaranties are secured by liens on substantially all Company assets, including accounts receivable, chattel paper, commercial tort claims, documents, equipment, fixtures, instruments, inventory, investment property, pledged deposits and all other tangible and intangible personal property (including proceeds) and certain real property, but excluding accounts receivable (and related credit support) subject to any accounts receivable securitization program permitted under the 2007 Credit Agreement.  Also securing these obligations are first priority pledges of all of the capital stock of USSC and the domestic subsidiaries of USSC.

The 2007 Credit Agreement and 2007 Note Purchase Agreement prohibit the Company from exceeding a Leverage Ratio of 3.25 to 1.00 and impose other restrictions on the Company’s ability to incur additional debt. Those agreements also contain additional covenants, requirements and events of default that are customary for those types of agreements, including the failure to pay principal or interest when due. The 2007 Credit Agreement, 2007 Note Purchase Agreement, and the Transfer and Administration Agreement all contain cross-default provisions.  As a result, if a termination event occurs under any of those agreements, the lenders under all of the agreements may cease to make additional loans, accelerate any loans then outstanding and/or terminate the agreements to which they are party.

10.          Retirement Plans

Pension and Postretirement Health Care Benefit Plans

The Company maintains pension plans covering a majority of its employees. In addition, the Company has a postretirement health care benefit plan covering substantially all retired employees and their dependents. For more information on the Company’s retirement plans, see Notes 12 and 13 to the Company’s Consolidated Financial Statements for the year ended December 31, 2009. A summary of net periodic benefit cost related to the Company’s pension and postretirement health care benefit plans for the three months ended March 31, 2010 and 2009 is as follows (dollars in thousands):

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Effective March 1, 2009, the Company froze pension service benefits for employees not covered by collective bargaining agreements.  As a result, the Company incurred a curtailment loss of $0.2 million in the first quarter of 2009.  The Company also reduced the Pension Benefit Obligation (“PBO”) by $11.8 million as a result of this action.  The PBO reduction led to an $11.8 million reduction in the “Accrued pension benefits liability” and a corresponding increase in accumulated other comprehensive income, net of tax.

The Company did not make cash contributions to its pension plans during the first quarters of 2010 and 2009.  The Company plans to contribute $7.4 million to the non-union pension plan and $1.3 million to the union pension plan in 2010.

On April 15, 2010, the Company notified the participants in the Retiree Medical Plan that, effective December 31, 2010, the Company would be terminating the Retiree Medical Plan.  The termination of the Retiree Medical Plan will eliminate any future obligation of the Company to provide cost sharing benefits to current or future retirees.  The Company anticipates that the curtailment of the Retiree Medical Plan will result in a future gain ranging from approximately $3.5 million to $4.0 million.  This gain will be amortized equally over the remaining quarters of 2010.

Defined Contribution Plan

The Company has defined contribution plans covering certain salaried employees and non-union hourly paid employees (the “Plan”). The Plan permits employees to defer a portion of their pre-tax and after-tax salary as contributions to the Plan.  The Plan also provides for discretionary Company contributions and Company contributions matching employees’ salary deferral contributions, at the discretion of the Board of Directors. The Company recorded expense of $0.8 million for the Company match of employee contributions to the Plan for the first quarter ended March 31, 2010.  During the same period last year, the Company recorded $1.3 million for the same match.  Effective May 1, 2009 through December 31, 2009, the Company temporarily suspended the matching of employee contributions to the Plan for all exempt associates, which was reinstated beginning January 1, 2010 at a reduced matching percentage.

11. Other Long-Term Assets and Long-Term Liabilities

Other long-term assets and long-term liabilities as of March 31, 2010 and December 31, 2009 were as follows (in thousands):

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12. Accounting for Uncertainty in Income Taxes

For each of the periods ended March 31, 2010 and December 31, 2009, the Company had $5.0 million in gross unrecognized tax benefits.  The entire amount of these gross unrecognized tax benefits would, if recognized, decrease the Company’s effective tax rate.

The Company recognizes net interest and penalties related to unrecognized tax benefits in income tax expense.  The gross amount of interest and penalties reflected in the Consolidated Statement of Income for the quarter ended March 31, 2010, was not material. The Condensed Consolidated Balance Sheets for each of the periods ended March 31, 2010 and December 31, 2009, include $1.1 million accrued for the potential payment of interest and penalties.

As of March 31, 2010, the Company’s U.S. Federal income tax returns for 2006 and subsequent years remained subject to examination by tax authorities. In addition, the Company’s state income tax returns for 2001 and subsequent years remain subject to examination by state and local income tax authorities.

Due to the potential for resolution of ongoing examinations and the expiration of various statutes of limitation, it is reasonably possible that the Company’s gross unrecognized tax benefits balance may change within the next twelve months by a range of zero to $2.6 million.  These unrecognized tax benefits are currently accrued for in the Condensed Consolidated Balance Sheets.

13. Derivative Financial Instruments

Interest rate movements create a degree of risk to the Company’s operations by affecting the amount of interest payments.  Interest rate swap agreements are used to manage the Company’s exposure to interest rate changes.  The Company designates its floating-to-fixed interest rate swaps as cash flow hedges of the variability of future cash flows at the inception of the swap contract to support hedge accounting.

On November 6, 2007, USSC entered into an interest rate swap transaction (the “November 2007 Swap Transaction”) with U.S. Bank National Association as the counterparty. USSC entered into the November 2007 Swap Transaction to mitigate USSC’s floating rate risk on an aggregate of $135 million of LIBOR based interest rate risk. Under the terms of the November 2007 Swap Transaction, USSC is required to make quarterly fixed-rate payments to the counterparty calculated based on a notional amount of $135 million at a fixed rate of 4.674%, while the counterparty is obligated to make quarterly floating-rate payments to USSC based on the three-month LIBOR on the same referenced notional amount. The November 2007 Swap Transaction has an effective date of January 15, 2008 and a termination date of January 15, 2013. Notwithstanding the terms of the November 2007 Swap Transaction, USSC is ultimately obligated for all amounts due and payable under its credit agreements.

Subsequently, on December 20, 2007, USSC entered into another interest rate swap transaction (the “December 2007 Swap Transaction”) with Key Bank National Association as the counterparty. USSC entered into the December 2007 Swap Transaction to mitigate USSC’s floating rate risk on an aggregate of $200 million of LIBOR based interest rate risk. Under the terms of the December 2007 Swap Transaction, USSC is required to make quarterly fixed-rate payments to the counterparty calculated based on a notional amount of $200 million at a fixed rate of 4.075%, while the counterparty is obligated to make quarterly floating-rate payments to USSC based on the three-month LIBOR on the same referenced notional amount. The December 2007 Swap Transaction has an effective date of December 21, 2007 and a termination date of June 21, 2012. Notwithstanding the terms of the December 2007 Swap Transaction, USSC is ultimately obligated for all amounts due and payable under its credit agreements.

On March 13, 2008, USSC entered into an interest rate swap transaction (the “March 2008 Swap Transaction”) with U.S. Bank National Association as the counterparty. USSC entered into the March 2008 Swap Transaction to mitigate USSC’s floating rate risk on an aggregate of $100 million of LIBOR based interest rate risk. Under the terms of the March 2008 Swap Transaction, USSC is required to make quarterly fixed-rate payments to the counterparty calculated based on a notional amount of $100 million at a fixed rate of 3.212%, while the counterparty is obligated to make quarterly floating-rate payments to USSC based on the three-month LIBOR on the same referenced notional amount. The March 2008 Swap Transaction has an effective date of March 31, 2008 and a termination date of June 29, 2012. Notwithstanding the terms of the March 2008 Swap Transaction, USSC is ultimately obligated for all amounts due and payable under its credit agreements.

These hedged transactions described above qualify as cash flow hedges under the FASB accounting guidance on derivative instruments and hedging activities. This guidance requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value. The Company does not offset fair value amounts recognized for interest rate swaps executed with the same counterparty.

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For derivative instruments that are designated and qualify as a cash flow hedge (for example, hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings (for example, in “interest expense” when the hedged transactions are interest cash flows associated with floating-rate debt).

The Company has entered into these interest rate swap agreements, described above, that effectively convert a portion of its floating-rate debt to a fixed-rate basis. This then reduces the impact of interest rate changes on future interest expense.  By using such derivative financial instruments, the Company exposes itself to credit risk and market risk.  Credit risk is the risk that the counterparty to the interest rate swap agreements (as noted above) will fail to perform under the terms of the agreements.  The Company attempts to minimize the credit risk in these agreements by only entering into transactions with credit worthy counterparties like the two counterparties above.  The market risk is the adverse effect on the value of a derivative financial instrument that results from a change in interest rates.

Approximately 98% ($435 million) of the Company’s outstanding long-term debt had its interest payments designated as the hedged forecasted transactions to interest rate swap agreements at March 31, 2010.

The interest rate swap agreements accounted for as cash flow hedges that were outstanding and recorded at fair value on the statement of financial position as of March 31, 2010 were as follows (in thousands):

(1)          These interest rate derivatives qualify for hedge accounting.  Therefore, the fair value of each interest rate derivative is included in the Company’s Condensed Consolidated Balance Sheets as a component of “Other long-term liabilities” with an offsetting component in “Stockholders’ Equity” as part of “Accumulated Other Comprehensive Loss”.  Fair value adjustments of the interest rate swaps will be deferred and recognized as an adjustment to interest expense over the remaining term of the hedged instrument.

The Company’s agreements with its derivative counterparties provide that if an event of default occurs on any Company debt of $25 million or more, the counterparties can terminate the swap agreements.  If an event of default had occurred and the counterparties had exercised their early termination rights under the swap agreements as of March 31, 2010, the Company would have been required to pay the aggregate fair value net liability of $28.2 million plus accrued interest to the counterparties.

These interest rate swap agreements contain no ineffectiveness; therefore, all gains or losses on these derivative instruments are reported as a component of other comprehensive income (“OCI”) and reclassified into earnings as “interest expense” in the same period or periods during which the hedged transaction affects earnings.  The following table depicts the effect of these derivative instruments on the statement of income for the three-month period ended March 31, 2010.

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14. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including interest rate swap liabilities related to interest rate swap derivatives based on the mark-to-market position of the Company’s interest rate swap positions and other observable interest rates (see Note 13, “Derivative Financial Instruments”, for more information on these interest rate swaps).

FASB accounting guidance on fair value establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s own assumptions (unobservable inputs).  The hierarchy consists of three levels:

·                  Level 1 — Quoted market prices in active markets for identical assets or liabilities;

·                  Level 2 — Inputs other than Level 1 inputs that are either directly or indirectly observable; and

·                  Level 3 — Unobservable inputs developed using estimates and assumptions developed by the Company which reflect those that a market participant would use.

Determining which category an asset or liability falls within the hierarchy requires significant judgment.  The Company evaluates its hierarchy disclosures each quarter.  The following table summarizes the financial instruments measured at fair value in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2010 (in thousands):

The carrying amount of accounts receivable at March 31, 2010, including $429.5 million of receivables sold under the New Receivables Securitization Program, approximates fair value because of the short-term nature of this item.

FASB accounting guidance requires separate disclosure of assets and liabilities measured at fair value on a recurring basis, as noted above, from those measured at fair value on a nonrecurring basis.  As of March 31, 2010, no assets or liabilities are measured at fair value on a nonrecurring basis.

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This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. Forward-looking statements often contain words such as “expects,” “anticipates,” “estimates,” “intends,” “plans,” “believes,” “seeks,” “will,” “is likely,” “scheduled,” “positioned to,” “continue,” “forecast,” “predicting,” “projection,” “potential” or similar expressions. Forward-looking statements include references to goals, plans, strategies, objectives, projected costs or savings, anticipated future performance, results or events and other statements that are not strictly historical in nature. These forward-looking statements are based on management’s current expectations, forecasts and assumptions. This means they involve a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied here. These risks and uncertainties include, without limitation, those set forth in “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year-ended December 31, 2009.

Readers should not place undue reliance on forward-looking statements contained in this Quarterly Report on Form 10-Q. The forward-looking information herein is given as of this date only, and the Company undertakes no obligation to revise or update it.

Overview and Recent Results

The Company is a leading wholesale distributor of business products, with 2009 net sales of approximately $4.7 billion. The Company sells its products through a national distribution network of 64 distribution centers to approximately 25,000 resellers, who in turn sell directly to end consumers.

As reported in the Company’s press release dated April 29, 2010, month-to-date sales in April were up approximately 4%.  The Company has begun to successfully execute its growth strategies and has seen modestly improving economic conditions.

Key Company and Industry Trends

The following is a summary of selected trends, events or uncertainties that the Company believes may have a significant impact on its future performance.

·                  There have been signs of improvement in the economy, particularly in industrial markets.  However, the Company remains cautious since white collar employment is recovering slowly from the economic downturn.  Furthermore, small business confidence levels have not returned to previously-seen levels.  Regardless, the Company is focused to deliver sales growth from several key initiatives, such as Cost-to-Serve, e-business development, private brands penetration, and new channels growth.

·                  Sales in the first quarter of 2010 grew by 3% to $1.15 billion, compared with last year’s $1.12 billion.  Revenue for the quarter was positively affected by increases across all product categories except for a 9% decline in furniture.  However, the year-over-year rate of decline within the furniture category improved each of the previous three quarters.  ORS Nasco sales grew 8%, primarily in the industrial and oil-field pipeline customer channels, as market share improvement efforts implemented in 2009 have begun to produce sales in 2010.  Sales in the janitorial and breakroom category increased by 5% mainly due to strong growth in the Company’s OfficeJan offerings.  The technology supplies category saw a 3% increase driven by printer imaging and double-digit growth in hardware.  Office products also grew 3% with relatively flat cut-sheet paper sales.

·                  Gross margin as a percent of sales for the first quarter of 2010 was 14.5%, down 20 basis points versus 14.7% last year. Gross margin benefited from higher inventory purchase-related allowances earned from suppliers.  This improvement was more than offset by the negative effect of significantly lower product cost inflation.

·                  Operating expenses as a percent of sales for the first quarter of 2010 were 11.4 % compared to 12.1% for the same quarter of the prior year.  Operating expenses in the 2009 quarter were 11.8% of sales after excluding a $3.4 million severance charge related to a workforce reduction.  This decline in operating expenses reflected lower depreciation resulting from reduced capital expenditures over the past several years and lower bad debt expense as the need for additional reserves stabilized.  Employee-related costs increased due to the reinstatement of certain costs that were part of prior period cost reduction actions and higher distribution labor to serve higher sales and inventory levels.

·                  Net income was $18.2 million for the quarter versus $13.5 million in the prior-year quarter.  As noted above, first quarter 2009 net income was negatively impacted by a $3.4 million severance charge.  The tax rate rose to 38.4% in the first quarter 2010 from 37.1% in the prior-year quarter.  This was due to discrete tax items in both periods.  The Company still expects the full-year tax rate to be approximately 38%.

·                  Diluted earnings per share for the 2010 quarter were $0.73, up from $0.57 in the prior-year quarter.  Adjusted for the previously mentioned severance charge, diluted earnings per share rose 11% to $0.73 versus last year’s adjusted $0.66.

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·                  Net cash provided by operating activities for the first three months of 2010 was $83.0 million versus $115.8 million in the same period last year. Excluding the impact of accounts receivable sold, net cash provided by operating activities for the prior-year quarter was $138.8 million. The decline in operating cash flows for the first three months of 2010 was driven by a $19.2 million increase in inventories during the first quarter of 2010 whereas inventories declined $108.3 million in the prior-year quarter.  Payables increased $42.9 million during the first quarter of 2010 versus a decline or use of cash of $22.2 million in the prior-year quarter.

·                  Outstanding debt totaled $441.8 million at March 31, 2010 versus $552.5 million at March 31, 2009.  The $110.7 million reduction in debt was the result of the Company’s strong operating cash flows and brought the Company’s debt-to-total capitalization to 37.7% at March 31, 2010 from 48.4% at March 31, 2009. The decline in debt led to a reduction in interest and other expense of $1.2 million from the prior-year quarter.  In addition, the Company’s cash and cash equivalents balances grew by $78.2 million over the past twelve months.

·                  During the first quarter 2010, the Company repurchased 198,074 shares for $11.7 million.  Through April 26, 2010, the Company has repurchased 417,411 shares for $24.8 million.

·                  The Company completed the acquisition of all of the capital stock of MBS Dev, Inc. (“MBS Dev”) during the quarter for a purchase price of $15 million and an additional potential $3 million earn-out based upon the achievement of certain financial goals.  The purchase price consisted of $12 million in cash at closing plus $3 million to be paid to the former owners over the course of the next three years, the timing (but not the amount) of which is based upon achievement of certain financial goals.  Net of cash held by MBS Dev at closing, the initial cash outlay was $10.5 million.  MBS Dev is a software solutions provider to business products resellers and allows the Company to accelerate e-business development and enable customers and suppliers to leverage the internet.  As a result of the acquisition the Company recorded $13.9 million of goodwill, $3.7 million in intangible assets, and $4.1 million of liabilities to be paid upon achievement of certain financial metrics agreed to in the purchase agreement.  The $4.1 million liability represents the combined fair value of both earn-outs.

For a further discussion of selected trends, events or uncertainties the Company believes may have a significant impact on its future performance, readers should refer to “Key Company and Industry Trends” under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year-ended December 31, 2009.

Stock Repurchase Program

During the first three months of 2010, the Company repurchased 198,074 shares at an aggregate cost of $11.7 million. No shares were repurchased in the first three months of 2009. Through April 26, 2010, the Company repurchased 417,411 shares for $24.8 million.  As of that date, the Company had $76.1 million remaining of existing share repurchase authorization from the Board of Directors.

Critical Accounting Policies, Judgments and Estimates

During the first quarter of 2010, there were no significant changes to the Company’s critical accounting policies, judgments or estimates from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

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Results of Operations

The following table presents the Condensed Consolidated Statements of Income as a percentage of net sales: