Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Valassis Communications, Inc (NYSE:VCI)

Q2 2010 Earnings Conference Call

July 29, 2010, 11:00 AM ET

Executives

Alan Schultz - Chairman, President, CEO

Rob Mason - Chief Sales Officer

Bob Recchia - EVP, CFO

Analysts

Alexia Quadrani - JPMorgan

Jim Boyle - Gilford

Chuck Cerankosky - Northcoast Research

Dan Salmon - BMO Capital Markets

Bob Evans - Craig-Hallum Capital

Dan Leben - Robert W. Baird

Bill Wilmington - Raymond James

Mark Picurin - Graystone Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Valassis second quarter 2010 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, July 29, 2010.

I'd like to remind you that discussions during this conference call will include forward-looking statements and the actual results could differ materially from those projected in the forward-looking statements.

The factors that could cause the results to materially differ from those expressed or implied by such forward-looking statements are discussed in the risk factors and other sections of the 2009 annual report on Form 10-K and in the report on Form 10-Q and Form 8-K filed with the SEC.

Also, discussions during this conference call will include certain financial measures that were not prepared in accordance with generally accepted accounting principals. Reconciliation of those non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in the earnings release furnished with the current report on From 8-K dated today, which is also available on Valassis' website at www.valassis.com on the home page of investor section.

I would now like to turn the conference over to Mr. Alan Schultz. Please go ahead.

Alan Schultz

Thanks, [Marissa]. Good morning and welcome to the call today. Joining me are Bob Recchia, our Chief Financial Officer, and Rob Mason, our Chief Sales Officer who will be our featured guest this morning.

Rob and I have some prepared remarks that we would like to share with you and then, along with Bob, we look forward to answering your questions.

As we discussed in our last earnings call, 2010 marks a transition in our organization's primary focus from cost containment towards revenue growth. We are thrilled with our sales team's performance this quarter. Their success in driving revenue growth across all four of our business segments resulted in an overall revenue increase of 6.6% for Q2 2010 versus the prior year quarter.

While our long-term goal is to deliver annual mid-single digit revenue growth, we expected low-single digit revenue growth in Q2 followed by mid-single digit growth in the second half of this year. So the superior execution of our sales organization got us to mid-single digit revenue growth a quarter earlier than we had expected.

Of course, I can't mention revenue growth without mentioning the strong operating leverage of our business. Single-digit revenue growth tends to drive double-digit earnings growth, as was demonstrated in this quarter.

There's been a great deal of speculation on what client marketing budgets will be doing in the second half of this year. Going forward, they will either be up, flat or down and by how much everyone wonders and that's why I asked Rob Mason to be here with us this morning to speak to you directly from the client and sales perspective and to share his insights and outlook for the second half of 2010.

I have a few highlights regarding this quarter and then I'll turn the call over to Rob Mason. As you can see in the release, we made the decision to raise full-year 2010 adjusted EBITDA guidance to $320 million. This decision was based on the strong performance that we had in the first half and our positive revenue outlook for the second half of this year. This update guidance factors in anticipated increases in paper costs in the second half of 2010.

As I have mentioned in the past, our paper supplier contracts include caps and collars designed to limit increases to a single-digit percentage within any given year. Our largest cost of goods sold item is postage. As you may be aware, after no increase in 2010 the Postmaster General is requesting a 4.9% increase from the postal rate commission to be effective in 2011.

If this increase is approved, this would mean an approximately 2.5% price increase for our clients. However, our client contracts state we will pass along postal rate changes and historically we have been successful in passing these postal increases through to our clients.

Additionally, this increase looks to be modest in comparison to the rate increases we believe clients are experiencing in broadcast for the new fall season. You will see that SG&A is up $6 million in Q2 2010 compared to the prior year quarter.

This is not our run rate going forward as this quarter's SG&A includes $7.9 million in noncash stock-based compensation which is based on accelerating vesting related to increases in our stock price.

Going forward, for the remainder of 2010, we would expect stock-based comp to be a more typical run rate of about $2.2 million a quarter. This atypical increase in stock-based compensation had a $0.07 negative impact on our earnings per share for Q2 2010 and beyond versus the normalized cost, or normal cost.

During the second quarter we repurchased an aggregate principal amount of $297.8 million of our 2015 8.25 senior unsecured notes through a tender offer and open market purchases. The premium and other fees related to these transactions had a negative $0.28 impact on reported earnings per share in this quarter.

Excluding the charges associated with the debt repurchases and the incremental increase in stock-based compensation I just mentioned a moment ago, earnings per share for this quarter would have been $0.56, a 70% increase over the second quarter of 2009.

By paying down a substantial portion of our most expensive debt we will save approximately $12 million in net interest expense in 2010 and $22.2 million in net interest expense in 2011 even after you net out the increase interest expense and fees associated with the April 2010 amendment to our senior secured credit facility, which allowed us to repurchase those 8.25 notes.

Our net debts to adjusted EBITDA leverage ratio at the end of the second quarter of 2010 was 1.6 to one, giving us a very comfortable level of leverage and providing us with substantial financial flexibility.

As a result of that financial flexibility, during the quarter we repurchased 1,619,600 shares of our common stock at an aggregate cost of $54.6 million at an average price of $33.71 a share under the stock repurchase program that we reinstituted in May of 2010.

We are limited by our credit agreement covenants to an aggregate share repurchase amount of $58.14 million during 2010. In 2011 we believe our basket to repurchase our common stock will substantially increase as our credit agreement basket is calculated in part at 50% of 2010's net earnings.

Assuming net earnings in our 2010 adjusted EBITDA reconciliation, as you see in our recent release, our 2011 stock repurchase basket could be approximately $195 million. But to be clear, we are under no obligation to buy back stock and, if we do so, it would be subject to the terms of the approved program. As I mentioned, we have a great deal of financial flexibility and this is an option available to us.

Regarding capital expenditures, we do expect to spend the full $25 million in 2010 as our guidance has consistently indicated. Our entire team, especially our sales organization, is glad to be in an environment that is conducive to driving profitable revenue growth.

Although the recent recession has had its challenges, there is a significant silver lining for our company and the silver lining is the permanent shift in consumer behavior towards value. This is something we've talked about for more than a year but the studies and the surveys keep pouring in as consumers continue to reshape their perceptions and attitudes towards spending and saving.

Consumers remain skittish. The Conference Board Consumer Confidence Index, which has been on the rise for three consecutive months, declined sharply in June and July. Even Fed Chairman Bernanke says the economic outlook is unusually uncertain.

On the consumer front, Deloitte and Harrison Group released the study on the consumer behavior earlier this month. Some of the highlights of the study include: 92% of the people surveyed have changed their grocery shopping behavior in the last two years. Americans are most strategic, informed and even calculating in their shopping behavior.

Though significantly, from my perspective, 93% of those surveyed said they will remain cautious and keep spending at the current level even if the economy improves. Let me repeat that. Consumers expect to continue this recession-inspired behavior even when and if the economy improves.

Deloitte's Vice Chairman and Consumer Products Practice leader in the US, Pat Conroy, said it this way, and I quote, "Our analysis concludes personal satisfaction and a desire to feel smart about what consumers are putting in their shopping carts are trumping brand satisfaction and that price consciousness, value orientation and bargain hunting will remain prevalent for years to come."

Make no mistake about it. This shift towards value is the new normal for shoppers. In 2001, about half of consumers thought of themselves as savers rather than spenders. Today, that number is 62%. In order to save more, shoppers have reduced their spending through a variety of strategies including trading down and seeking out deals.

Whether you are an upscale or downscale retailer or manufacturer, this shopping behavior is impacting client marketing decisions. Our RedPlum products are right in our clients' sweet spot as they look to reach and influence value-seeking consumers. Through our RedPlum medium we are the number one source of value to shoppers and the number one supplier of value-distributed media to our clients.

We believe this new normal in consumer demand for value will fuel our revenue growth for years to come. With that, I'd like to turn the call over to Rob Mason, our company's Chief Sales Officer.

Rob has been with Valassis for more than 15 years and leads the efforts of our 500 plus member sales organization. He spends most of his days talking with and about our clients' business and their plans for the future.

Rob Mason

Thank you, Al. Good morning, everyone. First of all, I'd like to begin by saying that I’m extremely proud of the efforts and accomplishments of our sales team. They have demonstrated a clear commitment to profitable revenue growth and our second quarter results are proof of that commitment. It's a true privilege for me to represent our sales associates and their leaders on this morning's call.

From my perspective, our 6.6% revenue growth this quarter was driven by clients responding to consumers' demand for value. Clients are investing in consumer promotion, in our products specifically, because they want vehicles that provide scale, are measurable and deliver a strong return on their marketing investment.

This is why we see CPG coupon distribution continuing to grow. According to NCH, year-over-year CPG coupon distribution increased by 11.4% or 18 billion coupons in the first half of 2010 over the first half of 2009 and overall redemption volume has increased 7.9% in that same period. These increases have allowed consumers to save nearly $2 billion in coupons in the first half.

We have all read and heard about the uncertainties that exist with the economy as well as overall marketing and ad spending. My goal this morning is to share with you what I’m hearing from our clients and their plans with our median products. Everything I am hearing indicates that we are in a strong position to continue to deliver mid-single digit revenue growth in the back half of 2010.

Now I'd like to move on to some Q2 2010 highlights in our individual business segments. Our Shared Mail segment continues to benefit from newspaper circulation declines as our clients, both current and new, gravitate to Shared Mail distribution as a viable alternative to reach the households that no longer receive the newspaper.

One of the key elements of our value proposition is based on our clients helping our clients optimize their media box. While our goal is to optimize client media buys with our products across our entire portfolio, blending newspaper with Shared Mail is a primary focus.

One of our key sales initiatives for 2010 is to increase the number of pieces in our Shared Mail package. Our sales force's successful execution of this initiative is a major contributor to our 4% revenue growth in Shared Mail.

Our pieces per package were up 1.7 pieces this quarter. In addition, unused postage was at an all time record low at 16% and our wrapped sell-through continued to be strong at 89.4% for this quarter.

Finally, the strong operating leverage combined with our continued strong cost management of the Shared Mail business have allowed us to convert a 4% growth in revenue this quarter to a 73.5% increase in segment profit for Q2 2010.

Moving on to FSI business, with the 2010 calendar shift moving much of the pre-Easter spend into the first quarter, we had expected the CFSI industry page volume decline in the second quarter of 2010. What we actually experienced was a 2.6% increase in industry pages versus the prior year quarter.

This contributed to an overall industry page growth in the first half of 6.6% versus the first half of 2009. Industry growth is being driven primarily by increased spending by the CPG vertical and consumer response to this increased promotion is exceeding our client expectations. Our Neighborhood Targeted segment is comprised of our ROP, newspaper inserts and polybag sampling products.

While overall revenue of this segment grew 17.5% in Q2 2010 versus the prior year quarter, we did have a number of unusual factors that influenced segment profit this quarter including: a shift in client and product mix; secondly, a $3.2 million increase in SG&A in this segment, nearly half of which was a stock-based comp that Alan discussed earlier; and margin pressure as a result of aggressively pursuing unique newspaper insert business that will allow us to offer clients the ability to optimize their print media buy through the use of Shared Mail.

By gaining market share and optimizing our clients' media buys, we maximize our ability to enhance client value and increase profit in the future as we migrate business in the Shared Mail.

This quarter was unusual for these reasons and we believe we will return to segment profit growth in Q3.

Within our International Digital Media & Services segment we continue to invest in our in-store and digital businesses. Between the two, our investments generated an additional $3.6 million in losses in Q2 2010 versus Q2 2009, which resulted in the decline in segment profit. Our sales force is excited about the expansion of our in-store efforts and that excitement has led to increased client participation within the in-store segment.

We're also pleased with the momentum in our digital portfolio. Clients value our ability to integrate their offline offers with online media as they look to extend their reach to consumers who prefer to receive savings digitally. We see our ability to seamlessly integrate offline and digital media as a growing competitive advantage.

To wrap things up, I'd like to comment again on our outlook for client spending trends in the second half. Based on our conversations with clients demand for our products continues to be strong.

While I'm not in the position to tell you what will happen with the economy and/or overall marketing budgets, what I can tell you again is that I am confident we are in a strong position to continue to delivery mid-single digit revenue growth in the back half of 2010. In the back half of 2010 we will get our share. Al?

Alan Schultz

Thanks, Rob. [Marissa], we'd like to open the call up for questions. So we've got Bob Recchia here, our CFO, and Rob Mason is going to stay here with us to answer questions. So please fire away.

Question-and-Answer Session

We will now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Alexia Quadrani - JPMorgan.

Alexia Quadrani - JPMorgan

A couple questions, first, just circling back on the strength in Neighborhood Targeted you saw in the quarter. I know you highlighted that the ROP business was a big driver behind the revenue growth there. Could you also comment a bit or give us a bit of color of how much this Shared Mail business influenced that growth in the quarter, meaning how much of the Neighborhood Targeted business you were able to move into Shard Mail in the quarter?

Rob Mason

Alexia, migrating newspaper vehicles, preprints primarily, is a key initiative of ours. We are pleased with the velocity of that migration into our Shared Mail product. But for competitive reasons I don't want to get into the specific percentages but only to tell you that we're very pleased to see the velocity of how we're able to migrate newspaper preprints primarily into our Shared Mail product.

Alexia Quadrani - JPMorgan

So I guess in other ways it contributed to the impressive revenue growth but it probably wasn't the majority of it.

Rob Mason

I would tell you that the revenue growth was a blend of that migration, our focus on attracting new clients and then also this shift to more promotional media that is happening within our current client base. So I think it's a blend of those things.

Alan Schultz

It's clearly across the board, Alexia. We've got all our existing clients for the most part are spending more with us, our value prop is allowing us to pick up new customers and then we're definitely seeing some migration from newspapers as those [circs decline] into our Shared Mail package. So it is the combination of all of the above for sure.

Alexia Quadrani - JPMorgan

Then jumping to the FSI, just for a question there; could you comment on what your market share was I guess in the outside business in the quarter, how that may have changed and were there any contracts that were up for renewal in the quarter that may have given you a bit of indication of how the competitive environment may have changed post the settlement?

Alan Schultz

Our market share was in the neighborhood of 44%, which is relatively consistent with what it was in the previous year. I think Rob can answer your question on contracts.

Rob Mason

Right now, actually, we've got about 75% of the deals done that will impact 2011. In terms of their impact upon share, I don't think that impact is going to be material. What I will tell you is that as opposed to focusing on market share, right now our sales organization is really focused on profit within that segment.

Alexia Quadrani - JPMorgan

When you say focused on profit, you're meaning by increasing pricing?

Alan Schultz

Lexi, we can't really discuss FSI pricing. We've been advised that that's something that's off limits, so we really can't get into pricing-specific conversations.

Operator

Your next question comes from the line of Jim Boyle - Gilford.

Jim Boyle - Gilford

Alan, it seems marketers and consumers alike, as you mentioned, are focused on value, which is obviously your sweet spot. That certainly helps with the fragile economy that's expected to continue for a while. But what might occur to value in the long term if the economic recovery becomes robust in the out years?

Alan Schultz

We have seen -- I guess, we're probably up to five or six now different research studies on that exact subject and everything we have seen, without exception -- we have yet to see an exception to this in any of the research that's been done -- everything indicates this new shopping behavior is here to stay and it's long term and it's definitely going to be long term well beyond when the economy improves.

I don't know when the economy is going to improve. It's clearly going to be here as long as the economy stays soft. All the research indicates it's going to be here well beyond when the economy improves.

What I would tell you is we much prefer a more robust economy because in a more robust economy we see marketing budgets growing at a much greater percentage. So we would prefer a stronger economy. We think we have the consumer on our side. We know that the marketing dollars follow consumer usage. So we feel really good about where we're at today. But make no mistake about it. We would prefer an improved economy.

Jim Boyle - Gilford

Mr. Mason, Q2 was the seventh straight CPG redemption volume growth quarter. When might that stop, if you gaze into your crystal ball?

Rob Mason

Jim, I wish I had a crystal ball. We don't see anything that's going to significantly impact that spend in the near term. What we are seeing is CPGs adjust some of their tactics. As we see rising costs associated with the increased redemption, we see them adjust their tactics but not reduce spend.

What they're doing is taking steps and doing tactical things like running FSI ads without coupons. They're shortening redemption times. Then they're also increasing the number of items that consumers have to buy to use a coupon. But in that crystal ball of mine I see nothing in the future that shows a material slowdown in the CPG client's migration to promotional media and/or FSI.

Alan Schultz

Jim, this is Al. I think maybe your question was a little bit more around the fact that we have been seeing redemption growth in the high teens, maybe even in the 20s over the last 1.5 years. Now we're seeing something in the high-single digit. I think that you're likely to see that number, in terms of percentage increase, continue to come down.

I think we were at 20 or the high teens. Now we're down to the high-single digits. I would say as the quarters go on you're going to see that get down to mid-single digits. Eventually it's going to migrate into low-single digits.

How long that's going to go on for, I don't really know. But what I do know is over the last seven quarters -- and I think it's going to continue for a number of quarters to come -- every time these redemption rates go up from a consumer perspective, the return on investment for our clients improves.

So all that happens is the products and services that we offer just get more efficient, more effective for our customers, which continues to attract more dollars into the media.

Jim Boyle - Gilford

If CPG as a vertical seems to be quite going well and comfortable, is there any vertical that keeps you up at night?

Alan Schultz

I'll let Rob talk about that. I know he has a couple of verticals that didn't do well in the second quarter and he can kind of share with you his perspective on those verticals and give you a sense of what he thinks going forward.

Rob Mason

Yes, Jim, I guess I'll qualify the answer telling you these observations are based on impact on overall revenue, not just our FSI product. But if there are verticals that are creating any kind of a drag on our revenue today they would be restaurant or food service.

I think there are some promotional tactics with a specific segment in there that have driven that: financial services where there's been I think an overall reduction in spend over the last couple of years and then discount stores, but that is primarily driven by impact from a couple of larger customers.

I wouldn't tell you that any of those things keep me up at night. We're aware of those things and they've tempered the growth but they're not keeping me up at night.

I think as it relates specifically to the discount stores, there are some things going on in the marketplace that I think could heat up competition in the discount stores in the relatively near future, which I think would be beneficial. So I would probably see that one turning around within the next few quarters.

Operator

Your next question comes from the line of Chuck Cerankosky - Northcoast Research.

Chuck Cerankosky - Northcoast Research

Bob, I got a question for you in looking at the one reconciliation. Wanted to make sure I get it down here, the reconciliation of adjusted EBITDA to net earnings and cash flows. It's got a big category here called "Changes in Operating Assets and Liabilities" and that ate up about $121 million of cash. I was wondering if you could get into the details behind that, please.

Alan Schultz

I know the answer to that one, Chuck, while Bob's looking. We had $120 million tax payment that we made in June. So that's the bottom line. So when you look at it from a working capital perspective, I think we had $102 million go to the Feds and $18 million go to the states. If you remember, when we got the settlement we made note of the fact that we were going to have to pay taxes on that and there would be some big tax bills coming in the future. That hit in June.

Chuck Cerankosky - Northcoast Research

So that's kind of a -- that should be backed out of there, the one we think about -- .

Bob Recchia

Yes, I think that that's a bit of an anomaly in terms of working capital.

Chuck Cerankosky - Northcoast Research

Turning to something we saw in an FSI recently, the front page of the RedPlum FSI had an ad by Lowe's, the building supply retailer, in which they had six coupons there, largely for non-food consumables like water and air filters. The coupons were good only at Lowe's. That was something that caught our eye. Is Lowe's new to the FSI and can you just comment on the significance of an ad of this nature?

Rob Mason

Chuck, I would tell you that Lowe's is new to the FSI in calendar year 2010. It's significant, I think, for a couple of reasons. It's a very, very prominent retailer and that kind of content within our FSI is valuable for consumers, clearly, but also attracting other retailers.

I think Lowe's presence in our FSI is indicative of the shift to more promotional market. There is no other vehicle that's as well known for promotional advertiser marketing that the FSI and I think that Lowe's interest and use of that product is indicative of both the shift in consumer behavior that Al referenced earlier and how customers are migrating budgets to more promotional media.

I think -- I don't have specifics for you but we've seen an uptick in retail-specific activity, both in and outside of the FSI.

Alan Schultz

Chuck, I would add that, from my perspective, Lowe's looks like a pretty sophisticated buyer of media and it seems to me like they're ahead of most of their competition in terms of looking at different media alternatives in order to meet this increasing consumer demand for value and deals. I think they have been a very good customer of ours in that regard.

Chuck Cerankosky - Northcoast Research

Are you aware of Wal-Mart doing something similar or using coupons in any media or in any test market?

Alan Schultz

We really can't talk about any clients in terms of what they're doing with us or any of their perspective activity. If you've seen something in the marketplace specifically that you want to ask about, Chuck, we can perhaps address that. But we just can't share that kind of information on a client-specific basis.

Operator

Your next question comes from the line of Dan Salmon - BMO Capital Markets.

Dan Salmon - BMO Capital Markets

Al, could you give us a quick update on the in-store business and maybe just an idea of where the footprint stands today? Then also how that figures in to your new guidance that's published here today?

Alan Schultz

Yes, in-store business is making progress. We're -- footprints about 2200 grocery stores today, primarily made up of SuperValu and Winn-Dixie. We really started the first execution at the end of June, which was the first cycle that we had executed against. So you're really not seeing any revenue from that in the second quarter.

The way we recognize the revenue is at the end of the cycle, so the very first cycle will end in July. So the revenue from the new in-store products will start to flow through in the third quarter.

The way we look at it today, Dan, is that we should see revenue starting to ramp up in the third quarter and based on the way things look right now in terms of the investments we've made and the revenue ramp-up, we would actually expect this new [NIO] marketing business to contribute to segment profitability in our International Digital Services segment in the fourth quarter. So we think it's going to contribute to profitability relatively quickly.

Operator

Your next question comes from the line of Bob Evans - Craig-Hallum Capital.

Bob Evans - Craig-Hallum Capital

A few things; first, can you talk about the FSI segment some more in terms of -- I understand volumes are up and costs are down. But it seems that the improvement in margin has to go beyond that.

I know you can't talk about pricing a lot but can you give us any level of commentary in terms of whether price was a factor in terms of the improvement in operating margin or maybe what you're seeing from an industry standpoint?

Alan Schultz

I guess what we could say, Bob, is that the pricing is in the range of what we had discussed previously. We had talked about the fact that we had a feel for where we thought pricing would go for 2010 and it's very close to what we had anticipated. There's really nothing new there from price perspectives.

Bob Evans - Craig-Hallum Capital

What was that still just to make sure I’m on the same page?

Alan Schultz

Again, our lawyers have advised us, under the circumstances, that we can't get into pricing-specific discussions anymore. So I can't -- I apologize. I can't add any color to that. My hands are tied.

Bob Evans - Craig-Hallum Capital

Even if it was a statement you made in the past?

Alan Schultz

Yes, I don't think I can even repeat what I've said in the past. But what I can tell you is that in essence the profitability here is being grown by industry unit growth and continued cost side of the business. Those are -- what I can say is those are your primary drivers in terms of the improved profitability in the FSI business.

One of the things that oftentimes people lose sight of is people focus a lot on the operating leverage in the Shared Mail business but the FSI business has a lot of the same characteristics in terms of operating leverage.

When you add additional leverage to that package the margin on those additional units is much higher than the average margin for the product. So it's important that you keep the operating leverage in mind when you think about this business.

Bob Evans - Craig-Hallum Capital

I apologize if I missed this, but the pieces per package for the quarter, for Shared Mail?

Alan Schultz

Yes, they were up about 1.7.

Bob Evans - Craig-Hallum Capital

Year-over-year, so 9.6?

Alan Schultz

Yes, you're pretty much in the ballpark.

Bob Evans - Craig-Hallum Capital

Neighborhood Targeted, the decline, I think you said it was primarily SG&A driven and a large part of it was stock comp. Is that why the disproportionate impact of stock comp in this segment? Is it just large numbers or small numbers?

Alan Schultz

Well, the way a lot of our allocation works is it's based on revenue and revenue growth, so what you had in this quarter, 17% revenue growth in the quarter, so it gets a bigger chunk of the SG&A than it would have in the past, so that's clearly a factor.

Then the other thing that was going on is the way we look at the Neighborhood Targeted businesses -- and I've said this in the past -- if it worked out perfectly we wouldn't actually show much growth in the Neighborhood Targeted business, either from a top line perspective or a segment profit perspective because really what we want to do with the Neighborhood Targeted businesses is we want to gain market share.

So if you can imagine, we want to put business in at the top of the bucket. We want to continue to fill that Neighborhood Targeted bucket with business and market share and we want to pull that out of the bottom and migrate it into the Shared Mail business.

So I think what happened here in the second quarter is we had an opportunity with some customers, who are not happy about declining newspaper circulations, who are looking at alternatives, and we were able to secure some of that business with the idea in mind that we would migrate it through in the Shared Mail in the future to help clients better reach those consumers no longer reading the newspaper.

Just the way it works is it comes in the bucket at the top at the start and it takes a while to get it out at the bottom and migrate it into Shared Mail and that's what was happening here.

Bob Evans - Craig-Hallum Capital

So you're basically in the process of that migration?

Alan Schultz

That's right.

Bob Evans - Craig-Hallum Capital

It's kind of lower margin migration, if you will?

Alan Schultz

Yes, again, keep in mind the idea is that from a margin perspective, the margins in Neighborhood Targeted are substantially lower than Shared Mail, so it really makes sense for us to secure new business and new customers, even if it's at a lower margin with the idea in mind that when we move it the incremental margin we get on putting that additional content in the Shared Mail package is substantially higher, which is why you saw such a substantial bump in Shared Mail profitability even with just 4% top line growth.

Bob Evans - Craig-Hallum Capital

There's been obviously a lot of questions and concern about a double dip recession and you've obviously had a strong quarter, good outlook. Can you give us a little bit more perspective in terms of raising your EBITDA guidance kind of in the face of maybe concerns over double dip, why maybe your company-specific trends might be different than macro trends?

Alan Schultz

Yes, I think you've got a number of things going on there. You've got -- what I've said -- and I've said this for quite some time now -- is marketing dollars follow consumer eyeballs. Consumers are using our products today, more so than they ever have before. It typically takes a while for those dollars to kind of follow the eyeballs. But what you saw here in the second quarter is those dollars finally arrived.

There's no reason for me to believe that those dollars won't continue to follow those consumer eyeballs. One of the things that we did not talk about when Rob went through a number of the reasons why he's confident about the back half of the year is over the last two years we've been working on dramatically improving our forecasting tools.

In the last year we've developed a much higher level of confidence in our forecasting tools than what we had in the past. So when you combine the conversations that Rob is having with customers, when you combine that with this consumer usage and the marketing dollars kind of following those and then you combine that with what we see in our forecasting tools, that's what gives us the confidence that we're in a position that we should be able to continue to grow mid-single digits.

Bob Evans - Craig-Hallum Capital

Last question and I guess this speaks to forecasting a bit, too. But Q3, how should we think about Q3 relative to Q2 from a seasonality standpoint or what puts and takes might there be that we might not think of? For example, last quarter we thought there might be an Easter impact for FSI. It turned out it was overcome.

Alan Schultz

Yes.

Bob Evans - Craig-Hallum Capital

But what other things should we think about?

Alan Schultz

Yes, in a very nice way, Bob, you're saying I was wrong about the second quarter.

Bob Evans - Craig-Hallum Capital

It was a good wrong.

Alan Schultz

So I appreciate what you're saying and how you said it, most importantly. But in the third quarter you've got back to school and right now we can see pretty clearly our back-to-school time period. It looks really strong to us. So I think we feel really good about the third quarter here.

Now the one area where we think we are going to see some fall-off in terms of revenue in the third quarter is the FSI business. The reason we say that is when you look at the calendar, the way the calendar falls, and if you look at our published date schedule of when we're going to be running programs, in essence what you've got is you’ve got a program that kind of moves out of the third quarter into the fourth quarter.

So I would expect, once again -- and maybe I'll be wrong but I don't think so -- I would expect our revenue to be down in the FSI business in the third quarter but then up again in the fourth quarter and we should see some overall revenue growth in the second half in the FSI business because the fourth quarter uptick should more than offset the third quarter being down.

Bob Evans - Craig-Hallum Capital

When you say down, are you talking sequentially or year-over-year?

Alan Schultz

I'm talking year-over-year, down year-over-year.

Bob Evans - Craig-Hallum Capital

But then up. It should be up nicely in the fourth quarter?

Alan Schultz

In the fourth quarter -- so that would be kind of the only sort of seasonal anomaly that I see in our business right now. I think the other businesses don't have that same issue in terms of how the calendar affects them. Rob, I don't know if you want to add anything to that.

Rob Mason

I think the only thing that I would add, Al, as it speaks to our improved accuracy in forecasting, we do have a pretty good look at Q3 at this point and that's why I can be very confident when I look at Q3 and say I think we're going to be looking at mid-single digit revenue growth in that quarter specifically.

Operator

Your next question comes from the line of Dan Leben - Robert W. Baird.

Dan Leben - Robert W. Baird

First off, Bob, could you just give us some insight into where the additional stock comp expense came in the segments? I know you talked about -- I believe it was Neighborhood Targeted, but if you could just give us the rest of the rundown?

Bob Recchia

In terms of how it's spread between all the segments?

Dan Leben - Robert W. Baird

Yes, how it's spread and what the -- because you talked about the one-time nature of the increase. Just trying to get a sense of what the impact was on that one-time impact.

Bob Recchia

It was about $7.9 million versus a year ago. I don't have how it's spread. I don't give that level of detail in terms of how it's spread to the individual businesses, though. But essentially, going forward, Al gave you the number $2.2 million per quarter.

Dan Leben - Robert W. Baird

Then on the FSI segment, operating expenses were down there pretty meaningfully sequentially, much more than you would expect given the slight downtick on the revenue side. Was that simply moving distribution more to the Shared Mail or was there something other than that?

Alan Schultz

I think you had two things going on there, Dan. They're very much related. As we move more into Shared Mail, which we did do -- we went from $11.5 million to just under $14 million back in May. So we would have got the full benefit of that in the second quarter. I'm sorry, we wouldn't have gotten the full benefit of that in the second quarter but we would have got part of the benefit for that in the second quarter.

Probably two of the three months would have been at the higher Shared Mail number. But I think the other thing that we're seeing is as we do migrate more of our FSIs into Shared Mail our newspaper partners would very much like to keep our FSI in their newspaper. As a result of that, they tend to get more aggressive in terms of their pricing in order to try to keep the FSI in the newspaper.

As a result of that, we've seen some decreases in newspaper costs beyond what we've been able to achieve in the past. So somewhat of a related issue but I think that's your difference.

The other thing -- there's probably a third component to media also, which is as the pages go up our average pages per book increase and as our average pages per book increase our cost per 1000 pages decreases. So when you combine those three factors together, I think that's what was driving the -- what looks to you to be an unusual decrease in cost.

Dan Leben - Robert W. Baird

Then earlier in the call you talked about the verticals that could keep you up at night. What's going the other way? What are the best performers within the segments that have been driving the growth?

Alan Schultz

I'll let Rob cover his star verticals.

Rob Mason

Dan, I think there's three and, again, these are across all of the product segments. But CPG with some of the uptick we reference earlier in terms of the number of coupons being distributed and their promotional focus is clearly a positive influence on the business; specialty retail, especially among some of the client segments that are more aggressively discounting and promoting; and then a segment that we call Consumer Services. Those are clients who would not fit within traditional retailing or manufacturing. They're more service oriented.

So those are the three in Q2 that drove our business and I don't see, as I sit here today, any significant variance in their behavior moving forward.

Dan Leben - Robert W. Baird

Then last one from me, just on the FSI side. I know some people are going to try to put the pieces together with revenue growth versus volumes and trying to back out a pricing number. Help us understand as pages continue to go up, are there volume discounts embedded in there? You don't have to get into the magnitude, just talk about whether those do exist or not.

Alan Schultz

I'm sorry, Dan. We can't get into anything price related. I really apologize for that but that's unfortunately just the way it is.

Operator

Your next question comes from the line of Bill Wilmington - Raymond James.

Bill Wilmington - Raymond James

I had a question on the polybag business. You've talked about it in the past as being a leading indicator for some of the consumer product company, new product pipeline. How is that business looking to you now as a leading indicator?

Alan Schultz

I'll let Rob cover that.

Rob Mason

I think the uptick we've seen in our polybag business, Bill, is indicative of greater health within the CPG segment where over the last two years we didn't see as much meaningful activity around new products and new product introductions.

Today we're seeing significantly more of that and I think on top of that you've got this focus on the consumer shopping behavior changes and the promotional spending that goes with it and I think those two things go hand-in-hand to identify a good story in that segment for us.

I mean, just to give you an idea of magnitude here, Bill -- because you're right. It is kind of an economic leading indicator. In Q2 we saw an increase that was over 30% in the sampling business. As we look out into the future, again, at least for us in the next couple of quarters it continues to look strong.

Again, we can't -- it's hard for us to say what's going on with marketing budgets everywhere else and spending everywhere else. We can look at our business and we do know our business well.

Bill Wilmington - Raymond James

A question for you on the guidance; you raised EBITDA guidance by an impressive $20 million for the year and that would seem to equate back of the envelope to about $0.23. The cash EPS looked like it went from about $3.07 to $3.14. I wasn't sure if I was using the right base number there or if there was something else in the calculation that would specifically impact the cash EPS. Am I looking at it the right way?

Alan Schultz

I think the cash EPS -- I don't have it in front of me -- went from $2.79 to that.

Bill Wilmington - Raymond James

That's the level you used as a -- .

Alan Schultz

Yes, the $3.07 was a hypothetical number based upon a new cap structure I think that we gave you last time. (Inaudible) $3.14.

Bill Wilmington - Raymond James

Now I wanted to ask about the supermarkets' talk about food price deflation -- that's been a popular topic with them -- and what that means for CPG companies in terms of whether that makes it easier, more difficult or a non-issue for them in terms of issuing coupons.

Alan Schultz

Well, in the past inflation has somewhat been our friend. What I mean by that is as prices have gone up you've typically seen more coupons issued to try to appeal to that value-conscious consumer who really doesn't want to pay that increased price.

I think the dynamics are a little different today, perhaps, than they've been in the past. The reason I say that is private label has become a bigger and bigger percentage of the marketplace. So what a lot of your branded companies are dealing with and struggling with today is there's still a pretty significant price differential between a branded product and a private label product.

Clearly coupons is a way to mitigate that differential. If there is deflation I don't think that problem goes away. You still have to mitigate the differential between your branded product and the private label product. The research study that I referenced earlier I think really talks to that issue and that problem.

Bill Wilmington - Raymond James

Then the last question for you is on the digital front. There's been a lot of press coverage on the increased use of digital coupons and I wanted to check in and see how your clients are looking at that, what their level of interest is, what their level of demand is?

Alan Schultz

Yes, I'll give you some statistics here. I guess, first of all, what I would say is I think during this recession we picked up the 20-somethings. The 20-somethings got into savings for probably the first time in their lives and they tended to lean more on digital. But if you look at it from a very large perspective, we're still in the very early days of digital, still a lot of clients in the testing phase.

Although we've seen impressive numbers in our digital business with most of our metrics being up triple digits in terms of digital distribution, it's still relatively small off of a relatively small base. That's what you always see in a business is you see these big percentage increases off of really small bases.

But if you look at it a little bit more in absolutes -- here's some interesting stats for you. FSI's coupon distribution went up 13.4 billion coupons in the first half of 2010 versus the first half of 2009.

Now if you look at digital coupon distribution it increased by 895 million during that same time period. So, in essence, the old FSI printed piece, published piece, outperformed digital by 15 to one in terms of coupon distribution.

Now, again, if you look at it in terms of percentages, the percentage is much lower in FSIs and much higher in digital. But if you look at it from an absolute perspective it was 15 to one and digital coupons today represent about 1.2% of all coupons distributed.

So, listen, we're excited about digital coupons. We're working on digital coupons. We're investing in digital coupons. We have a vested interest in digital coupons. We're building digital coupons into our offline buys and media plans with our customers on a daily basis and we're seeing tremendous growth there but I still think we're quite a ways out from it being a major contributor to our success. But we are investing and we're going to continue to invest on a very robust basis going forward.

Operator

Your next question comes from the line of Mark Picurin - Graystone Capital.

Mark Picurin - Graystone Capital

Just a couple of quick questions, most of the questions have been asked. I know you can't talk about specifics but did you actually begin distributing any product for news by the Shared Mail package this quarter?

Alan Schultz

No, no. One thing we have been able to disclose is that we will begin distributing News America FSI booklets in January of 2011 in our Shared Mail package. We can't disclose any other details about quantity or markets or anything of that nature but we were able to disclose the start date.

Mark Picurin - Graystone Capital

Then, Rob, good to hear on the visibility; my question is, going back to the ADVO days, one of the challenges in the Shared Mail business was always that retailers with their ad spending could ramp up and ramp down fairly quickly and, given the fixed cost nature of that business, could have some pretty important EPS ramifications.

Have you been able to restructure any of those contracts or, just through technology and systems and better sales execution, gotten to the point where you're more comfortable with the visibility going into, say, the last month of a quarter that changes in spending or a push-out in promotion could have such a big impact?

Rob Mason

Mark, it's a great question. I think it's a two-fold effort. One, in negotiating contracts with clients, we always want to get as many assurances as we can that when it rains those clients will be there. So that's an ongoing effort and I think it always will be.

I think one of the reasons we've put so much effort against improving our forecasting system was an outgrowth of what we experienced in the Shared Mail business. While it is a volatile business and subject to changes in volume because of the leverage, I think today we're in a far better position in terms of being able to understand what's in the forecast and have a greater sense of comfort and confidence in that forecast.

I think we've gotten much more forward-looking in the forecast and our sales organization as a whole has done a very nice job at pushing their vision out. I'll just tell you that we've got much more visibility today and that, in my mind, should mitigate any of the issues we saw back in the early days of the Shared Mail acquisition.

Alan Schultz

Mark, I'd just say -- I'd add one other thing is there's a lot of scrubbing in these forecasts that's taking place. What I mean by scrubbing is there's people like Rob and Rick Herpich, our EVP of sales and Marketing. They're monitoring what's going on with our major grocery retail customers in terms of their overall sales and financial success.

If they see some pretty robust activity from a retailer who appears to be struggling a little bit they're really challenging that forecast and taking it down if they're seeing that. So I think I'm much more comfortable with the level of scrubbing that's taking place today than I was two years ago.

Mark Picurin - Graystone Capital

One quick final maybe strategic question; as you're putting more of the FSIs into the Shared Mail packages, you've gotten probably a good 18 to 24 months of data points now. Are there any stats you can share in terms of viewership or redemption trends in general? Are the CPG customers comfortable with that as an alternate distribution methodology versus the Sunday newspaper?

Alan Schultz

I think the biggest stat in my mind is the fact that after two years from a move from newspaper into Shared Mail, the Shared Mail is redeeming literally at the average rate of newspapers. To me, that is the most important stat.

There was no doubt from day one as we moved FSIs from newspapers into Shared Mail absolute, incremental, unit volume moved was going to increase. There was absolutely no doubt about that in anybody's mind and we've seen that.

The question was how long would it take to duplicate the redemption rate that we were seeing in the newspaper business? That was the question because consumers had been trained for 40 years to look for those consumer packaged goods coupons in their newspaper and how long was it going to take us to train them to look in the Shared Mail package for them?

What we saw with the early moves we made from newspaper into Shared Mail is it took two years fro that transition and focus to take place for the consumer. We have been working since then on plans to hurry up that process. We have been putting money into markets from an advertising perspective, marketing perspective to educate consumers on the move much quicker than we have in the past.

I don't have any new data on how quickly we're going to be able to do that, take it from two years to a 1.5 years to one year or whatever. But we're clearly working on that and that is part of our plan.

Rob Mason

The other thing I'd add is just anecdotally we have not had any customers opt out of our FSI because of that migration. So that just backs up what you're saying about redemption equity between newspaper and Shared Mail.

Operator

Ladies and gentlemen, that does conclude our question-and-answer session for today. I would now like to turn it back to management for closing remarks. Please go ahead.

Alan Schultz

Thanks, [Marissa], and thank you all for attending the call today. I mentioned earlier and I've said it many times before that marketing dollars follow consumer eyeballs. That's what we experienced in the second quarter. The marketing dollars arrived.

Consumer usage of our media continues to grow and, as a result, clients are reallocating their marketing budgets towards the projects and services we sell. Research on consumer behavior continues to flow in indicating the shift towards value and deals is here to stay.

You also heard Rob share his perspective based on conversations with his team and our clients and, as I mentioned in the call and we talked about considerably here near the end, is our ability to forecast and the tools that we have available to us have dramatically improved over the last 12 months.

So when you combine what we're seeing in these tools with the consumer and client trends, everything we see today indicates we will continue to put up mid-single digit revenue growth throughout the balance of this year.

Thank you all for attending the call and we look forward to talking to you at the end of the next quarter. Thank you.

Operator

Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to the replay of today's conference please dial 303-590-3030 or 1-800-406-7325 using the access code 4319118. Thanks for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Valassis Communications, Inc. Q2 2010 Earnings Conference Call Transcript
This Transcript
All Transcripts