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Valassis Communications, Inc (NYSE:VCI)

Q3 2010 Earnings Call

October 28, 2010 11:00 a.m. ET

Executives

Alan Schultz - President & CEO

Robert Recchia - EVP & CFO

Analysts

Chuck Cerankosky - Northcoast Research

Dan Salmon - BMO Capital Markets

James Boyle - Gilford Securities

Bill Warmington - Raymond James

Alexia Quadrani - JPMorgan

Mig Dobre - Robert W. Baird

Mark Argento - Craig Hallum

Timothy Dowd - MLB Capital Management

Faz Saheed [ph] - DA Capital Management

Operator

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 Principles. 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 Form 8-K dated today, which is also available on Valassis' website at www.valassis.com on the home page of investor section.

I’ll hand over the conference over to Alan Schultz, Chairman and CEO. Please go ahead, sir.

Alan Schultz

Thank you, good morning everyone, welcome to the call. Joining me today is Bob Recchia, our Chief Financial Officer. We had the occasion to meet with most of you recently at our investor conference in New York on September 30th, where we had a five hour action packed agenda with updates on our business and plans for the future.

We were really pleased that so many of you were able to attend both in person and kind of following on by web cast. For those of you who were not able to join us at the investor conference, the conference presentation materials, the web cast, recording and the transcripts are available in the investor section of our web site, valassis.com, under presentations and they will be available there for your review through September of next year. And because of our recent investor conference, out of respect for your time, we've shortened our prepared remarks today for the call, and of course as always Bob and I really look forward to answering your questions.

Our Q3 results are really in line with our long term plan to deliver annual mid single digit revenue growth and double digit earnings per share growth. Compared to the prior year quarter, Q3 revenue grew 5.2%, earnings per share was up 85.7% and adjusted EBITDA increased by nearly 25%.

Because of our current results and outlook, we expect to meet or exceed our full year 2010 adjusted EBITDA guidance of $320 million in spite of increased paper cost in the second half of 2010. We did revise our full year 2010 diluted cash earnings per share guidance up from $3.14 to $3.20.

From a capital expenditure standpoint our guidance remains at $25 million. As you know the last few years we’ve really focused on adjusted EBITDA as our key operating performance metric. As a highly leveraged company it was the most reflective measure of our business results.

In 2010 we have been successful in dramatically reducing our debt leverage; in fact, we anticipate year end net debt to adjusted EBITDA to be approximately 1.5:1. As a result we believe it is appropriate to shift our focus to a more traditional GAAP measure of earnings per share beginning in 2011.

We will continue to report both earnings per share and adjusted EBITDA for the reminder of 2010 but plan to shift to annual earnings per share guidance in 2011. We expect to announce full-year 2011 annual earnings per share guidance in mid December, after our Board of Directors has had an opportunity to approve a budget and set performance targets for 2011.

Our written earnings release, I think, does a great job of recapping our Q3 results but I would like to make a few additional comments regarding cash flow and revenue growth in our Shared Mail and Neighborhood Targeted segments. Regarding cash flow, we mentioned at our September 30th Investor Conference that we expected to finish the year with 220 to 250 million in cash depending on the impact from changes in working capital. We still believe this to be the case. We had nearly 209 million in cash as of September 30th, down from nearly 229 million at the end of June.

We made nearly 62 million in income tax payments in September and estimate that we will make additional income tax payments in December of approximately $56 million. This is due in large part to the remaining estimated payments due on the litigation settlement we received earlier this year. I would like to reiterate that even with these deferred tax payments, we expect to finish 2010 between 220 and 250 million in cash on the books. In terms of where we finish within that range, it will be somewhat dependent on changes in working capital.

Moving onto Shared Mail revenue, there were several factors that really influenced our 2.1% revenue growth in the Shared Mail segment this quarter. Growth was driven primarily through volume with 1.3 more pieces per package this quarter versus a year ago. These revenue results also reflect the negative impact of a reduction in the average pages per insert in the grocery vertical, a reduction in pricing and the final planned reduction of package distribution due to our optimization strategy for 2010.

As you know, media rates have been soft across the board over the last couple of years although there are indication that rates will be firming up and have been firming up in a variety of media this fall. We are pursuing a two-part strategy to help drive Shared Mail growth. One, build market share in this paper distributive products; and two, migrate newspaper business to Shared Mail distribution to ensure clients achieve their desired market coverage.

We're doing an excellent job with this strategy. Pieces per package in our Shared Mail business are up 15.3% this quarter versus a year ago and revenue in our Neighborhood Targeted segment grew 23.9% in Q3 preceded by 17.5% increase in Q2, both versus the prior year quarters. We believe this just creates more opportunity for Shared Mail growth in 2011 and beyond.

The audit bureau of circulations announced earlier this week that average daily newspaper circulations fell another 5% in the last six months on top of the 8.7% in the previous six months. As you heard in detail at our Investor Conference, there are many reasons why Shared Mail is an ideal solution to reach the households no longer reading the newspaper.

Our ability to offer clients blended newspaper and Shared Mail distribution in a single optimized buy remains a key competitive advantage for us and a way for us to accelerate this migration from newspaper to Shared Mail; we must continue to capitalize on this opportunity.

I also wanted to make a few comments about coupon trends. During the past two years, growth in coupon redemption has out paced distribution. As we discussed in our Q2 conference call we are seeing a slowdown in the rate of growth in total coupon redeemed. While consumer demand remains strong, marketers are deploying tactics to control redemptions and their budgets.

Examples of these tactics include shortening of coupon expiration periods and increasing the number of products consumers need to purchase to redeem the coupons. Distribution growth is now out pacing redemption. The good news is, is we make more money on distribution then we do on clearing and CPG coupon distribution was up 12% in Q3 versus the prior year quarter.

That wraps up our prepared remarks for this call and we now like to open the call up to questions.

Question-and-Answer Session

Operator

Thank you sir, we'll now begin the question and answer session. (Operators Instructions). Our first question comes from a Chuck Cerankosky with Northcoast Research, please go ahead.

Chuck Cerankosky - Northcoast Research

Good morning.

Alan Schultz

Good morning, Chuck.

Chuck Cerankosky - Northcoast Research

When looking at the FSI migration that you folks are doing from newspaper to Shared Mail, can you give us a chronology of where we are at the beginning of the year, it stepped up mid year, where we are now and how do you think that’s going to shape up in 2011?

Alan Schultz

You know, Chuck, we started the year in the neighborhood of 11-ish -- little more than 11 million circulations in Shared Mail. We'll finish up with about 14 million in Shared Mail distribution so I think that's up roughly 25% this year. We'll be starting out a little over 14 million circulations as we go into the New Year.

Little hard to say at this point in time how much more migration we'll see in 2011, we're working on our plans right now Chuck and we plan on giving guidance in sort of the middle of December of this year for next year.

By that time we should have flushed out pretty well what we anticipate in the way of an increase in Shared Mail distribution of the FSI product, but we're not quite there yet.

Chuck Cerankosky - Northcoast Research

All right, now when you talk about your strategy of migrating newspaper circulars into Shared Mail, does that go hand in hand with moving your FSIs into Shared Mail or does one draw the other?

Alan Schultz

Well, there is some sort of -- there is definitely a relationship there Chuck because what we've seen is, is when we put the FSI in our Shared Mail package, which typically includes grocery retail circulars, there are a number of benefits that are associated with that. One is we typically get alignment with the retailers' price break. So now the coupons are now available in the marketplace the same time the retailers' price break is available in the marketplace.

So, what you'll see is the redemptions then to come much earlier in the redemption cycle because of that. Obviously, there's benefits from a consumer perspective now in that the retailed circulars and the FSIs are together in one place so they can take advantage and really maximize their savings opportunity. So, yes, we think there's clearly some sort of a relationship there between the two.

Chuck Cerankosky - Northcoast Research

Okay, you mentioned in the press release moving some of the option expense from January into the fourth quarter. What's the thinking behind doing that, and how does it affect some of the guidance you put out there realizing, of course, it is non-cash expense?

Alan Schultz

Yeah, Chuck, one of the reasons that we're looking at December in terms of doing it is if we do it in December, we'll know if the stock price is at that date, we'll know what the volatility is at that date and therefore it gives us a high level of precision in terms of estimating the total non-cash stock-based compensation expense for 2011. If we basically approve the plan in December like we've historically done, and then actually do the issuance in the new year, there is just less precision in the estimate, and we have been struggling a bit this year in terms of estimating non-cash based stock compensation because as our stock moves up, our volatility moves up and then the value of an option moves up which means the expense moves up.

And then of course, we have some accelerated investing based on increases in the stock price until, we just feel it's going to make it a lot easier for us to project it and give guidance going forward to the extent it gets done in December.

Chuck Cerankosky - Northcoast Research

In other words get some noise out of the way.

Alan Schultz

Yeah and then I think this year also because of the acceleration of the stock price is a little bit of an anomaly year. Anyway, in terms of -- for the total amount of stock-based compensation and so we feel like going forward doing it this way, we should be able to get to a more normalized rate in 2011 and beyond.

Chuck Cerankosky - Northcoast Research

All right, thank you.

Operator

Thank you. Our next question comes from the line of Dan Salmon with BMO Capital Markets. Please go ahead.

Dan Salmon - BMO Capital Markets

Good morning, guys and thanks for taking my question. For either Al or for Bob, I know on these calls and the analyst day and in private conversations you talked to us a little bit about how the shift between different segment lines for both revenues and costs take place as some of these products get distributed differently, but I was hoping you could just walk us through that one more time, specifically for three things; when you put your own FSI into the Shared Mail, when you start putting in News Americas on January 1st, their FSI into the Shared Mail, and then although we don't talk about it quite as much. Also how the flow of revenues work for inserts when they are neither in the newspaper or in the Shared Mail.

Robert Recchia

Okay, Dan. On the first one as we put our FSI into Shared Mail, there is a cross charge that is eliminated. All of the revenue is still reported in the FSI segment, so think of Shared Mail as simply a delivery vehicle that we have a cross charge internally for -- that is eliminated in the consolidation, so the revenues and the business model for FSI is still very pure, okay.

As This America begins next year inserting their insert into the Shared Mail package, that will be Shared Mail revenue, alright, and then as we bring inserts in, many times we have some that go Shared Mail and some that go newspaper and that is divided equally amongst the two. So half of its going Shared Mail, and half of its going newspaper, the revenue is split.

Dan Salmon - BMO Capital Markets

And on the inserts, the costs are also aligned with the segments, is that correct?

Robert Recchia

Yes.

Dan Salmon - BMO Capital Markets

Okay, very good.

Alan Schultz

Dan, one of the ways to look at it in the FSI when we put our own FSI and our own Shared Mail packages, is we're substituting distribution costs, right so where when we distributed through newspaper, we have immediate distribution cost which we pay to the newspaper, so when we distribute through shared mail, we have immediate distribution cost, it’s just shared mail.

So really for the FSI business you're just substituting one distribution cost for the other.

Dan Salmon - BMO Capital Markets

Great, thank you.

Operator

Thank you, our next question comes from the line of James Boyle with Gilford Securities, please go ahead.

James Boyle - Gilford Securities

Good morning. Is there any advertising category that is just simply not coming back at this point?

Alan Schultz

There are two categories that have been slow for us, the restaurants have been slow for us -- I am talking about the third quarter now and then the other is discounts stores.

Those have been the two slow ones. As far as on the positive side we've seen CPG category continuing the spend and they've been a pretty consistent growing spender with us even over the last couple of years here now.

The specialty retail category is coming back and spending more lot of what we would put in the kind of consumer services, it’s coming back. We're seeing some moderate growth even in the financial sector, telecom is spending pretty strongly and satellite is spending pretty strongly.

The only two that I can point to that are really negative are restaurants and discount stores. They haven't really got into the full swing.

James Boyle - Gilford Securities

And are the advertisement rates starting to climb back as fast as you expected, or is the demand, near to mid-term simply not robust enough?

Alan Schultz

Well, our situation is a little bit different than other media, and what I mean by that is in the FSI business in our contracts average 28 months in duration, and so a lot of our business is locked in and we don't necessarily have an opportunity to improve the pricing in the short term, it's a longer term opportunity.

When you get into Shared Mail business a lot of our contracts are one and two year contracts and most of those contracts tend to be on a calendar year basis, so we now have started to see in a variety of media, looks like prices coming up here in the fall, but prices coming up in the fall don't necessarily give us much of an opportunity for price improvement because most of our business, whether Shared Mail or free standing inserts is locked in under contracts that were done a year ago, two years ago.

James Boyle - Gilford Securities

And what about the rates for the contracts that have started to roll off?

Alan Schultz

Yeah, I can't -- legally, I've been told like I can't really talk about what's going on with future contracts.

James Boyle - Gilford Securities

Okay and finally what trend in the second half of this year either disturbs you or puzzles you looking forward?

Alan Schultz

What trend puzzles me -- I don't think we've seen anything puzzling at this point. We said in the last quarter and we said at our Investor Conference that as an example, couple redemption volume had been up probably over the last two years, totaled over 30% and distribution hadn’t been keeping pace with that. And what we thought was that marketeers are going to start to do things to try to bring down those redemptions but likely a distribution which started to catch up to redemptions and that has clearly started to happen in the third quarter.

So I don't think that was a surprise to us because like when you look at a client's budget, a consumer package's goods company, when they do an FSI program, their budget as an example might be $1.3 million and let's say 300,000 of that is for media and $1 million is for redemptions. Well, if redemptions are up 30%, what that means is your million dollar budget goes to a $1.3 million and they're trying to control that redemption cost. And from our perspective, that's not necessarily a bad thing because the reason that they want to control the redemption cost is they want to continue to do the media and do the distribution.

And so -- and I wouldn't say that's perplexing to us. We sort of anticipated that that would happen and started to hear from clients that they were starting to look at those different practices to reduce redemption rates.

James Boyle - Gilford Securities

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Bill Warmington with Raymond James. Please go ahead.

Bill Warmington - Raymond James

Good morning.

Alan Schultz

Good morning, Bill.

Bill Warmington - Raymond James

Congratulations on a strong quarter.

Alan Schultz

Thank you.

Bill Warmington - Raymond James

A couple of questions here, first P&G has been doing some very heavy new product introductions, including special coupon books coming out, putting up a temporary store in New York for customers to try out the new products, new website. Are you guys seeing that flow through to your business and how?

Alan Schultz

Well, we can't -- we can never talk about specific customers in terms of what they're doing other than to say what everybody has seen in the marketplace over really the last two years, which was P&G as you would expect. It was one of the first companies to pick up on the concept that consumers are really interested in value and they have to try to provide more value to consumers to continue to build their business and share and move units and they continue to act accordingly. I think everybody’s seen that in the marketplace and, of course, we've seen that too. We really can't talk about any clients in terms of their prospective plans and how we anticipate it’s going to affect our business.

Bill Warmington - Raymond James

I wanted to ask some metrics questions. The wrap sell through, how that is looking and also unused postage as a percentage of the base postage.

Alan Schultz

Yeah, the wrap sell through percentage was around 85, 86, if I remember right, Bob, is that right?

Robert Recchia

Yeah, that's right. 85.6.

Alan Schultz

Yeah 85.6%, unused postage was a little below 17%.

Bill Warmington - Raymond James

And then the -- I wanted to check the number of packages delivered, and I wanted to double check the number of pieces and make sure I got that number right.

Robert Recchia

All right, packages were just over 900 million and pieces per packages about 9.8.

Bill Warmington - Raymond James

And then on FSI units, how were the industry units versus how you guys were doing this quarter?

Alan Schultz

Industry units were actually up roughly 2.9% I think, so units were up. We had two less publishing dates in the quarter and I think news had one or maybe two more publishing dates in the quarter. So I think the industry dates were relatively flat but the units were up.

Bill Warmington - Raymond James

Now, are you guys in line with that unit growth level?

Alan Schultz

No, our unit growth was not there. They had the additional date so they got unit growth. There is kind of a two sided sword there, one is, if you have more dates you can drive more revenue, but what it tends to do is bring down your average book size and when you bring your average book size down, it negatively affects your profitability. So actually by having fewer dates, even if you have a little less business, if your average book size is up, it drives increased profitability because it drives primarily more media efficiencies.

There’s other efficiencies that it drives too with a larger average page count in a book but media would be the biggest variable. So that's why you actually see us with a revenue decline and an increased profitability in this case, it had to do with an increase in the average number of pages per book.

Bill Warmington - Raymond James

Okay. I just wanted to double check the number of publishing dates that were actually in the quarter and the number that you expect in the fourth quarter.

Alan Schultz

Yeah, so for us in the third quarter we had 10 dates, regular co-op dates and three what we call custom co-op programs and in the fourth quarter we'll have 10 regular co-op programs and anticipate four custom programs at this point. And what that would mean is that you’ve seen a two date shift or two program shift from Q3 into Q4.

So Q3, we had two less programs and Q4 we'll have two more programs than the previous year.

Bill Warmington - Raymond James

Got you. All right, well thank you very much.

Operator

Thank you. Our next question comes from the line of Alexia Quadrani with JPMorgan, please go ahead.

Alexia Quadrani - JPMorgan

Thank you. I have got a couple questions. First, was there any variability in performance as the quarter progressed, or are the months pretty much the same?

Alan Schultz

Alexia, I guess what I would tell you is we kind of started out with back to school at the end of July and in the early August which was relatively strong. And then we went through kind of a little lull there at the end of August and early September and then kind of picked up again at the end of September. So on a monthly basis and seasonality taken into consideration; quite frankly, I think it was probably fairly steady.

Alexia Quadrani - JPMorgan

And speaking specifically about the Shared Mail business, has that pick up in the end of September? Has it continued, I guess what are you seeing early in the fourth quarter? And then staying on the Shared Mail business for a bit, I might just be confused about a comment you made earlier, to an earlier question. On the contract that you have in the Shared Mail business, can you give us a sense like how much of that business is generally under that longer term contracts and how much is more last minute business and how the pricing may compare in the two segments?

Alan Schultz

Yeah, Alexia, I don't have the same data on Shared Mail contracts that we have on FSI contracts. I mean there's something that we can get our hands around but I just don't have the answer readily available on that.

Alexia Quadrani - JPMorgan

Just sort of -- I can circle back after the call, but I didn't know if the majority of the business was sort of long-term commitment or if it was just a small part of it. But I can circle back if you don't have it in front of you.

Alan Schultz

Yeah, Alexia, I guess what I can tell you is that we have strategic accounts and field accounts, and the strategic accounts pretty much all tend to be under this one to two-year contracts and that usually represents a little over half the business. And then we have another half of the business which is field accounts of which our larger field accounts are probably under one and two-year contracts and our smaller accounts are not. So maybe I'm guessing we have to get to these numbers, maybe 50% of the field is under contracts. So I guess that would -- and again please don't anybody take these numbers as gospel. I'm just -- my gut's telling me it's probably around 75% under contract.

Alexia Quadrani - JPMorgan

Okay, now that's very helpful. And is it like the FSI business where the contracts are generally renewed or the bulk of them are renewed around the same time of the year? Or are they sort of spread out? I'm trying to get a sense of when you may see a pick up in pricing? That's all.

Alan Schultz

Yeah, you're right. There're done typically around the end of the year for the next year or two. So they're typically done late in the year.

Alexia Quadrani - JPMorgan

Okay, great. And then I may have missed it, but did you comment on how the Shared Mail is trending into the fourth quarter?

Alan Schultz

Yeah, I think Shared Mail is going to look sort of similar to Q3 in terms of pieces for packages, looks like they're going to continue to be up, will continue to have some soft pricing. I would assume the grocery category is going to continue to do what they sort of did in the third quarter. So I think Q4 is going to sort of look like 3.

Alexia Quadrani - JPMorgan

Okay, and then jumping to the FSI, I know you can't talk at all about forward pricing in the industry, but can you give us details on the performance in the quarter, you know, volume versus pricing in the quarter?

Alan Schultz

Yeah, the pricing was down, sort of and what we have said, sort of the mid single digits within the quarter. So nothing real unusual there and as I've said, the units were down a little bit due to the date reduction.

Alexia Quadrani - JPMorgan

Perfect, thank you very much.

Operator

Thank you. Your next question comes from the line of Mig Dobre with Robert W. Baird, please go ahead.

Mig Dobre - Robert W. Baird

Thank you, good morning. On analyst day, Michael Kowalczyk had some comments about in store business as far as signing new business looking toward the latter part of the year. Can you give us an update on that?

Alan Schultz

No. Typically when we do a new retail contract we'll make it a public announcement at the time we do that contract because we have to get out and start selling into those contractual periods and so we will make a press release at the time that those things happen.

Mig Dobre - Robert W. Baird

Okay, but would you say that your outlook has -- for that business has improved or remained the same, or how should we think about that?

Alan Schultz

Yeah, I don't think our outlook has really changed. When we look at our digital business and our in store business, we're counting on them to deliver somewhere in the neighborhood of $40 million in incremental revenue between the two and that still remains the plan, nothing’s really changed in that regard.

Mig Dobre - Robert W. Baird

All right, my other questions have been answered. Thank you.

Operator

Thank you, our next question comes from the line of Mark Argento with Craig Hallum Capital, please go ahead.

Mark Argento - Craig Hallum

Good morning. When we think about -- you mentioned incremental or the increase in paper cost. Is there anyway you can quantify what kind of impact that had for you in the third quarter or for the second half of this year?

Alan Schultz

Yeah, I guess -- here is what I can tell you, we do have long term paper contracts in place and those paper contracts will typically allow for paper prices to adjust up or down within a collar and usually that is kind of within a single digit range. And so you'll typically see in a year where paper prices are going up significantly, you'll see us with like, lets say a 9% increase. And so we've kind of tried to design things in a way to keep paper prices in the single digit change area.

Mark Argento - Craig Hallum

And when we think about kind of the Shared Mail business and what the drivers are to see that business continue to grow, you know, I know you grew a couple percent in the quarter. We were modeling a little bit higher. What are the puts and takes in terms of getting that category to grow, and is it -- should we look at it as you are going to convert bigger chunks of revenue over, so growth is going to be a little bit more -- a little less linear and a little bit more chunky from quarter to quarter? Could you just walk me through how to think about Shared Mail conversion as we look out?

Alan Schultz

Yeah, it's a great question, we -- Bob and I have talked a lot about this. Our ideal scenario would be, we've got a big pipe and what we are doing is, is we're securing market share in newspaper delivered products and at the same rate we are bringing it in, we're kind of pushing it through the pipe into our Shared Mail business.

Unfortunately, it just isn't perfect in that regard so sometimes what we see is, is we see a funnel at the end of that pipe on the newspaper side, which we basically saw in Q2 and Q3, where we're getting a lot more share of newspaper distribute product and we just can't get it pushed through the pipe fast enough over in the Shared Mail because there’s just too much funneling into it. And then there are other times where we don't have as much coming in the Neighborhood Targeted product and we're attempting to pipe out. So what that causes is definitely some lumpiness in our Neighborhood Targeted area and some lumpiness in our Shared Mail area and it's not ideal but from our perspective when we have an opportunity to capture newspaper targeted distribution or newspaper distribute market share we want to capture it because it becomes opportunity for the future.

The other thing that I think is really important in terms of the Shared Mail business is what you've seen this year is we've actually done an excellent job of migrating more and more customers in the Shared Mail and you've seen 15 to 20 plus percent increases in the number of pieces per package depending on the quarter but what you've got is you got pricing working against you in an environment where pricing has really been soft.

Now, our hope is as we've seen media price to start to firm up here in the fall in a variety of different media categories, what our hope is, is that we start to see that price start to benefit us going forward, and it's not a drag in terms of top line revenue growth.

Of course, in addition to that, we've had optimization efforts going on where we've been shrinking the number of packages and when we do that, that also has a negative impact on revenue and that can be a little lumpy also just in terms of what we do in a given quarter. So I guess the long and the short of it is, yes, you should anticipate some lumpiness.

Mark Argento - Craig Hallum

That's helpful. In terms of talking with some CPG companies and also reading it in the press, it seems the consumers aren't quite responding to promotion maybe the way they were a year ago or even two years ago. Maybe they are a little less -- you know, a deal today, everybody has got a deal today or a special. That said, also talking with these guys, it doesn't really mean they're going to spend any less in terms of continue to promote the products, but what do you think, I mean, do you think that we go through a period -- is there risks that we see overall spend in the category decline if the economy starts to get a little bit more healthy, or how do you guys think about kind of the spend levels relative to if consumers are responding or if they are a little worn out on the promotion side?

Alan Schultz

Yeah. We haven't seen any research that indicates the consumers are kind of slowing down in their appetite for deals. In fact, all the research we have seen indicates that they continue to have a strong appetite for deals and that's the behavior that they’ve learnt in this recession. They plan on continuing long after this recession is over.

Now, what we have definitely seen is we've seen marketers do things differently and the reason they're doing things differently gets back to what I said earlier where we've seen redemption rates increase by 30 plus percent in terms of consumer package goods companies and we've actually seen a response rates in the Shared Mail business over the last three years up 49%. What we've seen is marketers try to think how to design their promotions in a way where not as many people are able to take advantage of the promotion. So they're shortening expiration dates. We’ve seen a lot of people go from 60 days, where an offer is alive down to 30 days.

So they get the initial bump, but they're cutting off the long tail and we think they are going to continue to do that and then we've seen marketers do more of these buy two, get one free offer, where they are really trying to move incremental volume.

But the problem you run into is that offer is less appealing to a consumer than a buy one, get x amount off offer, so you get a lower redemption rate. No, we have not seen anything like that. In fact from a manufacturer stand point, as I said distribution is up.

Mark Argento - Craig Hallum

That's good. Good information. And lastly, on the digital side, I know you guys in the segment break down, you have international lumped in with digital media and services, but overall – I mean is digital - I mean digital - it seems like there is a lot of runway for that business clearly and the growth rate there. Is that a double-digit growth rate in that category. I know international is probably a pretty good chunk of that category. Maybe you can segment that a little bit and talk to what your outlook for digital is. I think clearly there has been a lot of press around digital couponing over the last few months in particular. But would you really think that business is a big opportunity for you and maybe talk a little more about your outlook there.

Alan Schultz

I think from an industry perspective, Valassis aside for a second, I think the most recent data indicates that digital couponing is up about 60% in the consumer package goods phase and about 23% more CPG clients are doing digital coupons.

So we're seeing more clients, more distribution. Reality is, is digital spill only remains about 1% of the total market, so it’s still relatively small, so that's the industry.

But for Valassis, actually in this quarter, digital revenue was up probably over 500%. So we're clearly out pacing the market by quite a bit right now, but it’s off a very small base for us. And so as that base grows, that percentage will go down, but we continue to see - as you said there is a lot of runway here for growth in digital.

We continue to work on ways to put ourselves in a more advantageous position to capture a bigger and bigger market share of digital. And we think our real long term advantage is that once digital becomes more mainstream that our customers who currently have a separate group that manages their digital distribution, they will eventually lump that together in one group and they will want to buy offline media and online media and have it blended together in an optimized solution. And to my knowledge we're the only people that have the capability to do that and are working on investing to do that to even a greater degree that what we're able to do today.

So that's how we feel like we win in the long term but, we're -- people that are selling digital are feeling pretty proud of 500 plus percent increase, even though it's off a small phase.

Mark Argento - Craig Hallum

Sure. Great. Thanks for the help.

Operator

Thank you. Our next question comes from the line of Timothy Dowd with MLB Capital Management. Please go ahead.

Timothy Dowd - MLB Capital Management

Good morning, gentlemen.

Alan Schultz

Good morning.

Timothy Dowd - MLB Capital Management

Nice quarter.

Alan Schultz

Thank you.

Timothy Dowd - MLB Capital Management

I noticed in this particular quarter you had significant stock-based compensation. And I wondered if you had an EPS number or a non-GAAP number that would exclude your stock-based compensation?

Robert Recchia

The cash-based -- let me give you the cash-based EPS of 320 as we define it that does exclude the stock-based compensation.

Timothy Dowd - MLB Capital Management

Ok, that's on a fiscal year. I guess my question is relative to this particular quarter, Q3.

Robert Recchia

(inaudible)

Timothy Dowd - MLB Capital Management

That's something that many organizations provide GAAP earnings and then non-GAAP if there are any special charges and then typically exclude stock-based compensations. I know from the analyst community that, that's probably, would be considered a one-off item and not included in their consensus estimates. So in order to identify the strength and the power of earnings going forward, and you guys alluded to the challenges of trying to predict stock-based compensation going forward and I see in Q4 you're identifying $10 million in additional stock-based compensation and might provide investors and the analyst community a little cleaner number if stock-based compensation was included in the GAAP number and then a non-GAAP number was also provided to isolate those unique circumstances with regards to stock-based compensation.

Robert Recchia

Okay. So for the quarter while you were talking here we just ran they numbers, it's $0.10 in EPS for the quarter.

Timothy Dowd - MLB Capital Management

$0.10, okay.

Robert Recchia

$0.10. So you just --

Timothy Dowd - MLB Capital Management

So that would be a $0.62 number on an EPS standard? That's after-tax I assume, correct?

Robert Recchia

Yes.

Timothy Dowd - MLB Capital Management

Okay. And then for 2011 you mentioned you are going to provide GAAP guidance. Because of the significant issues with stock-based compensation, will you also be providing on a quarterly basis then or have considered a non-GAAP number as well?

Robert Recchia

Yeah, we will give you GAAP number and a -- we think the most relevant number is cash earnings per share as we define it, because we’ve got a big difference every year and is going up for a couple of years now and the difference between depreciation and amortization which is north of $60 million and a CapEx number which last year was in the low 20s and this year is 25. So it highlights the difference which has historically been $0.75 or $0.80 a share.

Timothy Dowd - MLB Capital Management

Okay. And the other was --

Alan Schultz

We'll try to give you definitely some more color on this and part of the idea of doing the grants in December is so that we can provide you more color for the next year. And we should even be able to get down to sort of a quarterly basis kind of going forward with the exception of the difficulty will be in Q4 of 2011 because there we won't know what the stock prices and we won't know what the volatility is, right? So that will be a little bit of a guess, but…

Timothy Dowd - MLB Capital Management

Yeah, that's why I suggest if you provide a non-GAAP number you get away from the noise of trying to predict that on a go forward basis. You can try to predict it, but if you give a GAAP and a non-GAAP number, you provide the Street with a clean look. Right now the shares are getting pounded, when you actually if you adjust for non-GAAP or stock-based compensation, the beat was tremendous. And many companies provide that, and I'm just trying to get to an apples to apples comparison of what other companies are doing to provide a clean look of the operation excellence that's being made at Valassis on a quarter to quarter basis, and getting away from heavy lifting of trying to predict what you eluded to earlier was the volatility of the share price and the stock options and how those are going to be valued in the future. The easiest way that I can see to do that is provide a non-GAAP number, and that leaves the burden off of the analysts as well trying to predict what that is going to be going forward. Just a thought there.

Alan Schultz

Yeah, we recognize that, that's why we started to move in this direction and we -- I don't think most folks realize how much volatility affects it. Our volatility went from let’s say roughly 30% to 60% and what that does is it doubles the value of that option or it doubles the expense just because of that volatility increase.

Timothy Dowd - MLB Capital Management

That's a nice problem to have when I want to go from $1.50 to $38. I mean, I wouldn't complain about the volatility going that way. The volatility complaints should come when it goes the other way. The question I have, if you can provide a little color on your adjusted EBITDA number and changes in operating assets and liability, almost $60 million and your recon.

Robert Recchia

Yeah, that's the estimated tax payment that we've made related to the litigation settlement during the quarter.

Timothy Dowd - MLB Capital Management

Okay.

Alan Schultz

Well, we -- as supposed to paying all the taxes back in the first quarter when we’ve got the settlement, we were able to spread it out throughout the year. But what that means is, is you’re paying substantially more tax in a quarter than what you really incurred based on your results for that quarter because of the deferral from the first quarter.

Timothy Dowd - MLB Capital Management

"News America" are they - is everything lined up to kick off January 1, or do you anticipate a feeling out process or lag?

Alan Schultz

That is the agreement, is that they start January 1 and we trust that they're going to honor that agreement and we have been working with then to get them all the information that they need to successfully sell in the FSI distribution and Shared Mail.

So it is a -- sort of an evolutionally process and a learning process and our sales organization has been at it for three years now, their sales organization is getting started and obviously there is some learning and positioning that needs to take place.

Timothy Dowd - MLB Capital Management

Let me backtrack on your revised cash number for the year. I'm assuming that does include the forecasted $10 million in stock-based compensation for Q4.

Robert Recchia

Yes, that is back in there.

Timothy Dowd - MLB Capital Management

Okay, that's included, okay. You touched on the digital strategy. I think that's good insight. Any thoughts on the private label situation with some of the retailers? I know Procter & Gamble talked a little about that and there is slowing growth with regards to the private label. Do you see any benefit in terms of going forward with additional spend from CPGs trying to really capture that particular segment of the marketplace?

Alan Schultz

Yeah, private-label incursion into the CPG's business has always been good for the couponing business and the reason is people buy private label products not because they think it's a better product than the branded product, they buy it because it's cheaper. And the bottom line is if you are in a category where private-label incursion is becoming a bigger and bigger problem, one of the best tactics for you is to distribute coupons that lower the price differential between your branded product and the private-label product so that value conscious consumers who are looking to buy that private-label product because of the price differential, you can mitigate that and keep them in the brand. So private-label incursion is a good thing for the coupon business.

Timothy Dowd - MLB Capital Management

Validation of the value-added, I assume through Valassis?

Alan Schultz

Right, yes.

Timothy Dowd - MLB Capital Management

Okay. Last question I have, in 2011, you have significant latitude to return capital to shareholders whether it'd be share buyback or dividends. Any thoughts or comments with regards to potential dividend in 2011? Is that still on the table, or is the focus still going to be on share buybacks?

Alan Schultz

Our Board looked through a lot of detailed analysis at the last board meeting and where they came out at the time was that the leaning was towards share repurchase more so than the dividend, but what they've said is they like to review that again in December and literally review that analysis every Board meeting going forward. But I think the latest information would indicate a preference towards share repurchase.

Timothy Dowd - MLB Capital Management

At any price of the equity?

Alan Schultz

Well, as I said, they want to review, review it every Board meeting, look at the data. But everything we've run so far and showed them so far would indicate that share repurchase is the best alternative.

Timothy Dowd - MLB Capital Management

Okay. That's all I got. Thank you guys.

Operator

Thank you. Our final question comes from the line of Faz Saheed [ph] with DA Capital Management. Please go ahead.

Faz Saheed - DA Capital Management

Hi, good morning.

Alan Schultz

Good morning.

Faz Saheed - DA Capital Management

A couple of questions, one is just following up on an earlier question about, you know, input costs, specifically paper costs, you mentioned that you have contracts that expire [ph], so you have seen no more than I guess a high single-digit price increase?

Alan Schultz

Right.

Faz Saheed - DA Capital Management

I'm wondering if as your contract sort of expires, is that going to be more than that, how should you model in sort of - maybe like the second - first half of next year?

Alan Schultz

Yeah, our -- most of our paper is covered by contact through 2011. So we -- as it relates to 2011, and those kind of parameters in terms of a collar are relevant for '11.

Faz Saheed - DA Capital Management

Okay. So even through 2011, sort of - basically paper price have sort of increased more than you’ve realized, and you will realize no more because you have these contracts; is that fair to say?

Alan Schultz

Yeah, well, so in essence right the way our contracts work is they can give us, let's say a 9% increase this year and another 9% on top of that next year. So this kind of single digit number relates to a 12 month period.

Faz Saheed - DA Capital Management

I see.

Alan Schultz

With all that said, where paper prices were firming up this summer, right now it looks like the market's starting to get a little softer again. So right now I can't tell you exactly what's going to happen with paper prices in 2011, whether they're going to be up or down.

If you asked me two or three months ago, I would have said they are going to be up. If you ask me today I'm not sure.

Faz Saheed - DA Capital Management

Got you. Okay. And the second question I have is - I think I missed an earlier answer from you guys about industry trends for pages per book and number of units. Could you just repeat that, please?

Alan Schultz

I was talking about the FSI business, I think is what you're referring to and what I said was that in the third quarter we had two less books that we distributed. As a result of that our average pages per book was higher for the books that we did distribute, which gives us increased efficiency primarily in the media distribution area, which resulted -- which was the main driver in our increased profit.

So what you saw is actually less revenue, primarily due to two less dates, but a substantial increase in segment profit due to an increase in the average number of pages per book.

Faz Saheed - DA Capital Management

Got it. I guess if you could sort of the think about your overall volume that you are doing between your three - your various segments, how would you characterize that year-over-year in Q3 and looking out, I guess, for next quarter?

Alan Schultz

I don't think I can talk about next quarter, but what I would generally tell you is, is that our goal is mid-single digit top line growth. We think the way we get there is, you get sort of mid-single digit top line growth in the Shared Mail business, that's kind of the target for us to be in that range.

The Neighborhood Targeted area if it worked out ideally, we would be in a scenario where you wouldn't see a lot of growth in there because we would be migrating it into Shared Mail, although the last two quarters you've seen quiet a bit of growth in there.

When you get in the FSI business, one of the things that we talked about is, is if you went back eight years ago, the FSI business was generating in the neighborhood of $190 million in segment profit, this year maybe it will be in the neighborhood of $30 million in segment profit.

There is the opportunity for some significant restoration there, so the hope is primarily when we get out into 2012 that you'll see the FSI business start to grow at a rate better than sort of mid single digits. And then in our International, Digital Services area that, that final segment, you know, the goals there is that we see kind of high single-digit or double-digit growth there because we've got some new business initiatives in there driving that.

And so when you roll those three segments together then that's how you get to the sort of mid single-digit growth.

Faz Saheed - DA Capital Management

Okay. Thank you so much.

Alan Schultz

Thanks. If everything works according to plan every quarter, you know that's sort of the way it looks like but it's going to be -- it's going to move around and be a little lumpy from quarter-to-quarter.

Faz Saheed - DA Capital Management

Got it. Thank you.

Operator

And now I would like to turn the call back to the management for any closing remarks.

Alan Schultz

All right, thank you Chardonnay. I just like to thank everyone for tuning in to the call today and thank you for your questions. I guess from our perspective, we look at it and we really started to focus in Q1 of 2010 on revenue growth. We really moved our focus from the cost side of the business to the revenue side of the business and we started to see some revenue growth in Q2, we've now seen revenue growth in Q3, and we continue to pursue that long-term plan of delivering mid single-digit revenue growth on an annual basis. And our belief is that our strong operating leverage and cash flow generation characteristics put us in a situation where we should be able to drive double-digit EPS growth as well.

And from a consumer demand perspective, we think demand continues to remain high for value and when you look at it from a marketer perspective, their desire for measurable results and the ability to link marketing spend to incremental units in revenue generation, is going to continue and that really creates an environment for us that is ideal for sustainable, profitable revenue growth for our products. And that's kind of our long-term plan and that's what we plan on executing again.

And so in conclusion, we really look forward to providing you with our earnings per share guidance in mid December for 2011. And again, thank you all for tuning into the call and have a great day.

Operator

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. If you would like to listen to a replay of this conference please dial 1-800-406-7325 or 303-590-3030 and entering the access code 4319120. We thank you for your participation and you may now disconnect.

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