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

Valassis Communications (NYSE:VCI)

Q4 2010 Earnings Call

February 17, 2011 11:00 am ET

Executives

Robert Recchia - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Treasurer, Director and Member of Executive Committee

Alan Schultz - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Robert Mason - Executive Vice President of Sales and Marketing

Analysts

Townsend Buckles - JP Morgan Chase & Co

Daniel Salmon - BMO Capital Markets U.S.

Daniel Leben - Robert W. Baird & Co. Incorporated

James Boyle - Gilford Securities Inc.

Mark Zgutowicz - Piper Jaffray Companies

Edward Atorino - The Benchmark Company, LLC

Charles Cerankosky - Northcoast Research

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Valassis Fourth Quarter and Year-End 2010 Earnings Conference Call. I'd like to remind you that the discussions during this conference call will include forward-looking statements, and actual results could differ materially from those projected in the forward-looking statements. The factors that could cause the results to be materially different 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 reports on Forms 10-Q and Form 8-K filed with the SEC. Also, the discussions during this conference call will include certain financial measures that were not prepared in accordance with generally accepted accounting principles. Reconciliations 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, and/or posted on Valassis website at www.valassis.com in the Investors section. [Operator Instructions].

I would now like to turn the conference over to Mr. Alan Schultz, Chairman and CEO. Please go ahead, sir.

Alan Schultz

Thank you, Jeremy, I appreciate it. I'd like to welcome everyone to the call this morning. Joining me is Bob Recchia, our Chief Financial Officer. And after going through my prepared remarks, Bob and I really look forward to answering your questions.

On December 15, when we announced our full year financial guidance for 2011, we also reiterated our adjusted EBITDA guidance for full year 2010, expecting to meet or exceed $320 million for the year. Then on January 26, after the close of our year, Ultimate Electronics, a client who owed us $5.6 million, filed for Chapter 11. As detailed in our release, this led to the addition of $4.5 million in bad debt expense for the fourth quarter. Without the impact of this bankruptcy and the associated additional bad debt expense, our full year 2010 adjusted EBITDA would have been approximately $323 million.

Historically, we've done a great job in terms of managing bad debt and have accrued an average of $7 million per year in reserves for doubtful accounts. At 3/10 of 1% of revenue, this puts us in the top quartile of our media peers in the management of bad debts and receivables.

Ultimate Electronics is a privately held company and was a new client for us in 2010. They began running with us in March of 2010 and ramped up their spending in the fourth quarter, which is not unusual for a large electronics retailer during the holiday season. As of October, they were still current on their payments and we received payments throughout December. We understand that Ultimate may have a covenant issue and was forced by its secured creditors into liquidation.

We have been listed as an unsecured creditor for the amount of $5.6 million in this case. Although we have historically done a very good job managing our exposure to bad debts, as I said earlier, we are making adjustments to our credit procedures to improve the management of credit, especially during the fourth quarter for our retail customers who tend to ramp up spending around year end.

Moving on to the financial highlights. Overall results for 2010 were consistent with our long-term goal to drive single-digit revenue growth and double-digit EPS growth. With revenue up 4.3% and diluted earnings per share up 39.7% when you exclude the negative effect of costs related to our tender offer for our 2015 senior notes and the positive impact of the litigation proceeds.

In 2010, we continued our recession-based strategy to drive volume and increase market share across our portfolio. For example, we distributed over 3 billion more Shared Mail pieces in 2010, a high-single digit increase over 2009, driving Shared Mail segment profit up over 42% for 2010 versus the prior year. However, much like the rest of the advertising industry, pricing was under pressure, with a year-over-year decline in the mid-single digits. As a result, despite the volume gains, revenue in the Shared Mail segment was up just 2.2% for the year. Going forward, we are focused on monetizing these volume gains as the economic environment improves.

We started planning for this potential improvement in the pricing environment in mid-2010 when we saw a lift in ad industry pricing, specifically television broadcast rates for the fall 2010 lineup were up. This planning included investing in sales training and value-added selling and negotiating skills and implementing the rate incentive programs for 2011 to drive profitability and pricing discipline in our sales organization. In addition, we took pricing decisions out of the hands of the sales teams. Our new structure includes a staff of 40 experienced associates outside of the sales function. They analyze the market, review and approve contracts and have ultimate responsibility for setting pricing objectives and implementing our three-year post-recession pricing improvement strategy. It is important to remember since we have multiyear contracts in many of our product lines, we expect to see this price improvement ramp up on a quarterly basis over time as we work our way through these recession-based contracts.

I think it is important to note that our plan does put some volume at risk in 2011 as we transition to this new strategy. Although we do not give quarterly guidance, we expect revenue to be flattish in Q1 2011 versus the prior-year quarter due to the combination of some at-risk volume, Easter shifting into the second quarter and we project a decline in ROP revenue. However, we do expect to see significant improvement in earnings per share in the first quarter when you exclude the cost of our most recent debt refinancing.

As I mentioned previously, given the nature of our multiyear contracts, we expect to see the cumulative effect of our post-recession strategy over the coming quarters as our contracts come up for renewal. As this unfolds, in 2011, we expect momentum in revenue and profitability to ramp up throughout the year and set the stage for a strong 2012 and 2013.

Moving on to a few other financial details. SG&A was up 4.6% in 2010 versus the prior year. This includes $25 million in incremental, non-cash stock-based comp in 2010 over 2009. When you remove the impact of this unusually high, non-cash stock-based comp, and the 2009 legal expenses associated with the News America lawsuit, SG&A was basically flat in 2010 versus the prior year. It's worth noting we handled significantly more volume in our existing products, and we invested in In-store and Digital without increasing our overall SG&A. This demonstrates our ability to drive efficiency improvements on an annual basis. Many of you have heard me talk about the fact that all of our functional areas are expected to handle 5% more volume on an annual basis, with no increase in SG&A costs.

During our guidance call on December 15, we spent considerable time discussing our opportunity to use our cash to drive shareholder value, specifically via stock repurchases. We can now confirm the basket available for stock repurchases, under our credit agreement, is $192.7 million in 2011. Based on current conditions, we still intend to spend the majority of that basket for stock repurchase, the impact of which is not incorporated in our guidance for 2011. We specifically and significantly improved our financial position and capital structure with our recent refinancing of our 8 1/4% March 2015 notes that will save us approximately $2.8 million in annualized interest expense; extended the maturity to February 2021, reduced the interest rate to 6 5/8% and provided a less restrictive covenant package. We ended 2010 with a net debt to adjusted EBITDA ratio of 1.4:1 and with $245.9 million in cash on the books.

I'd now like to move on and share some highlights for the quarter in our individual business segments. I already spent time discussing our Shared Mail business, with strong demand in volume, combined with our focus and priority on price improvement, we anticipate increased revenue growth as we move through 2011 and beyond, consistent with our long-term plan to drive overall mid-single-digit revenue growth and double-digit EPS growth. As the only national network for Shared Mail distribution, we expect strong demand for Shared Mail due to continued newspaper secular decline. As you know, there is significant operating leverage in the Shared Mail business, so as momentum builds, there is significant upside to this segment's profitability in the future.

On the Shared Mail cost side, the U.S. Postal Service has been seeking an overall 1.75% rate increase for mail delivery in 2011, yet we expect our class of mail will incur less than a 1% increase. Our contracts with customers do allow us to pass this cost adjustment on to clients, and at less than 1%, it should have minimal impact on client budgets and also help us with revenue growth.

Moving on to the Neighborhood Targeted segment, as you know, our Neighborhood Targeted business can be a bit bumpy on a quarterly basis. Revenue in this segment increased about 8% for the year and just over 6% in Q4 versus the previous year. Segment profit declines were affected by pricing, product mix, bad debt associated with Ultimate Electronics and the impact of non-cash stock-based compensation. Category strengths in this particular segment included the communications client vertical and Specialty Retail customers actually represented over half of our newspaper insert volume in the fourth quarter.

Newspaper insert volume was up 10% in the fourth quarter versus the prior-year quarter. In 2010, we continued to pursue our strategy of building share in newspaper insert distribution, even though Solo Newspaper Insert business is a lower margin business for us than our cooperative media, we want to capture this spend, knowing this content will eventually need somewhere to go as newspaper circulations continue to decline and marketers still need to reach consumers who no longer read the newspaper. Our solution is clearly Shared Mail. And we can blend newspaper and Shared Mail into a seamless execution for our clients. Building share in the Neighborhood Targeted segment has been a part of our growth strategy for Shared Mail.

Another bright spot in the Neighborhood Targeted segment is our Product Sampling business, which is up nearly 12% in the fourth quarter versus the prior-year quarter, driven primarily by top consumer packaged goods manufacturers. As you know, sampling and Polybag Advertising are our most cyclical products and are fueled by new product introductions and store grand openings. Increased client investment in sampling is a good leading indicator for anticipated growth in overall economic activity, and currently this trend looks to be continuing in the first quarter of 2011.

In the FSI business, industry page volume was up 4.6% for the year. While our revenue was up 3.7% in Q4, the majority of the increase was the result of an additional custom co-op date and one additional regular co-op date versus the prior-year quarter. As discussed in our earnings release, without the impact of non-cash stock-based compensation expense, segment profit for the FSI business in Q4 would have been up 8% versus the prior-year quarter. This was the case even though the cost of paper was up significantly in the fourth quarter versus the prior-year quarter. And I'd like to reiterate, we expect paper prices to increase in the mid- to high-single digit range in 2011 versus 2010.

Moving on, we have a lot to talk about in our International, Digital Media & Services segment, beginning with In-Store. As you know, in the first half of 2010, we began developing and investing in an In-Store advertising model that gives retailers better control of shopper experiences. Q3 and Q4 of 2010 really marked our launch into this industry. With over 2,000 stores in our network by year end, most notably SUPERVALU and Winn-Dixie, we plan to grow our network by another 1,000 stores, with the addition of A&P and others in 2011. Combined with our Digital portfolio, we expect our investments and innovation and new products in these two areas to bring in an additional $40 million in revenue versus 2010 in 2011.

Moving on to the Digital business. Full year revenue for the Digital portfolio increased over 300% in 2010 over a small base in 2009. Consumer interest in digital coupons and offers continues to grow. While Digital still remains less than 1% of total coupon distribution, according to NCH, recent research from Booz Allen & Company indicates consumers are increasingly using digital coupons to supplement their savings efforts. We continue to develop and invest in our Digital portfolio, which includes e-mail, print-at-home coupons, display ads, discount through identifications such as a frequent shopper card or a mobile phone. Our expanding digital distribution channels include e-mail; the destination sites of redplum.com and Save.com, as well as our RedPlum Network, which includes 1,200 affiliates, including retailers, mobile networks and affiliated websites.

While we are pursuing development in a variety of interactive channels, the two greatest opportunities we see to monetize our efforts in the near term are secure print-at-home and offers direct to unique IDs such as frequent shopper cards. Secure prints in our RedPlum Network grew over 300% in 2010 versus 2009 and eclipsed historical baselines in January of 2011. Offer new ID was new for us in 2010 and momentum built quickly throughout the year. Offer download volume increased over 1,000% in the second half of 2010 versus the first half of 2010. We expect Offered ID, also known as coupon-to-card, to become an even bigger factor in our digital coupon arena in the near future.

On January 25, we announced our strategic relationship with AOL to create one of the largest digital coupon footprints in the United States, including over 7,500 grocery stores. This agreement enables the sharing of digital coupon offer content across each other's online and mobile networks. This joint effort provides advertisers with a vast distribution channel capable of reaching 127 million frequent shopper card holders across the country on a weekly basis. We are really excited about this venture. As you know, more than 80% of shoppers participate in grocery and drug frequent shopper programs. And research indicates an overwhelming majority are interested in receiving savings from the Internet directly to their frequent shopper card or unique ID.

While there's a lot happening in the digital arena, I believe there are three primary needs that must be met to capitalize on the growing opportunity in this space. All of our efforts are focused on meeting the following needs: Number one, consumers are looking for a quality experience; number two, advertisers need reach and scale significant enough to drive measurable business results; and number three, retailers are looking for content. Our AOL partnership meets all three of these needs and significantly advances our distribution footprint. As I have said previously, we expect clients to eventually look to integrate their off-line and online promotions, as they do with all of their promotional media, and when they do, we have a significant advantage over pure play digital providers.

Consumer behavior remains entrenched in value-seeking behavior. Just as the generation who lived through the Great Depression had their values about money and savings permanently changed, our thesis is that consumers who increase their value-seeking behavior during the Great Recession will continue this behavior through recovery. Research continues to support this thesis as being true. Consumers saved $3.7 billion on consumer packaged goods products using coupons in 2010. A third of the respondents in NCH's recent annual consumer survey said they actually used more coupons in 2010 than they did the prior year. As I assess our 2010 operating performance, on a GAAP earnings per share basis, there were four unusual items that impacted 2010.

I wanted to share with you the after-tax and related payments' impact of each of these items on our diluted earnings per share. Number one, we received a litigation settlement in February of 2010 which increased our diluted cash earnings per share by $5.80; number two, in the second quarter of 2010, we repurchased $297.8 million of our 8 1/4% notes which decreased our diluted earnings per share by $0.28; the third item was during 2010, we incurred incremental non-cash stock-based compensation expense beyond what was recorded in 2009, which negatively impacted diluted earnings per share by $0.29; and finally, the bankruptcy of Ultimate Electronics on January 26, 2011, reduced diluted earnings per share by $0.05.

I hope you find this information helpful in your assessment of our 2010 operating performance. This wraps up our prepared remarks, and at this time, Jeremy, Bob and I would like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mark Zgutowicz with Piper Jaffray.

Mark Zgutowicz - Piper Jaffray Companies

Your press release indicated some weakness related to the bankruptcy in the Neighborhood Targeted segment. And I was hoping you could maybe quantify that, and if there are any other segments that were impacted and quantify that as well, if possible. And then secondly, the at-risk volumes that you mentioned in Q1, how much of that is due to the new pricing strategy, and maybe just explain that a little bit more, are you sort of holding price there and is that causing some of that weakness? And then secondly, what gives you the confidence that you'll see that weakness subside as you enter Q2 and beyond?

Alan Schultz

Mark, Ultimate Electronics, literally all the business they were doing, was in our Neighborhood Targeted area. So 100% of the business fell into that segment. They basically owed us $5.6 million. Now we had adequate reserves in our allowance for doubtful accounts to cover part of that, so we only had to kick up bad debt by $4.5 million, and all of that again, went into the Neighborhood Targeted segment, and really none of the other segments were affected by bad debt in what I would call an unusual way. Obviously, that's a pretty big one for us on a historical basis. And quite frankly, what makes it unusual is not so much that a client filed bankruptcy because we know that, that is going to happen and we build that in on occasion. What's kind of unusual about this one is that as opposed to happening in the course of the year, it actually happened well after the close of the fiscal year. So that's kind of the story on that one. In terms of at-risk volume, I actually sat down with our sales organization just two days ago. We really launched this program in terms of our price improvement strategy starting the New Year in 2011. And we went through literally all the business volume that we lost as a result of trying to improve pricing. And we basically came to the conclusion that if you look at the overall gain, in terms of profitability that we picked up from the price improvements that we were able to achieve, versus the lost profitability from the volume that was at-risk and we lost due to our price improvement strategy, that the payout was very good for us. So from a profitability perspective, the gains that we got far outweighed the lost profitability on the volume. So we feel pretty good that we're going at this with the appropriate level of aggressiveness and that we are taking very calculated risks on the business that we're losing. And at the end of the day, it's paying out in a way that we hoped it would. From a confidence perspective, this is clearly a change in strategy for us. This is a transition for us to make. The good news is, is that we really started focusing on this, what would be about eight months ago now, and really started putting together everything that we felt was going to be essential to make sure that we were successful. I would tell you the other thing is I just have a lot of confidence in Rob Mason and his team and our sales and marketing organization to get the job done. And I think a lot of confidence in our organization in the sense that when we tend to focus on important strategic issues, we tend to be very successful in those. And this is one we're watching very closely and measuring very closely, as evidenced by the fact that I said just two days ago, we went through sort of a complete analysis on are we getting the expected impact that we anticipated. And the fact is we are. Now with that said is understand based on these multiyear contracts that we do have contracts in place that were struck during these recessionary times, which basically provided for lowering costs. So as time went on, the lower the cost got. And obviously now, we're in a price improvement mode. So every quarter, we've got a percentage of our contracts are expiring, and then obviously the plan is that those lower-priced contracts and that volume is replaced with higher-priced contracts. So as the year goes on, that tends to accumulate in terms of its effect. And that cumulative effect has both positive impact on revenue and a positive impact on profitability because as you know whatever you get on your revenue line falls right down to your pretax profit line.

Mark Zgutowicz - Piper Jaffray Companies

It sounds like you're expecting to see some better margins than one would expect at sort of flat top line growth in Q1 and I appreciate the guidance there but if I look at the range on the street on the bottom line, it's quite a wide gap. And I'm just wondering if you guys can maybe provide a little better guidance in terms of what the profit side of the equation looks like and there's a couple of moving parts obviously in there. We have Easter shifting and the pricing impact. Is there some way to sort of tighten that range a bit? It would be helpful.

Alan Schultz

Just in terms of profitability, what I can say is this was anticipated when we built our plan. And so when we built our plan, we felt as if revenue would kind of ramp up as the year went on and profitability would ramp up as the year went on. I think basically, the earnings per share numbers that we gave you year against year were up 40-some percent for the year '11 versus 2010. So I would expect Q1 to be something less than in the 40s, right. And as the quarters continue to move on, it will continue to move up. Now with that said, I got to reiterate, we don't give quarterly guidance. We develop a quarterly model, but we don't necessarily provide quarterly guidance. And obviously, we're not a widget manufacturer in the sense that it is a perfectly smooth quarter-over-quarter growth and year-over-year growth. That's just not necessarily the way our business works. In fact, I'm not sure how many businesses work like that anymore.

Mark Zgutowicz - Piper Jaffray Companies

IDMS, you saw some real good strength there. Can you better quantify where that was coming from, In-Store versus Digital?

Alan Schultz

The strength on the revenue side came in both Digital and In-Store. So they both had very nice upticks from a revenue potential. Now when you get into the profit potential, a little bit of a different story. In terms of percent increases, Digital actually had a bigger percent increase than In-Store did, but both of them, very, very substantial increases in terms of percentages. But the In-Store business, as we mentioned, we felt it was a very unusual circumstance in the sense that you usually don't have a business that you start in the first half of the year, and it’s profitable by the fourth quarter. It was in fact profitable in the fourth quarter. So it contributed from a profit perspective. The Digital business, although the revenue was up over 300%, the losses in the Digital business continued to grow and on a pretty substantial basis, because we continue to invest heavily in the Digital business. And quite frankly, our plan is to continue to invest heavily in the digital business through '11 and through '12, and we don't really plan on mining the Digital business for profitability until we get into '13.

Operator

And our next question comes from the line of Chuck Cerankosky with Northcoast Research.

Charles Cerankosky - Northcoast Research

When you're looking at 2011, we've got a lot of issues out there from raw material costs affecting the CPGs, they're taking various strategies on how fast they want to pass that through. What are you seeing in terms of the CPGs using couponing and promotional activity to help blunt price increases that they're talking about?

Alan Schultz

Chuck, CPGs are sort of in an interesting situation and your question is real relevant because from a historical perspective, whenever CPGs have increased prices, what they've done is they've increased their couponing. And the reason they increase their couponing is they know there's a segment of population which is very price sensitive and when that segment sees those higher prices, they may not buy that brand. They may buy down to a lower quality brand, they may even go into the private-label category. So typically, what we'll see is we'll see increased coupon activity to offset that portion of that price increase for those really price-sensitive shoppers. In this case, it's really hard for me to say what's going to happen, Chuck, because what we've seen over the last two years is such a dramatic increase in coupon redemption rate, that what we started to see in the second half of 2010 was CPG companies looking at their redemption rates and saying, wow, I'm getting way more redemptions than I thought. It's costing me more money than I thought in terms of redemption. And we saw them actually start to implement tactics designed to bring redemption rates down by shortening expiration dates, requiring multiple purchase of the product to get the discount. So it's really sort of a situation, Chuck, that I've never seen before, and therefore, it's really hard for me to anticipate exactly how they might handle it. And I would say, in the conversations that we've had with CPG so far, I don't think it's real clear to us how they plan on handling it. So I wish I could do a better job with that question, but that's kind of the landscape.

Charles Cerankosky - Northcoast Research

When you're looking at achieving price improvement in 2011, what kind of improvements or goals do you have?

Alan Schultz

Chuck, the goals really vary by product line. The targets are really different based on the product line and based on where that product sits in terms of its historical pricing baseline, and so it really varies by product line. But what I would tell you is what you got going on is you got these contracts that exist today with built-in lower prices. So keep in mind, you're kind of starting out with the base, it's probably already got sort of a mid-single digit decline built into it. So when you start layering on these increases, the first thing you got to do is you got to overcome that kind of mid-single decline base that's built in to get back to even. And that's why I really say that 2011 is a transitionary year because to the extent we're successful at doing that and actually overcoming that mid-single digit drag that exists with price increases and getting something to the positive side in 2011, that really sets the stage for '12 and '13 in terms of much more robust growth in terms of profitability.

Charles Cerankosky - Northcoast Research

Where would you put the at-risk volume you spoke of? Which segments would that be greatest in?

Alan Schultz

We went through it account by account, Chuck, and I can't say that right now, it's fallen into any one particular area. It's kind of spread across the board, it's in all of our product lines, it's in field customers, it's in strat customers. It's kind of spread across the board. But again, we went through the analysis that said what are we getting on the price side, what are we giving up in terms of profitability on the volume side. There's definitely a multiple of what we're getting on the positive side versus the negative impact. And so we think we got the right level of risk built in.

Charles Cerankosky - Northcoast Research

Is there any haste here to file this, maybe this is a Bob Recchia question, is there a certain amount of haste here to file the 10-K, so you can start buying back stock, given recent price action?

Robert Recchia

I don't know what you mean by haste. We're obviously working on it as we typically do, and we'll get it done as quick as we can get it done, but I would tell you it still going to be first part of March.

Alan Schultz

Just from a kind of what it looks like today, Chuck, just to be clear, it sort of looks like March 1 is probably the date we'll file. That's the due date and then I'm sure, I haven't talked to our lawyers about it, but I'm sure our lawyers will say you've got to wait three days for all the information to get digested into the marketplace until you can do anything. So we probably won't be able to be in the market until sometime in early March.

Operator

And our next question comes from the line of Alexia Quadrani with JPMorgan.

Townsend Buckles - JP Morgan Chase & Co

This is Townsend Buckles for Alexia. Going back to your Q1 expectation for flattish revenues, how big of an impact should the late Easter be on what would be more of a shift into the second quarter?

Alan Schultz

The late Easter has an impact across our portfolio. I would say the biggest impact is in the FSI business. That's where we'll see the biggest impact, but it really does affect us across the portfolio. And I gave some percentages, in terms of the negative impact that it would likely have on the pre-Easter promotions and I don't have them with me right now, but I did give them on our guidance call in the middle of December, Townsend. So either if you have access to that or if you don't have access to that, we can give you that information. I'm going by memory here, that could be very dangerous, but I want to say kind of like the pre-Easter promotion, it's probably in that particular insert date’s like 30-some percent and then the one before that is maybe in the teens or something. So that’s just ballpark if you can’t find it, but we'll get you the correct info.

Townsend Buckles - JP Morgan Chase & Co

And then on the In-Store business, how should we think about the revenues there ramping up through the year. Would it be more of a stronger start and some moderation in the second half? And then any competitive responses you're seeing from news since your successful win such as terms they're giving to their clients?

Alan Schultz

From an In-Store perspective, it should ramp up because we'll continue to add stores throughout the year. So if my memory serves me correct, A&P is being implemented near the end of the -- or into the first quarter, beginning of the second quarter. So really you won't get A&P-related revenue until, I think, starting in the second quarter and then obviously there tends to be some ramp-up associated with that, too, and then there'll be other retailers that we’ll be adding into the network which there are some additional retailers that will be coming in, in the second quarter and I know some in the third quarter to ultimately get to 1,000 by year end. So you should see each quarter showing sequential revenue growth versus the previous quarter through 2011. From a competitive standpoint, I would tell you, it really is about sort of our approach to the In-Store business versus the competition's approach to the In-Store business and our model versus the competition's model. I think it's really the decision about what's right for the retailer, the retailer is basically making a decision about do I want to have more control of the shopper experience, or is it that all that important to me and which business model do I like best and the retailer’s making the choice based on the business model I would say more than anything. We have a business model and our competitor has a different business model and the client just has to choose which one they like best.

Townsend Buckles - JP Morgan Chase & Co

Okay, and do you see that changing at all in the future if you keep winning some of these big accounts or do you think you can still announce some good wins in the near future?

Alan Schultz

Obviously, we feel like we're going to increase the size of the network by 50% in 2011 versus '10. So it's another 1,000 stores. A&P was -- it was a chain of about 375 stores, kind of going into it through conversations. We sort of anticipated there'd be about a 25-store reduction as part of their restructuring. So we assumed, going into that it would be about 350 stores. I think based on some of their recent announcements, it looks as if that 25 store closure number was pretty close to an accurate number. And so, that's around 350, and then we've got some others in the Q that we will likely announce here in the near future.

Operator

Our next question comes from the line of Dan Salmon with BMO Capital Markets.

Daniel Salmon - BMO Capital Markets U.S.

First, you reiterated your guidance for mid-single digit increases in -- or your expectations for mid-single digit increases in paper costs. I know you have some contracts in place around that, that put some collars on it and I think they're due up this year. Does that expectation assume a renewal of those contracts, or just how do those two things play amongst each other? And then the second question is on your term loan and possibly renegotiating it to some extent to allow for more share repurchase in 2012 and beyond, and maybe if you could update us with your thoughts on that, and that's all.

Alan Schultz

In terms of paper contracts, we probably have somewhere in the neighborhood of 80% of our tonnage, 85% of our tonnage at this point in time, committed under long-term contracts that at this point, go basically through the end of this year. It does have a cap and collar arrangement in it. We think based on that cap and collar arrangement that we're somewhere in the mid- to high-single digits in terms of year-over-year increase and in terms of the cost of paper for the FSI and for the paper cost associated with our ramp in the Shared Mail business. Likely, there will be some discussions over the next couple of months that will deal with extending those paper contracts into 2012, but exactly how far we go at this point in time is hard to say. And we're just not there yet. That will be something that will be negotiated over the next couple of months. But the paper market has got a little bit of steam right now and they have been successful in terms of putting through some increases. And we're assuming, obviously, in terms of our plan that they're going to be successful in putting through some future increases. So that's that. As it relates to the term loan, the answer is yes, the term loan does create the basket and restrict the basket for share repurchase. We think just talking amongst ourselves and the board that at some point near the end of 2011, we're probably going to want to do something different with that term loan, and what exactly that's going to be, whether it's another term loan B with a different set of covenants that are less restrictive in light of the fact that we have a whole lot less leverage today than we had back when that term loan was struck, or whether it's going into a term loan A with less restrictive covenants, there's a lot of potential options that are available to us. And I think we think that the timing is sometime in the second half of 2011. We probably need to make some decisions about what's the best strategy for us on a going-forward basis with that term loan B.

Operator

And our next question comes from the line of Jim Boyle with Gilford.

James Boyle - Gilford Securities Inc.

You mentioned the various advantages that you would have over the pure play digital coupon providers. Of those various ones, which one do you consider the actual biggest advantage? And then flipping that on its head, what sort of disadvantages or what would be the biggest disadvantage you might have versus Groupon?

Alan Schultz

I would say the biggest advantage that we probably have is probably two of them I’d point to. Number one, client relationships. We've been doing business with these people for 30, 35, 40 years now. So when they give us something and it's new and it’s experimental in nature, they know they can count on us to deliver because we have to deliver because if we're not, we're jeopardizing a lot of other potential business. And as a result of that, they tend to have a pretty high level of confidence that we're going to do what we say we're going to do where the pure plays can kind of come and go. The other thing I would say is it's our targeting capability, and we have already invested a significant amount of money here in 2010 to enhance our targeting capability to incorporate in our Digital products. So we have now developed the capability where we can add in Shared Mail distribution along with Newspaper distribution and Digital distribution into one single optimized buy. And nobody else in the marketplace has the ability to do that, coordinate that with clients. Now that is an advantage today. The thing is, is that most of our customers today really have different people doing the buying for their digital products and their off-line products. So although we're prepared to do it, the customer isn't structured to do it. At some point in time when digital becomes mainstream, we believe that those off-line and online areas will be integrated together structurally at which case that's really when the main advantage starts to materialize for us. As it relates to a Groupon, the Groupon is really sort of a different customer base than us. If you look at most of what we do, we help marketers develop and build their brands. And many of these brands that we work with are well recognized, right? So they're not willing to spend quite frankly a fortune for somebody to find out what the Crest toothpaste brand is, right? Where on the other hand, the Groupon model is really developed around primarily smaller local market retailers who are willing to spend a tremendous amount of money from a customer acquisition standpoint, with the hope that when they attract those customers, they're able to retain them. So it's a little more of a hyper local strategy than what we have, and our customer base is really made up more of mid-sized customers and large customers as opposed to the hyper local type. So a little bit of a different business model between us and Groupon. Although, we do have some interest in Groupon-type models like I think a lot of other people do. But there are probably other media companies out there who have even a greater sense of urgency than us around a Groupon model because it is their customer base. And when Groupon does take new customers in, that money could be coming out of their media budget versus our media budget. So that's kind of my assessment on Groupon.

James Boyle - Gilford Securities Inc.

And as they move up the ladder in terms of client size, what disadvantage would you have if they start to chew in lower on down versus your big guys which might be safer?

Alan Schultz

Well, I would say that our clients are of a size and they base their decision on metrics and return on investment. There are already a lot of questions, I think, around the Groupon model in terms of return on investment and retention of the customers that you acquire when you participate in a Groupon model. And again, our business is ongoing business relationship with our customers. We have a lot of customers. We're in call on them every week. We're literally there every week and a lot of them run a program with us every week. The Groupon model is one of more like a one-off. You run a Groupon model, you might not run another one for six months, you might not ever run another one based on your return on investment. Our clients that we do business with have good metrics and they base their buying decisions on those metrics. Groupon would have to dramatically change their business model in order to compete with and for our customers.

Operator

And our next question comes from the line of Dan Leben with Robert W. Baird.

Daniel Leben - Robert W. Baird & Co. Incorporated

First off, in the Shared Mail business, can you just talk about it as we work from the 4% growth rate in the second quarter down to the 2% in the second half, did pricing change at all or was it pretty consistent through the year?

Alan Schultz

Well, I would tell you this, the pricing was deteriorating as the year went on. Again, in the second half of 2010, you were at the tail end of our recessionary base volume strategy. And pricing, in our business, was continuing to erode really through the end of 2010. And we really flipped the switch. January 1 of 2011 is when we started to move on our price improvement strategy.

Daniel Leben - Robert W. Baird & Co. Incorporated

And then just as a follow-up to that, help us understand why you have the comfort level, six weeks roughly into the year with the new pricing strategy with probably a limited number of renewals, that you’ve got the right strategy and you're comfortable with the mix in spite of a lot of pricing pressure coming from some of these newspapers that are struggling.

Alan Schultz

I'll tell you, we're basically six weeks into it and based on what we’ve reviewed, as I said, a couple of days ago in the first six weeks, we like our strategy. It seems to be working. It's achieving the desired result. As it relates to newspapers, the newspapers are really sort of a mixed bag in terms of their competitive pricing approach as it relates to competing against Shared Mail. We definitely have some newspapers that are struggling in a lot of different respects and definitely struggling in terms of their penetration of the market. And in those situations, we're seeing them be aggressive in terms of pursuing business and pricing from a very competitive nature. In other markets, we see newspaper rate cards because we buy a lot of newspaper that are actually going up in terms of price. So it’s a little bit of a mixed bag and it's a market by market sort of basis. And I think the other thing, and I mentioned this in my script, Dan, is I say this with great affection, salespeople do what they're paid to do and we got the right compensation program in place in 2011 for them to accomplish these goals.

Daniel Leben - Robert W. Baird & Co. Incorporated

Bob, what's the annual spend on paper? And then secondly, Ultimate Electronics, what did it contribute to the top line in 2010?

Robert Recchia

Ultimate Electronics in '10, we started in March. Rob, you might even know this one, it's got to be sub $10 million, I think.

Robert Mason

It was between $6 million and $8 million.

Robert Recchia

$6 million to $8 million. So we were just getting started with them as the year was coming to an end.

Alan Schultz

In March, they basically tested, right? So it was kind of testing from March on until the fourth quarter. And then they really started to run heavy in the fourth quarter.

Robert Recchia

And then paper, I think what you really want is paper that we have exposure on. Not the pass-through paper. You're probably looking at around, in the FSI, just around $90 million of paper and then on the wrap, Al, $30 million, $35 million?

Alan Schultz

Probably $40 million.

Robert Recchia

$40 million. So you’ve got $125 million to $130 million of paper where we take the paper risk. Everything else that we would do for other products is pass through.

Operator

And our next question comes from the line of Ed Atorino with Benchmark.

Edward Atorino - The Benchmark Company, LLC

Regarding the FSIs, it looks like the revenue per program really took a hit in the fourth quarter. Was there some unusual pricing in the fourth quarter in the FSI business?

Alan Schultz

Ed, basically what happened there is we had an extra custom co-op date in the fourth quarter and an extra regular co-op date. So there's really two more dates going into the fourth quarter which then brings down the average pages per book. So it had more to do with the date scheduling than anything else, Ed.

Edward Atorino - The Benchmark Company, LLC

In the press release, you give an earnings per share number, I think it's what, $1.76, but if I add up my quarters I get a different number. Maybe you could -- I'll get you online or send it. So can you give me the adjusted quarters? I must be missing something. But my other question has to do with again the Shared Mail. Are you continuing to transition the Shared Mail piece into the FSI? And is that sort of running out or has this more room to go?

Alan Schultz

No, I think there's more room to go, Ed. I think as newspaper circulations continue to decline and the penetration level just isn't sufficient for customers, it creates more and more opportunity. We’re at about 14.4 million circulation of our FSIs are now distributed through the Shared Mail Package. We'll do our next market list update in the fall. And so we're literally in the process right now of going through and analyzing penetration on a market-by-market basis, seeing what the newspapers can deliver and then determining where it's appropriate to bring more Shared Mail into the mix.

Edward Atorino - The Benchmark Company, LLC

Remind me where this In-Store is, is that in the other or is it in Neighborhood Targeted?

Alan Schultz

The In-Store is in the International Digital and Media Services.

Edward Atorino - The Benchmark Company, LLC

Neighborhood Targeted was awfully lumpy last year. There were some big increases. Is that going to mean a very difficult quarterly comparison going forward or is there enough new business to have a steady gain?

Alan Schultz

I think it probably is going to make for some difficult comparisons and one of the reasons that, that segment has not done well from a profitability standpoint but was good from a revenue perspective, is we had some big bumps in terms of the ROP business, which helps us from a revenue perspective. On the other hand, the margins are pretty low so it doesn't do a lot in terms of margin help and therefore, it’ll hurt us a bit from a revenue perspective, but won't hurt us as much from a profitability perspective, and we had some unusual items in there. For instance, there was a fair amount of ROP business in 2010 that was as a result of the BP oil spill. They were running a fair amount of business with us. So there will be some difficult comps there. And strategically, Ed, we kind of pushed it from a revenue perspective with somewhat disregard for pricing and profitability, too, because we view it like we're sort of building up a book of business at some point in time that should start to migrate into Shared Mail. And when we talk about migration to Shared Mail, it really comes in two ways. One is as we pick up Newspaper business into our Neighborhood Targeted segment that we then try to move into Shared Mail which we haven't moved as fast as we'd like to. We’ve made some progress, but not as quickly as we'd like. And in other situations where the customer basically says newspapers just aren't penetrating the market anymore for me and they come immediately into our Shared Mail Package without going through the Neighborhood Targeted segment. So that's another form of migration, both from newspapers.

Operator

Thank you, and management, there are no further questions in queue.

Alan Schultz

All right. Well, thank you, I really appreciate everyone's time. And in closing, I just wanted to add that our products are performing for our clients better than they've ever performed before and providing the best return on investment in the history of this company. We're really focused during this post-recession environment on getting fair value in return for the exceptional value we provide our advertisers. And we've made the structural changes, investing in training and putting incentives in place to achieve our three-year plan to drive sustainable, profitable growth and deliver mid-single digit revenue growth and double-digit EPS growth. As we plan for increased paper cost and increased inflation, really, ensuring that we are receiving fair value in return for the exceptional value we provide in service we provide, is priority number one. So I want to thank you all for your time and attention today, and hopefully everybody will have a great day. Thanks. Bye.

Operator

Ladies and gentlemen, this concludes the Valassis Fourth Quarter and Year-End 2010 Earnings Conference Call. If you'd like to listen to a replay of today's conference please dial 1(800) 406-7325. For international participants, you can dial 1(303) 590-3030 and enter the access code 4392554 followed by the pound key. The replay will be available until February 27, 2011. Thank you 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' CEO Discusses Q4 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts