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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

Daniel Salmon - BMO Capital Markets U.S.

Daniel Leben - Robert W. Baird & Co. Incorporated

Mark Argento - Craig-Hallum Capital Group LLC

Mark Zgutowicz - Piper Jaffray Companies

Alexia Quadrani - JP Morgan Chase & Co

Charles Cerankosky - Northcoast Research

Valassis Communications (VCI) Q1 2011 Earnings Call April 28, 2011 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Valassis First Quarter 2011 Earnings Conference. [Operator Instructions] I'd like to remind you that the 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 be materially different from those expressed or implied by such forward-looking statements are discussed in the risk factors and other sections of the 2010 Annual Report on Form 10-K and in the reports of Forms 10-Q and Form 8-K filed with the SEC.

Also, the discussions during this conference 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 homepage Investor section.

I will now hand the conference over to Mr. Alan Schultz, the Chairman, President and Chief Executive Officer. Please go ahead, sir.

Alan Schultz

Thank you, Pamela. I'd like to welcome everyone to the call this morning. Joining me today is Bob Recchia, our Chief Financial Officer; and Rob Mason, our Executive Vice President, Sales and Marketing. After our prepared remarks, we look forward to answering your questions.

Overall, Q1 2011 financial results were in line with our discussion during our last earning call. Diluted earnings per share was up 39%, when you exclude the negative effect of the cost related to the first quarter 2011 tender offer for our 2015 senior notes, and of course, the positive impact of litigation settlement proceeds from the first quarter of 2010.

Revenue was relatively flat versus the prior year quarter, driven by the impact of Easter shift to Q2 and also due to a $20 million decline in ROP revenue in our Neighborhood Targeted segment. Based on the trends we see today, we are projecting ROP revenue being down more than $60 million in 2011 versus 2010 due to client spending cuts in the telecommunications category and the energy vertical, as well as an overall decline in ROP spending.

As you know, there have been some announced consolidation in the telecommunications industry, and I believe this is clearly impacting telecommunications spending in ROP. This projected decline in ROP revenue in 2011 could represent as little as 2.5% or as much as 3.5 percentage points of our overall 2010 annual revenue base. This current projected ROP shortfall, in a year where our 2011 revenue plan included more moderate volume growth and a price improvement initiative will make it difficult for us to get to our mid-single-digit revenue growth goal in 2011.

Based on our projections, we also expect Q2 revenue to be relatively flat. Fortunately, Run-of-Press is our lowest margin business. Therefore, the decline in ROP revenue will not significantly impact our bottom line results. Although this is what we see today, I should also mention that it is early in the year, and as quickly as the ROP switch can be turned off, it can be turned on again. It is our shortest lead time product. Typically, ROP is used by our clients for its mass reach and quick response to changing market conditions. With one phone call, we can place very large orders within 24 hours.

So when you look at our current year and long-term plan to drive sustainable, profitable growth, we obviously have some choices to make. In a number of our product segments, we are moving from an environment of declining rates to an environment where contracts are including appropriate rate escalation to reflect the value we provide and cover anticipated cost increases, especially rising paper and transportation costs. Understanding all of this, we are not willing to compromise our goal of long-term profitable growth to achieve a single year revenue objective.

Regarding our other full year 2011 financial guidance targets, our confidence in the strength of the Shared Mail business in the second half of the year leads us to believe we are well positioned to achieve our other full year 2011 annual profitability guidance targets for full year diluted earnings per share, diluted cash, earnings per share and adjusted EBITDA.

The Shared Mail business delivered a strong performance this quarter. With revenue up just 3.1%, we drove segment profit up 33.2% versus the same quarter last year. There are a number of factors which lead us to believe that the Shared Mail revenue will grow substantially in the second half of 2011. Rob Mason is our Executive Vice President, Sales and Marketing who I introduced earlier, and is responsible for the sales forecasting process. He recently completed a second half 2011 bottoms up forecast for the Shared Mail business, which shows significant revenue growth compared to the first half of 2011.

At this point, I'd like to ask Rob to talk to you and talk you through the outlook for second half of 2011.

Robert Mason

Al, thanks very much. Good morning, everybody. To build on Al's comments, we did recently complete a bottom-up forecasting process. And it's a process that involves our sales people looking at every client on their responsibility list. Every one of our sales divisions goes through this forecasting process, providing all revenue projections where they have specifics, such as planned program dates, page counts, circulation, et cetera. Currently, both our strategic and field sales organizations are forecasting Shared Mail revenue to be up mid-single digits in the second half of this year.

The second part of our forecasting process is something that we call our pipeline. Pipeline is business where we've had conversations with clients, and while budgets exist, we do not yet have specifics for these opportunities. Both our strategic and field pipelines are up by double digits in the second half of this year compared to the same period last year.

There's several reasons why I have confidence in our back half forecast and pipelines, as well as our ability to deliver mid-single-digit revenue growth for our Shared Mail business. First, we've seen the migration of several large national retailers into our Shared Mail package. These are both new and existing clients who have contracted to run significantly more business in the second half of this year compared to last year.

Second, when I look at the robust forecast and pipeline from our field sales organization, it shows greater opportunity compared to this time last year. And I believe it is the direct result of a decision we made in the fall of 2010. At that time, we shifted a number of non-selling, administrative responsibilities from our sales organization to our client services team. This move freed up the equivalent of 30 sales executives in the field to enhance their focus on prospecting for new clients.

As a result, we've seen a 30.2% increase in new client calls, which is then translated into the double-digit increase in the field's pipeline versus last year. I fully expect that we'll see this increased prospecting activity continue and, given our typical sales cycle, this timing also makes sense to me. The increased forecast in pipeline in the back half of 2011 closely correlates with the market increase in prospecting activity we've seen in the first quarter.

Finally, we've been testing some new products in the Shared Mail business, including a solution targeted toward the automotive industry, as well as a variably imaged postcard tied to our Shared Mail package. And we believe these new products will contribute measurable, incremental revenue in the second half of 2011.

In summary, the combination of the migration of these large national retailers into our Shared Mail Package, our increased prospecting in the field and, finally, the fact that we are seeing a double-digit improvement in our pipelines and a mid-single-digit increase in both our strategic and field Shared Mail forecast leads me to believe that we will see a substantial increase in Shared Mail revenue in the second half of 2011.

Before I turn it back to Al, I want to reinforce something he said regarding our prospects for growth. Our direction is very, very clear. While it is way too early to throw in the towel on our 2011 revenue objective, our focus remains on long-term profitable growth. This long-term goal is much too important to sacrifice by focusing on a single year revenue objective in the back half of 2011.

I will leave you with this and say that I am very confident in our sales organization's ability to execute and our commitment to drive profitable revenue growth anchored by strong revenue and profit performance within our Shared Mail business in the back half of 2011.

Al, back to you.

Alan Schultz

Thanks, Rob. In addition to Rob's bottom-up forecast, I took a top-down look and sort of an analytical view and I also came up with a number of reasons why I'm confident in our back half 2011 Shared Mail projections.

There have been a number of drags on the Shared Mail revenue growth and as we approach the back half of 2011, these factors or these drags are becoming less of an issue. The first drag was since we acquired the Shared Mail business four years ago, we've been reducing the number of packages distributed to optimize package distribution and eliminate the less profitable packages.

In the first quarter of 2011, package distribution was down just 0.5% and is expected to be stable for the balance of the year. As a reference point, 2010 package distribution was down 4.8%. Obviously, when we reduce packages, we eliminate the revenue associated with those packages.

The second drag that I've identified is we have seen something in the past that we've called lightweight. And lightweighting is where retailers cut back on the number of pages in their circulars. In 2010, lightweighting had a negative $25 million effect on our revenue. Based on what we are seeing today, the revenue drag associated with lightweighting is expected to be reduced by more than half in 2011 compared to last year.

The third item that I'd like to discuss is we also expect to cycle through some of the lower rate contracts in the first half of the year. Shared Mail contracts average 18 months in length. During the recession, Shared Mail contracts have declining prices built into them in the mid-single-digit range. Essentially, this price decline has been masking the real volume growth we've been seeing in the Shared Mail business. In the first quarter of 2011, Shared Mail rates were just down 1% compared to last year's mid-single-digit decline. Lower-priced contracts will continue to expire as the year progresses and should be replaced with contracts that include appropriate price escalation.

And kind of the fourth area that I would identify is we continue to see newspaper circulations decline, and hence, the household penetration of the newspapers continues to decline. Shared Mail distribution is an ideal alternative for our customers to reach those households that no longer read the newspaper. And what this means is we've been able to bring new clients either directly into the Shared Mail product or we've been able to migrate it from our newspaper base products within our Neighborhood Targeted segment.

In addition to migrating -- or in addition to mitigating the revenue drags, we also continued to improve the operating leverage of the Shared Mail business. For example, unused postage was at a record low, 14.9% this quarter, beating our last record of 16% in Q2 2010. When we acquired the Shared Mail business in 2011, unused postage was running in the 22% range. Combined with increasing pieces per package, the operating leverage of the Shared Mail business means that a large percentage of incremental revenue falls through to the bottom line.

So when I combine all of these factors, strong Shared Mail forecast and pipeline, the migration -- or the mitigation of past revenue drags and the strong operating leverage of the Shared Mail business, you can see where we derive our confidence in delivering a substantial increase in back half revenue and segment profit in our Shared Mail business, which will also drive our earnings per share and EBITDA results for the year.

Moving on to our other business highlights for the quarter, starting with the Neighborhood Targeted segment. I've already discussed ROP. The big remaining question in the Neighborhood Targeted area is the decline in segment profit. In addition to the ROP revenue decline and profit associated with that revenue, there are a couple of other factors influencing this segment's profitability.

The first contributing factor actually has to do with the types of clients that we are targeting. We are strategically going after larger, high frequency newspaper insert clients. While this business is highly competitive and carries a lower margin, we also recognize these are customers who need optimized media solutions, which blend newspaper inserts with Shared Mail. Approximately 3/4 of these new lower margin newspaper insert clients are also buying Shared Mail from us.

As newspaper penetration and household coverage continues to decline, we expect our unique ability to combine Shared Mail and newspaper distribution to be a competitive advantage for us. And the volume of Shared Mail business will continue to grow. We are managing these relationships with customers, not by product, by looking at their overall spend with us across our entire portfolio.

The second contributing factor is the cost of on-boarding new newspaper insert customers at the beginning of this year. On-boarding a customer is an expensive process. All of the costs are loaded in early while you make little, if any, profit. This situation is typically rectified within 1 to 2 quarters as we complete the on-boarding process, then the expected margins kick in.

In the FSI business, industry unit volume was down approximately 4% in the first quarter of 2011 versus the first quarter of 2010, due primarily to the shift of Easter into the second quarter on the 2011 calendar. Unit volume is projected to be up 10% in April. So as we look at the first 4 months of the year, industry unit volume is relatively flat for the first 4 months compared to the same period in 2010.

As expected, FSI's segment profit was negatively influenced by high single-digit increase in paper costs and increased transportation costs. In addition, with one less custom co-op program and one more regular co-op date on the schedule in the first quarter of this year versus the first quarter of 2010, we had fewer average pages per program, which also negatively affects segment profit.

Moving on to the International, Digital Media & Services segment. We continue to invest in innovation, specifically in our In-store business and expanding digital portfolio. These two businesses contributed an additional $7.5 million in incremental revenue in the first quarter of 2011 over the first quarter of 2010. We believe both businesses will continue to ramp up revenue on a quarterly basis throughout the year.

We began investing in the In-store business in the first half of 2010. Quickly, the business became profitable in Q4 of 2010 and again contributed profits this quarter. We continue to work to expand our retail network. Installations at A&P began last month.

We just recently announced our newest partnership with Alliance Marketing to represent over 200 independent retailers across the country. With the addition of Alliance-affiliated retailers, our network has grown to nearly 3,000 stores. The reception to our entrance into the In-store business has been extremely positive from both consumer packaged goods companies and the retail community.

While we have made significant progress in our Digital portfolio to date, we would like to speed up our development process and improve our ability to bring innovation from concept to market more quickly. To achieve this, we recently hired Jim Parkinson as our new Chief Technology Officer for Digital Media. Jim comes to us with a 30-year track record of success in the software industry, including 6 years as the senior computing engineering executive at Sun Microsystems that changed the world of technology with the development of JavaScript, OpenOffice and the first utility computing platform that led to the introduction of cloud technology.

As we escalate our innovation and ramp up this business, we are also investing in having the back-office systems to manage a business that is measured in minutes, hours and days, not weeks and months. We expect to be in investment mode in the digital business through 2012 and continue to make progress on our Digital portfolio.

I'd like to share with you some of our digital metrics comparing the first quarter of 2011 to the first quarter of 2010. We drove 170% increase in display ad revenue. We drove 181% increase in display impressions, a 21% increase in secure printed home coupons and amazingly, an over 2,000% increase in Offer-to-ID, or coupon to frequent shopper card downloads, going from 1 million downloads in the first quarter of last year to over 26 million downloads in the first quarter of this year. We had a 215% increase in the number of emails from RedPlum, a 51% increase in the number of consumers opting in for emails, a 21% increase in network partners and an 81% increase in unique users using redplum.com and save.com.

Moving on to a few other comments regarding consumer trends. We know that, historically, $4 gas prices are a tipping point for changing consumer behavior. In the past, they have pulled back on spending, traded down on brands, they eat out less often and they delay purchases.

In response, clients have typically become more promotionally active when shoppers pull back to deliver value and incentives to value-conscious, deal-seeking consumers. In addition, today's producers are also raising prices in response to rising commodity prices. In the past, if consumers balk at price increases, producers and retailers have looked to value-oriented media to keep shoppers in their stores and in their brands. However, we are in uncharted territory, with both of these events happening at the same time. It is difficult to anticipate what client budgets will do this time around.

Finally, a few comments on our plans for stock repurchase. Given our positive Shared Mail outlook for the second half of the year and current share prices, we plan to continue to buy back shares under our share repurchase program restated by our board in May of 2010, subject to our credit agreement. Based on our expectations regarding Shared Mail performance in the second half and its impact on our overall company performance, we believe continued share buyback will be a very good investment for our shareholders.

At this point in time, Pamela, we'd like to open the call up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Mark Zgutowicz from Piper Jaffray.

Mark Zgutowicz - Piper Jaffray Companies

Just a question on the Neighborhood Targeted segment. Can you just remind us again what the ROP concentration is within Neighborhood Targeted? And then if you expect any growth in Neighborhood Targeted outside of ROP in '11?

Alan Schultz

Yes, if you look at it on a historical basis, if you go back to last year, in the first quarter, ROP represented about 35% of the overall revenue in Neighborhood Targeted. Obviously, it's a much, much smaller percentage today than that, up in the 17%, 18% neighborhood. But to answer your question, the bottom line is in the other products in Neighborhood Targeted, we actually did see some revenue growth in there. In fact, in Newspaper Inserts, we saw about a 12% increase in revenue. As I mentioned in my prepared remarks, we did see a falloff in terms of margin for the reasons that I articulated. And then actually in the Sampling business, we saw about 45% increase in revenue. So within the Neighborhood Targeted segment, the other products did very well in the first quarter. The problem was really isolated to ROP and primarily in that telecommunications sector.

Mark Zgutowicz - Piper Jaffray Companies

Okay, great. So you're still expecting some reasonable growth outside of ROP.

Alan Schultz

That is correct. Yes.

Mark Zgutowicz - Piper Jaffray Companies

Okay. And then on Shared Mail, maybe just looking at the second half competence, is that competence expected to grow through the year? And I guess what I'm trying to get at is if you look at mid-single-digit, obviously, that's somewhat of a wide range. So I'm trying to get a sense of is that at the low end of the range in Q3 and that potentially can build to the upper end of that range into Q4? And then sort of tied in with that, how does the pricing sort of factor into that outlook? And have you changed or have you had to change any sales incentives that were set at the beginning of the year?

Alan Schultz

Yes, I think when we look at the second half of the year, we see it kind of relatively flat in terms of revenue growth between the third and the fourth quarter. So I don't think we necessarily see a ramp up from Q3 to Q4. But we definitely see a ramp up in Q3 compared to Q1 and Q2. So it looks to date to be relatively consistent through the second half. From a pricing perspective, we anticipate that we're going to continue to see pricing improvement in Shared Mail contracts. And as these current contracts that have kind of price de-escalation built into them expire, they'll be replaced with contracts that'll have escalation in them. From a pricing incentive standpoint, really no changes. We had a program in place that rewarded individuals for getting price improvement, margin improvement. We've been executing against that program. We've been paying out people who have been successful in terms of doing that. And that program seems to be working just fine. So I don't anticipate any changes, but I'll ask Rob if he anticipates anything.

Robert Recchia

No, Mark. We did at the beginning of '11 in addition to rolling out a very focused incentive around pricing, also, modify the sales comp plan to put more weight behind Shared Mail. We did so in a very thoughtful manner because we want what we take to clients to be very client-centric and be the best solution to them. But we did make a very mindful effort to increase the weight in terms of compensation behind selling Shared Mail.

Mark Zgutowicz - Piper Jaffray Companies

Okay, that's helpful. And then one last one on Shared Mail, obviously some pretty impressive profitability in Q1. Just curious if there was any sort of onetime profitability effects in the quarter. I noticed that SG&A was down considerably x stock comp. So I'm just trying to get a sense of is that a new run rate? Or is that -- were there some onetime effects there in Q1?

Alan Schultz

Yes, I think the SG&A, we worked hard to control SG&A in the first quarter. That was kind of part of our plan to do that. I don't think I would use the SG&A number that we first, that we have in here for the first quarter as our run rate for the year. I think we're going to probably be up in the neighborhood of maybe $81 million a quarter, probably going forward from where we're at today, maybe $82 million. So I think the SG&A is probably a little low. But there's really nothing unusual about the Shared Mail business and the profitability in the Shared Mail business other than what I mentioned, which is we did have a new record low in terms of unused postage in the Shared Mail business. That was probably the only thing that I can think of that was unusual about it. We didn't have any unusual anomalies in terms of customer participation. We didn't have anything unusual from a cost perspective going on. In fact, like in our other businesses, we paid for the wrap, and we did have paper increases that flowed through on the wrap. And we do have transportation costs that are up beyond what they were last year because of the fuel surcharges associated with those. So yes, I think the answer to that question is no. Nothing really unusual other than that particular unused postage number. In fact, when you look at our wrap sell-through percentage, it was actually down a little bit versus last year. And I think we believe we could probably do better from a wrap sell-through percentage going forward than we did in the first quarter. So nope, nothing unusual.

Operator

Our next question comes from Dan Salmon from BMO Capital Markets.

Daniel Salmon - BMO Capital Markets U.S.

I got one for Alan and a couple quick ones for Bob. Al, you mentioned in the past that sampling oftentimes works as a bit of a leading indicator and obviously was strong this quarter, this past quarter. I know, as you mentioned, things are a little bit different these days and some different variables bouncing around, but do you still view the business that way? It sounds like obviously strong outlook for the second half, but just be interested to see how you think of that business these days.

Alan Schultz

Yes, well, we did see a strong first quarter in Sampling. I will tell you, the second quarter doesn't look as strong for Sampling. I don't know if it has something to do with the economy right now, gas prices at 4% increasing, spectrum of inflation, commodity prices being up. I'm not sure exactly what it is, but we definitely see a little bit of a slowdown in new product introductions there in the Sampling business in Q2. So I don't know what exactly that means economically. That's why I talked a little bit about the consumer side of the equation here. Historically, when these kind of things happen from a consumer's perspective, it's usually pretty good for us, right? So when customers are pushing through inflationary increases, that's usually good for us because what happens is oftentimes they'll do more couponing. And the reason they do that couponing is they want to mitigate that price increase for those value-conscious consumers to make sure they keep them in the brands. So they'll do more couponing for those real price-sensitive shoppers. That's usually a positive for us. With gas being at $4 a gallon, consumers once again get more value conscious. That's tends to be a pretty good thing for us. What we haven't seen, from my perspective historically, is these 2 things happening at the same time. And what we don't know is exactly what that means as it relates to client budgets and the economy.

Daniel Salmon - BMO Capital Markets U.S.

Okay, great. And then just a couple for Bob. First, in the cash EPS guidance, you didn't change the share count despite some buybacks this quarter. Was there a specific reason for that? And then the second one just if there's any update on renegotiating the term loan.

Robert Recchia

Yes, in terms of the share count, the way we drafted this thing from the beginning of year is we're going to hold a static share count not knowing exactly where it would go. So we left it the same and we just note that so that you can make those adjustments yourselves. I suppose as the year goes on, we'll take a look at that as we can start to narrow down where we think the share count will end. We'll take a look at it again, but we felt, for purposes of this, we just leave it where it's at. And in terms of the bank, you're talking about the term loan. We've got a couple years left on the term loan, like all of our pieces of financing, if you will. We take a look at it on a regular basis. The market is pretty good right now, so we'll continue to look at that. If we think it makes sense, then we would go down that path, but nothing to report there at this point.

Alan Schultz

And, Dan, on a share base, I think in the release, we did report what the actual share base was at the end of the quarter. So if you wanted to do that calculation, I think it does improve that number by a few cents.

Daniel Salmon - BMO Capital Markets U.S.

Yes, I know, I caught that. That's great. I just wanted to make sure there wasn't something causing the account to go back up. But it sounds like that's all clear. So thanks very much.

Operator

Our next question comes from Alexia Quadrani from JP Morgan.

Alexia Quadrani - JP Morgan Chase & Co

Thanks for all the color you gave on the outlook for Shared Mail. I appreciate it, but I did want to follow up on that a little bit. It sounds like pricing is going to be a driver for the growth you're expecting in the second half. Should volume also be up in the second half? It sounds like it should, but I just wanted to double check on your thinking there. And then, specifically, on the second quarter, I'm just trying to put the pieces together. I mean, with the benefit of -- a little benefit from the ladies served, [ph] shouldn't we assume some acceleration in Q2, as well?

Alan Schultz

Yes, the -- I guess we'll go to the Shared Mail side of the equation here first. Let me just go to Q2. I mean, when we look at Q2, we obviously have pretty good information at this point in time right now. And we think Q2 looks pretty similar to Q1, okay? So we have them very similar in terms of nature, and we got pretty solid information there. So we might see a little bit of uptick there, but I don't think we anticipate a lot. Clearly, we do see volume growth from the Shared Mail business, and I think Rob mentioned, we have some new contracted business that's migrated from newspapers into Shared Mail. These are contracts. So this is pretty solid information. And then as Rob mentioned, when we look at the pipeline, you've seen significant increases in the pipeline from both the field and the strats, so you definitely got a volume increase going on there. And from a price perspective, clearly, prices were still down about 1% in the first quarter, but as we get into the second half of the year, we're eventually going to, at some point in the fourth quarter, kind of switch over to having a price drag, to having price start to be complementary in terms of top line revenue growth. So we definitely see a combination of price and price and volume. And then I think the other thing to keep in mind when I say the second quarter we think looks pretty similar to the first quarter, particularly from a revenue perspective; we're assuming right now that the switch stays off in telecom, which is, in fact, something that we -- has been the case at least so far in the quarter. And again, we know that, that switch can turn on very quickly. And then the other thing is, is in the energy sector, we had business that was really kicking in, in the second quarter of last year that won't be there this year. We never expected it to be there this year, but we know that was a drag that we were going to have to try to overcome. And then of course, we see an overall decline in ROP revenues. So the opportunity to fill that hole from the energy sector doesn't look to be as strong as we once anticipated it to be. So clearly, ROP is going to be -- will continue to be -- at least we believe at this point in time, continue to be an issue for us in Q2.

Robert Mason

And just to add to that. When Al says Q2 looks similar to Q1, he means in growth percentage, not in actually revenue dollars, so just to be clear on that.

Alexia Quadrani - JP Morgan Chase & Co

And just a follow-up still on the Shared Mail business. You guys have done an incredible job in reducing the unused postage. How should we think about that longer-term? I mean, is there a target internally where you think you can get to or a number we should be thinking about? I know it's going to move around a bit from quarter to quarter, but over time, do you see it trending even lower?

Alan Schultz

In my opinion, as we get down to these levels, and interestingly enough, I looked at the month of March. And in the month of March, we were actually down to 13.5%. So the quarter was a little higher than that. And I think the month of March was again probably an all-time low. But I think reality is, as this package optimization kind of runs its course, then we really see packages being kind of flat on a going forward basis here down just to 0.5%% in the first quarter. I think we pretty much accomplish what we're going to be able to accomplish from an unused postage perspective. So could it get as low as 13.5%, as we saw in March? Yes, I guess it could. Could we continue around this 14%, 15% number? Yes. But I think it's pretty much run its course. We're down near the bottom of where unused postage can go. But the beauty of this business, as you know, is the flow-through of incremental revenue to the bottom line is very strong.

Alexia Quadrani - JP Morgan Chase & Co

And just lastly, I know you're somewhat limited on -- or fairly limited, I should say, on what you can say on pricing in the FSI business. But can you maybe talk generally? Is there any reason we shouldn't assume sort of just general revenue performance from FSI in 2012?

Alan Schultz

Yes, we really can't talk about the FSI business at all from a pricing perspective. And one of the things I try to be real clear about is the fact that we've got a number of different products and services, and every one of those different products has got a different pricing strategy. We've got different pricing strategies by customer. We've got certain regions and markets where we've got different pricing strategies. So it's a pretty complex kind of process that we go through from a pricing perspective. But clearly in the FSI industry, we just can't talk about it at all.

Alexia Quadrani - JP Morgan Chase & Co

I guess putting it a different way, let's put pricing aside then, are you generally optimistic about the prospects for the FSI business as a whole?

Alan Schultz

Well, as a whole, we saw Pages being relatively flat here for the first 4 months of the year. So from a volume perspective, I guess what I can say is, "hey, it's flat for the first 4 months of the year." What this whole -- what it's going to mean to the FSI business with gas at $4 a gallon and rising prices, I think you saw it just this week, a couple of big consumer package goods companies announced some price increases for products and services. Whether that's going to mean more opportunity for us in the second half of the year is hard for me to say at this point.

Operator

Your next question comes from Chuck Cerankosky from Northcoast Research.

Charles Cerankosky - Northcoast Research

Could you talk about the Shared Mail markets where News America has begun to put their FSI into your pack and what that action is doing to attract incremental pieces and circulars into the Shared Mail?

Alan Schultz

Chuck, I don't think we can talk specifically about those markets because I just don't feel like that would be appropriate. But I think we know from a lot of experience that content is really important. And the more content we have better increases our ability to draw other clients into the package. And one of the things we hear a lot from customers is adjacency. And when they see the kind of content in a package that they really want to be adjacent to and be part of, that helps draw other people in. Obviously, we feel as if coupon booklets with both food service clients and consumer package goods clients in them are really spectacular contents of package. So I'm sure it has a positive impact, but I don't think we could share anything specifically.

Charles Cerankosky - Northcoast Research

I was trying to ask the question in terms of all the markets they're in so far, not any specific markets, but looking at it in aggregate. But that's sort of a follow-up question. But also, Al, since you mentioned content drives incremental business, besides FSI booklets in the Shared Mail, what are some other drivers? What are some other pieces of content that seem to drive incremental business?

Alan Schultz

I'll let Rob talk about that because this is obviously something he's dealing with every day.

Robert Mason

Chuck, one of the things that we're excited about that I mentioned earlier was a market increase in large national retailer content in the Shared Mail Package. And that's the other component of this. Not only from a revenue profitability standpoint that gets us excited, but it draws eyeballs, it draws readers and, ultimately, we feel, both anecdotally and what we've seen in practice is it draws other clients. And that's the adjacency factor that Al's talking about. So our focus is clearly on attracting these marquee retailers to the package. And we feel they will be a build effect as we're successful in that effort.

Alan Schultz

I think, Chuck, probably what you're interested in is the verticals. And I think -- where we've done a pretty good job, I think, here recently, is in kind of the home improvement area. We've done a pretty good job. And we've also done a pretty good job in what I would call sort of sporting goods in general, both of which are perceived to be pretty darn good content.

Robert Mason

I think the other build that it offered, Al, in Q1 we saw upticks in terms of grocery and drug and specialty retail in the Shared Mail Package. And those tend to be kind of ritual categories that attract readership and is ultimately good for everyone in that package and our performance overall.

Alan Schultz

Rob brings up a good point. We did see increased participation from grocery and drug, which is also great content.

Operator

Our next question comes from Mark Argento from Craig-Hallum.

Mark Argento - Craig-Hallum Capital Group LLC

Quickly on the -- just to touch on Digital a little bit and the strategy there. I know you guys are going to continue to be reinvesting there. Is it going to be kind of extensions of the RedPlum platform and other types of digital offerings? Or could you guys perceive maybe launching a whole new platform, a whole different brand, something that could be much bigger or potentially grow organically very rapidly?

Alan Schultz

I think it's a great question. And I think our focus to date has been sort of protecting our incumbencies. So it's been more about kind of product development that kind of aligns very closely with our current customer base, our current Product portfolio. But with that said, we've got a number of different ideas that we think are kind of unique and different that we'd like to pursue. But from a development standpoint, we're just kind of struggling to find the time to put them against those efforts and really bring those to market. This is from a development perspective, which is why we hired Jim Parkinson. Jim has basically spent 3 weeks out of every month over the last 10 years in Palo Alto, California, working with innovative developers. Unfortunately for him in terms of his travel schedule, the other week a month, he pretty much spent around the world dealing with developers in India and other parts of the world. So he's traveled a lot. But we really think he can bring a lot to the party here to help us accelerate our development efforts.

Mark Argento - Craig-Hallum Capital Group LLC

Great. And then more of a numbers question, I know you kind of alluded to growth being similar in Q2 to Q1. Should we see kind of a margin profile pickup here a little bit as the mix of ROP is out of the model and we start to see more Shared Mail? Does that imply that we should be able to start to see EBITDA and then, ultimately, EPS growth, especially with the lower share count? That growth rates start to look and accelerate past the top line growth rate here?

Alan Schultz

Well, the way we have things modeled out today, we do see a little bit of gross margin improvement in Q2 versus Q1, so I guess the answer to that's yes.

Mark Argento - Craig-Hallum Capital Group LLC

Great. And then last question around kind of the environment right now. With higher commodity price, higher food prices, of course, higher energy prices, the kind of the frequency of the type of promotions you historically see maybe a little bit of shift there. Any kind of recent trends around kind of the mix there and what that could mean for your business both on the Shared Mail side and potentially some of the other categories?

Robert Mason

It's Rob. One of the leading indicators we're seeing is the significant increase in pipeline activity. It's paired with prospecting activity in our field sales organization. And I think through that, from a volume standpoint, we're seeing an uptick in local content. And we believe in line with the decision we made to kind of redeploy those administrative tasks that I talked about earlier in the CS and then get our sales organization, field sales organization more focused on prospecting and direct selling efforts, that we're going to continue to see relatively strong performance there. And I think on the other end of the spectrum, we see the increase in terms of these large national retailers coming into the package as kind of a bell tower effect. And our clear goal is to build upon their presence to draw others in that same kind of category and classification into the Shared Mail package.

Alan Schultz

I don't know if your question is kind of more economically related or not, but I think what we're saying when Rob talks about this pipeline, because the pipeline growth is not only double-digit in the field; it's double-digit in our strat team also. That sort of leads me to believe that clients are concerned about the economy. They are concerned about consumer spending, and they're going to jockey a little bit to make sure that they get their appropriate share of that consumer wallet. And they're going to do it with more value-oriented content is what it looks like to me at this point. It does take clients a little bit of time to pivot and transition. And I think that's why we see this pickup in the pipeline more in the second half than the first half.

Mark Argento - Craig-Hallum Capital Group LLC

My question was definitely more economic in nature, so that was helpful. Just kind of dovetailing out of that just quickly, I know you guys have talked historically about very -- the attractive incremental margins on Shared Mail. Do you still -- kind of your view there in terms of the margin profile, incremental margin profile, is that still intact?

Alan Schultz

Yes, there's really nothing that changes that. The bottom line is customers really need more of a blend of Shared Mail and newspaper inserts than ever before. And the beauty of what we're doing here is that we're doing what's right for our customers and they benefit from it and we benefit from it. So it's a good program.

Operator

Our next question comes from Dan Leben from Robert W. Baird.

Daniel Leben - Robert W. Baird & Co. Incorporated

First off for Rob. I appreciate all the color, giving us the insight into the forecasting process and Shared Mail and how you're feeling about that. I guess my first question is the last time you were on the call and we were talking about the second half and Shared Mail doing mid-single digits didn't quite come through. What's the difference between the forecast you had last summer versus where it's at today? And how do you gain the additional level of confidence that it's a better forecast this time?

Robert Mason

Well, Dan, I think our process of forecasting is one of continual improvement. And I take our sales organization: a, has gotten better at forecasting over the past year. We've certainly got more experience in the current process. Second thing I would tell you is what I mentioned concerning the pipeline. That significant growth in terms of pipeline that were identified as double-digits is something that adds enhanced confidence to our view of the back half. I did mention the difference between the pipeline and the forecast is the pipeline does not have budgets associated with it. It does not have program dates, page counts, circulation. So there's not as much certainty, but from experience, to see a double-digit increase in pipeline is another reason that I feel more confident. I talked about the presence of contracted significant national retailers who have moved into the Shared Mail package. That gives me additional confidence. Al touched on the impact of price, in terms of we see an improving pricing environment within Shared Mail that has really been something that's masked our volume increases. We know, as a sales organization, that our package count is going to stabilize instead of go down. And that kind of balances or creates more opportunity. And then finally, I touched on the innovation projects that we've launched within Shared Mail. And we think that product is targeted toward the automotive segment. And we're very excited about this variably imaged postcard contributing to our back-half growth. So there's a number of factors that increased my confidence that as we look at the back half of this year, we can state with a high degree of confidence that we're looking at a scenario where we can generate mid-single-digit growth in our Shared Mail business.

Daniel Leben - Robert W. Baird & Co. Incorporated

Great. That's really helpful, Rob. I appreciate that. From the pricing standpoint, obviously, you talked about quarter a lot about you've taken some of the power pricing bring it up to corporate away from the sales force. Could you talk about how kind of contract renewals in the first quarter were running on a price? Kind of give us a sense of what the price lift is on average knowing that they're all different?

Alan Schultz

Yes, I don't think, from a competitive standpoint, it's wise for us to get into kind of specific situations there. I think what we can tell you is that 20%, 25% of our Shared Mail contracts expire in the first quarter. So our biggest quarters in terms of Shared Mail contract expiration are Q1 and Q4. And so we'll continue to make progress as the year goes on.

Daniel Leben - Robert W. Baird & Co. Incorporated

And when you're getting these marquee retailers, do they come in at a lower price knowing that they're going to bring in additional volume with wanting to be in the same package as those guys?

Robert Mason

No, not necessarily. I don't know if we want to talk about individual clients or retailers or pricing either. I'm not...

Alan Schultz

I'm going to make just a general comment about pricing here, okay? We have to be very careful from a pricing perspective for 2 reasons: One is potential competitors who try to get a sense of what we're doing from a price perspective and get specifics about what we're doing; second thing is there are legal restrictions around talking about pricing. And we want to give you as much information, as much transparency as we can, but the bottom line is I think too much detail is not good for our investors, and the bottom line is, on a going forward basis, we'll probably talk a lot less about price than we have today.

Daniel Leben - Robert W. Baird & Co. Incorporated

That's fair. Just to shift to the Digital side. Al, obviously, had some great year-over-year stats there in terms of the traction you're getting with Digital. Help us understand the revenue contribution from that. What does that bring in incrementally versus the more traditional products? And then secondly, as you've seen those numbers come up, have you seen any change in redemption rates on the traditional side?

Alan Schultz

We don't give specific numbers on Digital. What I can tell you is the revenue overall within our Digital portfolio is up near 100% versus the previous year, but it's still off of a relatively small base. In terms of traditional redemption rates, in the first quarter, we did see a slight reduction in redemption rates in the traditional business. But again, based on everything we're talking about right now with gas prices and inflation, I think there's a good possibility that, that could start to swing back the other way.

Robert Recchia

And Al, I think that redemption rate difference, too, is comparing Q1 2011 and Q1 2010. And there's some kind of Easter effect I think involved in there, as well. Redemption was actually up versus the prior quarter Q4 2010.

Alan Schultz

That's a good point Rob brings up about the Easter effect.

Operator

This was our last question for today, sir. Please continue with any other point you wish to raise.

Alan Schultz

All right. Well, I trust that we explained today how we believe we can achieve our guidance metrics related to profitability and cash flow in spite of lower than expected revenue. Clearly, the anticipated Shared Mail revenue growth in the second half, combined with the operating leverage in that product, allows us to drive a significant portion of that incremental revenue to the bottom line.

Although we will never give up on our annual revenue objective in April, if we are in fact confronted with the choice of chasing revenue at the expense of our long-term plan to drive sustainable revenue and profit growth, we will opt for the long-term plan and sacrifice the single year revenue growth target. So I just want to be crystal clear about that.

And I really thank you all for your time and your great questions today, and I hope everybody has a wonderful day and enjoys the wedding tomorrow.

Operator

Ladies and gentlemen, this concludes the Valassis First Quarter 2011 Earnings Conference. Thank you for participating. You may now disconnect.

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