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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

Analysts

Daniel Salmon - BMO Capital Markets U.S.

Daniel Leben - Robert W. Baird & Co. Incorporated

William Warmington - Raymond James & Associates, Inc.

Mark Zgutowicz - Piper Jaffray Companies

Mark Argento - Craig-Hallum Capital Group LLC

John Harloe - Barrow Hanley

Alexia Quadrani - JP Morgan Chase & Co

Edward Atorino - The Benchmark Company, LLC

Valassis Communications (VCI) Q2 2011 Earnings Call July 28, 2011 11:00 AM ET

Operator

Ladies and gentlemen, welcome to the Valassis Second Quarter 2011 Earnings Conference Call on the 28th of July, 2011. [Operator Instructions] I would like to remind you that the discussions during this conference call 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 2010 Annual Report on Form 10-K and in the reports of Form 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 of the Investor section.

I will now hand the conference to Mr. Alan Schultz. Please go ahead, sir.

Alan Schultz

Thank you. I'd like to welcome everyone to the call this morning. Joining me today is Bob Recchia, our Chief Financial Officer. And after our prepared remarks, both Bob and I look forward to answering your questions.

I'd like to begin with sort of a midyear update with commentary on each business segment and some important initiatives, then I'll wrap up with some general remarks on the quarter before we take your questions.

Beginning with the Shared Mail business, the magic of this business continues to be its strong operating leverage. Our 3.3% increase in revenue drove the 17.5% improvement in segment profit. We continue to find new ways to operate this business more efficiently. We hit a new record low in unused postage of 13.8%, beating Q1's 14.9%, which was the previous record.

Both pieces per package and total packages distributed were up slightly compared to the prior year quarter. As you know, we had intentionally reduced package distribution as part of our optimization strategy during the last few years.

Long term, we anticipate package distribution growth to reflect U.S. household growth. We also continue to cycle through some of the lower-priced contracts during the first half. During the recession, Shared Mail prices have been declining in the mid-single-digit range, masking the unit volume growth in the business. In Q1, Shared Mail prices were down just 1% versus the prior year quarter, with Q2 down just 3/4 of 1% versus the prior year quarter.

We expect pricing to be a contributor to revenue and profit growth in Q3 or Q4 in the Shared Mail business. Lower price contracts will continue to expire as the year progresses. We are seeing some momentum in Shared Mail revenue, with a robust pipeline in the second half. We are expecting Shared Mail revenue growth in the back half of 2011 to be up in the mid-single-digit range.

In the last 30 days, however, we have seen some hesitancy from clients to move from planning programs to actually committing orders due to a number of macroeconomic reasons, which I'll get into later on in the call.

Moving on to the Neighborhood Targeted segment. As expected, we saw a significant decline in ROP revenue. This is not new news. During our last call, we discussed the ROP decline and estimated it would be down $60 million to $80 million for the year. This quarter, ROP revenue was down $20.8 million versus the prior year quarter. So it looks like the decline will be closer to the $80 million for the year.

In Q2 alone, the decline in ROP revenue represented a 3.6 percentage point decline in total company top line revenue versus Q2 in 2010. So actually, our non-ROP revenue was up slightly this quarter.

The change in ROP revenue is due mostly to reduced spending by 2 clients, one in the telecommunications category, and the other in the energy sector. It is not surprising that Polybag and Sampling business was down in Q2 versus the prior-year quarter. As our most cyclical product, it tends to follow economic news. We have seen some nice Polybag Sampling growth in Q1 when we were seeing signs of economic recovery. And as the economy slowed in Q2, so did Sampling revenue.

We are doing very well in Newspaper Insert volume. We have recently been targeting larger clients, and although they may have lower margins at the Neighborhood Targeted segment, we managed these clients by looking at their overall spending and profitability, and their overall profit potential across our entire product portfolio.

And with continued declines in newspaper circulation and coverage, this Newspaper Insert business we view as a great staging area for Shared Mail growth in the future. As we gain market share in Newspaper Insert spending, this business generates growth opportunity, not only for Shared Mail, but also for our Digital business.

Our ability to blend Shared Mail, Newspaper and Digital distribution is an important advantage for us. It also solves the household coverage dilemma for clients, allowing them to reach households no longer reading the newspaper.

Moving onto the FSI segment. As it relates to our reduced market share in Q2 2011, it is important to note that the industry had 2 additional cooperative programs compared to 2010 second quarter. Both of these additional programs were added by our competition.

NCH recently released their latest CPG, consumer packaged goods redemption statistics, and showed that redemptions were actually up 2.9% for the first half of 2011, and we saw a significant spike up in redemptions in May and June. In addition to the permanent change in value-seeking behavior and mindset of shoppers we have seen in the last couple of years, there are a number of macro factors, economic factors that are likely contributing to this recent increase in consumer response rates. This includes rising food and fuel costs, continued depressed home values, unemployment rates and lackluster economic growth.

We are also seeing some unique publicity that is elevating consumer awareness of value, including the explosion of daily deal sites and TLC's Extreme Couponing show. We believe it is the combination of these factors driving up consumer packaged good redemption rates, in spite of the fact that CPG companies are using a variety of different tactics in order to intentionally drive down coupon redemption rates. For the industry, FSI page volume was up double digits in April due to the Easter shift, but was down 1.5% through the first half of the year. We believe this is due in part to clients responding to the spike in redemption rates in May and June. Our 2011 plan had called for industry volume growth to be about 3% for the year. Consumer packaged goods marketers are responding to higher commodity prices, higher energy costs and the higher-than-anticipated redemption costs by reducing programs.

While the increase in redemptions may be stressing our clients' annual promotion budgets, this trend does reflect well for consumer engagement with our products and the power of promotion to drive incremental sales for our clients. We believe marketers need more time to respond to the increase in coupon redemption costs, as customer -- as consumers are required to -- I'm sorry, as customers are required to manage to an annual marketing budget.

Consumer redemption costs, we believe, are taking a larger portion of annual promotional budgets than clients had anticipated.

Although clients will struggle with marketing budgets in the short term, the improved return on investment and incremental sales generated should prompt them to increase future budgets for Free-standing Inserts. As anticipated, the FSI business also experienced cost increases in paper, production, energy and transportation. We are not in a position to short term to pass along these increases due to the long-term nature of FSI contracts. Fortunately, in many of our other business segments, we are able to pass along these increases in a more timely fashion.

Moving on to the International, Digital media and Services segment. The biggest positive in this segment this quarter was the strong performance by NCH, both from a revenue and profit perspective. Their great results were driven by the increased redemption in the U.S., and increased distribution and redemptions in Italy. This segment also includes 2 of our innovation initiatives, specifically our growing In-Store and Digital businesses. These 2 businesses contributed $15 million in incremental revenue in the first half of '11 compared to the first half of 2010.

We continue to be in investment mode in our Digital businesses and are primarily focused on 4 products: display advertising, coupon-to-card or unique identifier, prints at home coupons and acquisition email. We also continue to invest in our expanding In-Store network.

In Q2, we also launched an innovation line extension related to our Shared Mail product that we call our variable data postcard. This product accompanies our traditional Shared Mail package, but allows us to target consumers at a household level. We have the ability to vary the image and the offer to deliver powerful one-to-one messages to consumers from either a client database or even a purchased mailing list. There are substantial efficiencies in distributing our variable data postcard in conjunction with our Shared Mail package. It is still early but both existing clients and new clients are showing strong interests, including new client verticals that typically do not participate in Direct Mail programs. Testing is going very well. That wraps up the statement highlights.

There's a few other initiatives I'd like to update you on, the first of which is our capital structure. In the first half of the year, we have worked on our capital structure. We've really reworked it, specifically with the issuance of our 6 5/8's 10-year Notes due in 2021 and our new 5-year senior secured credit facility, initially priced at LIBOR plus 175. There are more details in our earnings release and SEC filings.

I'm very pleased with the work of our finance team to reduce our interest expense. For some historical perspective, annual interest expense for the last 4 years was approximately $99 million in 2008. It dropped down to $87 million in 2009. In 2010, it was $65 million, down $22 million from 2009. And we estimate annual interest expense for 2011 to be approximately $37 million, down another $28 million versus 2010. And with swaps in place we expect 2012 to be around $30 million in interest expense, assuming the current LIBOR curve.

Our new capital structure also provides us increased flexibility in how we use our free cash flow to create shareholder value. Cash flow from operating activities for Q2 2011 was an impressive $73.1 million.

Switching to SG&A. We continue to do an excellent job here. With the second quarter coming in at $80.8 million, under our quarterly run rate estimate of $81 million to $82 million for 2011. It is worth noting that we continue to invest more SG&A dollars in new product development, such as the variable data postcard and our expanding Digital and In-Store businesses, while reducing overall corporate SG&A. Our dedicated team continues to find ways to operate our existing businesses more efficiently, which frees up resources to redirect towards innovation.

With respect to pricing. As I mentioned in the past, we have different strategies and different products, different segments based on client verticals and in different geographies. Generally, we are very pleased with our progress to date. We continue to move from an environment of declining rates to an environment where contracts are including appropriate rate escalations to reflect rising cost and the value our products and services provide. While it takes time to work through lower-priced contracts, we are optimistic our plan to drive sustainable, long-term profitable revenue growth is on track. I believe pricing will soon be a contributor to revenue and profit growth instead of the substantial drag we experienced in 2009 and 2010.

So to wrap up the second quarter of 2011, revenue was down 2.2% versus the second quarter of 2010, as there was always so much we could do to overcome the $20.8 million decrease in ROP spending this quarter. We expect this $20 million per quarter revenue drag to continue in the back half of 2011.

We are pleased our Shared Mail business delivered another strong performance this quarter. And as I mentioned earlier, we continue to see a robust pipeline in the second half. In the last 30 days, however, we have noticed a slower conversion from pipeline to committed order, resulting in a lighter forecast than what we would have anticipated in Q3 at this time. There is still time to positively impact Q3, and many of the macroeconomic uncertainties responsible for consumers' increased response rates could also be contributor -- contributing to marketers' hesitancy to convert pipeline opportunities to committed orders at this time. It could be the political fighting in Washington D.C., the U.S. and European debt crisis, continued low consumer confidence and spending, the combination of high gas and commodity inflation or unanticipated jumps and response rates zapping clients' annual promotion budgets.

As we look at the first half of the year, we see a number of things going well: the Shared Mail segment, control of discretionary spending, consumer engagement is exceptionally strong and our excellent capital structure, to name a few. Capital expenditures also look to be coming in either at or under plan. And as we face headwinds in the Neighborhood Targeted segment and somewhat in the FSI business, our $355 million adjusted EBITDA guidance looks like the most challenging number in our plan. It will require excellence in sales and operational execution, some growth in promotional spending, and improved cost containment efforts in the second half. However, we do have a detailed internal plan to reach $355 million in adjusted EBITDA.

When we gave guidance for 2011, we mentioned we would be increasing focus on earnings per share measures of our performance, especially in light of our reduced leverage. We feel good about our full year diluted earnings per share target of $2.76, and diluted cash EPS target of $3.71 for 2011. We are creating substantial shareholder value by deleveraging the business and reducing the share base.

We will continue to invest in innovation and move our pricing initiative forward in order to drive sustainable, profitable long-term revenue growth. We will not jeopardize any of our long-term goals or initiatives by chasing short-term revenue objectives.

Moving forward, I really like our capital structure. Our cost of capital is very low and our tenure is well into the future. Our net debt to adjusted EBITDA leverage ratio is 1.6 to 1 at the end of the second quarter.

Regarding share repurchase, as conditions continue to be favorable, we believe stock buyback represents an excellent opportunity for us to use excess free cash flow to create value for our shareholders. We are thrilled with the relevance in consumer engagement with our RedPlum products, our consumers look to our media to help them find the value they seek. We know our products are delivering increasing return on investment for our clients, driven by higher-than-expected response rates. What marketers need is some time to budget for these increased expenses in their annual promotional budgets. At this point, Sarah, [ph] we're ready to open up the call for questions.

Question-and-Answer Session

Operator

.

[Operator Instructions] Our first question comes from Mark Argento from Craig-Hallum Capital.

Mark Argento - Craig-Hallum Capital Group LLC

When we're talking a little bit more about the Neighborhood Targeted, I know you had guided that business down last quarter. And right now, which I think you're bumping along, is essentially the segments' breakeven and current revenue levels. Do you think you could maintain kind of that breakeven for that segment or does that segment be a net-net cash burn at this -- the second half of this year?

Alan Schultz

No. I think our view is that it shouldn't go to a negative. I mean, we're willing to see some profit decline in that segment as we go for market share because we think that, that market share is -- has the potential to drive into our Shared Mail business, where we've got higher margins based on incremental revenue that we generate. And we really try to look at individual customers within that segment across our portfolio in terms of what they generate in terms of profitability. And the one other thing I would say is, is that the fourth quarter tends to be very strong for that segment. So not only would I expect us to continue to remain profitable, I think from a fourth quarter perspective, I think you'll see a fair amount of profit in that particular segment. So Q3, I think it'll continue to be profitable but not very. Q4, you'll see a spike up in profitability.

Mark Argento - Craig-Hallum Capital Group LLC

And talking a little bit about Shared Mail, where it looks like you continue to show some nice leverage there, the kind of the key metrics, unused postage, pieces per pack, what kind of trend should we be thinking about in Q3 and Q4, given kind of the economic factor out?

Alan Schultz

Well, I think from an unused postage standpoint, I said this the last time, which is it seems to me like where we're at, at 14.9% or whatever was awfully low and I wasn't sure we could get lower, and we set a new record. So I think the bottom line is, theoretically, there's no bottom unused postage. Theoretically, we could fill up all of our packages at 3.3 ounce minimum and not have any unused postage. But I think the bottom line is, our team is doing a really great job there. And so I think it'll probably continue to be around this level right now, kind of going into the back half of the year. In terms of pieces per package, I think our view is, is we're going to continue to see increases in pieces per package, not only in the short term but we think in the long term we're going to continue to see an increase in pieces per package. And really, what drives the profitability in this business is just that. The biggest driver of profitability is pieces per package. And as we look through, we have a number of different metrics that we measure in the Shared Mail business. And this kind of across-the-board we're seeing a lot of a positive signs in our Shared Mail metrics.

Mark Argento - Craig-Hallum Capital Group LLC

Last question, I know in over the last few months, there was kind of daily deal frenzy. My -- with my perception is, that's kind of cooled off a little bit, at least in terms of you're not getting hit with it every day, like you were for a while there. But from a mindshare perspective, are customers or clients better understanding that the pros and cons, of the daily deal activity and does that -- do you feel like you're competing directly against that? Or have you figured out a way where you can use that to your advantage?

Alan Schultz

No, I don't think we really feel like we're competing against the daily deal companies. For the most part, the daily deal companies are dealing with clients that we don't really do business with. And it's just a totally different business model. As you know, most of those clients that are running these kind of daily deal kind of programs, they might do one of those programs a year, 2 of those programs a year. I looked at a really interesting statistic in our Shared Mail business recently, which was 97% of the volume that runs in our Shared Mail business, those that comes from customers, those customers run 12 or more times a year with us. So I mean there's just a -- it's just it's just a totally different business model, right? And from -- when you look at it from a consumer's perspective, consumers have to pay to get the deals where literally, everything we offer to consumers is free. And if you've ever done any research on consumers, one of the things you'll learn real quick is the word "free" tends to be highly motivating to consumers. So I just think it's a -- I think it's a different audience, I think it's a different customer base. It's clearly -- from a competitive standpoint in the marketplace, it's clearly a different business in the sense that there are, I think, 400 or 500 different daily deal sites in the U.S. now. There's couple of hundred of them abroad. And when you look at our product portfolio, we're typically participating in categories where we're dealing with 2 competitors, 3 competitors, 4 or 5 competitors. And for the most part, we tend to be #1, #2 or #3 in all the different products and services that we compete in. So I think it's a totally different business model. Now a lot of these daily deal sites are going to try to do some things with our customer base. And I'm sure our clients are going to test different programs but I haven't seen anything yet that, I think, is going to be compelling in terms of moving dollars out of our programs into theirs.

Operator

Our next question comes from Mark Zgutowicz from Piper Jaffray.

Mark Zgutowicz - Piper Jaffray Companies

Al, could you just quantify what you said, lower conversion heading into Q3, what that means relative to them in single digits that you were previously anticipating?

Alan Schultz

I think we still see the kind of mid-single digits. It doesn't change the mid-single digits but all I was really trying say is this -- the last call we had was roughly 90 days ago. And we have seen a little bit of a change in the last 30 days in terms of what we would have expected to move from the pipeline to committed order has definitely slowed down a little bit. And obviously, there's just -- there's a lot of kind of unusual things taking place, I mentioned kind of a laundry list of those when I went through my prepared remarks, that I think are having not only an impact on the psyche of consumers but also on clients where they're just -- they're waiting until the last possible moment to release funds and to commit to programs. At the end of the day, I think we believe that those programs in the pipeline are going to be committed at the same percentages that we have experienced in the past. But we just feel like right now, they're on a little bit of a delay track. But we still kind of see the mid-single-digits number for the Shared Mail business in Q3.

Mark Zgutowicz - Piper Jaffray Companies

Okay. Is it safe to say, since we're about through the way through, that the mid single digits that you talked about is probably more at the low end of mid single digits versus the, I don't know, call it the mid to upper end?

Alan Schultz

Well, I think -- I would say low to mid is probably right. I would not say upper end at this point in time. So with that said, hey, there's so many unusual things going on right now. If those things get resolved in the next few days then that could start to push us more towards the upper end. But right now, I think our expectation would be in the lower to middle range of the mid single digits, yes.

Mark Zgutowicz - Piper Jaffray Companies

And then just shifting into the FSI segment. So you talked a little bit about -- just a little more clarification there, did you see a positive Easter impact of which obviously would have seen in early part of the quarter. And if so, can you quantify what that was relative to the negative impact that you saw in Q1?

Alan Schultz

Yes, we did see a double-digit increase in the month of April. So from our -- and in fact, when you look at kind of the first 4 months of the year, the industry was pretty flat. And so we start to see a little bit of tailing off in May. And then really, June is where things started to fall off. And I think it was clients starting to come to grips with 2 things. One is as our customers really starting last year, I think it was sort of middle of last year, maybe even second quarter of last year, we saw our customers using a variety of different tactics to try to bring down redemption rates. They felt they were too high. So we saw them shortening expiration dates on coupons. We saw them going to multiple purchase requirements on coupons. Those things typically drive down redemption. But in spite of all those customer efforts to drive down redemption rates, redemption rates were actually going up. And then in the May, June time period they actually really began to spike up relatively significantly. And so I think from a client perspective, it's definitely putting some pressure on their annual marketing budgets. And it's a little frustrating for us in the sense that the clients know what that means, we know what it means. We know it means they're getting a better return on investment from their programs with us. We know it means and they know it means they're getting more incremental sales associated with these programs they're running. But the frustration is they still have a boss who says, you have a budget of this for the year and I expect you to deliver it. So it's not like they're just going to blow that budget. They have a responsibility to kind of manage within that budget, and I think that's having a bit of a negative impact on FSI pages, that's why we saw pages actually down in the first half when we had anticipated pages would probably be up about 3%.

Mark Zgutowicz - Piper Jaffray Companies

Okay, and your comments in the press release mentioned reduced share. I'm assuming that's relative to your counterpart as opposed to the industry in general. Is it safe then to assume that pricing got a little more aggressive in the second quarter versus what you saw in the first quarter?

Alan Schultz

Well, no, I would not say that. What I said in the script, and you may have missed it, was that there were 2 more cooperative Free-standing Insert programs in the second quarter, both of which were added by our competition. So our date schedule was static versus the previous year. So our competition had a larger percentage of the programs available in this quarter versus last year. And typically, you would expect to see a shift in market share associated with that.

Mark Zgutowicz - Piper Jaffray Companies

So that's just a Q2 phenomenon that you shouldn't likely see that all things equal in Q3?

Alan Schultz

Yes, all things being equal, that should not be the case, yes.

Mark Zgutowicz - Piper Jaffray Companies

Okay, and then just a question on the Neighborhood Targeted segment. Just hoping you could quantify to the linearity of the remaining $40 million of ROP that you're expecting to see in terms of shortfall year-over-year? And I know we originally talked about $60 million, $80 million is sort of another number. I'm curious, is that $80 million all relative to telecom and energy or are you seeing an incremental $20 million shortfall in some other industry segments as well?

Alan Schultz

It really does come down, I think, at the vast majority of it is those 2 clients and those 2 verticals and we would anticipate it to be about $20 million a quarter. I think we think it's pretty consistent. And when we talked in the first quarter based on what we're seeing at that time, we felt like for the year, it was going to be down maybe $60 million at best, $80 million at worst. I would say right now it looks like worst-case scenario, it looks like down $80 million based on everything we see.

Mark Zgutowicz - Piper Jaffray Companies

And then just one last quick one on the Digital side, that I'm just curious how you're selling and pricing the postcard. And it sounds like it's obviously in early days there, but also looking here just trying to understand how you're using that just specifically to better target relative to your -- the futures that you already have are recently in Shared Mail for...

Alan Schultz

Yes. So first of all from a pricing perspective, it's a rate card product. So there's no real variants in pricing. We've got a rate card product. But the way in terms of, kind of differences in terms of the product, in the Shared Mail business we basically sell in zones of 3,500 households and, of course, we know everything about each of those zones, all the data that's really critical to customers to help target those zones for our customers. The shared -- the variable image postcard -- variable data postcard, basically what we have the ability to do is target individual households. So if we wanted to put someone's name on it in some offer that's very specific to them, we could. And then for someone who, for instance, the client may have a database, what we do is we can deliver one offer to known customers of theirs, and make a substantially higher offer to noncustomers of theirs, right? And so it's -- it really is one-to-one marketing. And, of course, the kind of a magic in this for us is there's some real efficiencies, I mean substantial efficiencies associated when you drop the postcard in conjunction with the Shared Mail package, versus a postcard alone if you don't have a Shared Mail package. And of course, we have the only national Shared Mail distribution platform in the country for this type of content. So it is kind of a unique advantage to us in the marketplace. And because of that increased efficiency, we've gone to some customers that are now participating in the program that, to our knowledge, have never done any direct mail at all because this kind of, what I would call solo direct mail, one-to-one direct mail, tends to be very, very expensive.

Operator

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

Daniel Salmon - BMO Capital Markets U.S.

Two things, Al, you mentioned that sort of laundry list of factors that sort of weighing over visibility right now, both for consumers and for clients. But at the same time, sort of noted that it feels like that lack of visibility is ramped up in the last 30 days or so, and I can't help but note that one of those things on your laundry list, the debt ceiling debate sort of correlates well with that. So I'm wondering if maybe there's a bit of an outside effect in some of your conversations of that economic factor in particular. And then second, just maybe a quick update on the In-Store pipeline and particularly your thoughts about maybe moving beyond grocery.

Alan Schultz

Yes. I guess I'll -- obviously, the nice thing about the sort of U.S. debt ceiling is, is we're 5 days away. And so from my perspective, that's going to get resolved one way or another. That kind of uncertainty is going to be kind of eliminated. There could be other uncertainties created in 5 or 6 days, but that particular one should be alleviated in the next 5 or 6 days. And I think it's definitely having an impact on both. In terms of the pipeline for In-Store, we definitely got some verbal commitments from retailers to come into the program. We should be sending some releases out in the not too distant future, and so we'll continue to build that network. And we do continue to be interested in moving outside of just grocery, and we're actively working on those also.

Operator

Our next question comes from Bill Warmington from Raymond James.

William Warmington - Raymond James & Associates, Inc.

A couple of housekeeping items. First, the number of packages you guys shipped in the quarter?

Alan Schultz

Yes. Up slightly -- let me find it here. Yes, 912.

William Warmington - Raymond James & Associates, Inc.

Okay. And also the share count exiting Q2?

Alan Schultz

The actual...

William Warmington - Raymond James & Associates, Inc.

The fully diluted. I should say.

Alan Schultz

Fully diluted shares at the end of Q2 is just over 49 million.

William Warmington - Raymond James & Associates, Inc.

49 million. So that looks like a very aggressive quarter for the buyback. And spending at a $105 million for the year, that looks like you've bought in 7% of shares outstanding already. What are the plans for the buyback this year?

Alan Schultz

Well, I think what we've said in the past is that we were going to spend the majority of that $193 million sort of basket that we had previously. We've done that. But with that said, I think from a board perspective, our board feels that our stock has been sort of trading in a range where when they look at it from a long-term perspective, then where we think we're going, that's a very attractive place for us to buy. And so when we look at it versus other alternatives, it looks like it's the best alternative for us. So I think what you're going to see is just as long as the stock continues to trade in the range it's been trading at, we're probably going to continue to be an active buyer.

William Warmington - Raymond James & Associates, Inc.

Okay. Now on your comments about the economic softness that you or the macro concerns impacting or seeing some softness in some of the verticals, any particular verticals showing more softness than others?

Alan Schultz

I would say that the client categories that we're seeing the biggest downticks in are -- continue, and financial continues to be soft. Discount stores is a little soft, and telecom is a little soft. And of course, we've recently started to see some softness in the consumer package goods clients too, so I'd say those are our kind of our 4 categories. We talked about -- I guess I should add we talked about energy earlier specifically in ROP. We don't really do a lot in energy other than ROP. But those would be your 5 on the soft side. And then on the other hand and I guess on the positive side, grocery and drug has been growing nicely. Specialty Retail has been growing nicely. Satellite has been doing well and interestingly enough, restaurant, which had slowed down for a while, has at least picked up in this quarter, so we're seeing there's got a little bit of research in the restaurant category also.

Operator

Our next question comes from Alexia Quadrani from JPMorgan.

Alexia Quadrani - JP Morgan Chase & Co

Just a couple of questions. First, when you were talking earlier about pricing being a positive going forward, were those comments just limited to the Shared Mail business or was it companywide?

Alan Schultz

Well, I have to speak relatively generally about pricing because specifically within the FSI business, I've been advised like I can't talk about pricing at all. So I try to make the pricing comments more general in nature specifically when you keep in mind that we've got different strategies for different categories, different segments, different geographies. With that said, we have been pretty specific in the Shared Mail business, and we're pretty comfortable talking about kind of what's going on in Shared Mail. We don't think that causes any issues or problems.

Alexia Quadrani - JP Morgan Chase & Co

And then on the $50 million in the In-Store and Digital that we saw, should we assume that to ramp up in the second half of the year in that segment?

Alan Schultz

Well I think $50 million, we felt pretty good about that in the first half of the year. Our comps get more difficult in the second half of the year. And we've got work to do there. We definitely got to go.

Operator

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

Daniel Leben - Robert W. Baird & Co. Incorporated

First question, just all the commentary you gave on the verticals was great, but was that just for the quarter or is that also further where you're seeing some of these incremental delays in the last 30 days on the pipeline conversion?

Alan Schultz

I was really talking about the quarter, and I don't have an analysis pipeline of vertical on the pipeline conversion, Dan. I'm sorry but I don't have that.

Daniel Leben - Robert W. Baird & Co. Incorporated

Any anecdotal comments you could give us just in terms things you've heard, when people have been slowing down?

Alan Schultz

I think it's more of a function of they're just waiting for more information, more data, trying to get a handle on their budget, look at sales data. It could have something to do with being at midyear. A lot of clients are on a calendar-year basis, and they're closing out on June, and they kind of want to see what their budgets look like, in that regard. And so -- and of course, in the CPG arena, I think consumer package goods companies are surprised by the redemption rates because historically, when they've employed these tactics to reduce redemption rates, they've been successful. They've been able to control the redemption rates. This is the first time I recall in my 27 years in this business where clients specifically employed tactics to drive down response rates and still saw response rates go up. I don't ever remember that happening before. I'll have to ask Brian Husselbee, who runs our NCH business. He's been with us for 39 years. If he ever recalls that happening, but I haven't seen it in 27 years.

Daniel Leben - Robert W. Baird & Co. Incorporated

Okay. Well I hate to imply a causation, a correlation but since it's so unique, with the Extreme Couponing show coming on in April and seeing the spikes in May and June, are we in a situation where the dynamics have actually changed and the CPGs are coming back and looking at couponing and realizing, "Hey, some of the strategy doesn't make sense." because somebody shouldn't go and get turn a bowl of the hot sauce for free?

Alan Schultz

Yes, I think the bottom line is in the Extreme Couponing show is I think it's a very, very, very small percentage of the population of couponers. That's probably some fraction of 0.10%, and I think generally, that's not the way consumers operate. But I think just this whole concept that daily deals and this Extreme Couponing show have just got people more focused on value than ever. But I would point out that this focus on value has been accelerating for the last 2 or 3 years now. And the research that we've seen previously says this is a permanent change in behavior. And there's one other factor, Dan, that I think is probably has something to do with the spike in redemption rates in May and June, and that is another area that we've done a lot of research in is this $4 gas. When gas gets to $4 a gallon, people change their buying behavior, and they get way more focused on value, and of course, if you kind of look at the history of gas prices, gas prices I don't remember exactly, but they kind of tip back up above $4 a gallon again, kind of on average across the country, I think back in April, May time period, and I think that has an impact too. So it's just a lot of unusual things going on, and it's hard to draw real clear conclusions at this point. I just hope some of this uncertainty gets eliminated from the mix.

Daniel Leben - Robert W. Baird & Co. Incorporated

Great. And then last one for me. A very intriguing new product with a variable data postcards. Could you give us a little sense of kind of some of the vertical industries you're targeting that have not been a part of the Shared Mail products that are now opened up because of the product?

Alan Schultz

Yes. So here's kind of our list. Automotive and automotive dealerships, healthcare industry, entertainment industry, education and believe it or not, even legal services. So those are categories that we're pursuing, and we're seeing a fair amount of kind of interest in. So those are really good for us, and I think -- the other thing I would say is we've seen some pretty good interest across our current customer base also. Again, from a lot of people who view solo, one-to-one targeted direct mail as being too expensive for them to participate in. So I think we're really opening this up to a whole new class of customer who hasn't necessarily been doing these one-to-one marketing programs.

Operator

Our next question comes from Ed Atorino from Benchmark.

Edward Atorino - The Benchmark Company, LLC

Looking at the Neighborhood Targeted, you've got 2 quarters here around $90 million. Last year, the third quarter was $90 million, and then it jumped up again. With that, is the $20 million that falls -- are going to repeat or is that sort of go away?

Alan Schultz

Well, we think we'll lose $20 million in the third, and we'll lose $20 million in the fourth.

Edward Atorino - The Benchmark Company, LLC

That's versus last year?

Alan Schultz

Versus last year. With that said, Ed, you're absolutely on the mark in terms of your comment that the third quarter tends to be a little more flattish versus the second quarter, but where there is a spike up is in the fourth quarter.

Edward Atorino - The Benchmark Company, LLC

Right. But we should think that's going to be $20 million below last year at least anyway?

Alan Schultz

That's right. Our view is that you'll see that spike up in Q4 versus Q3, but year ago, pure quarter against quarter, yes, you should assume there's going to be $20 million less in ROP in both quarters.

Edward Atorino - The Benchmark Company, LLC

Yes, you've done a good job, again the gross margin's up. You're over 74% the first couple of quarters. Should we cross our fingers you're going to stay at that level or maybe get better or worse?

Alan Schultz

Yes, I think our plan is to try to get a little bit better in terms of margin, yes.

Edward Atorino - The Benchmark Company, LLC

And I guess with interest expense, you're running through the swaps period now, right? And this drops off again?

Alan Schultz

Yes, we've got a swap that goes through June 30 of next year...

Edward Atorino - The Benchmark Company, LLC

Right. And that stays what? $40 million and that was a $40 million on an annual basis or?

Alan Schultz

Well, we'll put on a new swap. And so we'll go from -- right now, we're going at a clip where we'll do about $37 million in interest expense this year. Next year, it should drop down to about $30 million. So $7 million savings versus where we think we're going to end up this year. But obviously, as I run through in my script kind of a history on interest expense, and there's been some dramatic reductions because back in 2008, we were $99 million in interest expense. So I think to your point, we went from $99 million in 2008 to, if we go to $30 million next year, you're looking at $69 million reduction in interest expense since 2008.

Edward Atorino - The Benchmark Company, LLC

Yes, on the share base, there was a sort of 50.2, million what was the -- just for my fill-in the blank, what's the basic? Basic shares?

Robert Recchia

As the end of -- you're talking about the average basic?

Alan Schultz

Yes, for the quarter. 52 million? No, 51 million.

Robert Recchia

Hold a second. Hold on for just a second. The basic was about 48 million, weighted average basic in Q2, and then there's about 2.39 million in dilution.

Edward Atorino - The Benchmark Company, LLC

Yes, dilution was?

Robert Recchia

2.3 million.

Edward Atorino - The Benchmark Company, LLC

Yes, so it's 50.2 million, right?

Robert Recchia

50.2 million, that's correct.

Edward Atorino - The Benchmark Company, LLC

And so you'll be buying shares, so we should assume that total goes down somewhat, some more?

Robert Recchia

Yes.

Edward Atorino - The Benchmark Company, LLC

Okay. One last question on the Shared Mail. Could you talk about the implementation of your pricing strategy? How's it working out? Is it coming along the way you thought?

Alan Schultz

Yes, I think it's coming out as we -- pretty much right on plan. I'm really proud of the team because when you switch a sales organization from kind of mid-single digit decline in price a couple of years to get to just kind of flip the switch, and say now prices are going to start to go up, that's a difficult thing to do. But the sales organization has really responded well.

Edward Atorino - The Benchmark Company, LLC

One last question. You've got a nice positive trend in terms of year-to-year change in Shared Mail. As you look ahead, what's your feeling regarding maintaining that type of progress? You probably can't answer that but...

Alan Schultz

Well we think it's going to get a little bit better than the first half. We think the second half in terms of growth in Shared Mail should be better than the first half.

Operator

Our next question comes from John Harloe from Barrow, Hanley.

John Harloe - Barrow Hanley

Want to start quick in the earnings release. What earnings are before marketing expenses, et cetera? Can you hear me?

Alan Schultz

Yes, I hear you, John--

John Harloe - Barrow Hanley

I have a couple of questions. One, I want to understand with the change in the covenants, how that influences the pace of the buybacks going forward?

Alan Schultz

Yes, all right. So we are much -- our restrictions have been dramatically reduced in terms of buybacks. So I think from a board perspective, I think the board kind of viewed the $193 million this year as the upper end. We've spent $106 million. So there's another $87 million to spend before the end of the year. If we elect to spend it, I think based on where the stock has been trading at today, I think it's the inclination of the board to probably spend that money. From a covenant perspective, the way it's designed today is as we literally can use all of our cash flow, if we want a share repurchase as long as our leverage ratio stays below, I think, 2.25:1, and we're obviously below that leverage ratio, so that restricted payment basket concept that we had in the past that limited us to $193 million has now been eliminated, that on a going-forward basis. And so I think where we sit today is that we're probably working towards that $193 million number as long as the stock continues to trade kind of in a range it's been trading. And once we get beyond that, the board has got to figure out exactly what we're going to do at that point in time. But I think that's kind of the path run at the moment. Obviously, this is something that our board reviews at every call.

John Harloe - Barrow Hanley

But you've actually got capacity if it was -- if you wanted to actually borrow money and buy back stocks. Is that correct?

Alan Schultz

I think that is true. I would tell you, John, that I don't think that's the way our board thinks. I don't -- they're relatively conservative. I don't think that people are interested in levering up to buy stock, but I think people are pretty comfortable with spending 100% of our excess free cash flow on share repurchase, if it's trading in a range that is perceived as being attractive. And clearly, the range it's been trading in this year is perceived as being attractive.

John Harloe - Barrow Hanley

What percent of Shared Mail and the FSI has now been repriced?

Alan Schultz

That's a good question. I don't know if I have all the data on that. I'm going to...

John Harloe - Barrow Hanley

I can follow up later.

Alan Schultz

Yes, I think we'd have to run that, John.

John Harloe - Barrow Hanley

I found something yesterday on the Internet that says, I think I got it off of one of your website's -- NCH's. It says Kantar Media reports digital coupon events were flat in the first half of 2011. This digital thing is the elephant in the room, and I was surprised at this. Would you talk about -- and flipping in terms of where the digital coupons, the card versus printing at home year-over-year has just literally reversed itself. I guess I'm curious if you believe these numbers are an analysis that's accurate and just take it from there. I think that most people think that digital couponing is going through the roof. I don't know what you see in your business then you would also have some insight into -- we have a small ownership in, I'm sorry.

Alan Schultz

Yes, I know. I think that's an interesting question, and I think we saw some interesting things here as of late. #1, what I can tell you is that in the consumer package goods space that digital couponing is recorded in the all other category of couponing today, and the all other category of couponing is less than 2% of all CPG coupons. So what I can tell you today is less than 2% of all CPG coupons are being distributed digitally. Another sort of interesting fact is that FSIs, the Free-standing Insert product, has been distributing in the neighborhood of 87% of all consumer package goods coupons over the last few years here. The most recent numbers I saw was that it actually climbed up near 89%. So amazingly enough, it looks as if to emphasize our contributing or distributing a bigger portion of all CPG coupons than even before.

John Harloe - Barrow Hanley

And is Shared Mail counted in that?

Alan Schultz

Yes, when you distribute FSIs through Shared Mail, yes, we count that. so we count those as FSI coupons. And so, yes, I understand what you're saying. We've certainly seen our digital business, substantial growth in the triple digit range but I think overall, when you look at growth in digital couponing, it's probably less than what people anticipated. And amazingly enough, this Free-standing Inset product is garnering a larger share, which I think is a little bit of a surprise to folks. But it's not so much of a surprise to us in the sense that the FSI, you can buy a page in the FSI for less than $0.05 to household, and we charge $0.08 to $0.10 to deliver a digital coupon. So the digital coupons are far more expensive than the print version. And when you buy a digital coupon, all you get is a digital coupon. You don't get any advertising value to go along with it. With the FSI, you got a full page of four-color advertising to go along with the coupon. And so and we all know that redemption rates have been going up in FSI, so we know that the return on investment continues to get higher in FSI. So I guess it shouldn't be a surprise that the FSI product continues to perform well. And on an absolute basis, we look at some numbers back a while ago that we looked at the absolute number of increase in the number of digital coupons through the other terms of absolute terms compared to the number of coupons on absolute terms distributed by FSIs, it was like 15 to 1. There were 15 more incremental FSI coupons for every one digital coupon. So I say that just to put it all in perspective, and give you a kind of a balanced view, we're obviously excited about what we're doing in the digital business. We're focused on the digital business. We're investing in the digital business. But it probably hasn't ramped up as fast as people would have thought it will.

John Harloe - Barrow Hanley

What explains the complete reversal from below the card[ph from going to 33% last year to 57% market share this year. I think it's like right in your wheelhouse [ph] because that's what I think we're doing or have a little leadership there I think.

Alan Schultz

Yes, I think it just has to do with the consumer experience, and their experience with print-at-home versus downloads. So I think at the end of the day, what we really try to always focused on is what's the consumer experience and a lot of it has to do with just ease of use.

John Harloe - Barrow Hanley

Okay. Then what kind of rate of gain in coupon digitally have we experienced this quarter? This first half?

Alan Schultz

Again, our -- I think our revenue in the digital business in the second quarter was up, I want to say 100 -- what was -- 126%?

John Harloe - Barrow Hanley

Yes. Okay, there's the same valuations going on and this kind of stuff if we talk about -- I know this is the same question probably to you but monetizing some of the separate. This is a separate business.

Alan Schultz

Yes, actually, we have because what you see is that you see pure digital companies getting these multiples of 10 or 20x revenue and getting very, very high valuations. And so people like...

John Harloe - Barrow Hanley

The valuations exceed of course, the entire Valassis, come on.

Alan Schultz

Right. So we feel as if the valuations are excessive, to say the least, in a lot of these digitally-related products and services and therefore, we have looked at will it make sense to structure it differently so that digital is apart from the remainder of the business so we can get that kind of valuation on the digital business. It's because clearly, we don't get the valuation within our business, right? So within Valassis, we don't get credit for those same types of multiples, for what we're doing digitally as a pure play. When at the same time, we feel like we have a competitive advantage versus the pure play because from a client perspective, they want to really blend their distribution of coupons online and offline. That is a competitive advantage for us in the long term. So not only do we not get credit for what we're doing, we also don't get credit for our ability to blend. And so yes, the question is does it make sense to structure things differently so we get that value?

John Harloe - Barrow Hanley

That makes sense.

Alan Schultz

So we have looked at that.

John Harloe - Barrow Hanley

Yes, good. I hope you do something like that.

Alan Schultz

All right. Well we'd like to thank everybody for participating on the call, and thank you all for joining us. Just to wrap things up, I'd like to say that there are obviously a number of macroeconomic factors creating a certain level of uncertainty for both consumers and clients. But what I'm most energized about are the things that I'm seeing that have a long-term nature associated with them. And what I believe from a long-term perspective is, is there's no doubt that for quite some time now, research is telling us that the value-seeking mindset of consumers is a permanent shift in behavior. That benefits value-oriented media. Our products generate substantial incremental sales per client and a really strong return on investment. #2 from a long-term perspective, it is no doubt that our pricing initiative, and investments innovation, are setting us up for enhanced long-term profit and revenue growth. And #3, there's no doubt that we have an exceptional low-cost capital structure in place that provides us tremendous flexibility for us to use our substantial free cash flow to drive long-term shareholder value. Thanks, we really appreciate all your time and attention, and have a great day.

Operator

Thank you. This does conclude the Valassis Second Quarter 2011 Earnings Conference. Thank you for your participation. You may now disconnect.

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