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Valassis Communications, Inc. (NYSE:VCI)

Q1 2008 Earnings Call Transcript

May 1, 2008 11:00 am ET

Executives

Alan Schultz – Chairman, President and CEO

Rob Mason – Chief Sales Officer

Bob Recchia – CFO, EVP and Treasurer

Analysts

Paul Ginocchio – Deutsche Bank Securities

Troy Mastin – William Blair & Co.

Alexia Quadrani – Bear Stearns

Mark Bacurin – Robert W. Baird & Co.

Dan Salmon – BMO Capital Markets

Chuck Cerankosky – FTN Midwest Research

Edwards Atorino – Benchmark Co.

Operator

Welcome to the Valassis Communications First Quarter 2008 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. And following the formal presentation, instructions will be given for the question-and-answer session. As a reminder today's conference is being recorded today, May 1, 2008. I would like everyone to please refer to the Safe Harbor language on the earnings document released this morning. This call will be governed by the language stated there in.

At this time I would now like to turn conference to Mr. Alan Schultz, who is Chairman, President and CEO. Sir, you may now begin your call.

Alan Schultz

Thank you, Craig. I'd like to welcome everyone to the call. Today I have with me Bob Recchia, our Chief Financial Officer, and our featured guest today is Rob Mason, our Chief Sales Officer.

This quarter's results represent the third consecutive quarter of solid performance as we continue to make progress in the integration of the Shared Mail business. When we acquired the Shared Mail business in March of 2007, we developed a plan to immediately focus on cost synergies followed by optimization of the Shared Mail business, and finally to drive long-term profitable revenue growth by cross-selling our combined product portfolio to our expanded client base.

We are well into the execution of this plan and while there is still work to be done, we are very pleased with our progress to date. The primary driver of our 47% increase of adjusted EBITDA was the strong performance of our Shared Mail business. Segment profit for the Shared Mail business was $31 million for this quarter.

A year-over-year comparison is complicated as the business was not under our management in January and February of 2007, and those numbers were unaudited for that time period. We made an estimate to get an apples-to-apples look and measured the impact of our stewardship of the business. In our estimate, the segment profit for the Shared Mail business for the full first quarter of 2007 was a loss of $800,000 in terms of segment profit. Even when you exclude litigation and one time merger-related charges, obviously moving the Shared Mail segment from a loss of $800,000 to a segment profit of $31 million, is a tribute to our newly integrated Management team.

I would like to review in more detail the drivers behind the significant increase in profitability of the Shared Mail business this quarter. There were four key drivers. The first was cost synergies, and the savings and printing costs are ahead of plan. We're obviously producing the wrap from our Shared Mail product and we are doing that much more efficiently than we anticipated.

Unfortunately newspaper alliances are behind plan and when you net the two of these together, we are pretty much on plan. So, we do expect to achieve accumulative $38 million in cost synergies that we targeted for 2008.

The second area was operational efficiency. Operational efficiencies are ahead of plan as our production facilities continue to do an outstanding job. In fact, during the month of March, 2008, our LA Shared Mail production facility had a record production week with 128 million pieces processed, beating the previous record by 15 million. They also achieved 100% delivery within the promised two-day delivery window, a real tribute to the team work of everyone involved in setting this new record. Improvements in Shared Mail operational and production execution resulted in $4.4 million reduction in client credits for this quarter versus the first quarter of 2007.

The third area is business optimization. Our business optimization efforts where we reduce oversupply and deliver more profitable packages are ahead of plan. We eliminated 46 million packages due to our optimization effort versus the year ago quarter. The revenue associated with the elimination of these 46 million packages combined with the revenue loss from the discontinuation of the detached address label, represents 3.9% revenue drag in the first quarter, making the 7.2% Shared Mail revenue increase all that more impressive.

The fourth area contributing to Shared Mail profitability was revenue growth. Revenue growth in the Shared Mail business is obviously ahead of plan. There is tremendous operating leverage in the Shared Mail business. As we grow revenue, a high percentage drops to the bottom line. The 7.2% Shared Mail revenue increase in spite of that 3.9% revenue drag was more than we expected and contributed mightily to our quarter's overall strong performance. We also continued to see strong wrap sell through, 83% through this quarter, up from 75% in the first quarter of last year.

In addition, pieces per package increased by 3.5% in the quarter. Since our increase in Shared Mail revenue was such an important contributor to our first quarter results, Rob Mason, our Chief Sales Officer, for the Company is here to share his insights and provide you with more color on not only the Shared Mail business but overall sales momentum. Rob?

Rob Mason

Al, thank you very much. Good morning, everyone. It's great to be here. There's a number of positive factors contributing to the momentum we are seeing in the Shared Mail business and our sales teams overall success. And I'd like to take a few minutes this morning to share them with you.

In Q1, we grew Shared Mail revenue by almost $24 million, compared to Q1 of 2007. Of this increase, we can attribute approximately $3 million to migrating business from the Neighborhood Targeted segment to our Shared Mail segment. Meaning about 3% of our newspaper delivered Neighborhood Targeted business migrated to Shared Mail. These clients will represent a forecasted $11 million on an annual basis.

The migration is attributed primarily to declining newspaper circulations and our client's desire to still reach these non-newspaper reading households. As you may have read in the Wall Street Journal this past Tuesday, average daily newspaper circulations were down 3.6% over the past six months.

Shared Mail offers an ideal alternative to reach those lost newspaper readers. It isn't surprising that the 3% shift from our Neighborhood Targeted segment closely approximates the average newspaper circulation decline. While we anticipated Shared Mail to benefit from newspaper circulation decline, it is happening more quickly than we anticipated.

From a Shared Mail customer vertical perspective, we recognized measurable growth within our grocery, drug, discount and mass merchandise categories as well as the quick service restaurant category. At the local level, our field sales team generated 1,031 new clients this quarter, putting a solid land [ph] to achieve our goal of 4,000 new local clients for calendar year 2008.

Moving forward, we expect the Shared Mail business to continue to drive revenue growth for our Company, and we also expect to increase our cross-selling success as the year progresses. Early in the integration process, Al identified four key initiatives that would be essential to driving cross-selling on a scalable basis. As a Company and as a sales organization, we've made tremendous strides in executing these initiatives and they are now fueling our sales efforts.

First, we completed the integration of our sales organization in December. Our new sales structure is comprised of our strategic sales division that calls on our large national clients, while our field sales division is responsible for growing our critically important local client base. These two organizations are supported by sales specialist teams that create demand for our new product development initiatives such as redplum.com. We also have a decentralized telesales group that focuses on decentralized franchise concepts, and a new account development team dedicated specifically to the acquisition of large new clients.

Secondly, we instituted a new sales compensation plan this past January. The plan has the entire sales organization fully aligned with our corporate goals and objectives. By design, it favors the most profitable product solutions and is a major contributor to the momentum we are experiencing in the Shared Mail business.

The third initiative to drive cross-selling on a scalable basis was the development and implementation of a Company-wide targeting system. Prior to its completion, we were able to do some cross selling, however it was a very labor intensive process to develop the needed targeting and media plans. We did this on a limited proof of concept basis and through that process learned that clients are very interested in and will buy blended media solutions, featuring both newspaper and Shared Mail distribution.

Our strategic account organization working closely with our new account development and ROP sales teams have been early adopters of cross-selling and are having success in generating incremental revenue from traditional Shared Mail clients. We've secured $30 million in planned annualized newspaper insert placement and $11 million in annualized ROP business, which we expect to begin to flow in the back half of 2008.

Our new targeting system, Integrated Media Optimization or IMO as we call it internally, went into client beta testing on April 1. After a year in development, a team of dedicated and talented individuals brought the IMO system to life, and within three weeks, we experienced our first sales win with IMO. With IMO, we are able to analyze more variables than would have previously been possible and to deliver multiple comprehensive media plan alternatives to our clients within three working days.

Under the previous system, it would have taken over ten days to deliver just one single media plan. Our sales team is enthusiastically taking this system to more clients as we speak. The final key initiative with the cross-training of our sales organization, which began in August of last year and is ongoing. While we'd like to tell you that the nearly 600 members of our newly combined sales organization are fully up to speed on our entire portfolio of more than 20 products and services, I can't. However, I'm happy to say that from a sales learning and development perspective, we are making significant progress.

As of April 15, through formalized training and a certification process, we've identified that about 85% of our sales organization is proficient at selling our top three products: Shared Mail, newspaper preprints and a cooperative FSI. Due to selling lead times, the result of that focus in training will begin to be realized in the third and fourth quarters of 2008.

Our sales organization has made enormous strides in becoming a fully integrated team, yet these changes cannot take place without some level of disruption. A measurable portion of our clients, representing an estimated 15% to 20% of our Company's $2.5 billion in revenue, have experienced a change in sales representation in the last five months. It takes time for new introductions. It takes time for account transitions and it takes time for relationships to be forged.

In addition, as with all major reorganizations, we've had to make some adjustments and tweaks recently. For example, to create greater focus, we are moving our mid-level consumer packaged goods clients out of our field division and into the strategic sales division. These changes have been made and we hope to be running a fully functional sales team within the next six months.

I believe the dust is settling within our sales organization, and we will be in a strong position to leverage our sales training and new targeting system to drive overall low-to-mid single-digit revenue growth in the back half of 2008. I think it's also important to tell you that while under my watch, we will pursue profitable revenue.

We will not pursue business that creates an inordinate amount of work for our organization without contributing to the profitability of the Company. Our sales team is committed to growing revenue, growing adjusted EBITDA and maximizing free cash flow for the Company. We believe we can accomplish these goals and at the same time help our clients accomplish their critically important marketing objectives.

In closing, I would like to take a moment to recognize the efforts of our entire sales organization. Our sales leaders and their teams have worked tirelessly through a period of enormous change, and I'm sincerely appreciative and truly grateful of their continued commitment and effort. They are a group that continues to create extraordinary results in a very challenging and competitive environment.

Thanks for your time this morning. I'm going to turn it back over to Al.

Alan Schultz

Thanks, Rob. As you've read in the earnings release, based on our first quarter results and our current outlook, we remain comfortable with our guidance and are leaning toward the upper half of our range of $260 million to $280 million in adjusted EBITDA. While some of you may be asking why are we not increasing our guidance range at this time, I wanted to share with you some of the factors we took into consideration while evaluating our current outlook.

Our FSI business once again did not meet expectations. The good news is, that the industry faired well, growing units by 2.5%. This is not a surprise. As marketing budgets have tightened, the FSI has been the beneficiary of marketers shifting dollars away from traditional image advertising towards value oriented cost-efficient media that delivers measurable results. Pricing was down in the FSI business low-to-mid single-digits as we had anticipated.

However, lower than expected market share was the primary factor in our FSI business results. The contributing factor was the halt in marketing spend of one of our large financial services clients in August of 2007. This volume decline continues to impact our comps through August of this year. We also expect a couple of significant customers that allocate business between us and our competitor to positively skew our share of the business to the third quarter of 2008.

We've made some leadership changes in the FSI business and believe we have the right general management and sales leadership team to energize this segment going forward. We expect market share to improve in the second half of this year. On the cost side of our business, our contracts with paper suppliers do have quarterly caps and collars. So as the price goes up, we trail the market.

The first quarter did not fully account for the cost increases that the industry has experienced. As a result, future quarters will demonstrate increased paper costs beyond what was reflected in the first quarter. We also expect some non-recurring expenses during the balance of 2008, including litigation expenses due to our ongoing legal action against News America and additional costs associated with bringing the operation of our outsource data center in-house.

This transition will require $11 million investment which is part of our planned $35 million capital budget, as well as an additional $5 million in expense associated with the testing, parallel running of and termination fees associated with the discontinuation of this long-term outsourcing contract.

Once this transition is completed, we expect savings of $5 million on an annual basis. We also anticipate investing more in redplum.com. We've been successful in generating significant client demand for redplum.com with very few customers opting out. To date only 49 clients have opted out and we've a client base of over 15,000. However, today, only 15% of our off-line content has been uploaded to redplum.com. We hope to significantly improve this percentage over the next three months.

Our plans also include developing an enhanced consumer interface to provide a more robust consumer experience along with significantly more content. Once these two objectives have been completed, we expect to make additional investments in redplum.com to drive increased consumer traffic.

In closing I'd like to comment on the economy in what I believe its effect will be on our business both in the near and long term. While client marketing budgets have tightened, we are beginning to see shifts towards more value-oriented media such as ours. In the long-term however, I believe today's economic environment will have a lasting impact on consumer behavior just as the great depression created a generation very concerned about getting value for their buck and distrust of financial systems, I believe today's economy will create a new generation of consumers.

Today's enduring housing market slump, distrust of subprime mortgage lenders, unemployment and the Bear Stearns collapse have driven consumer confidence to a five-year low as the Conference Board reported on Tuesday, and the University of Michigan Consumer Sentiment Index has reported I believe last Friday is at a 26-year low. Just about everyone knows someone who has lost their job or their home. Even when you have the money, it feels smarter to drive through McDonalds to get your coffee, shop at Wal-Mart or Costco and pay off your credit cards.

The lasting effect very well may be a generation of consumers who focus more on value and want a deal before they part with their money. And whether they want it or not, marketers even iconic brands, such as Starbucks, I'm reading these days, are turning to value-driven media to activate consumers to buy. And I believe this permanent change in consumer behavior positions Valassis and our products very well for future growth.

At this time, Craig, we'd like to turn the call over to questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator instructions) And our first question comes from the line of Paul Ginocchio with Deutsche Bank. Please go ahead at this time.

Paul Ginocchio – Deutsche Bank

Thanks for taking my questions. So first of, looking at new categories, where the (inaudible) I and that was the old management teams so that what they wanted to do, you are obviously doing a great job on volumes and driving revenues. So, have you been able to expand the (inaudible) or the RedPlum package to new categories? And then second looking at that $3 million that shifted out of I think Neighborhood Targeted into the Shared Mail package. Can you talk about the change in profitability in that $3 million or as it fully comes, what the full impact of profitability will be on the business? Thanks.

Alan Schultz

Yes, I'm going let Rob answer the question on new categories. But in terms of profitability, we've been doing a fair amount analysis on it. And what we've seen is you are talking typically about from a gross margin perspective anywhere from a double to a tripling as we move incremental volume from newspaper into Shared Mail. So, where we see a lot of our newspaper margins for preprints average in the neighborhood of about 15% gross margins, when we look at it on an incremental basis overall, what we see is those margins, the incremental margin on that business move tends to be 30% and maybe even as high as 45% depending on the footprint that those preprints move into.

Paul Ginocchio – Deutsche Bank

Okay. Are you having to offer any kind of incentive for them to move out of newspaper into Shared Mail?

Alan Schultz

No, not at all, Paul. In fact, one of the things that I think is very appealing about this from a client perspective is when you look at the cost of running preprint and newspaper and the cost of running it in Shared Mail, the pricing is very similar. So from a client perspective, the shift from newspaper into Shared Mail is a pretty simple alternative for them to consider because it really doesn't change the pricing or cost dynamics for them.

Paul Ginocchio – Deutsche Bank

So last one. So it sounds like the response rate or redemption rates whether it's Shared Mail or newspaper seems about the same otherwise the companies would go for it?

Alan Schultz

I think clearly from a – it really varies by market, it varies by category, it varies by form of retailer, and the whole concept of blending newspaper and Shared Mail together in our IMO targeting system is to really look at what the client's objective is, what they are trying to accomplish and then determine what is the appropriate blend of newspaper and Shared Mail to accomplish that client's objectives. So, I can't make an overall comment on that, Paul. There are times based on the objective where newspaper is going work better than Shared Mail, and then there's times where Shared Mail's going work better than newspaper. Clearly, we think the magic is in blending the two. I want Rob to address your question in terms of our new categories driving the revenue growth or how much of a role our new categories playing in driving that revenue growth.

Rob Mason

Paul, I would tell you that in Q1, new category growth did not drive any of those results. Our focus instead was aimed at using our product portfolio and the breadth of that portfolio to capture a bigger share of current clients' current advertising and marketing spend, and that's the formula that we're going pursue through cross-selling through the back half of the year. So, if you are looking for any measurable growth or material growth in new categories, I'd tell you there was none. And from an intuitive standpoint what you would see in terms of measurable growth by category perspective, discount retailers as consumers look for better deals there, quick serve restaurants as consumers trade down in terms of their dining choices, those kinds of categories are ones that really contributed to our growth in the first quarter.

Alan Schultz

And Paul, if I could add, we did obviously have a tremendous amount of success in terms of new local customer participation. But much of that success, in fact the bulk of that success is in the same types of categories that we are doing on a daily basis. So, it wasn't like we were going after new categories with those new local customers. It was just more penetration in the categories that we are already participating in.

Paul Ginocchio – Deutsche Bank

Great. Well, when somebody who ADVO I think what you are doing with ADVO right now at this point in time is pretty impressive, so congratulations.

Alan Schultz

Thank you.

Operator

Our next question comes from the line of Troy Mastin with William Blair & Company. Please go ahead.

Troy Mastin – William Blair & Co.

Thank you, good morning. Another question on the Shared Mail business. With organic growth here in the quarter, looks like over 10%, correct me if I'm wrong on that when you back up the address label card and the reduction in circulation. I'm curious why you are expecting a significant deceleration in growth in this business, let me know if I'm wrong on that, with the launch of the new targeting system or perhaps you are just being rather conservative here?

Alan Schultz

Well, I guess first of all, I cannot correct you on the 10% because you are absolutely right. There is the 3.9% revenue drag that works against us in discontinued packages and the detached address label that's pulling revenue down. So, you are right, we had to sell over 10% more in order to generate 7.2% revenue increase. As you know, our plan overall was really to grow revenue in the first half flat-to-low single-digits really focusing on this concept of overall and then move that to low-to-mid single-digits in the second half of the year as we increase the training of our sales organization and get the IMO system implemented. Clearly, the Shared Mail segment was up more than we anticipated and some of our newspaper delivered products were less than we anticipated. But overall our focus is really on improving and driving increases in overall client spend with us. Our focus isn't necessarily on any one particular product. So, in the first quarter, the Shared Mail business was more of a beneficiary than our other products. Obviously, as the year goes on we hope to see more success particularly in the second half of the year in some of our newspaper products. And Troy, I think a really important point to make is, is when you take 100 legacy Valassis sales associates who had been selling 18, 19 different products and you give them one more product to sell, Shared Mail, it's much easier to get them up to speed on doing that. When you then take a sales organization with over 450 people in it who've been selling primarily the Shared Mail product and ask them to learn how to sell 18 or 19 new products, that's a much more difficult task. So, by definition as a sales organization today, we are much more productive and efficient at selling Shared Mail than we are newspaper products. As the training progresses and as the IMO system facilitates we would expect that to be much more balanced as we move into the back half of the year.

Troy Mastin – William Blair & Co.

Okay. And is there anything in the first quarter that was lumpy or unusual that might have boosted the growth rate in the Shared Mail business?

Alan Schultz

No. I can't think of anything. I'll ask Rob if he can think of anything.

Rob Mason

No. I would say, no. There's nothing extraordinary about that growth we saw in Q1.

Troy Mastin – William Blair & Co.

Okay good. And then Rob in your prepared remarks, you made mention of some numbers. I think it was in reference to some of the shifting you've seen. But I want to make sure you weren't making reference to the new targeting systems. You mentioned $30 million in newspaper inserts I think shifted into Shared Mail and $11 million in annualized ROP revenue. Was that due to the targeting system or was that separate?

Rob Mason

No Troy, all of that work, all of that cross-selling has been done prior to the roll out of the new integrated media optimization targeting platform. That was done through that more manual process that I've referenced. And that business is really, there's a very small segment of that that appeared in Q1. It is that business you will see calenderized throughout the back half of 2008, but it was not done via using the IMO system.

Troy Mastin – William Blair & Co.

Okay.

Alan Schultz

And Troy, I want to be real clear on this because I don't want there to be any confusion here. What we are talking about there with that $30 million and the $11 million is we went to Shared Mail customers and we picked up $30 million worth of new newspaper business. We went to Shared Mail customers, we picked up $11 million worth of new ROP business. When I run the math on the media plans for those clients, it looks like about $4 million worth of that falls into the first half of the year. The balance of it starts to fall in, in the back half of the year. But as example, if you look at a customer that currently has another provider and they have a contract with them through the end of September, well our – we've won that business today. We've got that contract today, but we won't actually start to see revenue for that customer until October 1. So, when Rob talks about that $30 million worth of annualized revenue, in that particular case, that portion won't start until October 1 and it'll run for the next year.

Troy Mastin – William Blair & Co.

Okay and …

Alan Schultz

Sense?

Troy Mastin – William Blair & Co.

Yes, it does. And can you give some perspectives in terms of the scale of the customer base you called on with this cross selling initiative relative to your overall customer base because I'm just trying to understand how much more can you go after with this new targeting system?

Alan Schultz

Yes Troy, we, on a manualized – manual basis, we made over 100 presentations prior to IMO kicking in. And that was over 75 customers that we had presented this to. And I think, Rob, you've – the numbers $30 million and $11 million of additional pick up, you probably know how many clients make up that.

Rob Mason

There's about a dozen clients in that total revenue number, Troy. And our focus in terms of cross- selling is really within our strategic account group. That by definition our clients that tend to be in the $10 million plus annual spend with us in terms of revenue across the portfolio. So, it's primarily directed to our larger clients who have larger buckets of money available for us to cross-sell into and within.

Alan Schultz

And so Troy, said another way. We scored on about 12 of let's say 75 presentations, we actually created a winner with. Now I do want to point out there's a big difference between doing this manually versus doing this with IMO and it is more than just timing. Okay. As Rob said, I believe used to take us 10 days or more to do this manually. Now with IMO, three days it's ready. But more importantly than that, when we develop our targeting recommendations with IMO, we're typically going in with three different alternatives for the customer to consider. When we were going in previously with this over 100 presentations and 75 plus customers, we were going in with one recommendation because quite frankly that's all we could produce with the manual intervention.

Troy Mastin – William Blair & Co.

And that 75 customers, do you have a sense for what percentage of your total revenue base that those 75 make up and what kind of list you might be getting?

Rob Mason

I don't know if I feel comfortable …

Alan Schultz

Yes, I don't think we got that handy.

Rob Mason

I can't find that number, Troy.

Troy Mastin – William Blair & Co.

Okay, good. And I don't want to take too much time. Just quick questions for Bob. SG&A has been in the $96 million, $97 million range. Three of the last four quarters you had some one time items, last quarter. Curious if that's a reasonable run rate in total costs going forward? And then if you could give us some sense on interest expenses given the likely retirement of the convert?

Bob Recchia

Yes, I think the $97 million that you saw this quarter is probably pretty reasonable. You've got these litigations expenses that are flowing through there, they are pretty high right now. So we are somewhere hopefully between the $96 million, $97 million range is what to look for. In terms of interest expense, I think you guys have all got it targeted and net interest expense around $89 million, $90 million I think that's probably about the right number for the year on a net basis.

Troy Mastin – William Blair & Co.

Okay. Thanks Bob.

Operator

Our next question comes from the line of Alexia Quadrani with Bear Stearns. Please go ahead.

Alexia Quadrani – Bear Stearns

Hi, thank you. Just a couple questions. First following up on your commentary about the Shared Mail product, I can assume I guess from you are positive outlook that the trends in Q1 have continued or are continuing into April. And then also if you could maybe, along those lines, discuss the impact the earlier Easter may have had on either Q1 or Q2?

Alan Schultz

Yes, like I said the – as far as trends go, I mean I think we – we clearly see Shared Mail continuing to grow. Okay. And I don't – I think we'd all be pretty surprised if we don't see year-over-year annual growth in the Shared Mail business based on what we are seeing today. Whether we are going to see 7.2% growth, every quarter going forward, I don't think we are going to count on that. I don't think we are going to build that into our plan. Would we be really happy and pleasantly surprised? Sure. But we think there's going to be growth but quite frankly we are not anticipating it's going to be that high. As far as Easter goes, I don't think we see a lot of Easter impact here that's affected things one way or the other.

Alexia Quadrani – Bear Stearns

Okay and then on the FSI you commented some reasons for the shortfall in your opening remarks. I guess the sizable financial services client that you've lost or pulled back, I should say, in August, could you give us sort of just a general sense of how much you think that accounted for the shortfall and how much was sort of other issues?

Alan Schultz

Yes, that client was basically running just about every week. So, I think, I think you are probably looking at about a two share points.

Alexia Quadrani – Bear Stearns

Okay. That's an obvious sort of reason why you should see a pick up in the back half of the year post August?

Alan Schultz

That is correct.

Alexia Quadrani – Bear Stearns

Okay. And then just sort of a bookkeeping question for Bob. On the balance sheet you've seen bigger declines and the cumulate other compensation gain loss sign. What's driving that?

Bob Recchia

That is the market-to-market to-swap – the swap marking to market. We've interest rate swaps on quite a bit of the term loan B. And the accounting for that is between other liabilities and the accumulated other comprehensive loss. And that is just marking those to market because obviously the swaps that we did with what's happened to rates, it flows through there, it does not flow to the income statement.

Alexia Quadrani – Bear Stearns

Okay. Thank you.

Operator

Our next question comes from the line of Mark Bacurin with Robert W. Baird. Please go ahead at this time.

Mark Bacurin – Robert W. Baird

Hi, good morning. Couple of things, Rob, good to hear from you.

Rob Mason

Good to talk to you. Mark, how are you?

Mark Bacurin – Robert W. Baird

Doing well. Couple – I guess Rob, maybe if I can start with you. On the cross-selling, it seems pretty logical selling some of these retail clients back and forth between the two products, but I'm curious if you've had or seen any success with the CPGs who've historically have been FSI only looking at Shared Mail either as an independent single sheet type opportunity or their thoughts about moving into Shared Mail through the FSIs?

Rob Mason

Mark, we've. We had seen contributions from CPGs in a couple forms. And CPG is looking for increased penetration and leveraging Shared Mail, and also in cooperative programs with big retailers to drive more products off the shelves of those retailer stores. So, the answer to your question is, yes. We have seen participation within the CPG vertical in that cross-selling effort.

Alan Schultz

And Mark, it depends on what market you are in. We can't necessarily disclose specific client information, but we've got one CPG that I can think of offhand that bought a very significant portion of the wrap, the Shared Mail wrap as part of a tie-in with the retailers that were inside the wrap.

Mark Bacurin – Robert W. Baird

And are those general branding dollars or are they actually putting consumer promotions, coupons etcetera in the Shared Mail product as well?

Alan Schultz

Yes. It tends to be more field dollars. The CPGs have marketing dollars that they have a corporate, which tend to be more of the promotional dollars and then they have field dollars that are designed to develop promotional activity at the local level in support of the retailer. And this is those local marketing dollars that are coming from the CPGs field sales organization.

Mark Bacurin – Robert W. Baird

That would be trade promotion type stuff?

Alan Schultz

Well, it's not really trade promotion. What a lot of the larger CPG clients have done, is they built these sales teams that typically call on the top ten largest retailers in the country. And then what they've done with those sales teams is they've actually given them promotional marketing budgets to do local market promotional activity with the retailer, tying-in with the retailer. And it's really those budget dollars.

Rob Mason

It ends up being accounts specific dollar that are dedicated to specific retailers.

Alan Schultz

Yes, that's what Rob has hit the exact terminology. It's what the CPG would refer to as account specific marketing dollars.

Mark Bacurin – Robert W. Baird

Okay, perfect. And then I guess sticking with the question about FSIs and Shared Mail. I know you have in certain markets trialed putting FSIs or start using Shared Mail distribution for the FSIs. Given how slim the margins are now running in the FSI business, I was hoping maybe you could try to quantify for us what the margin opportunity might be for accelerating that process, and trying to take some of that media cost out of the FSI business?

Alan Schultz

Yes. Right now it's about four or five margin points. If we look at what the savings is from distribution through newspapers, the distribution through shared mail, it did improve our margin by about four or five points I believe if I'm doing all the math right in my head, which Bob can crunch in his head and see if I'm right.

Rob Mason

It'd probably take a lot of analysis. We've a cross-charge, I think that's what Al's referring to. We haven't gone through and looked if we were to move mass amounts over exactly how that would flow through in today's postal rates, at least I haven't looked recently. So, it's at least four margin points.

Bob Recchia

And there's a lot of market level dynamics that go into getting to the bottom of that analysis, too because every market performs differently from a profitability and volume standpoint as well.

Mark Bacurin – Robert W. Baird

Well I guess part of that is also how you stand in each market on an underweight basis and I didn't hear updates with regard to the overall ADVO or Shared Mail distribution platform, how much of that is underway at this point?

Alan Schultz

You know what, we are digging for that number right now. It is on a piece of paper here somewhere.

Mark Bacurin – Robert W. Baird

Okay.

Alan Schultz

Mark, we might have to come back to that one, but we got it here.

Mark Bacurin – Robert W. Baird

Yet on the presumable, the FSI shift would happen in those markets are underweight. I mean that would be the logical place to target those FSIs moving into RedPlum?

Alan Schultz

Well it's really a combination, Mark. One of the other things we look at is strong retailer participation. And so if we've got strong retailer participation and we got an underweight market, that's obviously ideal scenario.

Mark Bacurin – Robert W. Baird

Okay. Shift over this may be a question for Rob as well. Just wondering what you are seeing in terms of trends in California and I guess more specifically the market where you have the LA Times partnership. California has obviously been very weak. But I think most of the type of distribution you guys do is more at the national advertiser type level. So, just curious if you are actually seeing growth in that market at this point, and what that might mean for additional partnerships getting formed?

Alan Schultz

Yes, I'm going to turn now on over to Rob because I know he tracks results on a regional basis. So, I'm sure he has that information.

Rob Mason

Mark, that's a great question. I think you probably realize is that that's a very competitive marketplace. But I will tell you that in Q1 we grew revenue in Southern California by about 4 percentage points and given the competitiveness of that marketplace and the dynamics of the economy, we feel pretty good about that number.

Mark Bacurin – Robert W. Baird

That's impressive. Can you break that down between price and volume or is that too nitpicky for you, Rob?

Rob Mason

That is a little nitpicky for a sales guy, Mark. We can get back to you with that answer but I'm not going give it to you off the top of my head.

Mark Bacurin – Robert W. Baird

That's fine. And then just finally, I know you've got various suits against News America in different jurisdictions. Can you give us a timetable for when the next hearing might be, and obviously not expecting you to predict what might happen, but just trying to get a feeling for when we might be hearing something out of those different suits?

Alan Schultz

Mark, our hope is to get a verdict in one of those suits this year. That's our goal, that's our objective.

Mark Bacurin – Robert W. Baird

When will be next hearing actually occur though, are there a date on the schedule?

Alan Schultz

There are hearings that is in motions that are being heard on a regular basis.

Mark Bacurin – Robert W. Baird

Okay.

Alan Schultz

Yes, there's active hearings, motions, meetings being discussed on a regular basis.

Mark Bacurin – Robert W. Baird

No visibility into a potential judgment, though, in terms of timing?

Alan Schultz

Again here, I think our goal is to get a verdict in one of those jurisdictions this year.

Mark Bacurin – Robert W. Baird

Okay, great. Thanks, guys.

Alan Schultz

Thank you, Mark. Hey, Mark, we are going to have to get back to you on the unused postage percentage because in our finders of information we can't seem to put our finger on it right now.

Mark Bacurin – Robert W. Baird

No problem. Thanks.

Operator

And our next question comes from the line of Dan Salmon with BMO Capital Markets. Please go ahead.

Dan Salmon – BMO Capital Markets

Thanks guys. I'll switch gears a little bit. You had lots of commentary on the targeting system and Shared Mail strengths. So, while I ask, you mentioned with redplum.com there's still a lot inventory to get up there on the site and some initial steps to get done, but mentioned that once that's up and running that you expect to do some investment there. Could you help us understand what types of investments is that? Building out the site a little bit more? Is it establishing some partnerships to drive traffic there? Or is it just pure marketing or paid search spending to drive traffic there? Thanks.

Alan Schultz

Yes, one of the investments is that we will put a new skin on it in May. So, you'll see a new consumer interface come live in May. Everything is on track for that to happen. So, we hope that that's going to provide a really wonderful consumer experience and then our goal is to try to get a lot more of the content uploaded. In terms of how we are going to drive traffic, right now the plan is being developed for driving traffic. And we haven't made that decision yet in terms of how we are going to drive traffic other than to say we are going to do it in the most efficient way possible, and you hit the nail on the head. One way to drive traffic is with network partners. And so we are definitely going do that because that's a very inexpensive way. There's another way you can drive traffic, which is you can buy traffic from the search engines or you can do traditional marketing in order to drive traffic or you can use our media to drive traffic. So, what we are basically doing is we are looking at those four different alternatives in terms of traffic, and then we are going to make a determination on just exactly what is the best most efficient plan for us to use.

Dan Salmon – BMO Capital Markets

Right, that's great. Thank you.

Alan Schultz

And Mark Bacurin, we did finally put our finger on the document. Unused postage is down to 20% in the first quarter.

Operator

And our next question comes from the line of Chuck Cerankosky with FTN Midwest Research. Please go ahead at this time.

Chuck Cerankosky – FTN Midwest Research

Good morning, everyone.

Alan Schultz

Good morning, Chuck.

Chuck Cerankosky – FTN Midwest Research

Just want to touch on working capital management to start off with. The used in working capital in the quarter, I was wondering if anything was going there and might that be a source of cash over the course of the full year. And also, Bob, do you need to end each quarter with around $100 million in cash or are we going to see those levels get lower as you pay off debt?

Bob Recchia

Yes, on the working capital front, I would say we probably can squeeze a little bit more out throughout the year. In the first quarter, we payout profit sharing and bonus plans. So, that there is going to always be a shift there between the two of them, there's probably $15 million outflow that goes out there. The movement – you sell a little bit more movement in payables where you are comparing December to March. So you've got different volumes in December. You've got a lot of year-end spend and ROP spend in December that you don't have in March. But we will be able to take a little bit more throughout the year out of the working capital and we will see the cash balances come down a little bit. We are still trying to get some money out of Europe. If we can do that, I think we can bring the cash balances down even a little bit further. So, the answer is, yes. I don't have a target number right now. We are still working through that. And you may see and I'm going to qualify that. You may see in the back half of the year starting to build a little bit of cash again because remember we've got the '09s that are going to be coming due in January. So, we are working through that right now. If we are able to get some of those in the open market, we'll be buying them along the way. If not, you'll see cash come down a little bit and then start to build towards the back half of the year.

Chuck Cerankosky – FTN Midwest Research

Got you. All right. Al, could you comment or maybe Rob, on the test you are doing in Rhode Island with the FSI and the Shared Mail?

Alan Schultz

Yes, I'll let Rob talk to that.

Rob Mason

That test is ongoing, Chuck. We have not gotten any material reads in terms of performance, but right now we are seeing participation levels hold both on a solo or preprint basis as well as the cooperative FSI. So, we don't have any performance metrics as of right now.

Bob Recchia

And just to qualify performance metrics, where we've got a primary performance metric and a secondary performance metric that we will be looking at, we just don't have sufficient data and data points yet. But the first is merchandising support from the retailers in the marketplace that are participating in our package, that's the primary, and then the secondary would be redemption rates. And then there's probably another secondary which gets beyond merchandising support, which is incremental product movement through the scanner.

Chuck Cerankosky – FTN Midwest Research

Are you looking at moving that test or expanding that test to any other metropolitan area?

Rob Mason

The answer to that is, yes. Probably at some point in the fall it looks like right now. It's been a source of debate, Chuck, in terms of when that should be done. But I would say fall to January 1 is probably the time period.

Chuck Cerankosky – FTN Midwest Research

All right. When you are talking about the management or leadership changes in the FSI business, what changes can we expect to see there as they deal with the challenges in that business?

Rob Mason

I think, Chuck, what we are trying to achieve there is just laser focus on that product. There is obviously a significant amount of competitive pressure, it's a core part of our business. We want to do everything we can to retain every share point, and every penny of price that we can in that market, and having the right leadership in place is a key to achieving those goals. And I think we've cracked that code with some recent moves that we've made.

Alan Schultz

So, we've made the changes we want to make from a leadership perspective. They basically have just become effective in the last couple of weeks.

Chuck Cerankosky – FTN Midwest Research

And now if we can talk a little about the Shared Mail operating margin in the quarter, it was a pretty healthy 8.7%. What that tell us about the remainder of the year with some of the synergies for the full year, can we expect it to get a little better over the course of 2008?

Alan Schultz

Chuck from a gross margin perspective and this is what we've been tending to focus on more. When we acquired the business it was 20%, 21% gross margin business. If you looked at it on a historical basis, I think the all time high goes back to sometime in 2001 where I think margins got up close to 28%, gross margins 27.7%. Our goal was is we felt like we could get it back to 26% margin business. I want to say in the first quarter we were getting pretty close to 26%, somewhere between 25% and 26%. So, I would tell you we probably got a little bit of room there left to get that target 26% level. And whether we can get it back to the all time high ever achieved or not is we still have to prove that to ourselves whether that's a doable proposition or not.

Chuck Cerankosky – FTN Midwest Research

I guess some of that's going be influenced by the cost of paper as well.

Alan Schultz

It certainly has an impact when you look at the wrap paper because we just don't have really a lot of ability to pass that along.

Chuck Cerankosky – FTN Midwest Research

Very good performance in the first quarter.

Alan Schultz

Thank you, Chuck.

Chuck Cerankosky – FTN Midwest Research

Thank you.

Operator

And we have time for our final question and it comes from the line of Edwards Atorino with Benchmark. Please go ahead.

Edwards Atorino – The Benchmark Co.

All questions have been answered.

Operator

Thank you. Gentlemen at this time there are no further questions. Please continue with any closing comments that you may have.

Alan Schultz

Thank you. I guess there's one point that I would like to make in closing. And you heard us talk a lot about back half, back half, back half, and people may get the impression that we've a back half loaded plan and there's just something I want to point out about that. And that is, we really have a back half loaded business. Reality is, there's probably somewhere in the mid-to-upper 50s percentage of our business is going come in the second half. When you combine these companies on a pro forma basis going back in history, that's what it looks like. So, this is a back half loaded business. And then, of course that's combined with the fact that from day one of this acquisition, we said we were going focus on cost synergies, business optimization and really revenue synergy was not going be our focus until the back half of 2008. And we are now at the point where really everything that we had hoped to get in place that would facilitate that back half growth in 2008 is in place. The only exception to that at this point in time is sales training. As Rob had indicated, we still have 15% of our sales organization that isn't yet fully qualified to sell our top three products let alone all 20 products. Now, what that means is 15% sounds like a small number but when you look at the size of our sales organization, we are talking about 80 people that still are not qualified to fully and confidently sell our three primary products. So, we still have progress to make, but clearly we think the focus, time and attention we are putting on sales training, and bringing those 80 people to life and getting them out there actively selling along with our other 500 plus people is really going have a positive impact as we get into the second half of the year. So, I just want to make sure everybody's [ph] clear about that, and I really appreciate your time and attention and participation in the call today and the questions that you had. And I really hope everyone has a wonderful day. Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference call for today. If you would like to listen to a replay of this conference, you may do so by dialing either 1-800-405-2236 or for international participants they may dial 303-590-3000. You will need to enter the access code of 11102665 followed by the pound sign or hash key. Those phone numbers once again are 1-800-405-2236 or for international participants, 303-590-3000 with the access code of 11102665. We thank you for your participation. You may now disconnect your lines at this time.

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Source: Valassis Communications, Inc. Q1 2008 Earnings Call Transcript
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