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Valassis Communications, Inc. (NYSE:VCI)

Q2 2008 Earnings Call

July 31, 2008 11:00 am ET

Executives

Alan F. Schultz - Chairman of the Board, President & Chief Executive Officer

Robert L. Recchia - Chief Financial Officer, Executive Vice President & Treasurer, Director

Eva Kohn - Senior Vice President, Strategic Account Sales

John Rogers - Senior Vice President, Field Sales Organization

Analysts

Alexia Quadrani – J.P. Morgan

Mark Bacurin – Robert W. Baird & Co., Inc.

Charles Cerankosky - FTN Midwest Securities Corp.

Matt Chesler – Deutsche Bank Securities

Troy Mastin – William Blair & Company, L.L.C.

Edward Atorino – The Benchmark Company

Analyst for Todd Morgan – Oppenheimer & Company

[Raffy Savitz – Credit Suisse]

Operator

Good morning ladies and gentlemen and thank you for standing by and welcome to the Valassis Communications’ second quarter 2008 earnings conference call. During today’s presentation all parties will be in a listen only mode and following the presentation the conference will be open for questions. (Operator Instructions) As a reminder this conference is being recorded today July 31st, 2008. I would like to remind all participants to please refer to the Safe Harbor statement language on the earnings documents released this morning. This call will be governed by the language stated therein.

At this time I would now like to turn the conference over to Mr. Alan Schultz, Chairman, President and Chief Executive Officer.

Alan F. Schultz

Good morning. I’d like to welcome everyone to the call. Today I have with me Bob Recchia, our Chief Financial Officer and our featured guests are Eva Kohn, Senior Vice President of Strategic Account Sales and John Rogers, Senior Vice President of our Field Sales Organization. Both Eva and John report to Rob Mason, our Chief Sales Officer who was with us on the last earnings call.

As you know when we acquired the shared mail business in March of last year our plan from day one was to focus on driving cost synergies and optimization through the first half of 2008. We also started the process of getting things in place to drive profitable revenue growth through cross-selling and new client acquisition in the second half of 2008. We put the needed sales structure and compensation programs in place, invested $10 million in developing IMO our new integrated targeting system and have continuously engaged our sales teams in extensive training programs. We are pleased with our first half results and have had success in both cross-selling and new client acquisition with our new client value proposition. During the first half momentum was building as our success in these areas acted as proof of concept for long term profitable revenue growth.

Eva and John as key sales leaders are accountable for this profitable revenue growth. They are here today to update you on their progress in new client acquisition and cross-selling success. Before I turn the call over to them I’d like to provide you with some additional color on our results.

I’m pleased to tell you that through the first half of the year we are on plan. While the first quarter exceeded our expectations and the second quarter was somewhat below quarter-to-quarter variance was anticipated and is the reason we provide guidance on an annual basis. We expect quarterly results to be a bit lumpy and they have been. On a monthly basis results are even more so. In fact June in particular was a soft month. Through the first half revenue was flat and we expected flat to single digit revenue growth and our EBITDA is on plan. As a result we expect adjusted EBITDA of $260 million to $280 million for 2008 consistent with the original 2008 guidance that we provided on December 18th, 2007.

Obviously a high point of this quarter’s results was once again the profit performance of our shared mail business. Segment profit was up over 18% versus the previous year. This profit improvement was achieved with only 4/10 of 1% increase in revenue. These results again emphasize the progress we have made on cost improvements in the optimization of this business. Our shared mail optimization efforts designed to eliminate unprofitable packages in combination with the discontinuation of the detached address label resulted in a planned 1.8% reduction in revenue. So our modest increase in revenue was achieved even though we had planned on a revenue reduction of 1.8%. In essence we outperformed the shared mail market as evidenced by the 20% decline in shopper revenue at Harte-Hanks in the second quarter.

It is important to note that while the bulk of the cost side in optimization improvements the shared mail business were made through the first half we are continuing to pursue additional opportunities in the second half of 2008. Our Neighborhood Targeted segment has been affected by the negative newspaper trends in the first half of 2008. Our first half 5.5% revenue decline actually outperformed the newspaper industry which is reporting 10% to 15% revenue declines in the first half of this year. When you take into consideration the fact that we shifted approximately 3.5% of our Neighborhood Targeted revenue into our shared mail product we actually had about a 2% decline in revenue from our Neighborhood Targeted products in the first half of the year.

Facing an environment of 10% to 15% newspaper budget declines by our clients we were able to mitigate approximately 80% of this negative impact by cross-selling and new client acquisition in the first half of the year. We have made the assumption that these trends will continue to negatively impact our Neighborhood Targeted business in the second half of 2008. When we combined this estimate of declines in our Neighborhood Targeted segment with our estimated FSI revenue declines associated with reduced pricing we anticipate approximately a $35 million revenue deficit in newspaper distributed products in the second half of 2008 that we must overcome. With our first half results in mitigating approximately 80% of the newspaper declines and our increased momentum in cross-selling and new customer acquisition we believe we are well positioned to more than offset this $35 million revenue drag in the second half of 2008.

Our top financial priority continues to be debt reduction. As of June 30th of this year we had approximately $192 million in cash. On July 3rd of this year we made an additional debt payment of $28.8 million. We are currently making process changes to more efficiently manage working capital including optimizing accounts receivable and accounts payable in addition to implementing a global cash pooling system. We believe as these changes are implemented we will be able to operate with a minimum cash balance of approximately $60 million by the end of this year. In January of 2009 it is our plan to pay off the $100 million worth of six and five ace bonds with existing cash from our balance sheet leaving our $120 million revolver untapped. Once we pay off these bonds we have no significant liquidity events until 2014. It is currently our plan to continue to build cash on the balance sheet until the 2009 bonds are retired. While very conservative in our approach our Board believes this plan is wise considering the current state of the financial markets.

I’d also like to recognize Lorne Groe, our VP of Finance and Corporate Development. He and his team worked hard in managing our balance sheet in the second quarter and helped to put us in a very strong position.

Another important point from a financial perspective is our investment in four initiatives in the second quarter of 2008 which we do expect will provide significant long term value and benefit. These items were noted in the press release. There was $2.2 million in News America litigation costs in the second quarter. There was $1 million for running Parallel Systems for our data center in sourcing in the second quarter, $1.3 million in costs and losses related to RedPlum.com and $230,000 invested in new business initiatives in China. In total these initiatives represent $4.7 million in negative impact on Q2 EBITDA.

While we are well positioned from a financial and liquidity perspective equally, if not more important, we are very well positioned from a consumer usage perspective. Ultimately consumer usage determines the future growth or decline of any media. In today’s economic environment consumer usage of value oriented or promotional media such as ours is on the rise. While our current plan is not dependent on growing client budgets but increasing share of client spending in products we compete in we are expecting that the cyclical budget cuts made by our clients due to economic conditions that those dollars will ultimately return to Valassis as the economy improves.

More importantly it is our belief that the upswing in consumer usage of promotional media is not a cyclical shift but a permanent change in consumer behavior. As evidence coupon usage is up. When big research asked consumers this month how they would change their behavior in reaction fluctuating gas prices 30% of the women with children said they are likely to use more coupons in 2008 than 2007 and 46% of the challenging 18 to 24 year old demographic said they were more likely to use coupons in 2008 versus last year. We believe today’s economy, the unprecedented housing market declines, energy cost increase, low consumer confidence and high unemployment will have a permanent effect on consumer psyches and behavior creating a generation of consumers that will continue to demand more value for their dollar not only today but well into the future.

According to our company NCH 2007 marked the end of a 16 year decline in total coupon redemption volume. The grocery segment experienced a 6% increase. The average consumer can save about $1,000 per year, dedicated couponers even more, substantially more. So it is not surprising that retailers are reporting significant increases in coupon redemption at their stores especially those that are positioned in the market as low price leaders. We noted in our press release that overall US coupon clearing volume is up again in 2008 on top of 2007. Meijer a chain based here in Michigan is seeing more than 10 times the normal coupon redemption volume based on a recent newspaper article. Current consumer usage trends position our RedPlum media portfolio well for the future.

With that said, I’d like to turn the call over to Eva Kohn who leads our strategic account team.

Eva Kohn

I’d like to start out by giving a brief overview of the strategic sales organization. Our go-to-market approach is based on client focus teams supported by nearly 120 sales professionals. The strategic sales organization represents approximately half the company’s overall revenue and is comprised of approximately 80 accounts generating or having the potential to generate more than $10 million in revenue within several key verticals, consumer packaged goods, grocery, drug, mass merchandise, restaurant and food service, telecomm, specialty retail as well as a new account development team.

Within the strategic sales team we have three key initiatives for 2008 that capitalize on the strength of our integrated sales organization and I’d like to address each of these three initiatives separately. The first is to cross-sell which is essentially getting our clients to buy more products which in turn generates more revenue. A key component of this initiative is understanding our clients’ budget and developing strategies to capture increased share. To do this we’ve quantified our head room opportunity. Today we’re capturing nearly 19% of the $5.3 billion spent by our clients on products and services we offer and we know that this strategy will work because we’ve already demonstrated success in the first half of this year.

When we look at clients who are buying more products from us in the first half of 2008 versus the first half of 2007 our year-over-year revenue for this group increased by 9%. For example, in the first quarter earnings call Al and Rob shared with you that we were forecasting $30 million in annualized newspaper preprint business from our traditional shared mail clients. I am pleased to tell you that through the first half we’ve realized about half of that $30 million forecast. We also shared with you that we were forecasting over $11 million in annualized ROP revenue from shared mail clients.

Again I’m happy to report that Larry Berg and his ROP team made significant progress and we actually achieved more than $12 million in ROP revenue from our traditional shared mail clients in the first half. All up the newspaper placement from shared mail clients is forecasted to be around $50 million on an annualized basis and we continue to build momentum. Through a continued focus on cross-selling within five years our goal is to have more than a 25% share of our client spending for the products and services that we offer.

The second initiative is to capitalize on our enhanced value proposition to attract large new potential clients. Greg [Vogage] and his new account development team play a critical role within our strategic sales organization. In addition to driving the $30 million in newspaper business from shared mail clients that I referenced earlier Greg and his team are also responsible for bringing our enhanced value proposition to large new prospects that we historically had a hard time penetrating via the combined shared mail and newspaper expertise that the new account development organization. Through June this team has generated more than $10 million in brand new business and established new relationships with many of the nation’s largest advertisers.

The third key initiative is to help our clients reach their current and potential customers by migrating newspaper inserts to shared mail in the face of declining newspaper circulation. We’ve been able to increase value by evaluating and optimizing our clients’ media buy and developing the right mix of newspaper and shared mail. Through this process we’re able to analyze our clients’ media spend, optimize their buy and deliver enhanced ROI or return on investments. Our clients need to reach the households of their current and potential consumers and with newspapers reaching fewer and fewer households we’re able to help our clients by supplementing their newspaper buy with shared mail that reaches the non-newspaper reading household. Through the first half we’ve shifted $7.3 million in newspaper business to shared mail which results in enhanced reach and improved response for our clients.

In closing the acquisition of the shared mail business by Valassis has afforded us a unique offering to bring increased value to our clients by optimizing their media investment. Our new account development team continues to be a bright spot by generating new revenue from some of the country’s largest advertisers. Our clients have great interest in our incredibly robust RedPlum media portfolio as demonstrated by our cross-selling results in the first half. Finally I’m very proud of the way that the strategic sales organization has executed these initiatives to date and I am confident that this team will continue to build momentum and contribute to driving low to mid single digit growth in the back half of 2008.

Thank you and I’d now like to turn it over to John Rogers.

John Rogers

It’s great to be here this morning. I’d like to start by giving you an idea of what the field organization is comprised of. We have about 480 sales professionals working directly with clients in seven geographically defined regions and one region that is dedicated to the franchisee community. The field handles clients that spend less than $10 million annually with us and my team represents approximately 50% of the company's revenue. Today I’d like to focus on three key initiatives and our progress against in 2008.

The first initiative is our goal to secure 4,000 new local clients. Through the first half of 2008 we have contracted 2,049 new clients. Our sales executives have embraced the concept of activity based selling and our productive activity metrics reflect that new client calls have increased by approximately 50% as compared to Q4 of last year. Proposals are up 33% and new client contracts have gone up by 25%. Right now based on an estimated client retention of 50% in our estimated average contract value we would calculate that those 4,000 clients will provide about $29 million of top line revenue in 2008. As we continue in future years if we continue to acquire 4,000 clients on an annual basis we believe we can positively impact the top line by about $46 million annually with this initiative. We plan to continue improving in the three key areas that have the most positive impact on results which are the number of new client contracts we secure, increasing the average value of those contracts and of course the retention of newly secured customers.

One of the other components of our initiative to acquire 4,000 new clients is our new go-to-market approach for the smaller, local market clients. Early on during the integration I was challenged by Al to find a more effective and more efficient to sell and fulfill advertising for the smaller, local market clients. In recent years, ADVO had significantly decreased sales focus on the small clients but these smaller, local market clients are relevant to consumers and enhance the content of our shared mail package. We launched a project called Project Simplify and from that we identified various ways that we could improve our efficiencies in handling smaller clients and improve the customer experience for this important client segment.

Some but not all the components of Project Simplify are as follows, first our field franchise team is a new more efficient lower cost and no travel approach to the franchise community with a sales group that can effectively reach a large number of franchisees each week. In the first half of this year we have secured business from 522 new franchisees with this new team. These newly acquired franchisees are in addition to the 2,049 new clients I referenced earlier. The next issue is the Neighborhood Advantage Program which provides a more efficient approach to the local market customer by utilizing our Oracle enterprise wide system capabilities for pricing and contracting. We estimate that this saves approximately 50% of a sales associate’s time setting up new clients.

Our Neighborhood Direct Program is a new online solution for local clients that enables online ad building and ad management and online ordering of Valassis products and services for small customers. This system is in test right now and will be up and running during the back half of 2008. All of these efforts are aimed at significantly improving both the customer experience as well as the efficiency of our sales process for the local client segment that spends between $5,000 and $60,000 annually. I am particularly passionate about this initiative because this is a segment where I believe our competition has outperformed us and we are very focused on becoming the media of choice for the small, local client that has been buying from our local competitors in the past.

The next initiative I’ll touch on is our goal of having 70% of field sales executives cross-selling both shared mail and non-shared mail products. As you know our new integrated sales organization is about seven months old. The field organization’s experience base is heavily skewed toward shared mail expertise based on the number of sales executives that have a background in shared mail versus newspaper. We established a goal for 2008 of having a minimum of 70% of field sales executives cross-selling both shared mail as well as non-shared mail products and in 2009 that goal will move to 100%. We have had intense training on our product portfolio and have tasked the field sales executives with broadening the number of products our customers buy from us and cross-selling both shared mail and newspaper products to our clients.

Our sales teams have embraced this broadened portfolio of products and we continue to provide learnings on our more than 20 products and services. Through the first six months of this year our data reflects that currently 53% of field sales executives have had success cross-selling shared mail and non-shared mail products.

The last initiative I’ll discuss today is our return to market P&L management and accountability within the field organization. You’ve heard Al reference our business optimization efforts and one of the key areas of focus on optimization is within the shared mail business. The accountability for how an ATZ or zip code performs within a market now resides with the local sales team and management within that market. If we have underperforming zip codes within a market the local sales team owns the process of uncovering the customer opportunities for that geography that are going to improve the financial performance of that package within that market.

In 2008 we aligned our objectives and our compensation for field sales directors and regional vice presidents to the profitability of the markets they were geographically responsible for. This alignment enhanced focus and accountability within our field sales leaders directly contributes to our efforts to maximize profit contribution for our shared mail business within each one of the field regions. One example of this area of focus for field leadership is in our shared mail wrap. Each regional leadership team has direct responsibility for percent sold and profit performance for the wrap within their specific geography. We finished the first half of 2008 with wrap percent sold of 84% versus 80% in 2007 and 72% in 2006.

Another great example of this initiative at work is the consolidation of our two shared mail programs in the Pittsburgh market effective in July of 2008. We have consolidated two weekly in-home dates into one in this market. Our consolidated program has better content and better financial performance than the dual in-home dates that we’ve had in the market for several years. Through this cross-functional effort we were able to create a win for clients and a win for the company with these market changes.

In closing I am pleased with our progress through the first half of 2008 within the field sales organization. We are facing a touch economy right now but we have a focused and engaged sales organization that understands what it takes to produce results. Everything is in place to build on the momentum and the results of the first half and generate low to mid single digit profitable revenue growth in the back half of 2008.

Thank you and I’ll now turn the call back over to Al.

Alan F. Schultz

Thanks John and thanks Eva for that additional insight. Craig at this point in time I’d like to open up the call for questions please.

Question-And-Answer Session

Operator

(Operator Instructions) One moment please for our first question. Our first question comes from Alexia Quadrani – J.P. Morgan.

Alexia Quadrani – J.P. Morgan

This is [Townsend Buckles] for Alexia. A few questions, first can you talk about the degree of slowdown at ADVO you saw in June and are you seeing this extend into Q3 and are there certain geographies or verticals where you are seeing this weakness?

Alan F. Schultz

Certainly ADVO was part of our June slowdown. I think the June slowdown was kind of across the board though. We saw it in a variety of different products and services. It’s my belief that basically what happened is, is clients were dressing up Q2 a little bit and cut back on some of their spending in Q2. I think that explains the June situation. At this point in time based on what we can see in the third quarter I think things look like they’re back to normal based on what we see at this point in time.

Alexia Quadrani – J.P. Morgan

Does this impact your outlook for the year at all? Do you still expect to hit the top half of your guidance?

Alan F. Schultz

I think the $260 million to $280 million is the range that we’re in. We had obviously a great first quarter which was much better than we anticipated. That got us really leaning towards the upper half of that $260 million to $280 million range. Now we had a second quarter which was not quite as good as we had originally built in our plan so I think we’re back into the $260 million to $280 million and we’re back into the center of the range again.

Alexia Quadrani – J.P. Morgan

Finally what are your expectations for paper pricing in the back half of the year and any indications for 09? Are you seeing clients cut back on pages as part of this spending pullback?

Alan F. Schultz

I think paper price increases are certainly having an impact on what we see in the preprint side of our business. Preprints paper is actually a pretty big cost component of those programs and as paper prices go up clients are not necessarily looking to spend more money in their budgets these days so I think in an effort to keep their budgets flat what you’ll see is perhaps the reduction in distribution or media costs to offset that increased paper cost, it certainly part of what’s causing the problem there in the preprint business. In terms of what paper prices are going to do on a going forward basis, I really think that is totally dependent on what happens with energy costs and what happens with the US dollar. If the US dollar should strengthen, if oil prices per barrel should go down, I think you’ll probably see paper costs start to decrease, certainly stabilize at a minimum. If oil prices continue to run up and the US dollar continues to be weak, then I would assume we’ll probably see paper price increases.

With all that said, I just spent some time with one of our major paper suppliers last week and what they told me is they’re seeing a dramatic fall off in demand for paper right now. So they’ve actually been pushing through price increases in an environment where demand is declining solely based on what’s happening with their input costs are driving prices up. Again I think if oil comes down and the currency strengthens, I think we’ll see some relief there. But I think it’s totally dependent on that.

Operator

Our next question comes from Mark Bacurin – Robert W. Baird & Co., Inc.

Mark Bacurin – Robert W. Baird & Co., Inc.

A few things, first of all looking at the shared mail product, obviously I understand it’s a lumpy business but I know there’s been one or two big retailers that have been doing some special project oriented stuff, just curious if you could give us any sense of whether or not that ramped down in the quarter and if that had an impact on the slower growth there?

Alan F. Schultz

The special stuff was relatively close to what we had experienced the year before so we did look at that. It was pretty darn close.

Mark Bacurin – Robert W. Baird & Co., Inc.

Second, I know Bob you’re trying to get away from the shared mail metrics, but just curious if you could give us any sense on what happened with regard to pricing or revenue per piece I guess is the closest metric we have there and that would have been the offset to the package contraction? And also then a pieces per package metric as well.

Robert L. Recchia

I don’t have all the revenue per piece and pieces per package stuff right now. We’ll put something together, Mark, but I don’t have that in front of me.

Mark Bacurin – Robert W. Baird & Co., Inc.

General sense of it? Obviously you took your packages down by a fairly good number so you are able to continue to push through price increases?

Alan F. Schultz

Mark, we found the mess of documents on the table that Bob needed.

Robert L. Recchia

The pieces per package were relatively flat with the prior year, down slightly. Then when the revenue per piece is up a little bit, I don’t really like to give you these metrics because there’s a lot that goes into these things and you blend it all together. So I’m giving you some idea of what’s happening with it but you’re not going to be able to tell much from it, to be honest with you.

Alan F. Schultz

Mark, one of the reasons we don’t like the metric revenue per piece is the fact that you could have a situation where the weight of the pieces goes up and the revenue per piece obviously goes up. If the weight of the pieces go down, the revenue per piece goes down and it has a whole lot more to do with weight than it really does with what’s really going in the marketplace from a pricing perspective. So that’s why we’re hesitant to give that number out because people look at it totally I think from a price perspective when there’s a really weight component added to that.

Robert L. Recchia

Right, because the day we eliminated the DAL our revenue per piece went up because it was the cheapest piece that we had. It’s a little bit misleading but that’s directionally what’s going on there and revenue per package is also up overall which is a key component for us.

Mark Bacurin – Robert W. Baird & Co., Inc.

Yes, I understand all pieces are not created equal. I’m a big fan of the revenue per ounce would be a great but I’m pretty sure I won’t be getting that.

Alan F. Schultz

That’s actually the number we’re trying to get to is revenue per ounce, we just have had some system constraints in getting there but that’s one of the things that’s on the list.

Mark Bacurin – Robert W. Baird & Co., Inc.

On postage rates, can you just comment about what you’re seeing in terms of the rate increases and impact on costs first of all and then on expectations for volumes and whether or not you’re able to push through any price increase there?

Alan F. Schultz

First of all let me say I’ve got a meeting coming up with Postmaster General here in early August so I’ll get more of a read on it but the general view that we have at this point in time is that we’ll probably see another increase in May, it’ll probably be an inflationary type price increase. The last price increase we had was in May. In essence we got something a little bit less than an inflationary type price increase and we put it through in the way of an increase to customers with 100% compliance. So we think we’re not going to have any difficult in terms of passing this along and also keep in mind, Mark, that postage is basically half of the cost to a customer of the program in total. If you get a 3.5% inflationary price increase, in essence you’re passing along 1.8% to the client in terms of their cost increase so it really hasn’t been a challenge for us to pass it along and all of our contractual relationships with customers allow us to pass it along.

Mark Bacurin – Robert W. Baird & Co., Inc.

Maybe, Al, you could just comment about what you’re seeing from a macro perspective? We’ve heard different comments from some of your competitors or just generally marketing services companies about softening marketing spending and maybe some thought that retailers may be pushing off some spend to save some dry powder for the fourth quarter. Are you seeing trends like that? It sounds like you’re still expecting a nice up tick in the back half of the year, so if you could comment on general trends?

Alan F. Schultz

I would say that our view is number one that we do have a business which our biggest quarter is clearly the fourth quarter, there’s no doubt about that. It’s not that it’s a back half loaded business it’s just a business which these days is very heavily retail based and as you know most retailers either make or break their year in the fourth quarter so spending for customers in the fourth quarter really is not an optional affair, it’s something that we need to do. And clearly as we built our models we’re assuming the fourth quarter is the big quarter. With all that said, we clearly are in a tough economic environment, client budgets are tight, clearly client newspaper budgets as you’re seeing from the newspaper industry are down 10% or 15%.

We’ve basically taken into consideration the fact that we think the kind of declines that the newspaper industry experienced here in the first half and the second quarter are going to continue for the back half of the year. In essence the way we have looked at is we’re starting out with a hole, we’re going to lose X amount of newspaper revenue and we have to start filling that hole in with new customer acquisition and cross-selling success. We’ve also taken into consideration all of the boogey men out there so to speak on a specific client basis that we think are struggling from a financial perspective and likely will be cutting back budgets. In essence the way we are looking at the back half of this year is we created a hole based on the economic conditions, the newspaper industry, specific client situations and then we’ve looked at our success in terms of cross-selling and new customer acquisition what we’ve achieved in the first half, what we think will flow through from what we’ve achieved in the first half in the second half and what additional we will sell in terms of cross-selling and new customer acquisition in the second half and when we roll that all up, we still get to our low to mid single digit number but clearly that hole that we’re digging out of from the start is a pretty big hole.

Mark Bacurin – Robert W. Baird & Co., Inc.

One final quick one, Bob, the rate for the quarter looked a little higher? What was going on there and what do you expect for the full year?

Robert L. Recchia

It’s probably the discreet items again but as we look at the tax rate, we’re getting more and more pressure from the state so we’re seeing a tax rate that’s creeping up over 39% right now. That’s been going against us as we go through these state audits one at a time.

Mark Bacurin – Robert W. Baird & Co., Inc.

Something North of 39% for the full year?

Robert L. Recchia

Yes, it’s in the 39.2% to 39.4%, somewhere in that range right now.

Operator

Our next question comes from Charles Cerankosky - FTN Midwest Securities Corp.

Charles Cerankosky - FTN Midwest Securities Corp.

Al, if you’re looking at some of the lumpiness of the first half of the year, do you expect it to be more or less going into the second half given as you just mentioned you’ve got some specific customers you’re probably keeping an eye on who are having some financial difficulties? And are there are any positive events you might have your eye on that could push some of the lumpiness in your favor?

Alan F. Schultz

Chuck, the answer to that is I think we were pretty realistic about baring out the hole that we needed to dig ourselves out of and the boogey men and the newspaper industry and that kind of thing. I think we were realistic about the cross-sell and new customer acquisition based on the success we achieved in the first half with some improvement in that in the second half. We are working on some things right now that do have the potential to be positive. From a positive perspective we haven’t necessarily factored those into our plan so we are working on some potential things that could be some substantial wins. We haven’t assumed those wins as we built our plan for the second half of the year.

I think the other thing that we’ve got going for us is the point I tried to make on the call which is media dollars tend to follow consumer usage and consumer usage and readership of our media is definitely improving and so I think we have the opportunity here in the second half of the year to see some budget dollars shift our way as those budget dollars follow that consumer usage and we haven’t factored that in either. There are a couple of potential positives that we haven’t baked into the mix that could contribute to some lumpiness also.

Charles Cerankosky - FTN Midwest Securities Corp.

You mentioned in the press release that the test results for the FSI going into the shared mail are positive, very positive I think it said, can you provide any detail on that and where it might be headed?

Alan F. Schultz

I’ll let Eva do that because she’s obviously been talking to a number of strategic accounts about those test results and so I’ll let her share what she has been sharing with customers.

Eva Kohn

The results to date are very positive and we’ve measured this several different ways and every way we’ve measured it, we’ve seen a higher sales lift with shared mail versus the newspaper. The other great thing is that we’re seeing consumers positively responding to having the FSI in the same place as the retailer circular as the speed of redemption is much quicker when the FSI is aligned with the retailer’s circular and their sales dates.

Alan F. Schultz

Eva, what kind of lift are you seeing on average? I think there’s been about 40 different offers or brands that have been part of this study. What’s the average lift?

Eva Kohn

We’re seeing up to 10%.

Alan F. Schultz

So you’re seeing just getting into a double digit lift in terms of sales and those sales are basically being, Chuck, measured through the retailer scanner.

Charles Cerankosky - FTN Midwest Securities Corp.

I think the last time we talked it was in Rhode Island and Las Vegas has it been expanded to any other markets?

Alan F. Schultz

Yes, the plan is here in January of 2009 when we come out with our new market list we certainly plan on adding more shared mail distribution to the market list. Chuck I think right now the total shared mail distribution in 2008 is about 5.7 million circulation. I would say right now we’re working on finalizing that and will be finalizing it in the next 30 days. You’re probably looking at a number that’s going to be up something just North of 10 million maybe in terms of circ that’ll be through shared mail.

Charles Cerankosky - FTN Midwest Securities Corp.

If it’s going so well why wait six months to push the circ up that high?

Alan F. Schultz

It has to do with the FSI sale and as you know with the FSI a lot of clients are booking their programs well in advance. So the problem that you have is we already have a significant amount of business booked for the third quarter and into the fourth quarter and to go to clients at that point in time and in essence change the buy after they’ve already made the buy I think is a challenging thing to do. It’s just something that we haven’t ever done in the past. It is positive so we don’t anticipate we’re going to get any real client push back on it. In fact, really to date this whole concept of the move to shared mail, we really only had one significant client push back at all on it and most of the other clients certainly understand that with negative trends in newspaper circulations the FSI needs to be distributed in an alternative format in order to continue to provide the market penetration levels that they’re looking for. So clients are pretty supportive.

Operator

Our next question will from Matt Chesler – Deutsche Bank Securities.

Matt Chesler – Deutsche Bank Securities

A follow up on the Providence test and the FSI shift, can you comment on what your analysis so far tells you is the profit benefit, if any, from shifting the FSI to shared mail as compared to what you’re seeing for preprint shifting?

Alan F. Schultz

Are you talking about profit benefit for Valassis or are you talking about improved ROI for the client, Matt? What are you talking about?

Matt Chesler – Deutsche Bank Securities

I’m talking about the benefit from your perspective? Is there a financial benefit from perhaps avoided media dollars paid to the newspapers if you’re able to put it into a shared mail package?

Alan F. Schultz

The answer to that is definitely yes. I’ll let Bob quantify it for you.

Robert L. Recchia

It obviously depends on the markets you’re moving because very newspaper has different rates but generally speaking the media rates using shared mail are 25% to 30% less than what it’s costing us in newspaper today. When you blend it all together that generally can be as much as 100% if we’re in an underweight market and it can be actually be even in some markets where the newspapers have very low prices. So we’d look at that as one of the considerations as we’re starting to build out this list going from the 5 million up.

Alan F. Schultz

There’s one other benefit of shared mail that has a potential financial impact which is newspapers when we run certain categories in the FSI will charge a surcharge. Obviously when we move to the shared mail package we don’t have to pay those surcharges. That really gives us two financial benefits, one is we don’t pay the surcharge. The second is it potentially opens the book up for us to sell clients into it that couldn’t necessarily run in that market or in that booklet if it was being distributed through newspapers.

Matt Chesler – Deutsche Bank Securities

In terms of our Neighborhood Targeted segment you’ve said it’s a little bit lumpy and you expected the softness there to continue but can you dissect the performance down a bit between some of the various newspaper delivery products that are in there whether it’s ROP, polybags and preprints? Where are you seeing the softness or is it broad based?

Alan F. Schultz

Actually in the ROP area we’ve actually been doing pretty good. Now keep in mind one of the benefits of ROPs is it’s very short notice so the advantage to having ROP is if you go to a client in the middle of April and convince them they should do their ROP business with you, you could start placing business on May 1st as an example. It can happen that quickly. Obviously when you get into preprints it’s a little bit of a longer lead time. In polybags even a longer lead time. So what I would tell you right now what we’ve seen is we’ve actually seen pretty good success in us cross-selling and acquiring clients’ ROP business for our shared mail customers and we’ve actually seen some growth there in the ROP business. The sampling business and polybag business I would say is pretty flattish, down a little bit and the biggest decline that we’ve seen is in the preprint area and one of the other reasons for that too is there is work to be done from a sales training standpoint. I think we’ve made a lot of progress in that regard but there’s still work to be done.

John mentioned the fact that he’s got roughly 480 people out in the field. The vast majority of those people come from a shared mail background in terms of their experience. They really have no newspaper experience so getting them up to speed on how to sell newspaper preprints is actually a little more complicated than selling ROP and as he indicated we’ve got about 53% of our associates now in his field organization that have sold newspaper products but that still means you’ve got 50% that haven’t yet. So there’s a lot of head room and a lot of opportunity there for us to make additional improvements.

Matt Chesler – Deutsche Bank Securities

We’re already seeing $2 million to $3 million of legal fees a quarter yet the Michigan Wayne County Circuit Court case which is the first case I believe isn’t on the docket for trial until January. Is this the type of run rate that we should expect from here?

Alan F. Schultz

No, I think the way the court case has been going there is a lot of electronic document discovery early on in the case which primarily was in the first half of this year. The electronic discovery process tends to be a pretty expensive process. We’d actually expect that to look more like maybe $1 million a quarter going forward into third and the fourth quarter as opposed to $2.2 million a quarter in the first two quarters because we’re pretty much through that electronic document discovery at this point.

Matt Chesler – Deutsche Bank Securities

How does your guidance treat your legal expenses?

Robert L. Recchia

It’s in there.

Alan F. Schultz

It’s in there. We’ve included it.

Operator

Our next question comes from Troy Mastin – William Blair & Company, L.L.C.

Troy Mastin – William Blair & Company, L.L.C.

I wanted to follow up a little bit on the question about the lumpiness for the variance on the quarter-to-quarter basis that was asked earlier, specifically how should we think about the second half of 2008 in terms of potential variation Q3 versus Q4? Might it look like last year in terms of the pacing of EBITDA? Is there anything that you see today that would result in EBITDA being skewed in a different manner than last year?

Alan F. Schultz

I think last year is a pretty good place to start, Troy. I would tell you that obviously the fourth quarter was a big quarter for us last year. We think it’s going to be a big quarter this year. Based on our conversation earlier one might even argue that the fourth quarter might even be bigger in comparison on a relative basis this year than last year because I think there’s a lot of retailers that are just going to have to make their year in the fourth quarter and obviously there’s a number of retailers that are going to be struggling through the first three quarters of this year. I think we’re pretty optimistic about the fourth quarter right now.

Troy Mastin – William Blair & Company, L.L.C.

You had outlined the $4.7 million in negative impact on Q2 EBITDA, you just commented on legal expenses, what about the other expenses you highlighted? How will those play out for the remainder of the year?

Alan F. Schultz

The RedPlum.com I think is the one that continues on. China is going to continue on.

Robert L. Recchia

And the data center goes away.

Alan F. Schultz

And the data center goes away.

Robert L. Recchia

[Inaudible]

Alan F. Schultz

Yes, in the third quarter we’ll probably have a little bit of duplicate expense because we just did that data center conversion, I think it was eight days ago or something like that. So there’ll be a little bit of redundancy in July. I think IBM actually goes dark here within the next seven days. I think they shut off power so you’ll basically have about a month of redundancy in the third quarter then you’ll get two months of savings in the quarter. I would think it would be pretty flattish probably in the third quarter and then you’ll start to see that $1 million plus savings starting to flow through fully in the fourth quarter.

Troy Mastin – William Blair & Company, L.L.C.

You mean flat with what you just reported for the second quarter?

Alan F. Schultz

No what I mean in the third quarter is there’ll probably be no additional cost increase because you’ll have redundancy costs for a month and you’ll have savings for two months. I think it goes away completely in the third quarter and the benefit starts to appear in the fourth quarter for the data center.

Troy Mastin – William Blair & Company, L.L.C.

Any major clients that have drastically, and I guess this more the retail vertical that I’m referring to, drastically cut their footprint? There have been a number of bankruptcies as well in the sector that impacted you in the quarter or that you see on the horizon in the third quarter?

Alan F. Schultz

I would say we’re monitoring clients pretty closely. We know who’s cut back on their footprint. We’ve baked that into the plan. I think we know where the boogey men are at right now.

Troy Mastin – William Blair & Company, L.L.C.

In terms of visibility, can you give us some idea of how your visibility looks today, if it’s gotten any better than where it’s been in past quarters just to help us get some comfort in your ability to hit your full year targets?

Alan F. Schultz

I think our best and most accurate way to look at it is on a macro basis and we’ve gone through a very specific analysis where we said, okay newspaper, we should get this much negative impact in the FSI, we should get this much negative impact from the Neighborhood Targeted segment and we actually broke it up into its components of ROP and preprints and polybag sampling, how much negative do we get from each of those individual components. We then went through specific customers that we know are struggling from a financial perspective and we anticipate will cut back on their spending. We pulled that spending out of the mix. We basically created a hole. We said here is this hole we’ve got to fill.

Then we went back through, did the analysis for cross-selling, where we had successes, where do we think we’re going to have successes in the future, what have we done with the way of new customer acquisition like in John’s case, keep in mind he’s acquiring these new customers throughout the course of the year. Well that’s about $29 million in new customer revenue for the year but that skews towards the back half of the year, probably $19 million of that $29 million are in the back half of the year because some of those customers you acquire in the first half of the year will repeat in the second half of the year and then you’ll acquire the new ones in the second half of the year. So that really skews roughly $10 million first half, $19 million second half. We’ve taken all that into consideration and when we total it all up we dig out of the hole we created and we see this low to mid single digit revenue growth.

Operator

Our next question comes from Edward Atorino – The Benchmark Company.

Edward Atorino – The Benchmark Company

Bob, with the restructuring the debt and the debt payment, what would interest expense look like for the rest of the year, I guess not much change, but 09? That would drop down quite a bit I suppose. The second question has to do with the shift of dollars from Neighborhood target into the shared mail which was flat in the first quarter then dropped $10 million in the second, how do we look at the second half? Last question, FSIs have been going down about $10 million a quarter, does that get any better in the second half?

Alan F. Schultz

I’ll take the last question first, Ed, while Bob is working on some of those others. When we look at the FSI hole for the second half of the year we actually see it, Ed, more as about a $5 million a quarter hole or really the way we looked at it was about $10 million for the second half. The reason for that is if you look at the first half hole it was really created by a combination of things, that low to mid single digit price decline. We had a little bit of softness in terms of units and we had a market share decline versus the previous year.

When you go into the second half of the year we actually think there’ll probably be a slight increase in units. We think our market share will actually be up a bit so that part of it goes away. We’re really more dealing with the price decline than we are anything else. The price decline is more like half of what we experienced in the first half of the year in the way of overall revenue decline from that product. As we calculated that whole I described earlier that we had to fill we assumed $10 million of it was in FSIs in the second half.

Robert L. Recchia

Ed, on the interest expense we just paid off about $29 million in July. We don’t anticipate making anything more than mandatory payments between now and January which are pretty minimal. In January we will pay out of existing cash $100 million to retire the 6-5/8 so if you assume we’re investing the $100 million this year at 2% and we’re paying off 6-5/8 you’re going to see a drop there and then obviously you’ve got the annualization of the debt repayments that we’ve made this year in continued debt next year. So I don’t have an interest expense number yet for you, but those are the big move that you’re going to see.

Then your last question was on the Neighborhood Targeted business and it’s kind of what Al said earlier, we’re hanging in there on the ROP business, we’ve gotten some new customers in there replaced some revenues, the polybag business is a little more economically sensitive so we’re down a little bit there. I think we’re going to continue to be down. The wild card becomes preprints. We’ve moved some over into shared mail and that’s worked effectively for us and for our customers, but there’s been, I think you look at the newspaper numbers. You can see the newspaper delivery preprints are way off and we don’t really have a way to go around that other than getting into shared mail as fast as we can. That’s the wild card, we’re going to have to wait and see how that plays out for the rest of the year in terms of it’s going to be heavily continued upon how the fourth quarter comes in.

Operator

Our next question comes from Analyst for Todd Morgan – Oppenheimer & Company.

Analyst for Todd Morgan – Oppenheimer & Company

I was wondering you sold your Windsor, Connecticut or did a sales lease back for that facility if you had any other real estate assets that you aren’t fully utilizing and could do something similar with?

Alan F. Schultz

The one other area that we’re looking at is we’ve got the European clearing operation which we’ve opened up a facility in Poland now. That facility, the first business that it will begin to process is the business from the UK so it is our plan to sell the building in the UK which is probably somewhere in the neighborhood of $7 million US building in terms of its value. It would be our plan to sell that. The way we worked the numbers out the sale of the building comes pretty close to funding the restructuring costs in the UK to shut down that UK facility and then get that operating rolling in Poland. That’s the only other building that we’ve got in the works right now.

Analyst for Todd Morgan – Oppenheimer & Company

With the 2,000 or so new customers that you have in shared mail, is there any type of customer? Give a little color on the new customers, if those are new dollars that they’re spending or is it taking money away from other types of local media?

Alan F. Schultz

I’ll let John answer it but I think for the most part what we’re talking about is competing with other local media companies that we haven’t really competed with aggressively in the past and going after that spend that John can certainly add more color on.

John Rogers

I would agree. There’s not a lot of new dollars out there so it’s really about share and for the most part the bulk of that new business from those new customers is taking their spend from a competitor and moving it over to us.

Analyst for Todd Morgan – Oppenheimer & Company

Is there any one type of program that they’re buying of or is it spread throughout?

John Rogers

It’s spread but I would say it’s heavily skewed toward shared mail.

Alan F. Schultz

Again I think part of the reason for that is our field sales organization, that’s what they have experience selling so that’s where you’d expect them to be most successful particularly early on in the process.

Analyst for Todd Morgan – Oppenheimer & Company

Have you seen recurring revenues from the new customers?

John Rogers

Yes, as Al said we obviously will have retention and we’re trying to improve upon that retention so we’ll lose some of those customers but we are seeing repeat business from those customers as we move through the year which is how we will build that momentum. The $29 million this year we obviously have to retain a segment of that business in order to move it next year to that $46 million revenue number that I referenced earlier.

Alan F. Schultz

Right now John’s experience is that we’re retaining about 50% of the customers we bring in the first time. Obviously one of his objectives is to try to move that percentage up beyond 50% and he mentioned earlier a number of different programs he’s working on that’ll improve the customer experience in an effort to try to do that.

Operator

Our final question will come from Raffy Savitz – Credit Suisse.

Raffy Savitz – Credit Suisse

When I look at your second half guidance it talks about a pretty material EBITDA bounce back $141 million to $161 million versus $119 million in the first half and I understand you talked about top line trends. What are you seeing so far in July? Are you seeing that kind of delta mid to high single digit improvement? Secondly in terms of the costs in the business, $38 million in synergies what is showing up so far in the first half numbers? What has to show up in the second half?

Alan F. Schultz

Bob will refer to the synergies on the cost side, but to your question on EBITDA I think if you look at last year and I don’t know if Bob’s got the numbers here handy but the difference between the first half of the year and the second half of the year there’s a pretty significant weighting towards the second half of the year. I don’t know if we have the percentage of EBITDA last year that came in the second half. Do we just have that percentage?

Robert L. Recchia

I’m trying to find that number for you.

Raffy Savitz – Credit Suisse

In terms of July are you seeing those trends already improve mid to high single digits?

Again I’m not going to comment from month to month. Our guidance is annual guidance and there’s going to be lumpy months, there’s going to be lumpy quarters. We’re really pretty comfortable with our annual guidance. We like what we’ve put together. We’ve got a plan, if we work the plan we’re pretty comfortable with the result we’re going to get. We’ve got about 59% last year of the EBITDA came in the second half versus the first half so I think it’s clearly skewed in that direction.

Robert L. Recchia

I think you can just look at the numbers for the second half, last year we did about $150 million in the second half. So if we did $150 million again this year it takes us right to the middle of the range.

Raffy Savitz – Credit Suisse

In terms of the synergies you had touched upon, the $38 million, what is showing up in the numbers so far and what are you hoping to get in the second half?

Robert L. Recchia

The only significant changes in the second half, we’re a little late on our newspaper alliances. We had hoped to have some of those going earlier in the year so they will kick in in the second half of the year and we’ll see some of that primarily in the fourth quarter, you’ll start to see a lowering of our costs there and then the data center that Al talked about earlier, there’s a little over $1 million in savings that’ll start kicking in in the fourth quarter. I think everything else is as planned.

Alan F. Schultz

Maybe you’ve got it skewed an additional $2 million to the back half of the year versus the front half of the year. That’s probably the way to look at it.

Robert L. Recchia

Then year-on-year your 09 versus 08 your alliances are worth about $5 million and we’re only going to pick up about $2 million of that in 08 so we’ve got another $3 million pick up in 09 plus what we do in 09 and that data center is worth about $4.5 million of which we’re going to get about $1.2 million in 08 so the delta there helps us in 09 if you’re trying to build a bridge on the synergies.

Raffy Savitz – Credit Suisse

Can I ask one follow up?

Alan F. Schultz

If I could just add one other thing, the other thing is Bob said we’re behind about $3 million on the newspaper alliance synergies but we’re ahead on the printing synergies and that’s why we’re still comfortable with the $38 million number. It isn’t that every component of our synergies is coming in on plan because in fact newspaper alliances are behind plan but the amount of money we’re saving printing our own product versus what ADVO is paying Quebecor to produce it and even what we anticipated ourself, we’re doing substantially better on the printing costs.

Raffy Savitz – Credit Suisse

Just one final question, in terms of the ADVO business, what’s the average length of contract and what’s the minimum length of contract you sign with a new client?

Alan F. Schultz

I’ll let Eva answer that and John. You’ve probably got two different scenarios here because you’ve got strategic accounts and you’ve got field accounts so you’ll get two different answers.

Eva Kohn

Our minimum contract is a year but for many of our strategic accounts we have longer contracts because of the size of the client and the amount of negotiation that needs to happen. I would say on average we’re probably about three years in terms of length of contract for the larger clients.

John Rogers

Within the field some of our larger clients do have multi-year contracts but I would say the majority of contracts within the field are one year in duration.

Raffy Savitz – Credit Suisse

What percentage of whatever you have in annual sales at ADVO are through strategic clients?

Alan F. Schultz

You’ve got about half and half. You’ve got about half of our revenue comes from strategic accounts. Eva has about 80 accounts that are on her list either as existing customers or prospects and then John has the other 14,800 and whatever, give or take a few, on his list.

Operator

At this time you may please continue with any closing comments that you may have.

Alan F. Schultz

I’d just like to thank everybody for attending the call today and their questions and also thank John and Eva for providing some additional insight to you. Hopefully that information will be helpful and valuable to you. Just a few closing comments. First I’d like to tell you that I’ve got tremendous confidence in Eva, John and also Rob Mason and really our entire sales organization. I’ve really got confidence in their commitment to and their leadership of our sales organization to drive that low to mid single digit revenue growth in the second half of this year.

I think clearly we’ve had proof of concept in our enhanced value proposition to customers is significantly increasing our success rate in terms of new customer acquisition. We’ve already begun to reap the benefits of our investment in sales training and the $10 million that we spent on our integrated media targeting system and all that clearly is helping us generate cross-selling success.

I recognize however with all that said, that we’re in very unusual times. We’re operating in uncharted economic territory and we realize that we’re starting with a hole here that we need to fill and we’re assuming that $35 million of that hole is created by the deficit that we think we will experience with newspaper distributed products. I believe we’re more than well positioned to overcome that deficit as evidenced by what we have accomplished in the first half. We did experience that same hole and that same deficit in the first half of the year and we originally assumed we’d be flat to low single digit revenue growth and we got the flat revenue growth for the first half of the year. I think the team has proven their ability to get it done. I think our products are really solid. I think clearly consumer usage of our products is improving and I think our momentum in the whole cross-selling, new customer acquisition continues to build.

I think the bottom line is what I said before and that is our success for this year is going to be determined by our own ability to take accountability for and execute the plan we put together. If we do that we should deliver what we expect to deliver.

I’d like to thank you all for your time today and once again appreciate your questions. Have a wonderful day. Good bye.

Operator

Ladies and gentlemen this does conclude the Valassis Communications’ second quarter 2008 earnings conference call. If you would like to listen to a replay of today’s conference you may do so by dialing either 303-590-3000 or 1-800-405-2236. You will need to enter the access code of 11102665. ACT would like to thank you for your participation. You may now disconnect your lines at this time.

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