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Valassis Q2 Profit Falls

Press release from the issuing company

Tuesday July 31 -- LIVONIA, Mich., July 31 -- Valassis today announced financial results for the second quarter ended June 30, 2007. The company reported quarterly revenues of $612.1 million, up 134.9% from the second quarter of 2006, due to the acquisition of ADVO, Inc. (ADVO) that was completed on March 2, 2007. Second-quarter net earnings were $9.8 million, or $0.20 in earnings per share (EPS). For the second quarter, operating income was $40.6 million and adjusted EBITDA* was $63.1 million. Adjusted free cash flow* was $25.1 million for the quarter.
"Since the close of the ADVO acquisition on March 2, we have been extremely pleased with our efforts to reduce costs and capital expenditures as we focus on maximizing free cash flow," said Alan F. Schultz, Valassis Chairman, President and CEO. "We expect to see the incremental benefits from our optimization efforts during the next 12 months, with the expected realization of revenue synergies beginning in the second half of 2008.
"Second quarter adjusted EBITDA was below our internal projections due to revenue shortfalls. As a result of reducing our revenue projections, we have lowered our previously announced 2007 adjusted EBITDA* guidance from $255 million to $241 million. Going forward, we expect to complete the sales integration process by Jan. 1, 2008. In addition, a new comprehensive targeting system will be completed during the second quarter of 2008. This proprietary system will provide scalable, multi-product solutions, enabling us to accelerate cross-selling opportunities.
"Let me share with you some of our recent accomplishments:
-- Successfully transitioned to a new ADVO ShopWise wrap format, eliminating the detached address label (DAL) by printing the consumer  address on the wrap. This transition has enabled us to avoid a double-digit postal rate increase and has set the stage to being able to target shared mail at the household level.
-- Started printing ADVO's shared mail wrap at the Valassis Durham printing facility during the last week of June. We expect to be producing the vast majority of the wrap in our printing facilities starting in the fourth quarter of 2007, saving approximately $8 million on an annualized basis.
-- Announced the shutdown of the weekend shared mail program in Southern California outside of the newspaper alliance footprint, as well as the second in-home date in Las Vegas.
-- Announced the shutdown of the Columbia, Maryland and Los Angeles II ADVO production facilities to drive efficiencies.
-- Announced the closure of ADVO's unprofitable New Jersey Shopper Guide product with the goal of transitioning any remaining customers into existing shared mail products.
-- Improved ADVO's shared mail gross margin percentage to 22.6% and lowered the amount of unused postage to 22.2%.
-- Continued to reduce accounts receivable at ADVO, reducing days sales outstanding (DSO) from 51 as of Dec. 31, 2006 to 44 as of June 30, 2007.
-- Reduced combined company capital expenditures for the second quarter to $6.6 million. ADVO capital expenditures for the second quarter totaled $2.3 million, significantly lower than its historical quarterly run-rate.
-- Made a second $25.0 million voluntary payment on the term loan B of our senior secured credit facility in July.
-- Entered into two interest rate swaps converting a total of $480.0 million, or approximately 89%, of the floating-rate term loan B debt to a lower, fixed effective rate of 6.8%.
-- Strengthened the strategic alliance with Insignia Systems, Inc., a marketer of in-store promotions, which expands Valassis' role to secure and service retail customers. In July, Valassis also received warrants to purchase 800,000 shares of Insignia stock.
-- Executed first mobile marketing program during the second quarter of 2007 helping our client reach consumers how, when and where they want."
*Further important information regarding operating results and reconciliations of these non-GAAP financial measures to the most comparable GAAP measures can be found in the "Reconciliation of Non-GAAP Measures" schedule following the financial statements accompanying this press release, which should be thoroughly reviewed.
Management noted that unlike the legacy Valassis business which had a relatively high degree of visibility given the amount and the way in which business is contracted, the combined business with the acquisition of ADVO is much less predictable. This is due to the significant operating leverage, movement in business primarily within the ADVO shared mail product, and the timing and manner in which management is able to see sales in progress. In any particular period, transactional fluctuations in the amount, timing, pages, weight and types of advertising pieces distributed by ADVO's customers can vary significantly. These fluctuations can make it difficult to predict and can materially affect revenue and profit results.
As a result of the current revenue forecast, the company updated its 2007 revenue and adjusted EBITDA* guidance from its guidance provided on May 3, 2007. The following figures represent a full-year for Valassis and the period of March 2, 2007 through Dec. 31, 2007 for ADVO.
-- Revenue of $2.22 billion to $2.25 billion, down from $2.25 billion to $2.35 billion; and
-- Adjusted EBITDA* of approximately $241.0 million, down from $255.0 million (includes cost synergies, but does not include one-time expenses associated with cost-to-achieve synergies). Expected one-time cost-to-achieve synergies of $25.0 million to be incurred in 2007, which includes $10.5 million of capital expenditures. In addition, the company made the following adjustments:
-- Expected cost synergies of $20.0 million for 2007. The company has increased the cost synergies expected for 2008 from $32.0 million to $36.0 million;
-- Expected capital expenditures of $53.6 million for 2007 was lowered to less than $50.0 million for 2007. Capital expenditures for 2008 through 2011 are expected to be approximately $35.0 million each year; and -- Expected tax rate for 2007 has increased from 37.2% to 37.8%.
Business Segment Discussion
-- Market Delivered Free-standing Insert (FSI): Co-op FSI revenues for the second quarter were $98.7 million, down 15.6% from the second quarter of 2006, due to an approximately 10% reduction in FSI pricing and a 4.6% decline in industry volume, coupled with a slight decrease in market share. Industry page volume for the first six months of 2007 was down 1.3%. Management noted that FSI cost of goods sold was down slightly for the quarter on a cost per thousand (CPM) basis. Segment profit for the quarter was $5.4 million.
-- Neighborhood Targeted Products: As of Jan. 1, 2007, the Neighborhood Targeted segment includes the Run of Press (ROP) business, previously reported as a separate business segment. Revenues for the second quarter were $120.2 million, up 18.1% from the pro-forma prior yearquarter. Segment profits were up 62.9% to $14.5 million for the quarter. The growth is due to increases in ROP, polybags/sampling and preprints primarily in the telecommunications, consumer packaged goods, financial services and grocery retail customer verticals.
-- Household Targeted Products: Household Targeted product revenues for the second quarter were $12.7 million, down 10.6% from the second quarter of 2006, due to continued softness in solo direct mail programs. Segment profit was $500,000 for the quarter. During the quarter, $700,000 in expenses associated with the company's investment in its new interactive initiatives were incurred and charged against earnings in this segment.
-- International & Services: International & Services revenues are comprised of NCH Marketing Services, Valassis Canada, Promotion Watch and in-store. International & Services reported revenues of $29.0 million for the second quarter, up 5.1%, due to higher coupon clearing volumes in the United States and the United Kingdom, and our in-store initiative. Segment profits were $1.9 million, down 13.6% from the prior year quarter, driven by a decline in profits of Valassis Canada and incremental costs of approximately $543,000 aimed at improving efficiencies in our European operations. Excluding the costs associated with this project, segment profits for the quarter were $2.4 million, up 9.1% over the prior year quarter.
-- ADVO: ADVO revenues for the second quarter were $351.5 million, down 9.1% from the second calendar quarter of 2006. During the second  calendar quarter of 2007, ADVO had one less week than the second calendar quarter of 2006 resulting from ADVO's historical 52/53 week accounting cycle. Excluding this extra week, revenues were down 4.6% and packages were down 0.5%. As a result of eliminating packages with higher percentages of unused postage, unused postage as a percentage of base postage decreased 1.1 percentage points from the prior year quarter. Advertising pieces were down 5.5% due to the reduction in packages, a reduction in Missing Child Card pieces (driven by the shift from a detached address label to printing the consumer address on the wrap) and a decline in insert volume resulting from grocery customer consolidation. As a result, pieces per package were down 5.4% for the quarter. Revenue per thousand pieces was up slightly due to the reduction in the lower priced Missing Child Card product and the partial quarter impact of the postal rate pass-through, offset in part by a shift to lighter weight products from the grocery customer category. The progress made in improving the ADVO cost structure and optimizing packages/profiles resulted in the shared mail gross margin percentage increasing to 22.6%, versus 21.4% in the prior year second quarter and 18.4% for the first quarter of 2007. Segment profit was $19.4 million for the quarter.