Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004 or

Commission File Number: 1-10991

VALASSIS COMMUNICATIONS, INC.

(Exact Name of Registrant as Specified in its Charter)

19975 Victor Parkway

Livonia, MI 48152

(address of principal executive offices)

Registrant’s Telephone Number: (734) 591-3000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and, (2) has been subject to such filing requirements for the past 90 days:

Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes  x    No  ¨

As of March 1, 2005, there were 50,599,731 shares of the Registrant’s Common Stock outstanding. As of such date, the aggregate market value of the voting and non-voting stock held by non-affiliates* of the registrant was $1,087,000,000.

The applicable portions of Valassis’ Proxy Statement for the 2005 Annual Meeting of Stockholders to be held on or about May 10, 2005 are incorporated by reference herein into Part III of this Annual Report on Form 10-K.

2

PART I

The Company

Valassis provides a wide range of marketing products and services to a variety of premier manufacturers, direct marketers, retailers, franchisees and other advertisers. We can provide these products and services at the market, neighborhood and household targeted levels and can combine all three levels of targeting into a single campaign. Valassis uses the term, integrated solution, to describe when a customer uses three or more of our products/services together in a single promotional campaign. We are committed to providing innovative marketing solutions to maximize the efficiency and effectiveness of promotions for our customers.

Valassis provides the following products and services to our customers:

Mass Products – products that reach a large area or “market” at a low cost:

Cluster Targeted Products – products that reach “neighborhoods” based on geographic and demographic targeting characteristics:

1 to 1 Products – products and services that target individuals or “households”:

International & Services:

3

Mass (Market-level Targeted Products)

Cooperative Free-standing Inserts

Cooperative free-standing inserts (FSIs) are four-color promotional booklets containing promotions from multiple customers, printed by us at our own facilities and distributed through Sunday newspapers. In 2004, we inserted our traditional cooperative FSIs in the Sunday edition of approximately 550 newspapers with a combined average newspaper circulation of 58.5 million on 41 publishing dates. Valassis also produces customized FSIs (custom co-ops) featuring multiple brands of a single customer.

Additionally, Valassis produces specialty FSIs including the C&D County insert for smaller rural communities which reaches 5.4 million households in the U.S., and the Hispanic FSI which reaches an additional 3.9 million households in Spanish-language newspapers.

The majority of cooperative FSI business is conducted under long-term, market share contracts. Under these market share contracts, customers guarantee Valassis a percentage of their cooperative FSI pages at agreed upon pricing covering a specified amount of time. The FSI provides product category exclusivity for its customers so that competing products in the same product category will not be printed in the same FSI book. If a category is not available on the date requested, the customer has the option to use our competitor’s FSI or select another date to include their promotion. Due to this environment, many customers reserve their space well in advance.

We typically develop our annual publication schedule approximately 9 to 12 months in advance of the first publication date for each year and customers may reserve space at any time thereafter. Valassis account managers work closely with customers to select their FSI publication dates from our schedule and coordinate all aspects of FSI printing and publication. Our proprietary order entry and ad placement software allows us to produce as many different FSI versions as customers require, typically over 450 different layout versions per publication date. By offering different versions in different markets, we offer our customers greater flexibility to target precise geographic areas or tailor promotional offers to particular markets by varying coupon values, promotion copy and terms of the promotional offer.

At the end of the selling cycle for each cooperative FSI program, there is generally space in the booklet that has not been sold. This “remnant” space is sold at a discounted price, primarily to direct mail or direct response marketers, who are placed on a waiting list for space that may become available. We select direct mail marketers as remnant space customers on the basis of a number of factors, including price, circulation, reputation and credit-worthiness. Remnant space customers are subject to being “bumped” in favor of a regular price customer in need of space at the last minute. Remnant space represents about approximately 20% of the FSI pages and the revenue is included in total cooperative FSI sales for financial reporting purposes.

The cost components of the FSI are media insertion, paper and print/freight costs, which represented approximately 44%, 30% and 26% of the total cost, respectively, for the year ended December 31, 2004.

Total cooperative FSI sales during the year ended December 31, 2004 were $493.8 million, or 47.3% of our total revenue. The top 10 free-standing insert customers accounted for approximately 45% of FSI sales during the year ended December 31, 2004, and one customer accounted for more than 10% of such sales for the same period.

ROP

Valassis offers its customers the ability to run their promotional advertising directly on the pages of more than 13,500 newspapers by brokering advertising space. We offer our customers the flexibility to run in any number of the available newspapers in our network. The short lead time associated with this business makes this medium attractive for last-minute marketing decisions by our customers.

Media insertion (newspaper placement fees) is the major cost component of ROP distribution, which generally accounts for approximately 99% of our total direct ROP costs. We believe that our customers use us to place ROP advertising because of our ability to negotiate favorable media rates, our experience in selecting the best newspapers to meet our customers’ needs, our well-developed production and national network placement capabilities and our ability to integrate ROP programs with our other products and services.

4

Total ROP sales were $114.2 million during the year ended December 31, 2004, or 10.9% of our total revenue. The top 10 ROP customers accounted for 94% of the ROP sales for the year ended December 31, 2004 and one ROP customer accounted for approximately 65% of such sales.

Cluster Targeted (Neighborhood-level Targeted Products)

Preprinted Inserts

Valassis offers our customers specialty print promotion products in customized formats such as die-cuts, posters and calendars, as well as traditional free-standing solo insert formats. Because these promotions feature only one customer, the customer has the ability to create a completely individualized promotion. This allows customers the flexibility to run promotions any day of the week in any newspaper throughout the United States. We specialize in producing full-service promotions for a wide range of customers allowing orders to be placed on a national or regional basis.

Product Advertising and Sampling

Valassis offers newspaper-delivered sampling products that give manufacturers the ability to reach up to 65 million households in one weekend. Samples can either be machine-inserted into newspapers (Newspac^® ), placed in a polybag around the newspaper, or pre-sealed in a pouch that forms part of the polybag (Newspouch^® ). In addition, Brand Bag^™ and Brand Bag+ ^™ offer marketers the opportunity to deliver an impactful advertising message on a newspaper polybag without a sample included. The bags feature the customer’s advertising with the option of a weather-resistant tear-off coupon.

In 2004, Cluster Targeted products generated revenue of $275.2 million, or 26.4% of our total revenue. The top 10 customers accounted for approximately 40% of Cluster Targeted sales during the year ended December 31, 2004. No single customer accounted for more than 10% of Cluster Targeted sales during the same period.

1 to 1 (Household-level Targeted Products)

Direct Mail

Valassis produces direct-mail programs based on multiple data sources. We have experienced increased demand for direct-mail programs targeted based on frequent shopper card data. These programs may utilize Valassis’ internal variable image print capability, VRMS’ software analytics and Valassis’ Aztec Code technology. In September of 2004, Valassis acquired Catalina Marketing’s Direct Marketing Services (DMS) business and has since integrated the sales and operations into the Valassis 1 to 1 business segment.

VRMS

VRMS is a 100% owned subsidiary of Valassis that provides proprietary software solutions for customer loyalty marketing.

PreVision

PreVision, a 100% owned subsidiary, is a high-end, full-service direct marketing agency. Through PreVision we have the ability to analyze the information marketers collect in databases; make strategic recommendations; develop and execute creative programs; and analyze program results.

1 to 1 revenue in 2004 totaled $61.8 million, or 5.9% of our total revenue. The top 10 customers accounted for approximately 44% of 1 to 1 revenue in 2004, with no single customer accounting for more than 10% of 1 to 1 revenue during the same period.

5

International & Services

NCH

NCH is a provider of promotion information management products, marketing services and coupon clearing in the United States and Europe and has production facilities in Mexico. Services include retailer coupon clearing, manufacturer redemption, electronic discount settlement and promotion analysis. During 2004, approximately 54% of NCH revenues were from Europe.

Valassis Canada

This 100% owned subsidiary provides promotional products and services in Canada, such as free-standing inserts reaching over five million Canadian households, as well as other promotion products and services.

Promotion Watch

Promotion Watch offers a variety of promotion security and consulting services, including the execution of sweepstakes and contests. Promotion Watch helps customers with the entire promotion process, from preliminary planning, through the writing of official rules, overseeing the printing and placement of winning pieces and conducting background investigations of winners.

International & Services generated revenue of $99.1 million in 2004, or 9.5% of our total revenue. The top 10 customers accounted for approximately 18% of International & Services sales in 2004. No single customer accounted for more than 10% of this segment’s revenue.

Competition

Mass

Our cooperative FSI competes principally with News America Marketing, a company owned by The News Corporation. We compete for business primarily on the basis of the following:

In the past, new competitors have tried to establish themselves in the FSI market. During such times, the number of FSI programs increased, resulting in periods of intense price competition and higher costs due to a decrease in pages per FSI program. Should a new competitor try to enter the FSI market in the future, it could have a material adverse effect on our financial performance.

Our principal competitor in the cooperative FSI market, News America Marketing, competed aggressively for FSI business. As a consequence, prices trended downward in 2004, although we were able to regain some market share in 2004 in comparison to 2003 and the industry grew by a percentage in the mid-single digits. The combination of these factors resulted in a slight increase in revenues and declining profitability for our FSI business. During the third quarter of 2004, we announced a strategy with the goal of increasing Valassis pricing without a loss of market share. The results of this strategy remain inconclusive and a continuation or acceleration of the competitive trends could have a material adverse effect on our financial results.

We compete with media other than FSIs for the promotion and marketing dollars of our customers. It is possible that alternative media, changes in promotional strategies or consumer utilization could make FSIs less attractive to our customers or could cause a shift in their preference to different promotional materials or coupon delivery modes. In addition, some of our competitors, particularly News America Marketing, have substantially greater financial resources than we do.

6

Our Mass products also compete with several newspaper network groups in the run-of-press market. While entering the ROP business does not require a significant investment in machinery and equipment, it does require a significant investment in systems and people in order to compete in today’s environment. An increase in the number of run-of-press competitors could result in a loss of market share.

Cluster Targeted

Our Cluster Targeted segment competes against commercial printers and media placement agencies for solo specialized promotional programs for single advertisers. While both types of competitors have a history of competing on the basis of price to increase volume and improve economies of scale, commercial printers tend to be particularly aggressive during the periods when they have overcapacity. In addition, we compete with Sunflower Marketing for polybag advertising and sampling. To the extent our competitors in these businesses decide to compete more aggressively on price due to excess capacity or for other reasons, it could materially negatively affect our revenue and profit margins.

1 to 1

Our 1 to 1 segment competes against full-service direct mail providers, commercial letter shops and direct/loyalty marketing agencies. To the extent that our competitors in this business decide to compete more aggressively on price, it could lower our market share and negatively affect our revenue and profit margins.

International & Services

In our International & Services segment, NCH competes against Carolina Manufacturing Services and Carolina Services, both owned by Inmar, Inc., and International Outsourcing Services, LLC for coupon clearing services in the United States. To the extent that our competitors in this business decide to compete more aggressively on price, it could lower our market share and negatively affect our revenue and profit margins.

Employees

As of December 31, 2004, we had approximately 4,100 full-time employees worldwide. Approximately 1,600 are employed in the United States. None of our United States employees are represented by labor unions; however, some of our foreign employees are represented by labor unions. We consider labor relations with employees to be good and have not experienced any interruption of our operations due to labor disagreements.

Segment Reporting

For segment financial information for the years 2004, 2003 and 2002, see the table titled “Results of Operations” under “Management’s Discussion & Analysis of Financial Condition & Results of Operations” and in Note 12 of the “Notes to Consolidated Financial Statements” under Item 8 “Financial Statements and Supplementary Data.”

Availability of Filings

Valassis makes all of its reports filed under the Securities Exchange Act of 1934 available, free of charge, on its Web site at www.valassis.com, as soon as reasonably practicable after electronically filing with the Securities and Exchange Commission.

During 2004, Valassis’ Chief Executive Officer (CEO) provided to the New York Stock Exchange the annual CEO certification regarding Valassis’ compliance with the New York Stock Exchange corporate governance listing standards.

7

Our principal executive offices are located in a leased office complex in Livonia, Michigan. We also lease sales offices in Los Angeles (Costa Mesa); Chicago (Deerfield); Dallas; Boston (Lincoln); Connecticut (Shelton); Cincinnati; Toronto (Mississauga), Canada; Hamburg (Elmshorn), Germany and Paris (Boulogne-Billancourt), France.

Below is a listing of our manufacturing and production facilities. These facilities generally have sufficient capacity to handle present volumes although, during periods of unusual demand, we may require services of a contract printer:

In February 2005, Valassis purchased a 55,000 square-foot facility in Livonia, Michigan to replace its leased Plymouth, Michigan facility.

On October 22, 2004, a shareholder class action lawsuit was filed in the United States District Court for the Eastern District of Michigan against Valassis, its Chief Executive Officer, Alan F. Schultz and its Chief Financial Officer, Robert L. Recchia. The Plaintiffs voluntarily dismissed the case on March 10, 2005, without any payment, compensation or fees being provided to them.

On November 9, 2004, Valassis received a letter dated November 8, 2004 from the Federal Trade Commission (FTC) informing us that the FTC is conducting a non-public investigation to determine whether Valassis may have engaged in unfair method of competition or unfair acts and practices in violation of Section 5 of the Federal Trade Commission Act by soliciting an agreement with a competitor to fix prices and to allocate customers. As the FTC pointed out in their letter of November 8, 2004, neither the letter or the existence of this investigation should be construed to indicate that a violation has occurred or is occurring. Valassis is fully cooperating with the FTC.

The primary relief generally sought by the FTC in these types of cases is equitable in nature in the form of a decree delineating acceptable future conduct. Although we cannot predict the timing or outcome of this investigation, one consequence of an adverse result might be that future public speech regarding changes to Valassis’ FSI pricing policies might be subject to restriction. We do not expect any relief to otherwise restrict the operation of our FSI business.

Valassis is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

None.

8

PART II

Valassis’ common stock is traded on the New York Stock Exchange (ticker symbol VCI). The approximate number of record holders of Valassis’ common stock at December 31, 2004 was 207.

High and low stock prices during the twelve months ended December 31, 2004 and 2003 were:

Currently, Valassis has no plans to pay cash dividends. In addition, should Valassis change its dividend policy, the payment of future dividends would be dependent on future earnings, capital requirements and other alternate uses of cash.

The following table provides information about Valassis’ purchases of equity securities that are registered by Valassis pursuant to Section 12 of the Exchange Act during the quarter ended December 31, 2004.

These shares have been repurchased under a 5 million share repurchase program authorized by the Board of Directors of Valassis on December 4, 2001. Previously announced programs of 5 million shares each, authorized in 1996, 1998 and 2000, respectively, have been exhausted. On December 7, 2004, the Board authorized an additional open market share repurchase program for up to 5 million shares.

9

(in thousands of U.S. dollars, except per share data and ratios)

This information should be read in conjunction with the Consolidated Financial Statements of Valassis and the notes thereto appearing elsewhere in this Report. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

10

FORWARD LOOKING STATEMENTS

Certain statements under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” including specifically statements made in “Business Outlook” and elsewhere in this report on Form 10-K constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks and uncertainties and other factors which may cause the actual results, performance or achievements of Valassis to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements and to cause future results to differ from our operating results in the past. For a discussion of certain of these risks, uncertainties and other factors, see “Risk Factors.” There can be no assurances, however, that our expectations will necessarily come to pass. Valassis disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

GENERAL

Valassis’ results for 2004 reflect revenue growth in all of our business segments. While FSI revenues were up only slightly, our Cluster Targeted, 1 to 1 and International & Services segments all experienced double-digit revenue growth in 2004. Our ROP segment also contributed to the overall growth with a revenue increase in excess of 100%; however, the majority of this revenue increase is attributed to the changing fee structure for certain ROP contracts.

The cooperative FSI industry experienced mid-single digit unit (page) growth in 2004. While industry page growth was positive and our FSI market share increased, overall FSI pricing declined in 2004, in comparison to 2003. This decline in FSI pricing had a negative impact on profits in the FSI segment. During the third quarter of 2004, we announced a strategy to increase Valassis pricing without a loss in market share. The results of this initiative are yet to be conclusive, although we are cautiously optimistic that Valassis’ FSI pricing will begin to improve. Due to the multi-year nature of FSI customer contracts, the economic impact of the competitive pricing environment will continue into future periods even if pricing improves for new contracts. 2005 FSI revenues are expected to be down by a percentage in the low-single digits due to lower pricing on contracts negotiated in 2003 and 2004 that will affect cooperative FSI business placed in 2005.

During 2004, we continued our strategy to grow our customer base. For the year ended December 31, 2004 approximately: 48% of our revenue came from consumer packaged goods manufacturers; 11% came from telecommunications; 11% came from specialty retailers; 9% came from food service; 8% came from direct response marketers; 6% came from grocery retailers (including drug, wholesale and mass merchants); 5% came from consumer services (i.e. financial, Internet); 2% came from other types of customers (i.e. automotive, hardware/software, newspapers).

The February 2003 acquisition of NCH, with operations in the United States, Mexico and Europe, has expanded our product portfolio to include promotion information management products and coupon clearing services. We continue to focus on NCH’s core expertise of managing the financial transactions between retailers and consumer packaged goods manufacturers related to their promotional activities.

While we believe there continues to be growth opportunities in the U.S, we are expanding our geographic reach by testing new media products in Europe. We began testing new products in Germany, Spain and Italy in 2004 and will continue testing new media products and services in 2005.

We expect many of the macro-economic trends we saw in 2004 to continue into 2005. It is anticipated that customers will continue to link marketing spending to revenue generation, leading marketers to choose promotional alternatives that provide measurable return on investment. Customer marketing budgets are projected to be up moderately and continued economic recovery should lead to additional new product introductions. Marketing dollars should also shift to home-delivered promotional media due to increases in television fragmentation, the rise of television commercial blocking products, growth in commercial-free radio programming and greater participation in the National Do Not Call list. These trends should continue to have a positive impact on our business, increasing the marketing dollars our customers will allocate to the home-delivered promotional products we offer.

11

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated, certain income and expense items from continuing operations and the percentages that such items bear to revenues:

12

Revenues

Valassis achieved record revenues of $1,044.1 million in 2004, exceeding 2003 revenue by $127.6 million, or 13.9%. Valassis experienced growth in all segments, however, revenue for the FSI segment grew less than 1% and continues to be negatively impacted by an intense competitive pricing environment. Revenue growth includes $9.0 million from the inclusion of a full year of results for NCH versus 10 1/2 months in 2003 and $6.0 million due to the purchase of Direct Marketing Services in September of 2004.

2003 revenues were up $64.2 million, or 7.5%, over 2002 revenue. The acquisition of NCH in February 2003 accounted for approximately $71.0 million in revenue in 2003. Without this acquisition, revenues would have declined by less than 1%.

Operating Costs

Cost of products sold was $748.1 million in 2004 compared to $619.9 million in 2003 and $538.6 million in 2002, increasing as a percentage of revenue each year. Gross margin in 2004 was 28.3% versus 32.3% in 2003 and 36.8% in 2002. The decrease in gross margin percentage from 2004 compared to 2003 and from 2003 compared to 2002 was primarily the result of competitive pricing issues in the FSI segment. FSI unit costs were flat as the result of mid-single digit increases in paper costs offset by decreases in media insertion due to an increase in average pages per book and a reduction in printing cost. Additionally, the gross margin percentage was negatively impacted by a change in mix resulting in a larger percentage of sales from lower margin products.

Selling, general and administrative costs increased in 2004 to $133.1 million versus $120.3 million in 2003. The increase resulting from a full year of costs from NCH, which was consolidated beginning February 13, 2003 was $2.1 million. Nearly half of the remaining increase was due to increases in performance based incentive plans, with the balance due primarily to the acquisition of DMS and investments being made in future growth opportunities. Valassis also incurred a charge for the write-off of a cost-basis Internet investment of $3.5 million.

Non-operating Items

Interest expense was $11.4 million in 2004, compared to $13.1 million in 2003 and $13.3 million in 2002. The refinancing of our long-term debt in May 2003 resulted in an overall reduction in our borrowing rate. In addition, Valassis entered into two interest rate swaps in 2004, which also lowered interest expense.

Included in other income for 2004 is a $6.5 million gain due to the settlement of a property claim related to a fire at the Corby, England facility.

Valassis incurred refinancing charges of $3.9 million in 2003 related to the partial buyback of convertible debt issued in 2001.

Net Earnings

Net earnings were $100.7 million in 2004, a decrease of $3.0 million, or 2.9% over 2003. Reported results include after-tax other income of $4.1 million, due to a property insurance claim settlement related to the Corby, England building fire and a $2.3 million, after tax, write-off of a cost-basis Internet investment in 2004 and after-tax refinancing charges of $2.5 million in 2003. Without the effect of these charges, earnings would have shown a decrease of 6.9% in 2004, due to the effects of the intense competitive pricing pressure in the FSI segment.

Diluted earnings per share were $1.93 in 2004, including the per-share effect of the property claim gain of $0.08 and the per-share effect of the investment write-off of $0.04, compared to $1.98 in 2003, and $1.77 in 2002, including the per-share impact of refinancing and impairment charges of $0.05 and $0.66 in 2003 and 2002, respectively.

13

Segment Results

FSI

In 2004, FSI revenue increased 0.7% to $493.8 million compared to 2003. The increase in revenue was primarily the result of an increase in units (pages) due to industry growth and a gain in market share of approximately 2%, offset by a high single-digit reduction of average price caused by the current intense competitive environment. The cooperative FSI industry continues to show unit growth with industry pages increasing by a percentage in the mid-single digits in 2004. FSI unit costs were flat as a result of mid-single digit percentage increases in paper costs, offset by the efficiencies in media insertion costs caused by higher average pages per book, and reduced production costs.

FSI revenues in 2003 were also impacted by downward pricing pressure as well as a loss in market share, resulting in a revenue decrease of 14% compared to 2002.

Paper represents approximately 30% of the cost of products sold for our FSI business. Valassis purchases a combination of coated and uncoated paper. To protect Valassis against the risk of price fluctuations, a significant portion of our paper requirements is purchased from two paper companies under long-term contracts. These contracts limit the amount of increases or decreases (to approximately 10% in any calendar year) of Valassis’ cost of paper purchased from these suppliers. Such cost can be adjusted quarterly. As of January 1, 2005, approximately 90% of our FSI paper requirements were under long-term contract. The remainder of our paper requirement is bought pursuant to contracts that are typically three to six months in duration or on spot basis. Valassis maintains on average less than 30 days of paper inventory.

ROP

Revenue for ROP increased 106.9% in 2004 to $114.2 million. Changes in terms of certain contracts away from transaction-fee based business (net revenue) to gross revenue business accounted for $48.6 million of this increase. The remaining 22% increase was due to incremental business, most notably in the telecommunications customer segment. The gross margin in this segment has declined, due to a shift in business to larger volume customers at lower margins, however operating profits grew in excess of 15% for 2004.

Run of press revenue was up 34.3% in 2003 to $55.2 million versus 2002. This increase was due to increased demand from both existing and new customers and an increased sales focus.

Cluster Targeted

Our Cluster Targeted revenue increased 9.8% in 2004 to $275.2 million versus 2003. The major drivers of this growth were increased demand for solo inserts and polybag advertising programs and a continued rebound in customer product sampling. A renewed focus on enhancing margins resulted in an improvement in gross margin of over 200 basis points.

In 2003 Cluster Targeted revenue was $250.7 million, a 26.3% increase over 2002. This increase was attributed to a strong rebound in product sampling and polybag advertising. In addition, solo preprints continued to grow, in part due to new customers in the retail category.

1 to 1

The 1 to 1 segment had revenue of $61.8 million in 2004, an increase of $23.0 million or 59.3% over 2003. Approximately $6.0 million of this growth relates to the purchase of DMS, the direct mail division of Catalina Marketing. The remainder of the increase is due to our enhanced retail relationships and increased demand for frequent shopper data-driven direct mail programs.

1 to 1 revenues were up 15.5% in 2003 to $38.8 million versus 2002. Approximately $4.2 million of this growth related to the inclusion of VRMS for the entire year in 2003 versus only six months in 2002.

14

International & Services

The International & Services segment contributed revenues of $99.1 million in 2004, a 22.0%, or $17.9 million, increase over 2003. The inclusion of NCH for the entire year in 2004 accounted for $9.0 million of this increase and favorable European exchange rates accounted for an additional $4.5 million. This segment had revenue of $81.2 million in 2003 versus $8.5 million in 2002, as the result of the purchase of NCH with revenue of approximately $71 million.

Financial Condition, Liquidity and Sources of Capital

Valassis’ liquidity requirements arise mainly from its working capital needs, primarily accounts receivable, inventory and debt service requirements. Cooperative FSI customers (except remnant space customers) are billed for 75% of each order eight weeks in advance of the publication date and are billed for the balance immediately prior to the publication date. FSI revenue accounted for 47.3% of Valassis’ total revenue in 2004. Valassis inventories work in progress at cost while it accrues progress billings as a current liability at full sales value. Although Valassis receives considerable payments from its customers prior to the publication of promotions, revenue is recognized only upon publication dates. Therefore, the progress billings on the balance sheet include any profits in the related receivables.

The majority of the revenue generated by NCH is from its coupon clearing business. NCH invoices the face value of the coupon, a retailer handling fee (if applicable) as well as NCH’s processing fee. The face value and the retailer handling fee are ultimately remitted by NCH to retailers and their agents. NCH records a gross receivable and payable for the coupon face value as well as the retailer handling fees and recognizes revenue only on the NCH processing fee.

Sources and Uses of Cash

Cash and cash equivalents totaled $188.1 million at December 31, 2004 versus $207.4 million at December 31, 2003. This decrease was the result of cash provided by operating activities of $76.8 million and cash used by investing activities and financing activities of $26.9 million and $71.2 million, respectively, during the year ended December 31, 2004.

Cash flow from operating activities was $76.8 million in 2004. This is the result of net earnings of $100.7 million adjusted for non-cash items, the largest of which are depreciation and amortization of $16.3 million. Changes in working capital accounted for a $52.0 million decrease in cash, primarily as a result of increased accounts receivable as of December 31, 2004. Accounts receivable increased due to increased sales activity to record levels in the fourth quarter of 2004. In addition, collections within our ROP segment have been slower than anticipated causing an increase in days sales outstanding.

Net cash used in investing activities was $26.9 million, down from $68.1 million in 2003. Cash used in investing activities decreased in 2004 due to the decreased level of spending on acquisitions during the year from $48.4 million to $5.5 million.

Cash used in financing activities was $71.2 million for the year ending December 31, 2004, primarily driven by $51.0 million used for the continued share repurchase program and the payment of $38.7 million in connection with the exercise of the June 6, 2004 put option by the bondholders of the Zero Coupon Senior Convertible Notes due 2021, as fully described below.

Current and Long-term Debt

As of December 31, 2004, Valassis’ debt was $273.7 million, which consists of $100.0 million ($99.9 million, net of discount) of its 6 ⁵/8% Senior Notes due 2009, $13.8 million of Zero Coupon Senior Convertible Notes due 2021, and $160.0 million of Senior Convertible Notes due 2033. In addition, we have a revolving line of credit of $125 million with a variable rate of interest calculated on either a Euro currency-based rate or a prime rate. During the year ended December 31, 2004, there was no outstanding balance under this line of credit. Valassis was in compliance with all debt covenants at December 31, 2004. All of our long-term debt contains cross-default provisions which become applicable if we default under any mortgage, indebtedness or instrument for money borrowed by Valassis and the default results in the acceleration of such indebtedness in excess of $25 million. Additionally, each of the Senior Convertible Notes contains conversion triggers based upon credit rating downgrades by either Moody’s Investor Service, Inc. or Standard & Poor’s Rating Group.

15

In May 2003, Valassis issued $160 million of Senior Convertible Notes due in 2033, with a yield to maturity of 1.625% per year. We utilized approximately $111.0 million of the proceeds to repurchase $185.3 million in face value of our Zero Coupon Convertible Senior Notes due in 2021. The resulting premium and write-off of fees and discounts resulted in a $3.9 million refinancing charge.

The holders of Valassis’ Zero Coupon Senior Convertible Notes due in 2021 (the “2021 Notes”) had the option to require Valassis to purchase all or a portion of their notes on June 6, 2004 at a price of $602.77 per $1,000 of principal amount at maturity, payable in cash or common stock at Valassis’ option. Of the 86,840 bonds outstanding at that date, 64,272 were put back to Valassis. Valassis chose to settle the put with cash and, as such, paid $38.7 million on June 7, 2004 to the trustee of the 2021 Notes. The remaining debt balance related to the 2021 Notes is approximately $13.8 million, which represents the accreted value of the 2021 Notes as of December 31, 2004. The remaining holders of the 2021 Notes may require us to purchase all or a portion of their notes on June 6, 2006, June 6, 2011 and June 6, 2016, at a price of $639.76, $742.47 and $861.67 per note, respectively, payable in cash. Valassis had the right to pay for the June 6, 2006 put in either cash or common stock. In connection with an amendment to SFAS No. 128, in December 2004, Valassis waived its right to settle this put in cash. Also, each holder may require us to repurchase all or a portion of such holder’s notes if a change of control of Valassis occurs on or before June 6, 2006. Valassis, at its option, may redeem all or a portion of the 2021 Notes at their accreted value at any time on or after June 6, 2006, for cash.

The holders of the Senior Convertible Notes due in 2033 (the “2033 Notes”) receive cash interest payments of 1.625% per year on the original discounted amount, payable semiannually from 2003 through 2008. The holders of the 2033 Notes may require us to purchase all or a portion of their notes on May 22, 2008, May 22, 2013, May 22, 2018, May 22, 2023 and May 22, 2028 at a price of $667.24, $723.48, $784.46, $850.58 and $922.27 per Note, respectively, payable in cash or common stock at the option of Valassis. In connection with an amendment to SFAS No. 128, in December 2004, Valassis waived its right to settle these puts in common stock. Also, each holder may require us to repurchase all or a portion of such holder’s 2033 Notes if a change of control of Valassis occurs. Valassis, at its option, may redeem all or a portion of the 2033 Notes at their accreted value at any time on or after May 22, 2008, for cash.

Future Commitments and Contractual Obligations

Valassis intends to use cash generated by operations to meet interest and principal repayment obligations, for general corporate purposes, to reduce its indebtedness, to make acquisitions and to repurchase common stock through our stock repurchase program.

As of December 31, 2004, Valassis had authorization to repurchase an additional 5.8 million shares of its common stock under its existing share repurchase program.

Management believes we will generate sufficient funds from operations and will have sufficient lines of credit available to meet currently anticipated liquidity needs, including interest and required payments of indebtedness.

Valassis’ contractual obligations as of December 31, 2004, are as follows:

16

Off-balance Sheet Arrangements

As of December 31, 2004, Valassis did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Capital Expenditures

Capital expenditures were $18.9 million (net of $3.1 million in assets purchased from a settlement of property insurance claim related to a fire at our Corby, England facility) for the year ended December 31, 2004, largely representing technology enhancements and the purchase of a new printing press. Management expects future capital expenditure requirements of approximately $20 million to $25 million over each of the next three to five years to meet the business needs of enhancing technology and replacing equipment as required. It is expected these expenditures will be made using funds provided by operations.

RECENT ACCOUNTING PRONOUNCEMENTS

On September 30, 2004, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus with respect to Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share.” The EITF’s consensus states that shares of common stock contingently issuable pursuant to contingent convertible securities should be included in diluted earnings per share computations (if dilutive) regardless of whether their market price triggers (or other contingent features) have been met. Additionally, in its efforts to converge with international accounting standards, the Financial Accounting Standards Board (FASB) has issued an Exposure Draft, “Earnings Per Share—an amendment of Statement of Financial Accounting Standards (SFAS) No. 128.” This Exposure Draft requires contracts that contain an option to settle in cash or stock be assumed to settle in stock for diluted earnings per share computations. Valassis has irrevocably waived its rights to settle the principal amount of its 2033 Notes and the June 6, 2006 put option related to the 2021 Notes in stock. Therefore, Valassis’ diluted EPS is not affected by this pronouncement at the current stock price.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” The standard, which is effective for the first interim or annual period after June 15, 2005, requires that all equity-based compensation be recorded in the financial statements at the grant date fair value. Currently, we disclose the pro forma net income and related pro forma income per share information in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” We are evaluating the method of adoption and the impact of this statement which could have a material impact on our results of operations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS 151 are effective for inventory costs incurred in fiscal years beginning after June 15, 2005. As such, Valassis is required to adopt these provisions at the beginning of fiscal year 2006. We are currently evaluating the impact of SFAS 151 on our consolidated financial statements and do not believe that its adoption will have a material impact on our financial condition, results of operations and liquidity.

17

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that in certain circumstances affect amounts reported in the accompanying consolidated financial statements. The U.S. Securities and Exchange Commission (“SEC”) has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results of operations, and which require us to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and estimates addressed below. We also have other key accounting policies, which involve the use of estimates, judgments and assumptions. For additional information see Note 1, “Significant Accounting Policies,” of our Annual Report on Form 10-K for the year ended December 31, 2004. Valassis does not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.

Impairment of Long-lived Assets – Long-lived assets historically have been reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows estimated to be generated by such assets. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Revenue Recognition

FSI

Revenue for FSIs and custom cooperative FSIs is recognized in the period that the product is distributed in the newspaper. In accordance with industry practice, Valassis generally pre-bills FSI customers (except remnant space) in advance of the related distribution date. However, these billings are reflected as progress billings (liability) until the appropriate distribution period. Provision for rebates or pricing adjustments are made at the time that the related revenue is recognized.

ROP

ROP revenue is recognized on the date that the advertisement runs in the newspaper. Some customers have contracts whereby Valassis earns a transaction fee and the media costs are pass-through costs to the customer. In such cases, Valassis only recognizes the transaction fee as revenue on the date the advertisement runs in the newspaper. Customer contracts can vary which may lead to material changes in revenue for this segment, while not affecting absolute gross margin dollars.

Cluster Targeted

The majority of Cluster Targeted products are newspaper delivered and revenue is recognized in the period that the product is distributed. For non-newspaper-delivered products, revenue is recognized when the product is shipped to the customer or distributed to the consumer via direct to door.

1 to 1

Revenue for direct-mail products is recognized when the product is inserted into the United States Postal Service mail stream. In most cases, postage costs are passed through directly to the customer and are not recognized as revenue. Revenues from software products are recognized per installation and revenues from services are recognized on a percent-complete method.

18

International & Services

Revenue for coupon clearing does not include the face value of the coupons processed or the retailer service fee. However, customers are billed for the face value and retailer fee which are included in both accounts receivable and accounts payable. Once coupon processing has been completed, fee revenues are recognized.

Stock Compensation – Valassis grants stock options to its employees under various incentive plans. Options are granted with exercise prices equal to the fair value on the date of grant. We account for all options under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and make various estimates used in calculating the pro forma results as required by SFAS No. 123. Valassis will adopt SFAS No. 123R, as required, in 2005.

Derivative Financial Instruments – Valassis uses derivative financial instruments, including forward foreign exchange and swap contracts, to manage its exposures to fluctuations in foreign exchange rates and interest rates. The use of these financial instruments mitigates our exposure to these risks with the intent of reducing the risks and the variability of our operating results. Valassis is not a party to leveraged derivatives. On the date a derivative contract is entered into, Valassis designates the derivative as either (1) a hedge of a recognized asset or liability or of an unrecognized firm commitment (a fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge) or (3) a hedge of a net investment in a foreign operation (a net investment hedge).

For cash flow hedges, the effective portion of the change in the fair value of the derivative is recorded in accumulated other comprehensive loss in the consolidated balance sheet. When the underlying hedged transaction is realized, the gain or loss included in accumulated other comprehensive loss is recorded in earnings and reflected in the consolidated statement of income on the same line as the hedged item. In addition, both changes in the fair value excluded from our effectiveness assessments and the ineffective portion of changes in the fair value are recorded in earnings and reflected in the consolidated statement of income as other expense, net.

Valassis formally documents its hedge relationships, including the identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. Derivatives are recorded at fair value in other current and long-term assets and other current and long-term liabilities in the consolidated balance sheet. This process includes linking derivatives that are designated as hedges of specific assets, liabilities, firm commitments or forecasted transactions. We also formally assess, both at inception and at least quarterly thereafter, whether a derivative used in a hedging transaction is highly effective in offsetting changes in either the fair value or cash flows of the hedged item. When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting. Hedge ineffectiveness, determined in accordance with SFAS No. 133, did not have a material impact on operations for 2004 or 2003. No cash flow hedges were re-designated or discontinued during 2004 or 2003.

Other Matters – Valassis does not have off-balance sheet arrangements, financings or other relationships with unconsolidated entities or other persons, also known as “variable interest entities.”

19

BUSINESS OUTLOOK

The following statements are based on expectations as of the filing of this document. These statements are forward-looking and actual results may differ materially.

Valassis expects earnings per share for 2005 to be between $1.80 and $2.00, based upon the following assumptions:

RISK FACTORS

A wide range of factors could materially affect the Company’s future developments and performance, particularly the statements made in the “Business Outlook” section. General factors affecting our operations and future financial performance include the following:

Risk Factors Relating to our Business

Increased competition could reduce the demand for our products and services, which could have a material adverse effect on our business, financial condition, results of operations and business prospects

Our Mass products compete in the cooperative FSI business principally with News America Marketing, a company owned by The News Corporation. We compete for business primarily on the basis of the following:

In the past, new competitors have tried to establish themselves in the FSI market. During such times, the number of FSI programs increased, resulting in periods of intense price competition and higher costs due to a decrease in pages per FSI program. Should a new competitor try to enter the FSI market in the future, it could have a material adverse effect on our financial performance.

Our principal competitor in the cooperative FSI market, News America Marketing, has been competing aggressively for FSI business. As a consequence, prices trended downward in 2004 although we were able to regain some market share in 2004 in comparison to 2003 and the industry grew by a percentage in the mid-single digits. The combination of these factors has resulted in a slight increase in revenues and declining profitability for our FSI business. During the third quarter of 2004, we announced a strategy to increase Valassis pricing without a

20

loss of market share. The results of this strategy remain inconclusive and a continuation or acceleration of these competitive trends could have a material adverse effect on our financial results.

We compete with media other than cooperative FSIs for the promotion and marketing dollars of our customers. It is possible that alternative media or changes in promotional strategies could make FSIs less attractive to our customers or could cause a shift in their preference to different promotional materials or coupon delivery modes. In addition, some of our competitors, particularly News America, have substantially greater financial resources than we do.

Our Mass products also compete with several newspaper network groups in the run-of-press (“ROP”) market. While entering the ROP business does not require a significant investment in machinery and equipment, it does require a significant investment in systems and people in order to compete in today’s environment. An increase in the number of ROP competitors could result in a loss of market share.

Our Cluster Targeted segment competes against commercial printers and media placement agencies for solo specialized promotional programs for single advertisers. While both types of competitors have a history of competing on the basis of price to increase volume and improve economies of scale, commercial printers tend to be particularly aggressive during periods when they have overcapacity. In addition, we compete with Sunflower Marketing for polybag advertising and sampling. To the extent our competitors in these businesses decide to compete more aggressively on price due to excess capacity or for other reasons it could materially negatively effect our revenue and profit margins.

Significant increases in the cost of paper (which we cannot control) could adversely affect our financial health

Our paper prices have historically experienced significant fluctuations. We have a limited ability to protect ourselves from these fluctuations or to pass increased costs along to our customers. We maintain on average less than 30 days of paper inventory. Significant increases in the cost of paper could have a material adverse effect on our financial performance. To protect Valassis against the risk of price fluctuations, a significant portion of our paper requirements is purchased from two paper companies under long-term contracts. These contracts limit the amount of increases or decreases (to approximately 10% in any calendar year) of Valassis’ cost of paper purchased from these suppliers. Such cost can be adjusted quarterly. As of January 1, 2004, approximately 90% of our FSI paper requirements were purchased pursuant to certain long term paper contracts which limit our exposure with respect to the price of paper during the term of those contracts. However, we cannot assure you that when such contracts expire that we will be able to replace such contracts with favorable terms or at all.

Significant increases in our media rates could adversely affect our financial performance and prevent us from fulfilling our obligations under these notes

Currently, our largest cost component of our business is our media cost, the payments that we make to newspapers for insertion of promotional materials. At this time, we have certain long-term contracts with newspapers providing for these services. We cannot assure you that when these newspaper contracts expire that we will be able to replace such contracts with favorable terms or at all. Consequently, an increase in media costs could adversely affect our profitability.

The uncertainty of current economic and political conditions make budgeting and forecasting difficult and may reduce sales promotion spending

The future direction of the overall domestic and global economies could have a significant impact on our overall performance. The potential for future terrorist attacks, increased global conflicts and the escalation of existing conflicts has created worldwide uncertainties that may have a negative impact demand for our products. Because all components of our budgeting and forecasting, as well as that of our customers, are dependent upon estimates of growth in the markets we and our customers serve and demand for our and their products, the prevailing economic uncertainties may render estimates of future income and expenditures even more difficult than usual to make.

21

These risk factors that may affect future performance and the accuracy of forward-looking statements is illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

Our principal market risks are foreign exchange rates at Valassis’ international subsidiaries, interest rates on various debt instruments and credit risk on investments.

Foreign Currency

Currencies to which Valassis has exposure are the Mexican peso, Canadian dollar, British pound and the Euro. Currency restrictions are not expected to have a significant effect on our cash flows, liquidity, or capital resources. Valassis typically purchases the Mexican peso under three to 12-month forward foreign exchange contracts to stabilize the cost of production in Mexico. Under SFAS No. 133, our Mexican peso forward exchange contracts meet the definition of a cash flow hedge. Accordingly, changes in the fair value of the hedge are recorded as a component of other comprehensive income. For the year ended December 31, 2004, we recorded an unrealized market value gain of $129,000 in other comprehensive income. Actual exchange losses or gains are recorded against production expense when the contracts are executed. As of December 31, 2004, Valassis had a commitment to purchase $5.1 million in Mexican pesos over the next 12 months.

Interest Rates

Valassis has a revolving line of credit of $125.0 million with a variable rate of interest calculated on either a Euro Currency-based rate or a prime rate. As of December 31, 2004, there was no outstanding balance under this line of credit and, therefore, no exposure to interest rate risk.

By balancing the mix of variable- versus fixed-rate borrowings, Valassis manages the interest-rate risk of its long-term debt. In June 2004, we entered into two interest rate swap agreements whereby we swapped fixed rates under our 6 5/8% Senior Notes due 2009 for variable rates equal to three-month average LIBOR, plus the applicable margin of approximately 230 basis points on $50.0 million notional value of debt. Three-month LIBOR was approximately 256 basis points as of December 31, 2004.

Valassis has performed a sensitivity analysis assuming a 10% (or approximately 25 basis points) adverse movement in rates applicable to our variable interest rate swap. As of December 31, 2004, the analysis indicated that such movement would not have a material effect on our consolidated results of operations.

22

VALASSIS COMMUNICATIONS, INC.

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

23

VALASSIS COMMUNICATIONS, INC.

Consolidated Balance Sheets, Continued

See accompanying notes to consolidated financial statements.

24

VALASSIS COMMUNICATIONS, INC.

Consolidated Statements of Income

See accompanying notes to consolidated financial statements.

25

VALASSIS COMMUNICATIONS, INC.

Consolidated Statements of Stockholders’ Equity (Deficit)