Although Valassis Communications (NYSE:VCI) may not be a household name, I am sure it has reached your household at some point. Valassis provides various types of marketing solutions to companies like Procter & Gamble (NYSE:PG), Yum! Brands' Pizza Hut and KFC (NYSE:YUM), Starbucks (NASDAQ:SBUX), and many others. Valassis creates free-standing inserts (FSI) in newspapers equipped with advertising and coupons, direct mail samplers, and direct mail specials for customers. It's a great way for companies to reach potential customers in a cost-effective way and drive sales.

According to the fourth-quarter and year-end earnings release, sales are on the rise. Revenue grew almost 27% in the fourth quarter, and Valassis just eclipsed $1 billion in yearly revenue. When you are good at helping product providers reach potential customers and turn them into buyers, people will pay for your services. On the conference call, management spoke about how it expects the momentum to continue into 2005 as well, earning Valassis an upgrade from the Robert W. Baird analyst to outperform.

But management was quick to point out something else clearly evident on the income statement. Even though revenues were rising due to higher volumes of FSI products, increases in bundled selling, and new customers, not all of the benefits dropped to the bottom line. That's because the cost of goods sold and selling, general, and administrative (SG&A) expenses have been rising faster than sales, as shown in the table below.

Q3 Q4
2003 2004 2003 2004
Cost of Goods Sold 67.8% 72.2% 70.3% 74.3%
SG&A 12.7% 12.9% 13.8% 12.6%

To increase volume and deal with competitors like ADVO (NYSE:AD) and HarteHanks (NYSE:HHS), FSI prices declined at a time when paper costs increased and customers moved to lower-margin products. On the call, management said that getting back to 2001 pricing levels for 2005 volumes would increase earnings per share by about $0.40. I hope it can do it.

While you can't argue with its past success, Valassis is in a tough business where it can get squeezed by both newspapers (the distribution system) and the product providers. It will have to continue to innovate in order to fight off the commodity moniker. And with its stock price reaching a 52-week high, I would wait for lower levels before buying.

Fool contributor David Meier does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.