Deluxe Corporation (DLX) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Second Quarter 2013 Deluxe Corporation Earnings Conference Call. My name is Dave. I'll be your operator for today. [Operator Instructions] As a reminder, the call is being recorded for replay purposes. I'd now like to turn the call over to Mr. Terry Peterson, Chief Financial Officer. Please proceed, sir.

Thank you, Dave. Welcome to Deluxe Corporation's 2013 Second Quarter Earnings Call. I'm Terry Peterson, Deluxe's Chief Financial Officer. Joining me on the call today is Lee Schram, Deluxe's Chief Executive Officer. Lee and I will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question. In accordance with the Regulation FD, this call is open to all interested parties. A replay of the call will be available via telephone and Deluxe's website. I will provide instructions for accessing the replay at the conclusion of our teleconference. Before I begin, let me make this brief cautionary statement. Comments made today regarding financial estimates and projections and any other statements addressing management's intentions and expectations regarding the company's future performance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Additional information about various factors that could cause actual results to differ from those projected are contained in the news release that we issued this morning and in the company's Form 10-K for the year ended December 31, 2012. In addition, the financial and statistical information that will be reviewed during this call is addressed in greater detail in today's press release, which is posted on our Investor Relations website at deluxe.com/investor, and it was furnished to the SEC on Form 8-K filed this morning. In particular, any non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release. Now I'll turn the call over to Lee.

Thank you, Terry, and good morning, everyone. Deluxe delivered another very strong quarter, and we are well positioned as we enter the second half of the year to grow revenue for the year in the mid-single digits, despite a continued sluggish economic environment. We reported revenue in the second quarter at the upper end of our outlook, and earnings per share far exceeded the high end of our outlook. Revenue grew about 3% over the prior year quarter. Small Business Services revenue grew 8%. Checks and forms performed well, and marketing solutions and other services revenues grew 21% over the prior year. Adjusted diluted earnings per share grew 13% over prior year. We generated solid operating cash flow, and we were not drawn on our credit facility during the quarter, increasing our balance sheet cash position $7 million from last December. We also repurchased $19 million in shares in the quarter and now, $32 million year-to-date. We acquired VerticalResponse in June to significantly improve our e-mail marketing capability and fill a gap we believe we had in our offerings in the promote and market services space for small businesses. We also recently announced an exciting partnership with VerifyValid in the secure online payment market. We continued our new brand awareness campaign to help better position our products and services offerings and drive future revenue growth. We also advanced process improvements and exceeded our cost reduction commitment in the quarter. In a few minutes, I will discuss more details around our recent progress and next steps, but first, Terry will cover our financial performance.

Thanks, Lee. Earlier today, we reported diluted earnings per share for the second quarter of $0.94, which included losses of $0.02 per share from restructuring and transaction-related costs. Excluding these costs, adjusted EPS of $0.96 far exceeded the upper end of our outlook and was 13% higher than the $0.85 reported in the second quarter of 2012. The restructuring charges are primarily for employee severance and infrastructure consolidations, and the transaction costs are associated with the VerticalResponse acquisition. Revenue for the quarter came in at $381 million and grew 2.8% over last year and almost 2% organically. Small Business Services revenue of $252 million grew 8% versus last year. While we continued to operate in a weak small business economic environment, we delivered growth in marketing solutions and other services, which included the impact of recent acquisitions, accessories and checks revenue. Our online Safeguard distributor, major accounts and dealer channels each reported strong growth in the quarter. Financial Services revenue of $83 million declined 3% versus last year. The impact of lower check orders offset the benefits of price increases and higher marketing solutions and other services revenue. Direct Checks revenue totaled $47 million, which was down 11% on a year-over-year basis. From a products and services revenue perspective, checks were $217 million and represented 57% of total revenue. Business products were $86 million or 22% of total revenue, and marketing solutions and other services were $78 million, which was 21% of total revenue. Gross margin for the quarter was 65% of revenue, which was down 0.6 points from 2012. Less favorable product mix and increased material and delivery rates were only partially offset by benefits from price increases and improvements in manufacturing productivity and delivery initiatives. SG&A expense decreased $3.3 million in the quarter, and was 43.1% of revenue compared to 45.2% of revenue in the same period last year. Benefits from our continuing cost reduction initiatives in all 3 segments and lower performance-based compensation and medical expenses were partially offset by increased SG&A in Small Business Services associated with acquisitions, commissions on increased revenue and higher brand awareness spending. Excluding restructuring charges and transaction-related costs, adjusted operating margin for the quarter was 22.1%, which was up 1.6 points from the 20.5% generated in 2012. All 3 segments delivered strong operating margins compared to expectations, aided by lower costs, including performance-based compensation and medical costs. Small Business Services operating margin of 18.8% was up 1.9 percentage points over last year due to cost reduction initiatives and lower costs. Financial Services operating margin of 26.5% was up 2.8 points from 2012 due to higher revenue per order, better product and services mix, cost reductions and lower costs. Direct Checks operating margin of 32% increased 1.2 points from 2012 as we continued to realize plant synergies from integrating Custom Direct. Turning to the balance sheet and cash flow statements. We increased our cash and cash equivalents balance by $7 million since year-end 2012 despite paying $27 million net for the VerticalResponse acquisition and repurchasing $32 million of our common stock. Total debt at the end of the quarter was $642 million, down $10 million from the end of 2012. Cash provided by operating activities for the first half of the year was $102.1 million, exceeding our expectations and up about $2 million from 2012. Compared to last year, stronger operating performance, lower contributions to fund future medical benefits and lower contract acquisition and income tax payments were partially offset by higher variable compensation earned in 2012 but paid out in the first quarter of 2013. Capital expenditures for the first 6 months were about $17 million, and depreciation and amortization expense was $32 million. On June 10, we acquired VerticalResponse for a net $27 million using cash on hand. During the remainder of 2013, the acquisition is expected to generate revenue of approximately $12 million and be approximately $0.06 dilutive to earnings per share after absorbing acquisition-related amortization expense. Given our strong performance in the second quarter and the addition of VerticalResponse, we are raising our consolidated revenue outlook for the year to a range of $1.57 billion to $1.59 billion. We are also raising our adjusted diluted earnings per share to an expected range of $3.72 to $3.82, including an expected $0.06 dilution from the VerticalResponse acquisition and excluding $0.06 related to restructuring and transaction-related costs. There are several key factors that contribute to our full year outlook, including: Small Business Services revenue is expected to increase 9% to 11% as volume declines in core business products are expected to be offset by benefits from our e-commerce investments; price increases; growth in our distributor, dealer and major accounts channels; and double-digit growth in marketing solutions and other services offerings, which now include the VerticalResponse acquisition. We expect Financial Services revenue to decline 2% to 3%, driven by recurring check order declines of approximately 5% to 6% and some pricing pressure, which we expect will be partially offset by our new national account win, continued growth from non-check revenue streams and price increases. Direct Checks revenue decline of approximately 9% to 10%, driven by check volume reductions; a continued sluggish economy; additional cost and expense reductions, which we now estimate to be approximately $55 million; increases in material and delivery rates; continued investments in revenue growth opportunities, including brand awareness; marketing solutions and other services offers and enhanced Internet capabilities; lower interest expense; and an effective tax rate of approximately 34%. We expect to continue generating strong operating cash flows and are raising our expected range to between $250 million and $260 million in 2013, reflecting stronger earnings and lower VEBA payments for future medical costs, offset by higher tax and incentive compensation payments. We expect contract acquisition payments to be approximately $12 million. 2013 capital expenditures are expected to be approximately $35 million, roughly the same as 2012. We plan to continue to invest in key revenue growth initiatives and make other investments in order fulfillment and IT infrastructure. Depreciation and amortization expense is expected to be $65 million, including $20 million of acquisition-related amortization. For the third quarter of 2013, we expect revenue to range from $392 million to $400 million. Adjusted diluted earnings per share are expected to range from $0.88 to $0.93. In comparison to the second quarter, revenue is expected to be higher in the third quarter primarily due to SBS revenue growth, driven by marketing solutions and other services ramps in wholesale and retail services, including VerticalResponse and our Safeguard distributors. Adjusted EPS is expected to be lower, driven by amortization expense from the VerticalResponse acquisition, higher expected medical expenses, a shift in product mix and lower cost reductions, partially offset by SBS revenue growth. Shifting to our capital structure, we expect to maintain our balanced approach of investing organically and through small to medium-sized acquisitions in order to drive our growth transformation. We also expect to maintain our current dividend level and repurchase shares to offset dilution. To the extent we generate cash flow in excess of these priorities, we plan to accumulate cash in advance of our 2014 senior note maturity. We may also, from time to time, consider retiring outstanding debt through open market purchases, privately negotiated transactions or other means. We believe our strong cash flow, strengthened balance sheet and flexible capital structure position us well to continue advancing our transformation. I will conclude my comments with an update on our cost and expense reduction initiatives. Overall, we had another solid quarter as we exceeded our expected cost and expense reductions towards our $50 million commitment, net of investments, for 2013. Year-to-date, we have already achieved approximately $29 million in reductions. Given our year-to-date progress and expectations for the second half of the year, we are raising our original $50 million reduction estimate to $55 million for the full year. Our focus in sales and marketing for 2013 is on sales channel optimization, platform and tool consolidation and leveraging order streaming and marketing efficiencies. We also expect to continue improving the mix of paper catalog and online search engine marketing. In fulfillment, we are continuing to focus on our lean, direct and indirect spend reductions; further consolidating our manufacturing technology platforms; driving delivery technology and process efficiencies; reducing spoilage; further enhancing our strategic supplier sourcing arrangements; and continuing with other supply chain improvements and efficiencies. Finally, for the Shared Services infrastructure, we expect to continue reducing costs in IT and other areas as more opportunities exist to improve efficiencies. I would like to close with an update on backfilling the Investor Relations and Treasurer position. I'm extremely pleased with the response to the open position, and we have assessed a strong slate of candidates. I'm happy to announce that Ed Merritt will be joining Deluxe in this role in mid-August. Ed's most recent IR and Treasurer experience has been with Digital River. Now I'd like to turn the call back to Lee.

Thank you, Terry. I will continue my comments with an update on our key revenue growth area, marketing solutions and other services, including perspectives on our recent VerticalResponse acquisition and insights to date on our new brand awareness campaign. I will then highlight progress in each of our 3 segments, including a perspective on what we hope to accomplish during the balance of 2013. Our primary focus in 2013 continues to be profitable revenue growth and increasing the mix of marketing solutions and other services revenues. The most significant revenue growth opportunities continue to be in marketing solutions and other services. We will continue to assess potential small to medium-sized acquisitions that complement our large customer bases with a focus on marketing solutions and other services. We are adding more products and services to our portfolio and believe our strong, small business channel reach, including financial institutions, online, retail, wholesale, feet-on-the-street distributors, dealers, partners and major accounts, is a differentiator for us in the marketplace. Deluxe is now more capable of helping small businesses pursue their passion as a trusted provider of a growing suite of products and services a small business needs to market and operate their business, and helping small to midsize financial institutions with customer acquisition, risk management and other value-add services offers. Here is an update on our 4 subcategories framework for marketing solutions and other services. We ended the second quarter right in line with our expectations for revenue and mix in the 4 subcategories basically in line with our expectations. First, small business marketing is expected to represent approximately 41% of revenue in 2013, with expected growth in the upper teens this year. We saw strong double-digit growth in the second quarter in the Web-to-print space as we cross-sold to our customer base and added new customers through distributors, dealers and major accounts. The second category, Web services, which includes logo and Web design, Web hosting, SEM, SEO, e-mail marketing, social and payroll services, is expected to represent approximately 32% of revenue in 2013, with expected organic growth rates in the mid-teens, although expected reported growth will be closer to 30%, driven by the VerticalResponse acquisition. We saw a little stronger rollout ramp in wholesale Web telco major accounts in the second quarter from the deals that we closed in 2012, which we expect will roll out throughout 2013. We saw growth from the prior year in cross-selling bundled presence packages to our retail base and added more new customers, resellers and partners. We continue to reduce Web design and SEM campaign cycle times, and churn rates remain low. We added payroll services customers, and many customers added new features, such as time and attendance applications. This category also is our focus area for tuck-in acquisitions, with VerticalResponse being a good example. VerticalResponse brings us a critical mass customer base, on top of what we believe was a gap in our services portfolio in the promote and market space. By expanding our portfolio with comprehensive promotion and marketing capabilities, we can now more effectively achieve our strategic goal of helping small businesses acquire more customers. VerticalResponse's primary offer is e-mail marketing, and they also provide social media and content management tools that make it easier for small businesses to manage communications across multiple channels. They have created a new integrated platform, providing a do-it-yourself entry point for all products and services and allowing do-it-for-me agent provisioning, and product extensions from e-mail to social to activation in an emerging fourth quarter expected release of a freemium model. They have approximately 45,000 active paying customers, both direct and indirect, a low churn rate and a seasoned management team. We expect their emerging freemium model will allow us to spur a mass trial and subsequent upsell and cross-sell penetration capability, first, into our retail, but then into our wholesale customer base. We closed the second quarter with over 625,000 Web hosting customers, and we expect to close 2013 with nearly 750,000 Web hosting customers or up 36% from 2012 as we expect migrations to ramp through the balance of the year. The third category, fraud, security and risk management services, are expected to represent approximately 22% of revenue in 2013, with expected growth rates in the high single digits. We had a strong second quarter as we added program services for new community banks and fraud and security offers for small businesses and direct to our consumers. We added Banker's Dashboard customers as well. Finally, other financial institution services are expected to represent approximately 5% of revenue in 2013, with very strong double-digit expected growth rates. Key growth initiatives here include adding new Cornerstone and SwitchAgent clients. We expect marketing solutions and other services revenues to be approximately $345 million to $355 million in 2013, up from $285 million in 2012, with organic growth in the mid-teens. If achieved, this performance would translate to a total revenue mix of around 22% of revenue, including a year-end exit run rate above 25% of revenue, towards our 25% mix goal and up from 19% in 2012 and 16% and 13% the previous 2 years. Now shifting to our new brand awareness campaign. We have completed 2 waves so far this year and have outperformed publishers' benchmarks for online ad click-through rates. We have seen strong traffic to deluxe.com, up over 20%, and YouTube views of the commercials are now approaching 1 million. Inbound call leads are converting to sales at a very strong rate of 20%. Based on the positive results to date, we plan to stay the course and continue our media efforts at various times through the balance of 2013 and focused first. We will also continue to modify deluxe.com sell paths for websites, printing and online marketing, which we expect will continue to improve conversion rates. For competitive reasons, we will not disclose investment levels other than to indicate it is a multimillion-dollar campaign, and all planned spending is included in our current outlook ranges. We have established return on investment criteria based on the number of impressions, expected site visits and online leads. We will use these results against our metrics to guide us as we progress on this new brand journey. It is important to remember this campaign is primarily focused on improving brand awareness and not a targeted direct-response campaign. We completed a brand awareness customer study after running our second media wave in the second quarter, and we saw awareness of the Deluxe brand jump considerably. Just some examples. Unaided awareness of companies that offer products and services to help manage and run small businesses increased significantly, including doubling among Deluxe customers, while familiarity with Deluxe website design and hosting services improved significantly, from 47% to 62%. Now shifting to our segments. In Small Business Services in the quarter, as expected, we did not see any notable improvements as the economic climate for small businesses remained sluggish. We had strong performance as revenue grew 8%. Checks and forms performed well. Our results from targeted customer segmentation in the call center improved. New customers from our financial institution, Deluxe Business Advantage Referral Program and through our direct response campaigns remained strong. Response rates, average order value and conversion rates improved. Our online Safeguard distributor, major accounts and dealer channels grew revenue over the prior year. We also saw strong growth in Web, SEM and payroll services. Again, we ended the quarter with over 625,000 Web hosting customers. We continue to closely monitor the small business market. Optimism indices increased in May -- in April and May, with May's readings the second highest since the recession started and a 12-month high. But as the quarter ended in June, there was a bit of a drop-off in optimism. Pessimism about the economy and the future moderated, and sales expectations are trending better. More owners are planning to hire in the coming months, and more new firms are starting than failing right now. They continue to spend cautiously, more in maintenance mode, scrutinize purchases and experience tight cash flow. In summary, current optimism indices have been sluggish but trending upward the first half of the year. However, they remain in recessionary levels. The good news is that other than taxes and regulation, increasing sales continues to be a small business owner's #1 pain point, and our portfolio is significantly more robust now with many offers to help them here. As the economy recovers, with the transformative changes we are making to deliver more services offerings that help small businesses get and keep customers, Deluxe is better positioned as that indispensable partner for growth. Our focus for 2013 is on accelerating our brand transformation and significantly improving overall market awareness while institutionalizing our brand promise for our customers; profitably integrating and extending our marketing solutions and other services portfolio, including our recent VerticalResponse acquisition; effectively acquiring and retaining customers across multiple channels; building a more effective retail services sales model; scaling major accounts and strategic channel partner relationships; and improving our customer experience. An example of an exciting strategic partner relationship is our recently announced partnership with VerifyValid. VerifyValid is a leading provider of electronic payment solutions that transforms how businesses and banks use and accept checks. Small business customers can securely make and receive check payments online, utilizing a virtual lockbox and virtual remote deposit capture system. We are introducing the electronic online payment solution to a portion of our customer base and have already seen strong initial acceptance and paying customers. In Financial Services, we have seen a year-to-date secular check decline rate of about 5.5%, with the decline rate higher in the second quarter versus our outlook of 5% to 6%, with rates consistent across both the national and community segments. We had strong overall new acquisition rates, and our retention rates remain strong on deals pending in the current quarter, well in excess of 90%. We are pleased to announce that we anticipate starting the migration soon with HSBC, which is the new client that we referenced on our first quarter call. In addition to gaining the consumer check business, this is an exciting opportunity for our DBA program as well, given HSBC's strong focus and commitment to small business customers. We are also beginning to work several more competitive opportunities. We simplified our processes and took complexity out of the business while reducing our cost and expense structure. Although the decline rate was a little higher in the second quarter, so far, in July, we have seen decline rates closer again to the 5% -- to 5%. And we are planning for check units to remain within a decline range of around 5% to 6% for the balance of the year. We also expect retention rates in excess of 90% on deals pending this year, and with approximately 2/3 of our 2013 community bank contract renewals already completed by the end of the second quarter, we are well ahead of the linear pace for the year. We made progress again in the quarter in advancing marketing solutions and other services revenue opportunities. Revenue grew over last year in these non-check services, which include customer acquisition, risk management and other profitability offers. In customer acquisition and specifically, our Cornerstone direct marketing analytics offer, we saw continued growth in new financial institutions and reported our highest quarterly revenue ever. Our small -- our all-branch rollout with a large financial institution for our SwitchAgent offering continues to gain momentum, and we implemented in the second quarter another nice-size branch rollout with a non-Deluxe check financial institution. We continue to believe it will be an important tool for banks beyond acquisition to anchoring profitable clients. Financial institutions that use SwitchAgent are realizing a more profitable new account base due in part to the role SwitchAgent -- due in part to the role of SwitchAgent in activating key payment services. Banker's Dashboard also continued to perform well in the second quarter. As you can see, momentum continues to build, and we expect strong double-digit growth in these marketing solutions and other services in 2013. In Direct Checks, revenue was slightly below our expectations, driven by lower initial orders and reactivations. We believe some of this is related to the timing of advertising placements. We continue to look for opportunities to provide accessories and other check-related products and services to our consumers. Although we have made significant progress with the Custom Direct integration, we are still working on a number of initiatives to create an integrated best-in-class direct-to-consumer check experience. As an example, we now have one integrated process producing all direct-to-consumer checks. We continued to see a ramp in revenue enhancement synergies through our call center scripting and upsell capabilities, as well as synergistic cost and expense reductions. For 2013, we expect Direct Checks revenue to decline in the high single digits, driven by continued declines in consumer usage in a sluggish economy. We expect to reduce our manufacturing costs and SG&A in this segment and hold our operating margins in the 30% range while generating strong operating cash flow. As we exit the second quarter on the heels of a very strong quarterly performance and a continued sluggish economy, we have made tremendous strides in transforming Deluxe, but we still have many opportunities ahead of us in 2013. Our strong first half of the year positions us well to grow revenue in 2013 for the fourth consecutive year. We are conservatively not expecting the economic climate to improve throughout the balance of the year until we get better clarity as the third quarter unfolds. If the economy improves, we should have upside in revenue. At the same time, we will not take our eyes off the cost reductions and process improvements, and we expect to continue to generate strong cash flows and provide a very attractive dividend. We have developed a strong platform for long-term growth, with the objective of transforming Deluxe to more of a growth services provider from primarily a check printer, thereby changing our product mix and resulting stock price multiple. Now Dave, we'll open the line, and Terry and I will field questions.

[Operator Instructions] And your first question comes from the line of Charlie Strauzer at CJS Securities.

Terry, Lee, if you could just talk a little bit more about margins. I mean, you had a very nice jump in margins in the Small Business segment sequentially from Q1 and nicely up year-over-year. And as we look out to the rest of the year and into next year, what are your expectations for margins in that segment? And are we seeing kind of, like, the bulk of the investment spend in some of the growth initiatives kind of starting to ebb a little bit there?

Thanks for the questions, Charlie. This is Terry, and I'll go ahead and address that. We're very happy with the margins that we really delivered in, actually, all 3 segments this quarter. They were quite strong across the board, but especially strong in Small Business Services, where we did see about a 3-point gain from first quarter and a nice year-over-year increase as well. We do -- the margin that we saw was stronger than, I think, we would expect to see on an ongoing basis. I think as we look at the first quarter to second quarter, we didn't have as much brand awareness campaign spending in the second quarter, and that was -- we planned it that way as well. So we did expect to see that pop up a little bit there. Plus, too, we referenced in our press release and some of the prepared comments there, too, that we did see -- we got a little bit ahead in our cost reduction, so that flowed through. And most of those cost reductions flowed through in the Small Business segment. And we also saw lower costs in some other areas, like the medical costs, and we aren't expecting that favorability will continue. So we do think that it'll bring our margins a little more in line with what we've seen in the past. Still, we really kind of expect over time that Small Business margin to be kind of in that 17% range, 17% to 18%, so in the 17s. That's probably more normal than something closer to the 19% we saw this quarter. So overall, we're, again, managing this business to deliver a stable and comparable margin rate, kind of in the low 20s, for the overall company, maybe just up slightly over time. But we're focused more on delivering increasing margin dollars with profitable revenue growth, not so much a higher margin rate overall. But again, we will see some volatility, especially at a segment level, from quarter-to-quarter.

Well said. That was very helpful. And Lee, maybe you could talk a little bit more kind of bigger picture. Now that you've kind of built out a nice portfolio of offerings in the Small Business, in the marketing services area, as you talk to customers and customers give you feedback, are there pieces that you feel that you're stronger in versus weaker in that you maybe can kind of bolster some of the weaker ones, like you did with the acquisition today -- that you announced today, I mean?

So I think, as we said in the prepared comments, the key for us in doing all our research and all the work we continue to do with Small Business customers, think of it like this. If you're an early in practice, so to speak, small business owner, we know now that they're looking -- once they've funded their small business and once they've come up with their idea, they generally go through a process of wanting to get -- brand themselves and start promoting themselves. So the presence package or the initial package is around logo and Web design, getting them hosted on their website. And then kind of moving up the maturity curve on marketing, as you kind of get more advanced on the Web and then get more advanced in social and then even head on towards wanting to find and get customers through search engine marketing and how you optimize there, and then continuing to move out in how you help manage and guide and handle and manage their marketing expense, an area that we found and we've been looking at very closely is how do we keep more day-to-day contact. So not just do a logo for somebody and put it on anything they want it on, or host their website or work with them on search. We wanted to get to the point where we were working more closely. And we felt -- we call that the promote and market space. And while we have an e-mail marketing offer, we just felt VerticalResponse is just a better offer than what we have. And the customer base. And then where they're going, they've completely revamped their model. I had my development people look very closely at the work they've done, and we've just been really impressed with what they've come up with. And that gap now we feel that we had is filled, and obviously, we've got to fulfill the promise now of that, but those are the pieces that were -- that was probably the biggest gap that we had in kind of that services mix. The other thing that I don't want to underscore is this VerifyValid announcement that we made a few days ago. If you think about the work that we've done around marketing services and continuing to fill that out and with other print offers that we have, we feel we're getting stronger and stronger there. And of course, we have checks, and checks is a payment vehicle for people. And what we like about VerifyValid is it's another more service-oriented and in an electronic payment way, although it takes the form of a check. We think it's a way to fill a gap. If a small business owner, for example, is moving from a check and paper and wants to move kind of into an electronified world, we see this as a wonderful bridge opportunity. And again, it's early, but the initial response we've seen from our small business customers has just been very positive. So those are areas that we've been trying to look at, Charlie, and fill in. And I can't tell you that we're done. As I mentioned, we're continuing to look, but I think we filled a big gap that we had with the VerticalResponse opportunity.

Well, clearly, when you've embarked on a path where you've maybe brought in a small company to get you a new leg of the stool, so speak, in the offering portfolio, you've realized that maybe you could find something that can bolster, like with the OrangeSoda acquisition, for instance, where it added on to what you already have there and it kind of turbocharged it. It seems like those are the methodology you've been kind of going down the path of. Are there other pieces that you think that are kind of like that you can turbocharge it a little bit more with some acquisitions?

We're always looking for customer bases that make sense for us. Were looking for technologies. We're looking for process improvements, things that we think can add to our infrastructure. What I would tell you, Charlie, is those are the things that we'll continue to look at as we continue to look for tuck-in acquisitions that make sense for us.

Your next question comes from the line of Randy Hugen at Feltl.

I just wanted to dig in a little bit on the VerifyValid. What does their current customer base look like? And also, what was the decision there on your part to partner versus buy?

The current customer base at this point, Randy, we're just getting started. So we basically -- a lot of things that we do, and whether it was initially what we did in the logo design area or what we initially did in the Web services area, is we try to pilot and test how our various offer is received by our small business or our consumers. And so the VerifyValid is a pilot opportunity that we've now decided is something that is significant enough for us in terms of the initial interest that we decided to form a stronger partnership with VerifyValid. So we're very early stage at this point in time. We're working through all of the ramifications for how we want to do the partnership, and we want to continue to test into that at this point in time. But we thought it was worthy of announcing because we test a lot of different things, and this one was one we just felt was -- it has an opportunity to take off more than other things that we've partnered in. What I would tell you at this point in time, it's just too early to make a decision whether there's an acquisition opportunity with them or in the space in general.

All right. And then on VerticalResponse, you mentioned that you're expecting about $12 million there in revenue for the rest of the year. How much of that was their existing clients versus, I guess, cross-selling into your customer base?

Here's the assumption that we -- that's a good question, Randy. Here's the assumption that we made at this point in time. That's going to mostly come right now from their base of customers because, as I mentioned, this new freemium model is going to come out here in the fourth quarter, and we're getting close to being able to get this out. And that's when we're going to start to work our retail base and then work our wholesale base into that. So think of it as we're kind of investing, completing the investment in the technology and the platform in the third quarter and then kind of kicking that off into the fourth quarter. So we're going to try to be really smart about how we do this. So most of that business is going to be from the current base we have. I would look at the opportunity for scale here, Randy, going forward as more as we head into 2014.

Great. And then on the increase in hosted websites, is there a specific channel that's driving that, or is that really broad-based across the business?

Right now, as we've mentioned on some of our previous calls, we had a number of telco and media company deals that we closed in the second half of 2012, and they all go through this rollout. And they're all different, depending on what the telco wants to do, when they're ready to roll, how many they want to put in. And so we expected it to be lumpy as we kind of work through the year. But it's both on the retail side, but it's more on the wholesale side, just given the fact that a lot of these telcos are now rolling and migrating in. And we get both a base when we migrate and then the new business that comes in. And then in some of the deals, it's all coming from an organic buildup as they never really had a website-focused solution. So I would say it's more wholesale right now, but I don't want to not say we're adding retail because that's happening quite nicely as well.

There are no further questions for you now, gentlemen, so I'd now like to turn the call over to Mr. Lee Schram for closing remarks.

Again, I'd just like to thank everybody for being on the call today and thank Charlie and Randy for their questions. As I normally say, we're going to get back to work, roll up our sleeves, and I and Terry look forward to providing a positive progress report on our next earnings call. And obviously as well, I'm excited about getting Ed Merritt onboard, and we'll have Ed back, and he'll participate in the third quarter call. You'll probably see Ed, Terry and I also out on several visits in investor presentations through the quarter. So with that, I'm going to turn it back to Terry, and he'll go through the wrap-up of the call.

Thank you, Lee. This is a reminder that a replay of this call will be available until August 9 by dialing (888) 286-8010. When instructed, provide the access code 37879348. The accompanying slides are archived in our Investor Relations website at deluxe.com/investor. Again, thank you for joining us, and have a good afternoon.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.