Mitek Systems Inc (MITK) 2003 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Mitek Systems fourth quarter earnings conference call. (Operator instructions) As a reminder, this conference Is being recorded.

I would now like to introduce your host for today's conference Miss Jocelyn Hunter. You may begin.

Good morning. Thank you for joining us for Mitek Systems conference call. Management will discuss the results for the fourth quarter of the fiscal year, end of September 30th, 2003.

By now you should have all received a copy of the press release. If you have not received it, please call my office at 310-407-6555, and we'll get a copy to you right away.

With us from management today are President and CEO James DeBello and Chairman and CFO John Thornton. Mr. DeBello will begin with a review of the quarter and open the call to your questions. With the exception of historical matters, the matters discussed in this conference call are forward-looking statements that involve risks and uncertainties under the safe harbor provision of the U.S. Private Securities Litigation Reform Act and detailed in the public filings of the S.E.C. on forms 10 K and 10 Q.

Forward looking statements include but are not limited to-- statements relating to the development and the pace of sales of the company's products; expected trends and growth in the company's results of operations, projections concerning the company's available cash flow and liquidity; anticipated penetration and new and existing markets for the company's products, and the size of such markets, and to stated acceptance of company's products by existing and new customers; the availability of the company to achieve or sustain any growth in sales or revenue; and the increased sales representatives and other personnel.

The company's actual results could differ from such forward looking statements. There could be no assurance that the company will achieve the results set forth.

With that, I would like to turn the call over to Jim DeBello, President and CEO.

Good morning, everyone. Thanks for participating on my tech's fourth quarter 2003 conference call. I would first like to comment on the fourth quarter performance, then review the results for the year. Following that, I'll discuss our strategic priorities and market focus, and I'll conclude with some insights on the business outlook and open the call to your questions.

Let me begin by going over our financial results. Net sales were below expectations and came in at $1.7 million for the fourth quarter compared with $3.8 million for the year ago quarter, and $3 million for the third quarter. Sales were lower across all product lines.

Gross margin was 40% for the fourth quarter, a decline from 60% for the same quarter last year and 54% in the third quarter of fiscal 2003. Margins were negatively impacted by-product mix, which favored lower margin bank installations involving hardware. Fiscal fourth quarter 2003 total cost and expenses were $2.3 million, or 134% of net sales, relatively unchanged on an absolute basis from the $2.3 million, or 61% of net sales reported in the year ago quarter.

Sequentially, total costs and expenses were lower, compared with $2.6 million, or 86% of net sales for the third quarter of fiscal 2003. Although our total expenses year over year were lower, sales and marketing costs were higher due to expanded investment in our field sales team throughout the year and those related expenses.

We reported a net loss of $1.6 million, or 15 cents per basic and diluted share for the fourth quarter. This compares with a net loss of $15,000, or break even per share, for the same fiscal quarter last year and a net loss of $953,000, or 9 cents per basic and diluted share for the prior quarter. For the 12 months ended

September 30th, 2003, net sales were $11.6 million, a decrease of 11% with the net sales of $13.2 million for the fiscal year 2002. Net loss for the year was $2.5 million, or 22 cents per basic and diluted share compared with a net income of $397,000, or 4 cents per basic and diluted share for fiscal 2002.

Now, turning to our balance Sheet, and despite our loss, our financial position remains solid. We ended fiscal 2003 with no bank borrowings on our balance sheet, and cash and investments of $1.8 million compared with $760,000 at the end of fiscal 2002. We had working capital of $2.3 million in shareholders equity, totaling $2.6 million at September 30th, 2003. Clearly, we are disappointed, with our fourth quarter performance. All indications pointed to the fact that the customers we pursued during the quarter were reluctant to make purchasing decisions at that time. We faced a very challenging sales environment, where this unwillingness to commit by customers continued to be a major factor of frustration for us.

We believe that there were three factors that contributed to lower fourth quarter revenues. First, persistent and unyielding economic uncertainties. Second, lack of clarity surrounding the passage of check 21, which we'll discuss in a few minutes. And thirdly and lastly, intensified competition for a smaller number of bank deals during the summer. Now on a positive note, I believe that this customer in decision will be reversed over the next 12 months with the passage of check 21 regulation. Immediately following the end of our fiscal year in October, check 21 was signed by President Bush and instituted. Banks have 12 months to comply.

We believe this is as significant to the banking industry as when [Micre] was introduced on checks in the late 1960s. Check 21 allows banks to substitute electronic check images for paper checks in the clearance process. This new and electronic format is expected to dramatically reduce bank operating costs and save banks millions of dollars each year.

It's a direct outgrowth of the disaster of 9/11 when the airports were shut down for five days, and checks could not be sent around the nation for clearing. Now banks can do this with images. We happen to produce software that creates those images. With check 21 calling for the use of electronic check images within a year's time, we believe this new regulation opens up a number of new sales opportunities for us. And we've already begun to work with major image exchanges to enable our customers to take advantage of these benefits.

In addition, one of the biggest problems that we've identified and that banks face today is check fraud. According to the American Bankers Association, criminals in the United States attempted over $4 billion in check fraud in 2001, and that bank losses from these attempts approached $700 million. That's a statistic from the ABA in 2001.

We believe that check fraud has grown dramatically. 51% growth in the last two years according to the ABA and community banks alone. Check fraud is pervasive. It's afflicting large commercial banks and local community ones alike. As a result, banks are increasingly seeking fraud prevention solutions to stem those losses. With our Fraud Protect software platform and several other new products in development, we believe that we have the best in industry solutions to assist our bank customers in the prevention of check fraud. We recently released the FraudProtect tool kit that enables banks to detect fraudulent checks as they are presented, and they help those banks reduce potential bank losses by identifying those fraudulent checks in the course of clearing.

FraudProtect performs image-based fraud protection, and can reveal a variety of obvious and subtle differences between images of genuine checks and images of checks that have been altered or counterfeited. We believe this technology is unique in the industry, having won an award for innovation at a major industry trade show. We've taken steps to patent our intellectual property, and while other fraud detection software tools only analyze transaction-based data, such as out of sequence check numbers or amounts, our FraudProtect software is unique in its ability to detect key words, layouts, logos, and signatures.

In the course of my visits to many prospective customers, I've seen a lot of fraudulent checks, some of which amaze me with the level of sophistication, and others with their sloppiness. Regardless, both of these can be detected by our FraudProtect solution. And our banks are already expressing interest in this product.

I believe that this market segment is currently underserved. While most large banks possess some form of technology that can detect fraud, many of these systems are still inadequate and a lot of fraud is being perpetrated. And in a few cases where major banks have proper protection, criminals have simply changed their targets and mid and small sized banks and have invested their resources in this area.

It's easy for a fraud perpetrator to go down to a local store, buy a high speed scanner, a very powerful PC and software and paper stock and create counterfeit checks today. As an innovator of cost-effective check fraud solutions, we believe we have a first mover advantage with the introduction of our product family that can fulfill an unmet need in the marketplace with our products.

I am optimistic this focus area will provide an additional revenue stream by creating new sales opportunities for my tech. Furthermore, we believe that our new fraud solutions expand our addressable customer base into larger banks. While we expect sales of check imaging solutions and recognition engines to generate the majority of revenues in the new term, I believe our growing portfolio of fraud detection products, and the attractive dynamics of this market segment will drive our long-term growth.

Early interest in our fraud solutions is promising, and we're working with a number of major banking institutions to incorporate our fraud detection technology into the systems.

As you know, in late act, Wachovia treasury services announced the availability of a new service called Payee Match that was developed in a strategic alliance with Mitek. We are also currently in evaluation with another one of the nation's largest banking institutions to utilize our fraud prevention software--again. more evidence that we're extending our market scope into larger banks as well as addressing community banks, our current target.

We are actively expanding our fraud detection capabilities and anticipate the launch of another new product to address this segment in early calendar 2004.

There's no question that fiscal 2003 was difficult, and the immediate challenge we face is to rebuild our sales momentum, and lay the foundation for a long-term growth. We believe that our new focus on the rapidly growing fraud protection market and those opportunities generated from the passage of check 21 will be the key catalysts to get sales back on track.

In combination with our strength in sales and marketing, we're confident that brighter days lie ahead. I believe that the key to our success this fiscal year is our ability to quickly introduce new products in the fraud protection segment. We're working very hard in that area. With the advent of check 21 in addition, we expect to see increased demand for our recognition addition ins bank branches with bank teller machines, ATMs, and beyond.

Furthermore, community banks face a growing risk from check fraud. I mentioned the ABA reporting a 51% increase in incidences. We think that is continuing to increase. Meanwhile, we'll continue to control our expenses and adjust as business conditions require. We are confident that these steps will drive Mitek to the next level and enhance shareholder value.

I'll conclude that we are positioning our business to take advantage of these new growth opportunities. This will take some time, but we're confident that these steps will drive our long-term success. All of us at Mitek and myself appreciate your continued support. That ends my presentation. John and I would be happy to take your questions now.

Thank you. (Operator instructions) Our first question comes from Don Keegan.

Hello, Jim, John.

Hey, Don.

Hi, Don.

In the past, in moving product, you partnered with larger companies--Banktech, Unisys. Are you pursuing this presently with this new legislation and the new products you have?

Don, the answer is yes. We are very actively pursuing those existing customers. You mentioned two of them who are very important to us -- and others.

What we discovered with check 21 and the legislation is that the dynamics of the market will allow -- and the technology will allow the capture of these images to occur on a more distributed basis at the local banks, further at ATMs, and eventually even at the point of sale, at the retail location, for example.

So really there is an increased demand that we anticipate for the tools that we provide in the recognition area, specifically as they relate to the flags of quality of images, and we can provide that with our current technology. So we are currently in discussions with these customers and negotiating additional benefits and contracts.

Thank you.

Our next question comes from Robert Dimarzo, private investor.

Hi, Jim. Gross margins. They seem to be dropping, and I know a lot of times that is a function of hardware. Are we looking more at 40% 50% 60% as Norm going out, or is it still quite a wild card?

Bob, you're right. They have been dropping. It is a function of hardware. Many of our installations in Q4 were at the hardware phase. You know that in our systems integration process, there's a software phase, there's a hardware phase, and then we wrap up with some training, and they all have different margins. The margins were not good in the last quarter.

We expect, as you have surmised, that our average margins will average that 40% or 50% range. My desire is to drive more of the software sales, particularly the major OEM customers, in addition to that, with fraud. I think that will improve our gross margins.

We are, though, experiencing price erosion through the competitive dynamics of the market, particularly on the check side. A lot of guys out there who have good products.

Now, we think ours has unique features, in terms of work flow and balancing that are superior. But from a customer's viewpoint, they may think that some of the competing products also have superior features. So really what we end up seeing is that the banks come back to us, and they are pushing us very hard on price.

And, again, we're chasing a smaller number of deals. We hope that number will increase with the final passage of this check 21, but I want to note that takes 12 months before banks have to be fully compliant. And we think the banks will drag their feet, and perhaps go beyond that.

So in light of our installation of hardware, in light of the price erosion, and in light of the dynamics of the system integration process, I believe that we'll consistently see 40% to 50% gross margins. We are taking efforts, though, to move the mix more towards software.

Fraud is part of that direction. And we think ultimately that could have a positive impact on gross margins.

Wachovia was mainly FraudProtect?

Yes. Wachovia Securities is a major money centered bank, and it was exclusively fraud tools.

Can you give us any idea of the dollar value of that?

Regrettably, I can't do that due to the confidentiality of our agreement with Wachovia.

So really at this point, no calls from banks with regards to check 21?

No, I don't think that's true. I think banks are now asking are we check 21 compliant? We are. Are we supporting image exchange? We do. And they are beginning now to see the benefit -- I think the benefit is going to be more acute in a year's time.

Let me tell you why. Right now, banks typically move paper checks throughout the nation through the federal system. The feds charge them money per check.

As less checks are actually physically transported throughout the nation, the cost that the feds will charge the banks for processing those checks will rise. We think 8% to 10% this year, perhaps even more in the future. There's going to be an inflection point at which point the economics just don't make sense to move paper.

There's a cost of carrying it, sending the checks from point to point. That's usually done with trucks, mail, or jets. And furthermore, there's the cost of the new system. So at some point, there will be a trade-off where the cost of the new system will be more economical.

So, again, I'm encouraged by that, but I don't think we're going to see a spike in the check processing area immediately. So I don't want to lay that plank right now. However, that combined with our fraud products and combined with the increased demand for recognition, I think, speaks to greater demand for overall product lines that we offer.

Working capital went from $3.9 million to $2.3 million, reflecting the $1.6 million loss.

Yep.

Cash went from $1.4 million to $1.8 million. So that, I assume, reflects some receivables or payments that came in?

That's correct. We have long-term deals with many of our major OEM partners. They are paying on a regular basis. Furthermore, the terms of our agreement with our banks requires significant portion of up front payment upon signing of contract. So this all had positive impact on cash. We think our situation financially probably is one of the strongest situations we've had in a long time. Of course, we've got to continue driving revenues to maintain that and bookings. But right now, as we enter the year, we ended up with a very strong balance sheet.

I want to note also we have no bank debt. That's important to us. We do have a bank line. And furthermore, we expect to keep driving our bookings, which would drive cash. So, again, we're confident, but we're cautious too. Clearly, with the loss we need to moderate and look very carefully at our expenses and how we're deploying our resources, and we're doing that.

My concern has been the sales force with a few disappointing quarters. Is it the same sales force, or have you changed people in there?

We have actually changed leadership, particularly on the OEM side. We think we are stronger then, than we have been in a long time. We are also adding some selected people in the sales force and making adjustments as we go along. So we constantly monitor that. We constantly try to improve that. And we think we have a strong team.

Thank you.

Our next question comes from Steve Kleeman.

Hi. I had just two quick questions. One, in light of the loss in the fourth quarter, are you looking to raise any additional equity funds? And also, I'm kind of curious, recently there's been quite a bit of activity in volume in the stock, and I wondered if you had any comments on that.

Steve, thanks. Yeah, on the issue of raising equity capital, we have received many inquiries from reputable firms that offer capital. So there's a possibility that may happen. We have made no commitments.

Secondly, with regard to the volume, we think that was in direct correlation, although we do not know, but we think it's in direct correlation to the announcement made by Wachovia Securities, unrelated to Mitek -- made by themselves is what I mean to say -- about the fraud solution payee match, and also the passage of check 21, both of which happened the same week.

As I explained earlier in my remarks, we specialize in the development of software that images checks and can do very interesting things with our recognition technology. And that seems to me a sweet spot now as these new -- as the new legislation was passed and, secondly, expressed in the interest by Wachovia.

Subsequent to that, I might add that additional banks have also contacted us with an interest in similar products.

Okay.

Thank you.

Our next question comes from Ben Segal of Winchester Capital.

Did you say you were hiring additional salespeople because of check 21? I've got a couple questions.

I didn't say because of check 21. I just think generally there's opportunity for our products, and we are hiring additional salespeople as appropriate.

When do you expect the check 21 legislation to affect sales? First quarter next year? Second quarter?

I think it's having an impact right now. Boards across the country and community banks are discussing this. And I think it had an impact both negatively before with regard to some uncertainty about requirements. And now with regard to compliance. It may stimulate demand.

Probably within a year we'll see some impact, and I say probably. Banks are cautious about their capital expenditures. This is a major investment. And so they will have to see the economics proven to them. And I believe, as I mentioned before, once the feds begin to increment their price of processing checks for truncation of settlement, that the inflection point will be reached. It's hard for me to predict when that will happen.

Now, I want to add one thing too. It's important to note we have a very broad product line of recognition products, both in engines that recognize characters, both machine print and handwritten, as well as tool kits that augment that, and products which read forms, all of which are interesting products, many of which are interesting directly to our banking customers.

So the efforts that we bring to bear with regard to additional sales force is really to sell that complete product line. So CheckQuest is one of our solutions and one of the products that we offer. It's an important one and will continue to be important, but it's not the only one in our product lineup, just for your information.

Are the consulting firms, any of them reselling your product?

There are consultants that do advise banks on their purchases? If you're referring to large consulting firms -- perhaps you are -- would you clarify that? You mean like --

For example, is [K&PMG] do they have their products that they're pitching to their customers?

That's typically them. We find that, in this sales cycle, it requires a lot of face to face interaction with these banks in particular. And so we deploy a direct sales force.

We do have some channel partners and we are trying to encourage more channel partners who have existing customer base of community banks to resell our products. And so that is our effort through an indirect channel. We do not employ a KPMG yet, or other comparable type consulting firms. They may be more appropriate for some of our forms solutions in their particular markets.

Thank you.

Our next question comes from Michael Crawl (ph) of Webb Bush Morgan.

To what extent do you think smaller banks will go the IRD route because of an inability to perform image exchange right away? And if this turns out to be a significant trend, how would it affect your sales?

Michael refers to IRDs. For everyone's information, that stands for image replacement documents. Check 21 required that banks be capable of accepting IRDs in lieu of the actual check. And it gives legal status to the IRD as opposed to the physical check.

So, in essence, what this means is that I can image at bank A, the receiving bank, and I can send that image across the nation to the settlement bank, the paying bank. And at that point, either the IRD can be printed and sent through their check processing mechanism, or that bank, if it's equipped, can accept the image directly and process the check without having any paper.

Michael’s question regards directly to the community banks, the small ones. As we have noted in the past, the community banks number around 8,000 in the country. If you add on top of that credit unions, total number is around 17,000. But there are a tremendous number of the 8,000 community banks which fall in the category of $250 million in assets and below. Many of these banks lack the IT infrastructure of the capital and the knowledge of check 21. They simply don't follow it based on their business requirements.

So we believe that the initial thrust of the smaller banks will be to accept and transfer IRDs and probably not be totally and completely image compliant. So their equipment that they purchase and deploy will have to accept these IRDs. That probably will have a positive impact on us with the right channel partner because right now these smaller banks lack the clarity of how to implement a system.

We believe that, with the proper channel partner, we can provide information, what I would call loosely, consulting and advisory services, and perhaps a version of our product which we're considering now, which would be less robust because of the less item processing volume, but adequate to meet their requirements today.

So there is a possibility that the smaller banks, as large as they number, as a proportion of the total number of banks, will have a bigger appetite for these check 21 compliant CheckQuest type services.

Thank you.

Gentlemen, I don't show any questions at this time.

Well, been delighted to speak with you on the phone. Again, we are working very hard to reverse negative trends, and the last year was not satisfactory to us. We, as a company, are committed to profitability, and creating shareholder value. We think we have a very interesting opportunity in the fraud area, as I discussed, as demonstrated by an appetite by major banks as well as smaller community banks. We're working very hard in the CheckQuest area. We're delighted with the passage of check 21. We don't pretend to think that's going to spike our demand in the immediate future, but within 12 months we should see an increase.

All in all, we think we will measure our performance and success by, obviously, financial results and our ability to execute on delivering new products to our customers.

I look forward to any of your questions or calls, if you want to call me individually or John, we're here to answer those questions. Thanks very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Thank you. And have a great day.