Mitek Systems Inc (MITK) 2005 Q4 法說會逐字稿

Good morning. I will be your conference facilitator today. At this time I would like to welcome everyone to the Mitek Systems fiscal year 2005 earnings release conference call. [OPERATOR INSTRUCTIONS] Thank you. Ms. [Desay] you may begin your conference.

Good morning and thank you for joining us for Mitek's Systems' conference call. Management will discuss our results for the fourth quarter and fiscal year 2005 ended September 30, 2005. By now you should have received a copy of the press release. If you have not please call my office at 858-513-4600 extension 340 and we'll get a copy to you right away. With us today from management is Jim DeBello, Chief Executive Officer, and Tesfaye Hailemichael, Chief Financial Officer. You can access their backgrounds on our Website at www.miteksystems.com. They will provide an overview of the quarter and year and we'll then open up the call to 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 statements provision of the U.S. Private Securities Litigation Reform act and are detailed in our public filings with the SEC on Form 10-K and 10-Q. Forward-looking statements include but are not limited to; statements relating to development and pace of the sales of the Company's product. Expected trends in growth in the Company's results of operations. Projections concerning the Company's available cash flow and liquidity. Anticipated penetration in new and existing markets for the Company's products and size of such markets. Anticipated acceptance of the Company's products by existing and new customers. The ability of the Company to achieve or sustain any growth in sales in revenue. And any increase in sales representatives or other personnel.

The Company's actual results could differ from such forward-looking statements. There can be no assurance that the Company will achieve the results set forth. With that, I would like to now turn the call over to Jim DeBello, Chief Executive Officer.

Thank you, Marie. We are pleased to announce our second consecutive profitable quarter. I'd like to welcome all of you to our first conference call in over a year. During the past 18 months, we have repositioned Mitek for growth. We have divested unproductive assets, recruited top management talent, and devoted our energy to building and delivering a software technology that shows tremendous promise ina number of different industries.

With our house now in order, I feel it's appropriate to reinitiate our quarterly conference calls and look forward to more frequent interaction with our shareholders. I appreciate your patience through this process and I'm encouraged by our progress and hope that you are, too. I joined Mitek 30 months ago with a mission to transform a Company with a basket of excellent technology into a market leader. We believe we have an exciting story to tell, as we have concentrated on a plan to leverage our expertise in recognition software into a global leader in image analytics used by industries to fight identity theft by detecting forged signatures and counterfeit documents.

Although we still face market challenges, as any business does, we feel that we now have the talent, technology, and strategy to deliver shareholder value. I would like to introduce Tesfaye Hailemichael, Mitek's Chief Financial Officer. Tesfaye has extensive public company experience and has provided tremendous leadership during his his six months with the Company. He will discuss our results from the fourth fiscal quarter and fiscal 2005. After which I will address our accomplishments and strategy for 2006. Tesfaye.

Thank you, Jim. Good morning. As you know, I joined Mitek about six months ago. And I look forward to becoming better acquainted with the analysts and investors who are involved with the Company in the months ahead. I would like to begin by reviewing the numbers for the quarter and for the year. Revenue for the fourth quarter was $2 million, and operating profit of $640,000, compared with $540,000 of revenue and operating loss of 157,000 in the same period of 2004.

Net profit for the fourth quarter of 2005 was $458,000, or $0.03 per basic and diluted shares, compared with a loss of $523,000, or $0.05 per basic and diluted share in the fourth quarter of 2004. Revenue for the 12 months of fiscal 2005 was 6.5 million, compared with 5.2 million for the same period of 2004. You will note that revenue has increased by 1.3 million over fiscal 2004. However, revenue increase was 2.2 million over fiscal 2004 when we take out the hardware product revenue, which we no longer carry.

Our software revenue grew by 100% in fiscal 2005 from the same period in 2004. Our revenue does not include hardware sales, since we exited from the hardware business in 2004. Operating loss for fiscal 2005 was $206,000, compared with operating loss of 3.5 million for the same period in fiscal 2004. Net loss for the 12 months of 2005 was $1 million, or $0.08 per basic and diluted earnings per share, compared with a loss of 3.8 million, or $0.34 per basic and diluted earnings per share in fiscal 2004, which is a significant improvement.

The reduction in expenses mainly reflecting management's strategic decision to divest low margin CheckQuest business and focus on high margin software products. Operating performance has improved dramatically. Obviously, the Company has made significant progress in controlling operating expenses and improving efficiency. And those are things that we will continue to focus on. Cash used by operating activities was 2 million for the year, compared with 3.4 million for the same period in 2004. We had 2.4 million in cash on the balance sheet as of September 30, 2005.

Our long term debt has decreased to 1.7 million as of September 30, 2005, compared with 2.9 million in the same period of 2004. We anticipate reducing our debt by principal payment and conversion of debt to equity. I'm happy to say that our debt balance has decreased to 1.3 million as of November 23, 2005, as noted in our 10-K SB. We'll continue to manage our resources wisely and explore ways to increase shareholders' value.

In summary, total revenue is up by 26% over 2004, increase in gross margin from 62% to 83%. Total expenses down from 8.7 million to 6.8 million. We reduced our debt from 2.9 million to 1.3 million. Increased stockholders' equity from negative $532,000 in 2004, to a little over a $1 million as of September 30, 2005. Now, I will turn it back to Jim.

Thanks, Tesfaye. I'd like to take the next several minutes to address our accomplishments in 2005 and our 2006 strategy. Fiscal 2005 is a cornerstone for Mitek's future. Our strategy during the past several months has had three primary technical components. First, eliminate non-productive business lines to enable greater operational focus. Second, accelerate development of innovative products, specifically advanced image based analysis products to detect signature forgeries and counterfeits. And third, expand our sales and marketing organization to fully leverage what we believe are large market opportunities in several industries for the Company.

I am pleased with our progress last year. Especially; our growth in revenue, our continued operating margin improvement, and solid cash position demonstrating our return to financial health. During the year, we completed our divestiture of the CheckQuest product line and resolved all of our litigation to the benefit of the Company. Importantly, as Tesfaye just mentioned, we materially reduced our debt to the Laurus Fund. We appreciate Laurus' continued support, particularly in our time of need, but it is our intent to eliminate the remaining debt.

We also achieved several technology milestones. We continue to invest in developing innovative recognition software products. And have 11 patents filed or in process to protect our technology intellectual property rights. Mitek launched its ground breaking fraud protect system designed specifically for community banks or credit unions, of which there are over 18,000 nationwide. According to the American Banker Association, 72% of all banks suffered from check fraud. With annual losses topping nearly $1 billion. Although declining, Americans still write over 35 billion checks a year.

Yet community banks and credit unions remained singularly unprotected and often conduct manual inspection of only a small fraction of checks they process. It's been proven that forgeries and counterfeits make up the bulk of the fraud. Our system provides the capability of 100% screening and automatically detects forged signatures and counterfeits. This is a particularly acute problem today, especially in an era of rapidly growing consumer concern over personal data theft and elder financial abuse perpetrated in the form of check fraud.

Our product protect system is rapidly gaining traction. We've installed ten systems to date and see our pipeline growing. The customers have been extremely satisfied with its performance. In one instance the ROI for our product was less than three months and saved over $150,000 in potential losses.

Another bank located in Minnesota, with five branches and assets of $600 million, selected our fraud protect system to provide 100% screening, reduce losses, and improve customer service. The banker was so enthusiastic he wrote to us and said this; "We were able to prevent a loss totaling $945.71 in our first week, using the fraud protect system. Somebody took one of our customer's account numbers and had their own checks printed. And then started writing up a storm with them. By the end of this week that number, I'm sure, would have been much larger. The other great thing was, when we called the customer to ask about these checks, he was very grateful that we discovered this.

Normally, these checks would have posted. And we would not have known about them until he either reconciled his account or he started getting overdraft notices. So we prevented a loss and provided customer service. That's a win-win". We have received positive responses from all of our customers, many of which can be read on our Website.

On a grander scale, this same technology developed by Mitek is being developed by major money center banks through the efforts of our channel partners. Recently, Bank of America prevented over $4 million of additional potential check fraud losses during a period of 12 months by deploying image analytics provided by Mitek and our partner. Segments of Wachovia and Citibank are also using Mitek technology. Our goal is to make our image analytics a standard fraud deterrent option.

However, the approval cycle is long and the commitments to new technologies are typically slow. We sell our products primarily through channel partners, and have a team of highly experienced sales professionals to attract and retain new accounts. In addition, we also sell our fraud protect system directly to community banks to seed the market and to learn from it. This high-touch approach has been instrumental to refining the product and securing referenceable accounts. However, in order to scale our business, Mitek must continue to collaborate with leading industry partners with large sales forces and established customer relationships.

To this end, we've developed our first strategic partnership with the John H. Harland Company. During 2005, we were pleased to accept an investment from Harland. And are collaborating with them to develop a fraud safe check called Validify to combat identity theft and check fraud. Some analysts hail this as the biggest innovation in check payments processing since the magnetic ink line 40 years ago.

Recently, we announced that our software enables Harland's new released Validify solution. Harland will deliver the solution to financial institutions, for which Mitek will receive recurring royalties based on Harland's sales of Validify printed checks. In addition, Mitek retains the exclusive right to license the validation software component to vendors of ATM machines, point of sale systems, kiosks, scanners, and other Check 21-compliant devices used to process check payments. Our relationship with Harland has become stronger than ever due to our timely delivery of the Validify product.

Harland unveiled Validify earlier this month in Orlando at the banking retail delivery show. We believe the adoption of Validify checks could be significant over time, although it's difficult to predict the rate of adoption. Currently, Harland has a 40% market share of consumer checks in the U.S. generating $600 million in revenue. Their nationwide sales force in the hundreds sells checks directly to 6,000 financial institutions. We believe there could be a sizable royalty stream as a result of their efforts beginning sometime late during next year.

This is the type of collaboration or go-to-market model that we seek with other industry leading companies in which our image analytics can provide a substantial product differentiation. In addition to the financial services industry, we believe that detecting signature forgeries and counterfeits at any point of presentment is valuable to several other industries, such as retail, healthcare, and homeland security. And we are actively pursuing these markets with our technology. As a result, we expect net sales in 2006 to be higher than in 2005. And continued improvement in our operating performance.

So to summarize, we believe that we've cleared our deck, allowing to us focus on growing the business. Specifically, we have accomplished two out of our three tactical goals. And now are concentrating on expanding our sales and marketing organization to fully leverage what we believe are large market opportunities for our image analytics in several industries. Our financial situation is greatly improved. We have an excellent and motivated team. And we are passionate about our plan. At this time, I'd like to open it up to questions. Operator.

[OPERATOR INSTRUCTIONS] Your first question comes from George Sutton.

Hi, Jim. Congratulations on the great numbers.

Thanks, George.

I wanted to make sure I understand the Validify deal and when that will begin to be sold, or when that will - - is that officially launched now, or is that early part of '06?

It is officially launched by Harland. It was publicly displayed and demonstrated at the Retail Delivery Show earlier this month in Orlando. The product will become commercially available we believe in early 2006. And there are several pilot customers, which have been utilizing the technology as pilots in banks and have been very satisfied with its performance. We expect that they will be the first and earliest adopters.

So, then it's just really a matter of how much of the 6,000 customers - - or how many of the 6,000 customers ultimately adopt the technology but it will be sold by the Harland sales force?

That's an important point, George. We are, by definition, a small Company. Although we are continuing to invest heavily, not only in R&D but also in our sales and marketing team and growing them, we think that we need to work and collaborate closely with big partners, like Harland. Who have hundreds of sales people in the field, nationwide with existing customer accounts. Harland is unique in the fact that they are the only company with digital printing presses. So, our technology embedded on the actual physical check is a real strategic advantage partnering with Harland who can now print this through their digital processes. And they can customize checks for each individual consumer who purchases their checks directly through the bank who receives and orders them directly from Harland. So, having those hundreds of sales people out there allows us to scale the business more rapidly.

Now, I've always viewed you from afar as a check related business. I think what you're saying is the technologies that you've developed can be applied to other markets.

That's exactly our plan. And as we move forward, we are in dialogues with other companies as we explore other applications for this same technology to leverage the investment we've made. Anywhere a check is used in the chain of custody, which represents the authenticity of that individual, is an opportunity for us to apply our technology. And up to this point, technology has not been able to automatically screen these checks for authentication. But in today's environment, with the increased processing speed, the lower cost of memory, the advances in algorithms and pattern recognition and neural networks that we deploy, we can now provide that kind of 100% screening. Automate processes which were formerly labor-intensive and not nearly as accurate. So, we think there's great opportunities in other markets in addition to the financial service sector.

Okay. Lastly, I was surprised at the level of profitability. Was there anything unusual in the quarter, as we see some of this Validify product and continued growth, should we see the same sort of scale?

Hi, George, this is Tesfaye. Obviously, the Q4 result is based on our higher revenue. So there's no really unusual in that revenue.

Super. Thanks, guys.

Your next question comes from the line of Mike Wallace. Hi, Jim. Hi, Tesfaye. To kind of piggyback a little on some of George's questions. As we look out into '06, it sounds like we might start seeing some revenues from Harland in the earlier part of the year. Is that a reasonable assumption, Jim?

Mike, I will address the question. It's difficult for to us predict what will happen, particularly with innovative and ground-breaking technology. As I mentioned earlier in my remarks, I truly believe this is the biggest innovation, as do many analysts in the industry, since magnetic ink was introduced to the check 40 years ago. So, this is new stuff. We believe we've proven it in pilots that have been privately conducted with banks. We believe that there will be an acceptance and adoption rate that will be exciting but we can't predict that. In our experience, managing technology companies for the last 20 years, often it takes longer than you expect. Because of the sales cycle, the adoption rate, and general education that has to occur before purchase orders are placed. So although the product will be shipped early in 2006 calendar year, we don't really expect a sizable royalty stream, maybe, until the second half of the year. But that's to be seen.

So how does the model work with Harland, Jim, in terms of revenue recognition? Is it when the checks are printed and the Mitek microcode is embedded on the check, then you get to be able to recognize the revenue? Or is it at the time that the checks are actually sold to the end customer and then Harland collects and then pays you back?

There are several components to the revenue stream, which makes it even more exciting for us, with the hope of early and rapid adoption. First and foremost, when Harland embeds the code, the secure code on the actual physical check, and delivers that to a customer, that transpires a revenue recognition event. And for that, we receive a royalty.

Now, we haven't disclosed, and we are prevented from disclosing the actual precise terms of that royalty arrangement. But nonetheless, there is a royalty that is paid to Mitek every time a box of checks is printed and delivered with our embedded technology on those checks, number one. Number two is, we also retain the rights, and this is part of our arrangement with Harland, that we will supply hardware manufacturers, ATM providers, kiosk providers, scanning companies, with the decoding algorithms that they will embed into their systems. For which we also expect to receive a royalty. So we think we get a very nice stream from Harland, potentially. And further, we believe that we can also create additional revenue streams from hardware manufacturers. That's in the financial services sector. As we expand into other industries and vertical markets, we expect to replicate the model.

What makes this model exciting to us is that now, once we establish the embedded software with these large collaborative companies, who have existing customers and large sales forces, we create a recurring and perhaps more predictable revenue stream. And this is exactly how we want to migrate the Company over a period of time. Today, our revenue generally recognized as software licenses. And they are either a term license, or they, in some cases, are perpetual licenses, which is common in the industry.

Obviously, our revenue has been lumpy in the past, but we want to smooth out those lumps. Although as a small Company, we still are dependent on some larger deals every quarter. And as we grow, we hope to become less dependent. And as we implement these type of licensing with large companies we are further less dependent on those large and singular deals.

Okay. A couple of follow-ups on those. First, were there any large deals in this quarter that drove the $2 million in revenues, or was it pretty broad-based?

We had received recurring orders from existing customers. We had signed new orders from new customers, and as we reflected in our 10-K there were two customers in particular who placed sizable orders with us. If you'd like more detail on that may I reference and suggest that you access our 10-K published online. Tesfaye - -

Yes, the 10-K has been filed yesterday, so you can access it.

Okay. I'll take a look at it. Thank you. And let's see, what was the second one? You brought up hardware manufacturers, and that was the other kind of general area I wanted to ask about, Jim and Tesfaye. Could you update us on your progress with the scanner manufacturers, the ATM's and the point of sales? And where you - - when do you think, or we can start seeing some of those things being embedded in the actual hardware solutions?

Mike, realistically on the hardware side - - and let me back up by saying; our goal clearly, is to have the authentication of these checks happen initially in the back office. More quickly following at the teller. And then ultimately pushed out to the point of the cash register at major a retailer. The goal, and we think the ultimate benefit, will be for the retailers and the consumer, who actually presents the check at the point of sale, and instead of walking without that TV with a forged check, that check can be identified as authentic or counterfeit at that point. And that will take, I think, 12 to 24 months.

So, I don't want to set unreasonable expectations, in terms of hardware adoption and deployment. This takes time. And you can probably reference in the past the adoption cycle of other hardware devices that you may be familiar with. So, it will take some time for this to be broadly accepted and furthermore broadly adopted in hardware devices.

That being said, we are actively in dialogue with one of our existing customers who is a leading, if not the leading industrial point of sale retail scanning company on this product. And we have had private discussions with them. And we expect that we will move ahead with them rather quickly. In addition to that, we've dialogued with other ATM vendors. They are natural suspects that you are familiar with, who have also expressed interest. To date, we haven't signed any deals with them, but we have a high level of interest.

Good. It sounds like you're making some good progress on that front, and it sort of closes the loop, right?

It does.

Ties the whole system together. And then I would think that you'd sort of hit some sort of tipping point and then the adoption rates really start to take off. And you've got both royalty revenue streams really coming at you.

Yes, you're right about that. And I'm glad you mentioned the tipping point or early adopters crossing the chasm. These are concepts which have been adopted in the marketplace for new technologies. And it does take some effort to educate. There are always the "early adopters," and then once you cross that chasm, it becomes more broadly accepted and the revenues scale more rapidly. And again, it's a timing issue, which is always the unpredictable part of it.

How much help can Harland give you regarding the hardware side?

A tremendous amount of help. Validify is their product and they've embedded our technology. And we are their exclusive partner. But Harland is a very credible company. They're over $1 billion in revenue. They're publicly traded on the New York Stock Exchange. You can access them via their ticker JH. They're well managed, conservative, hard working, and they execute well. We believe that riding their coattails, working close well them, and taking the lead on the technology, we can penetrate these hardware groups quickly.

Great, that will be helpful, too. So, circling because on the model and how it kind of shapes out for '06. The first couple of quarters may be somewhat lumpy and the revenue stream because it's still highly dependent upon the software licensing revenues. And there may be some good quarters. There may be some bad. And there may be some quarters where you'll make money. And there may be somewhere you may lose money, depending upon that revenue line.

Yes.

How does it flow through, then? Where do the lever points come? As you layer in the royalty stream, to the model, those will come in at very, very high margins. And I would assume that you're not going to have much additional costs to generate those royalty streams, especially if Harland is doing a lot of the heavy lifting on the sales side.

Correct.

And there may be some - - so how does it flow through? As those royalty revenues come in, is there much in terms of additional expenses that occur?

There is not, and that I think, is the beauty of the model. Our plan is to maintain our operating expenses at our current rate. There might be some slight adjustments as we hire headcount here or a headcount there. But fundamentally we have our staff fully staffed and capable. The royalty stream will be additive on top of that existing operating expense base.

Okay. So, we could use Q4 as sort of a basis for - - because you've got things pretty cleaned up now. As sort of total cost and expense of about 1.4 million a quarter as sort of a number we can use as a base line as we move out to '06?

I think, Mike, that is fair to say between the number that you have for Q4 reflects our current expense.

Okay. Very good. Super. Well, you guys are making some terrific progress and it's nice to see you generate cash and continue to clean up the balance sheet. And actually be making some money here in the early stages of this. So you got the core business in really good shape and now you just got to layer in this huge opportunity. So - -?

Mike, I really appreciate your comments and the compliments. There's a lot of work ahead of us, but we've got a very passionate team here, so I'm very proud of them.

Okay, thank you. I'm done questioning. Thank you very much for your time.

Your next question comes from Charles Hilton, private investor.

Hi, Jim. Hi, Charles. Listen, I'd just like to congratulate you on what appears to be just a super transformation here.

Thank you.

I've been a shareholder for a long time, a frustrated one, I might add. But it sounds like you've got a real Company now.

Charles, we believe, so and I appreciate your patience with us. I know it's been tough. It's good to talk to you again.

Just a couple questions. One is, from the questions that have been asked, are there some folks out there now who are covering the Company?

As a small Company, it's difficult to have analysts dedicated to us.

Sure.

However, we have several new people who represent funds and also serve as analysts who are following us.

I see.

And they have created additional interest in the stock. So it's our job, as management now, with this news, and with the new Mitek, to tell our story more actively. And that's our intent with Tesfaye here, with a very stable team of managers and professionals on staff. I think now it's appropriate for us to be able to go out and be a little more active and that's our intent.

Great. Well, I hope - - here in San Diego there's a stock and bond club, and at some point you'll be a good candidate for that. Got to get the price a little higher. But like I say, it sounds very good to me. One final question and we don't have to be precise, but can you give me a rough idea of the ownership? And I'm particularly interested in what Laurus has, if we really want to look at their - - the warrants and things like that? Where are they in the scheme of things? And I know Mr. Thornton has a stake of some consequence. So, just give me a rough idea where the ownership lies.

Sure. This is public information, Charles. We have no problem sharing that. Mr. Thornton, the Chairman, has about 19%. And also Laurus, obviously Laurus has warrants of 1 million. And they also have convertible debt as of today, 1.3, at $0.70 conversion. So, we don't know whether they're going to convert that. We don't know when they're going to convert. So they could have, if they converted that, they could exercise their warrants, they could have probably about 5%, 6%.

5% or 6%.

Right. So the other investors are basically individuals, and Harland has about close to 20% as well with warrants. So, the major shareholders are Mr. Thornton and Harland and obviously Laurus if they convert.

Okay. And then roughly, presently, how many shares are outstanding?

We have right now about 14 million shares outstanding.

1-4? 14?

Right. That is on our 10-K SB, which is the - - about that number.

Yes. And then if these warrants were exercised, there'd be another, what, 3? 3 million?

Well, the warrants are about 1.3 million, Harland and also Laurus, and then obviously Laurus still has convertible debt of 1.3, so that would be about, yes, about 3 million.

Super. Well, great job. I was quite impressed. Thank you.

Thanks, Charles.

Your next question comes from Joe Colbert, private investor.

Congratulations, Gentlemen.

Thank you, Joe.

Gentlemen, just looking to get some insight on the marketing of the Validify product. As far as how that will be incorporated and accepted by the concerned check writer that might want to purchase that product? Is it going to be a premium check they'd be purchasing through their bank or credit union?

Joe, that has not been determined. And that is a Harland decision as they go to market. They will train their sales force in January and continue to market this - - or begin marketing this to their accounts. And some banks have arrangements with Harland that allow them to purchase checks directly from Harland. And they - - Harland has a variety of checks. As you can imagine, walking into your bank and ordering checks, you can get checks with interesting graphics on them or no graphics, with your name or no name. And now you will have an option to buy a fraud-safe check.

What gives us encouragement is maybe what you've seen out there, the consumer concern about identity theft, the promotion by Citibank, as an example, with their 30-second TV ads. And also the publicity over the negative data theft. So as Harland has implemented their marketing programs, they've conducted focus groups and they've also conducted pilots. And the response have been overwhelmingly positive with regard to adopting and purchasing a fraud-safe check. This is very positive.

We think that the check is either an upsell, or it could be given at an equal price. We don't know. We encourage Harland and the market to dictate that. But if I were a consumer walking into a bank and for a slight premium I had a chance to buy a fraud-safe check, I know what my decision would be. And that's what we're excited about.

There could be an opportunity for Harland not only to gain market share by differentiating their product, but there also could be additional revenue generated. Again, that's a Harland decision, not a Mitek decision.

Okay. Well, thank you, gentlemen. And these are exciting times for your business and keep up the great work.

There are no further questions at this time.

Very good. Well again, in conclusion, I'd like to thank you for your support, for your interest in our Company. We continue to work hard here at Mitek. We continue to innovate. And we're passionate about the future. But we know that there's a long road ahead of us. So stay tuned, and we'll be happy to meet with you again via conference call at the conclusion of next quarter. Thank you very much for participating today.

This concludes today's Mitek Systems fiscal year 2005 earnings release. You may now disconnect.