Mitek Systems, Inc. (MITK) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Mitek Systems Earnings Conference Call. My name is Chanel, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Julie Cunningham, Vice President of Investor Relations for Mitek Systems.

Good afternoon, and thank you for joining us for the Mitek Systems First Quarter Fiscal 2012 Conference Call. Joining me on the call today is James Debello, President and CEO; and Russ Clark, Chief Financial Officer. The agenda for today's call includes commentary from Jim, followed by a discussion of the financial results from Russ. This afternoon, Mitek issued a news release announcing the first quarter 2012 financial results, which is available on our website at www.miteksystems.com. This call is being broadcast live over the Internet to all interested parties on Tuesday, February 7, 2012, and the information provided will not be updated. The audio of this call will be available on the Investor Relations page of our website and archived there for 30 days. As a reminder, this conference call may contain forward-looking statements that are not historical facts, but rather are based on the company's current expectations and beliefs. Mitek's results may differ materially. Please refer to Mitek's SEC filings for detailed information. In addition, non-GAAP financial measures will be used during this call. Reconciliations to the most directly comparable GAAP financial measures are included in the earnings release on our website. And with that, I'd like to introduce Jim Debello.

Thanks, Julie, and welcome to everyone on the call today. I'm going to begin with the discussion of market trends, and how we see these trends affecting our business. After that, Russ will go over the Q1 financials and will end by taking your questions. Before I discuss our results, I'd like to touch on why we're excited about Mitek's market opportunity. First, we're experiencing exciting growth, reporting 151% increase in revenue this quarter over last year. Second, we have a growing product pipeline and patents to protect our proprietary technology. Third, we've built market relationships with a diversified Fortune 500 customer base that is growing. Fourth, we have retained 100% of our customers, all of whom are experiencing increasing usage among their consumers. It is many of these very same customers who have requested direct relationships with us preparing for the launch of our next products. And fifth, being first to market is allowing us to gain even deeper expertise to develop other industry-leading solutions. The smartphone is all about convenience. And reducing keystrokes improves the consumer experience. Just as Siri on the iPhone 4S replaces the keyboard with voice commands to search the Internet, Mitek's Mobile Imaging technology allows you to snap a picture of any printed document or driver's license and it will enter information all without having to type on a small touch screen keyboard. This reduces errors and consumer friction. And I think, added convenience and simplicity is a fundamental desire of all users. As we speak, the smartphone is transforming the way industries are marketing to their consumers. Fundamentally, Mitek's Mobile Imaging solutions are enabling Fortune 500 companies to engage their next generation of consumers more rapidly and cost effectively. By applying Mitek's technology, companies are discovering new ways to drive their top line…

Thanks, Jim, and good afternoon, everyone. As I review the numbers, all figures quoted are on a GAAP basis unless specifically noted as non-GAAP. I will refer to non-GAAP net income and net income per diluted share, and we've provided a full reconciliation from GAAP to non-GAAP along with the earnings release on our website. For the first quarter of fiscal 2012, revenue totaled $3.5 million, a 151% increase over the year-ago period. Of that total, $2.9 million was software and $627,000 was maintenance and professional services. Our revenue growth was driven primarily by our Mobile Deposit product. As a reminder, we generally sell blocks of transactions or subscribers and recognize related revenue upfront so we expect our revenues to be lumpy quarter-to-quarter depending on the timing of these sales. Cost of revenue in Q1 was $302,000, and about evenly split between the software and maintenance professional services categories. This compares to $208,000 in the year-ago period. Gross margin for Q1 was 91% which was up from 85% in the year-ago period. The increase in gross margin in Q1 was primarily due to the higher mix of mobile products. Total operating expenses were $3.5 million compared to $1.8 million in the year-ago period. Now let me break down the expenses by category. Selling and Marketing expenses were $851,000 in Q1 or 24% of total revenues, compared to $399,000 in the year-ago period. R&D expenses were $1.2 million in Q1 or 34% of total revenues, compared to $589,000 in the year-ago period. G&A expenses were $1.2 million in Q1 or 33% of total revenues compared to $623,000 in the year-ago period. Our headcount at the end of Q1 was 43 compared to 20 a year ago. Our hiring has been primarily focused in the engineering, product management and direct sales areas.…

[Operator Instructions] And your first question comes from the line of Bhavan Suri of William Blair.

Just, it was a nice uptick you had in the license line. And I guess, as you look at that, could you give us some sense of sort of if there were any reorders in the quarter or if it was a largely sort of new banks signing up?

Sure, Bhavan. First of all, I'd like to address the size of the market. We continue to support the idea this market for Mobile Deposit alone is $100 million to $200 million market based on the number of checks that we expect to be diverted to the mobile channel, meaning people that would normally go into a branch use their phone to deposit a check. And we see that number growing monthly and quarterly with our current customers who are reporting back numbers to us. But importantly, with regard to usage, we have seen reorders from current customers and we are also getting additional initial orders from new customers. We reported now we have 8 out of the top 10 banks, and importantly, a new number: 24 out of the top 40 banks.

Great. And then as you look at the direct relationships with the top 40 banks and you sort of laid out that you're going to have all of them hopefully as customers by the end of the year. Two questions in there. Is there just any progress towards that? And then, more importantly, I think, could you just sort of help us understand how that will work with the existing channel today? So the channel sells to the same banks and they sell Mobile Deposit. And sort of how does that relationship work? And is there any sort of risk that the channel gets upset or the channel wants a part of the new platform because it is obviously a higher ARPU, too?

We don't think there's any risk. We sell to the large partners like Pfizer, FIS, NCR, Jack Henry, Wausau, a host of others. Really, our channel partnerships cover 95% of the banks in the United States, and there's about 10,000 financial institutions out there. Now within these larger groups, our channel partners, they are different divisions and so our agreements with specific divisions that sell remote deposit capture solutions or item processing solutions. This is distinct and different from other divisions that sell bill payment solutions. In fact, we are consistent and loyal to our channel for our Mobile Deposit products and we expect to leverage that channel into all of the banks in the U.S. and certainly, as I mentioned earlier, all of the top 40 by year end. As it relates to our other products, there is a tremendous amount of interest from channel players who want to resell our Mobile Photo Bill Pay or other types of products, but we feel now that banks are asking us for more direct relationships and that we need to honor that and be responsive to the banks. That helps our time-to-market, that helps the bank's time-to-market. And this allows us to be more in command of our relationships and also allows us to be more innovative with customers for future products.

Great, great. And then one other quick question there. You'd alluded to in the past about Mobile Photo Bill Pay being launched by year end with one of your largest direct banking customers, and I guess you're launching with someone else now. I just wanted to get clarity on, was something delayed there, or is that just a normal sort of par for the course here?

No, we actually believe we're on schedule. We still are on schedule with our initial large bank that we expect to be live mid-year. As we add new banks, though, of course, we're getting into their product integration and launch schedules, which will push some of those newer launches and newer customers to the latter part of the year. But we feel very positive about where we are with our second major product, Mobile Photo Bill Pay, and the reception that we've had among our customers.

Great. And I'll squeeze one quick one in for Russ before wrapping it up. Deferred grew nicely. Was there anything in deferred that was extraordinary there, Russ? Or was that just sort of a maintenance that will be recognized over the next 12 months?

Yes, nothing extraordinary in there, Bhavan. It's really just timing of maintenance renewals. And you've seen that balance fluctuate around to as low as 900[sic] to as high as 1.5 million over the last several quarters. So it's still in the range.

Your next question comes from Tom McCrohan, Janney Capital Markets.

Let's talk mobile bill pay and then go back to Mobile Deposit. On the bill pay, can you remind us, Jim, about the revenue model? It sounded like it was more recurring than how you sell Mobile Deposit. I wonder if there's been any change there.

There's been no change and we think the model is beginning to get traction. Unlike deposit, which is strictly based on the number of transactions, we believe that the Mobile Photo Bill Pay model will include both the platform fee and transaction fees based on the number of the bills that are paid. We see 2 use cases that are prominent among customers with whom we've contracted or in current pilots, first of which is to augment existing online bill activity by onboarding new, what we call, ad-hoc bills. Those are the new car lease that you may have this year or an occasional bill that comes in from a dentist and you want to onboard that. Instead of having to sit at your keyboard and physically keystroke each letter in, you can take a photograph and it's onboarded for you automatically. That's a huge reduce -- reduction of friction for the consumer, it adds convenience and, we think, will add and can make online bill pay systems stickier. The second use case is very interesting. There's only 45% of Americans who are using online bill pay in one form or another, either as a direct bill or as a consolidated bill pay through their bank. That means 55% of the U.S. does not, many of whom are carrying smartphones today. And so our belief is that there's a whole population of non-online bill payers who carry a smartphone who want the convenience of snap-and-pay, and that's provided by Mitek. So we think that's an untapped opportunity for us as we grow so having that click charge is really going to be valuable to us in that particular category. But combined is really how we're approaching the market. And again, this model is evolving but we believe now that the 2 components will be central to all of our future licenses for all of our future products.

That's interesting, the, that breakdown of 45% and 55%. The 55%, those called the Luddites, they don't use any technology today, why would they be inclined to, if they're not using online to pay a bill, why would they use the phone?

I think studies have shown that the complexity of actually logging on to a bank site to actually finding the online bill pay section, to enrolling, to entering all your personal data one key at a time is a cumbersome maneuver, and often, people opt out. So I just think it's the factor of complexity that's prevented people, who are not necessarily Luddites, who actually are now carrying probably the most sophisticated device in the history, being a smartphone, are actually now being nicely courted and brought into the modern age by being able to image capture as opposed to type on a keyboard or on a small touchscreen phone.

Fair enough. On Mobile Deposit, Jim, the 8th bank, top 10 banks that you signed, is it possible to tell us who that was for the quarter?

Tom, we'd love to. We haven't on purpose, all because, under our NDA with the bank, they prefer to hold that ammunition for their launch. And they're busily now integrating it into their systems. But we're very pleased with that. I encourage folks who are listening to the call, if they have a moment to go to the App Store, click on Wells Fargo, click on Bank of America, click on Citibank, these are banks that have currently contracted, for Mobile Deposit but haven't deployed, and look to see what their consumers are saying. In fact, in front of me now, I have the App Store reviews from customers for Citibank. "Where is the remote check deposit via iPhone? If you don't update this, I'm thinking of transferring to Chase." So this is stuff that's being written by consumers out there and I think it provides a level of urgency. Fortunately, Citibank is in pilot, they actually have had a soft launch and we expect them to be active in the market very shortly, followed by Wells Fargo, BofA and our other top customers. So we're really deep at the tip of the iceberg, as we like to say around here, the first inning of major deployments, Chase being in the market the longest, followed by PNC who is live, and also U.S. Bank. But they've only been live actually within the last 6 months so they're just getting their engines running right now. So we think there's a lot of headroom in what we're seeing in the marketplace. Plus, with the addition of new live launches from our customers, we're seeing more and more advertising spreading the word. And this is good for our viral growth and for the actual promotion and awareness of the product. Locally, here in Southern California, one of the more prominent community banks, San Diego County Credit Union, a Pfizer customer, has launched and they're doing TV, radio and print advertising. So we think this is a very positive sign. We look at 2012 as a key inflection point for the adoption and consumption of these transactions.

That makes sense. And just turning gears a little bit to Progressive. Did they have any revenues that contributed to this quarter?

No. We recognized revenue from Progressive earlier. And the important part about our deal with Progressive is really it puts the stake in the ground with regard to the opportunity ahead of us in other vertical industries of magnitude. Keep in mind, we are a tenacious, innovative company. We're showing the major enterprise customers. These are large institutions with millions of consumers, they have very rigorous processes not only for selecting their vendors but implementing and integrating and launching their products. So it does take time, but we're very delighted to work with Progressive. And we have others that we're currently working with that we haven't been able to announce yet but we look forward to in the upcoming quarters.

And Jim, I saw the YouTube clip that Progressive has because they have a whole website on YouTube to kind of see the kind of use cases visually. Is this product launched just in certain states right now, or is it in pilot mode? Okay.

It is. They did launch in selective states, there's 15 states in which they've launched the product. They do expect and want to roll it out nationally. So often as these companies do, they will put it out in selected states, get experience and then roll it out nationally with a supporting promotional campaign at some point.

That's great. And is the, is it a per-click revenue model for you folks in terms of as Progressive gets new customers that convert from a quote to a new signed?

There are fees involved, Tom. We haven't disclosed the nature of the terms of this agreement so we're going to have to respect our NDA with our customer on that one. But nonetheless, we think, ultimately, this could be a very lucrative deal for us and one for Progressive as they acquire new customers.

I have 2 just administrative questions for Russ on the model. Russ, the share count was a little higher than I was modeling for. Is that kind of a run rate, the 27 million, that we should be using for the rest of the year?

Yes, and that's right in the ballpark. I think, maybe before when we had a GAAP net loss in some quarters, the diluted securities options and so forth are not included in the share count. So with a flipping of net income in this quarter, it's put another 3.5 or 4 million diluted securities into the count.

Okay. And in terms of just kind of modeling out the R&D and G&A line, which obviously is going up due to the increased headcount, can -- any type of help there as far as how we should be modeling kind of R&D and G&A going out for the rest of year?

Yes. On the R&D line, if I look at the bulk of the hiring that we've done over the last quarter, it's really been in that area. And we'll continue as we're trying to get these next products to market to invest in that area, so that's really going to be the heaviest concentration of additional hiring during the year. G&A, on the other hand, we're in fairly good shape there. You'll, we'll be seeing some volatility in the G&A line just with some non-recurring charges here and there, but you shouldn't expect to see that grow that much over the course of the rest of the year.

Your next question comes from George Sutton, Craig-Hallum.

Jim, just a couple of questions from a Luddite. First, you have suggested since the beginning that Photo Bill Pay will ultimately be larger than the deposit piece of your business. When do think that will become obvious to the world?

Thank you, George. I did mention earlier in my first question from Bhavan the size and scope of the Mobile Deposit market and I listed that between $100 million and $200 million in total available market. What I'd like to do is add to that, George, and, as we do really with our investor presentations, talk about the size of the market for Mitek. And our mobile imaging technology, we think, far exceeds $1 billion. We think that the Mobile Photo Bill Pay could be worth up to 1/2 of that, in the $300 million to $500 million range. When you look at this market from the eyes and optics of the online bill pay experience and this is a validated experience promoted and conducted by companies such as Pfizer, which owns CheckFree, and FIS, which owns Metavante, and you know them well, George, these companies are, these divisions for online bill pay are well in the billion-dollar sizes for their respective groups, CheckFree and others. And so we think the market is extraordinarily sizable for online bill pay. But it has tapped out and not growing quite as rapidly as people again deal with the complexity of going online, entering data and conducting their bill pay. We think the convenience of the smartphone, a, provides more ubiquity in terms of a connected device and ease of use as a result of being enabled with our mobile imaging technology. So that's why we think the size of this market for Mobile Photo Bill Pay approaches $500 million just for photo bill pay. And we look at our economic model built on both click fees, meaning a number of bills you pay plus a platform fee. So combined, that's what makes up our market opportunity, going forward. It is sizable, it is new and it will be impactful, I think, to our overall revenue stream later this year as we sign our first customers and then more impactful, clearly, as it grows in 2013 and beyond.

Great. You mentioned that you were considering or planning to offer professional services as part of your solution, which is the first time I've heard you say that. What is the logic there? I certainly understand going direct with the sales force, I'm just curious on your thoughts on the services side.

So the revenue from our professional services group is not material in terms of our overall performance. It will grow, but here's why we are doing this: We are discovering that, in addition to our expertise in the area of imaging and image analytics, we have customers now who are looking to us to help them improve the user experience or use our knowledge of other customers to assist them in best practices. And so specifically, there are things that you can do on a phone device within your application that many of our newer customers are not aware of. As an example, on the iPhone, you have an accelerometer: It actually measures the movement of the phone device. And clearly, when the -- what we want to enact is the ability to take a clear picture without fuzziness. And so by using the accelerometer, you can cleverly program it: When it stops, meaning the phone is still for a microsecond, the shutter on the camera will snap. It actually makes it easier to take a clear picture without blurry images and this helps improve the recognition rates by eliminating bad images. So this kind of tricks are important and can be added to the actual application that our customers deploy to their consumers. And we have that knowledge and they often want us to share that knowledge with them, and for a small fee, we provide the type of services to cover our costs and add profit to the company.

Your next question comes from John Wiseman, Compass Capital.

I just have a question in regards to the revenue recognition. When a customer signs on for Mobile Deposit, do you guys recognize any deposit revenues upfront?

The revenue recognition model for business right now, as Jim mentioned: we access 95% of financial institutions through the channel in some of the channel partners that he mentioned. So we recognize revenue when we sign a deal and sell transactions to our channel partners. The numbers that we report for actual financial institution signings and lives are somewhere downstream when our channel partners are able to sign deals with end-user banks as well as go live with those banks on the live statistics.

So is it -- would it be possible that you guys have recognized revenues from, say, Bank of America or any of the other ones that haven't actually launched?

Yes, I mean, we, again, we recognize revenue on sales into the channel. So to the extent that we've recognized revenue to channel partners that are serving Bank of America or some of the others that Jim mentioned, then yes, we would have.

Okay. And then the other question I have is, there's a small company called DataTreasury who I believe is going after a bunch of banks about mobile capture. They actually went after U.S. Bank. I was wondering how Mitek's technology, if it infringes on that technology at all or how it compares to that technology.

We've studied the area of patents and the area of imaging for many years now. We've done tremendous amount of work in the area of patents. We have 12 patents that have been issued for Mitek and several more that are in the queue. We do not believe the DataTreasury patents infringe on ours nor are, is our area touching on theirs. So their patent structure is for image processing in terms of banks, processing images for transactions. It is different than the capture that we perform on mobile devices. They have been pursuing their activity for well over a decade, U.S. Bank is the latest of several that have been in discussions with DataTreasury. So no conflict there. And we have studied the area extensively. We feel very strongly about our patent portfolio, how it protects our intellectual property and how it substantiates our innovations in this whole area of mobile imaging.

Okay. And then other -- couple of small questions about expenses. I noticed that there was, I think, roughly 500,000 in stock-based compensation. How many stock options have you guys granted in the past 12 months? I'm trying to get an idea of how much we can expect, going forward.

Yes, I think, over the past 12 months, as I commented earlier, the increase in the stock price and the fair value has been a large contributor to the increase in stock comp expense. But I think, if you look back just at the option outstanding number, end of Q1 this year versus end of Q1 last year, it's fairly consistent. So I guess, if you want to do some more modeling on that, we'll have the Q on file here shortly with all the details of the stock roll. But yes, the number of outstanding options is fairly consistent. So you have some churn in there in terms of some exercised and some granted, but it's been fairly consistent.

Let me just add a few things to that, as well. We're a technology innovator in a very competitive market that is a high-growth market. This whole area of mobile, particularly as it relates to mobile imaging, makes it challenging for companies like ours to attract and retain excellence, and we do that by virtue of offering competitive salaries and stock options. And so we do it in accordance with industry standards as a means of incentive and compensation on behalf of our employees. And so all of our efforts really are to drive and build the strongest team we can and we feel that we've been successful using stock options to do just that.

Okay. And then, I guess, getting back to that question about the revenue recognition. I was just kind of looking at how many partners are live now versus last quarter and it looks like you had about a 60% increase, whereas revenues jumped about 17%. Is it safe to assume that, last quarter, you may have had revenues for, say, Bank of America or something like that, whereas obviously they're not launched so you're not going to get any reloads? Is that why there's a disparity between them?

I think, as I mentioned, revenues, we expect to be lumpy. And we recognize and we sell into the channel. And there is a lag between the point of recognition when we sell in and then the next stage in the process would be our channel partners signing up a bank, that's the signed number that we have, 250 to date. And then the next stage in the process is to go live where we have 56 to date. So depending on the size of the bank, the complexity of the IT environments, all things that are involved in the implementation for a large institution, the time it takes to get through that -- the entire cycle, even from signing to implementation, can be 6 to 12 months.

And I'll add a little bit to that, as well. The number of signed agreements and, separately, the number go-lives is a metric we use internally to indicate momentum in adoption of the technology. However, I want to underscore, it is disconnected from the revenue recognition piece because we do sell to those banks via an indirect channel. And so by virtue of that, a 2-tier channel, we sell to the channel partner who then resells to the banks and the banks then have another 6 months typically before they launch commercially. So please don't make the mistake of linking the two because they are disconnected. But the metric is very solid as it relates to the growth of the business and the momentum that it supports.

So is it, I mean, is that standard practice to recognize those revenues upfront for, say, a Bank of America that hasn't actually launched? Or should that really be in deferred revenues? I'm just curious as [Audio Gap] as far as the revenue recognition goes.

Yes, our contracts for Mobile Deposit, with limited exceptions, are with the channel partners so the terms of our arrangements with the channel partners are really irrespective of their sell-through deals with end-user banks. So that really drives our rev rate.

[Operator Instructions] Your next question comes from Phillip Lamoreaux of Lamoreaux Capital Management.

Jim, this is Ashok [ph] for Phil. I just had a quick question about -- I've been hearing about how some of the carriers are deploying another mobile payment technology, the Isis, and I've heard that Google is coming together with wallet, the Google Wallet. So I just wanted to see how, big picture, how this sort of technology compares to your offering?

I'd be happy to discuss that. There really is indication of this tremendous transformation in the payments industry by virtue of the adoption of smartphones. So in the course of the last year, we have seen Google introduce their e-wallet, we've seen Amazon stake a claim in that space and others hovering to try to figure out the best way to implement mobile payments or electronic payments or what's called e-wallet. That's all sort of the same mix. We play in that ecosystem. If you think about what others are trying to achieve in terms of eliminating the physical wallet in your hip pocket and putting that content into your smartphone or your mobile device, what lacks is the ability to facilitate that transfer from a physical world to a digital world, literally. To take your credit card information, to take your affinity cards and gift cards and enter that requires you to sit down and either type it in one stroke at a time or, potentially, speak it in, but more likely, photograph it in by taking an image and we capture the data and then input it and digitize it. And this is really how we play in that oncoming e-wallet or mobile wallet arena. So really, it's complementary or we're complementary to it as it evolves. It is at its nascent stage in the U.S. You will see more wallet activity in Europe in terms of micro payments or electronic payments through smartphones, we do see a smattering of it here in the U.S. but mostly experimentation. I think, recently, an experiment at Home Depot, for example, in selected markets. I think you've seen the Google Wallet experiment in different avenues. So we look forward to that evolution. We think that will happen over the course of the next several years, not immediately, and people are vying in a high-stakes game to transform the payments world. What I'm excited about is that Mitek and what we do plays a role in all of this evolution. And so as a result, all ships rise with a rising tide, we believe that we'll play a pivotal role in the adoption from a consumer perspective in terms of implementation and enrollment and that's why I mentioned earlier in my prepared remarks about mobile enrollment as being a very exciting avenue for us albeit at a very early stage.

You have a question from the line of Bill Weisner. He will just be one moment. [Technical Difficulty]

Okay. Anyway, I'm retired. And I was just curious, it seems like the government would be a natural as far as mobile bill paying. There's a lot of people that have to pay estimated taxes every year and so it seems there would be a great fit with the IRS.

I think there is a great fit, maybe not necessarily with the IRS, but with organizations and corporations who prepare taxes on behalf of millions of Americans. And so we have activity in that space, the ability to read W-2s, and shortly, we expect to have some announcements about that. As it relates to servicing the government market, it is a huge market, and it's growing, apparently. But as a result of that, we think it's a rich opportunity, but you have to always meter that with your ability and your resources to execute. And what we're doing here is focusing on financial documents primarily within financial institutions and insurance verticals and that could extend the tax preparation or other types of ancillary verticals that have high value in those documents. That means more revenue for Mitek and more profit for Mitek. Pursuing government deals is lengthy, cumbersome and often doesn't pay well, so for that reason, right now we're exclusively focused on our key verticals in which we have domain expertise and a stable of technologies to bear fruit.

It makes a lot of sense. By the way, I've been a member of USAA for over 45 years and they are a great organization.

They are terrific. We have nothing but praise for them.

And yes, and I'm one of these guys that I'd pay all my bills over the Internet so it's all done through USAA and they're terrific.

Well, thank you for your question.

Ladies and gentlemen, that concludes today's conference. That also concludes the Q&A session of this conference call. For the replay information, you may dial 1 (888) 286-8010, and that is toll-free, or the international, (617) 801-6888. The replay passcode is 78354785. And the replay will be available for 30 days. Ladies and gentlemen, thank you for your participation. You may now disconnect, and have a great day.