Inflection Point Reflection: Where Is Mitek Systems Now?

| About: Mitek Systems (MITK)

Introduction

In our April 16th, 2013 introductory article on Mitek Systems Inc., we intended not only to introduce the company to investors, but also to pose a question: Has Mitek Systems Inc. Reached Its Inflection Point? As we review the 2013 second quarter report, we realize we may have been a bit optimistic about how quickly Mitek would reach this point. That said, we continue to hold long-term convictions toward the company, and believe that, as in Aesop's famous fable The Tortoise and the Hare, "slow and steady wins the race". We may be down one run this inning, but we'd like to review the stats from this quarter.

We'll Take The Bad News First

The first data point is that the USAA litigation continues to be a black cloud hanging over the head of Mitek. In the first quarter of 2012, Mitek reported litigation expenses in excess of $300,000. The second quarter 2013 saw litigation expenses more than double, to approximately $700,000. On the second quarter conference call, CFO Russ Clark stated, "We expect these expenses to increase in the third and fourth fiscal quarters given the level of activity in the USAA case associated with fact discovery, which is scheduled to be completed in June and expert testimony, which is scheduled to be completed in November."

We share the shareholder's sentiment of distaste over this prolonged litigation process between Mitek and USAA Bank. In our original article, we decided to remain neutral with our opinion pertaining to the lawsuit. We felt that without a proper legal background it would be wrong to speculate in the public domain over any possible legal outcomes. However, we would like to remind investors that Mitek has put out quite a bit of information about the USAA vs Mitek lawsuit. Of all the parties involved, Mitek is the last party that wants to see this litigation drag on. Unfortunately, due to legal proceedings, Mitek cannot give investors any other information without risking their legal position.

The second data point was revealed in the first quarter 2012 conference call, when CFO Russ Clark stated: "We've been in a $4 million to $5 million range in terms of Total Operating Expenses per quarter and we would expect to continue to stay in that range if you exclude any litigation expenses." This range was short lived as they revised capital expenditure guidance going forward to a "Total Operational Expense run rate of $5 Million to $5.5 Million". Although we assumed that Mitek's first quarter Total Operating Expense guidance would last longer than one quarter, it's difficult to fault the company for deploying capital towards its Research & Development. Mitek also increased its sales force during this period of intense customer rollouts. These are the types of investments that tend to yield positive future growth. With this in mind, let's point out that the upward revised guidance in both the Total Operating Expenses and Litigation Expenses will create a greater profit hurdle before Mitek can reach GAAP profitability.

Lastly, as discussed in our original article, Mitek continues to be plagued by their RDC Block Revenue Model. Long term investors are all too familiar with the issue of "lumpy earnings". This phrase is now equivalent to a curse and has been used to obviate almost any positive progress in the company. The projections of management are one of the key items that so many analysts find helpful and convey a sense of continuity to the overall investment community. Until management figures out how to address this paradox, we are going to continue to experience this unwelcome volatility in the share price.

Patience Is a Bitter Pill to Swallow

Now, let us recall the Tortoise and the Hare. Even though shareholder sentiment is persistently impatient, our convictions remain strong: we expect to see Mitek reach its inflection point in the near future.

This past quarter was a one in which Mitek signed a record of 181 new banks to their Remote Deposit Capture (NYSE:RDC) product, bringing them to a total of 889 signed banking institutions. They also launched a record 137 banks in the quarter combining to a grand total of 445 live banks. This success confirms that banks continue to adopt Mitek technologies.

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To further the records achieved in this quarter, Mitek announced a record of 5 RDC Block reorders. This translated into software revenue of $2,174,878. In an April 17th, 2013 article entitled "Bank of America Reaches 12.6 Million Mobile Users, 30% YOY Growth" the bank disclosed that 9.3 million checks were deposited in the second quarter. CEO Jim DeBello stated in the second quarter 2013 conference call that "According to AlixPartners Consumer Research, the use of mobile check deposit among U.S. mobile banking adopters has grown to nearly 38% in the calendar fourth quarter of 2012 from just over 27% in the second quarter of 2012." Between the combination of verified third party user adoption and the continued success in RDC rollout, we recognize that Mitek has the right ingredients to sustain profitability.

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Mitek earns its revenue in two separate sources. The primary source of revenue comes from license agreements, predominantly through channel partners with the bank institutions, where they purchase "blocks" of mobile deposit transactions. The second source of revenue occurs in the form of Maintenance and Professional Services. Recently, Mitek's Maintenance and Professional Services fees have increased 42% quarter-over-quarter to $1,049,384. Given that this fee is paid per user, the number of banks going live bodes very well for the future progress of these earnings. As CFO Russ Clark stated on the second quarter call, "as we continue to sign and you see those numbers increasing on the signed and live. As we continue to sign those, we get more maintenance payments in that number, that number grows." We find the Maintenance & Professional Service Revenue jump to be a very impressive indicator of future revenue. As Mitek continues to sign additional banking institutions and launch new product lines, this revenue stream will serve as the backbone to their business model.

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The next item we were very pleased with was the announcement that there are now 7 banks signed up for Mitek's bill pay product in addition to 2 banks that have already successfully launched it. In a May 1st, 2013 article entitled "US Bank s Mobile Photo Bill Pay Users Doubled In Last Two Weeks", US Bank indicated that the system was off to a good start. Additional institutions signing up in the first quarter endorse this view. We expect these numbers to exponentially increase over time. This confirms to us that the second line of business is now sustainable. As Mobile Bill Pay continues to roll out, Mitek will begin to experience a smoothing in Software Revenue as they recognize revenue per usage, using a far less volatile model than the RDC's unloved block system.

There are two final items to take note of that bode well for Mitek. The first is the announcement that they signed their second property and casualty insurer to use their mobile imaging technology. This actually surprised us a bit, as we had felt the insurance product was perhaps a novel one off, but we begin to see that this could develop into a successful third line of business. The second surprise item pertains to their potential fourth line of business, Mobile Balance Transfer. Customers can get a better credit card interest rate simply by taking a picture of their credit card statement to initiate a balance transfer. CEO James DeBello, on the second quarter 2013 conference call said, "We expect to have upcoming announcements about commercial deployments of these other used cases this year." We look forward to hearing about future developments in this product line as well as the potential market for Mobile Balance Transfer.

Conclusion

We previously speculated that Mitek was hitting its inflection point. In the closing of this article we appreciate that there is more time until this story has fully matured. We feel that all the elements are coming together properly and look positively upon the company. Revenues are stabilizing for the first time quarter to quarter, new paying customers are being added both organically (via very strong growth of users at the bank level) and by adding new customers (the record additions to both signed and activated Mobile RDC institutions). Additionally, activity is increasingly occurring in the other two existing, but newer, business lines, with a potential fourth business line to be launched in the very near term. While the company is not without its blemishes, it bears repeating that once all of those blemishes fade and all of the company's development is obvious and complete, the investment opportunity will more than likely have passed investors by.

Disclosure: I am long MITK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We have no plans to transact on any other equity mentioned in this article over the next 72 hours. This article is not a solicitation to participate in any of Volte-Face's strategies or funds.