Mitek Systems Inc Q2 FY2020 Earnings Call

Good day and welcome to the Mitek Systems Second Quarter Fiscal 2020 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Todd Kehrli, MKR Group. Please go ahead now, sir.

Thank you, operator. Good afternoon and welcome to Mitek's second quarter fiscal 2020 earnings conference call. With me on today's call are Mitek's CEO, Max Carnecchia, and CFO, Jeff Davison. Before I turn the call over to Max and Jeff, I'd like to cover a few quick items. This afternoon Mitek issued a press release announcing its second quarter fiscal 2020 financial results. That release is available on the Company's website at miteksystems.com. This call is being broadcast live over the Internet, and the webcast will be archived on the Investor Relations page of the Company's website. I want to remind everyone that on today's call management will discuss certain factors that are likely to influence the business going forward. Any factors discussed today that are not historical facts, particularly comments regarding our long-term prospects and market opportunities, should be considered forward-looking statements. These forward-looking statements may include comments about the Company's plans and expectations of future performance. Forward-looking statements are subject to a number of risks and uncertainties which could cause actual results to differ materially. We encourage all of our listeners to review our SEC filings, including our most recent 10-K and 10-Q for a complete description of these risks. Our statements on the call today are made as of April 30, 2020. And the Company undertakes no obligation to revise or update publicly any of the forward-looking statements contained herein whether as a result of new information, future events, changes in expectations or otherwise. Additionally, throughout this call we will be discussing certain non-GAAP financial measures. Today's earnings release and the related current report on Form 8-K describe the differences between our non-GAAP and GAAP reporting and present the reconciliation between the two for the periods reported in the release. With that said, I'll now turn the call over to Mitek's CEO, Max.

Thanks, Todd. Good afternoon everyone. Thank you for joining us today. Jumping right in, as the COVID-19 pandemic continues to unfold, our foremost commitment is to ensure the health and well-being of our employees, their families, and our worldwide community. As such, we’ve taken all necessary measures to maintain continuity of our operation and to safely operate at full strength while complying with government-mandated stay-at-home directives. As a modern digital business, we were able to pivot to work from home within one day, and all of our team members continue to be highly effective in this environment, delivering on all committed service levels. As such, Mitek is steadfast in our commitment to empower trust and convenience in a digital world. Our identity experts are working 24/7 around the globe to ensure that more businesses are enabled to transact digitally and secure their platforms through easy, fast, and secure identity verification. We’ve increased human capacity to ensure more agents are available in more locations to support the increase in volumes for high assurance identity verification. We are also partnering with financial institutions, as well as the Federal Reserve here in the U.S., to expand usage of mobile check deposits among consumers. To sum it up, our cloud-first technology provides a secure environment for both existing and new customers. And now more than ever, our enterprise-class expertise, products, and services are being leveraged. This was reflected in our second quarter results where we delivered record revenue of $23.2 million, representing growth of 16% year-over-year. We also generated non-GAAP net income of $5.4 million, or $0.13 per diluted share, up 98% year-over-year, and cash flow from operations was $3.2 million. During the quarter, we continued to see ongoing positive momentum in the identity verification market. We expanded with our existing customers, particularly in the gig economy segment. Our identity verification solution continues to gain traction with our transactional SaaS revenue growing 38% year-over-year. We also continue to experience growth from our highly profitable deposits product line, with adoption and utilization continuing to increase. While the current environment is certainly challenging and uncertain, the way we live and work is forever changed. The need for fast, secure remote services is magnified, and regardless of where our customers are in their digital transformation journey, the time is now to accelerate. Providing secure digital identity verification isn't just a question of convenience during COVID-19; it's become a necessity for organizations making this urgent shift to digital. Identity verification is the essential digital use case, enabling businesses to onboard more good customers faster in this vital environment. Several of our customers escalated their transaction volumes during the quarter. Specifically, in the gig economy sector, we saw significant spikes from our home delivery customers, almost overnight they went from being a convenience to serving as a lifeline for millions of people following stay-at-home orders to slow the spread of COVID-19. Now more in demand than ever, Mitek is helping these customers bring new shoppers safely on board to meet the increase in demand. One of our customers in Europe, who is a leading provider of digital identities, also experienced exponential growth in traffic volumes into their service, being the gateway to access government services such as COVID-19 benefits. Increased demand for online banking, as well as insurance and lending, also contributed to transactional growth in the quarter. At the same time, we saw a slowdown in travel and hospitality sectors with slower than normal transaction volumes as a result of the pandemic. As we look forward from a revenue perspective, we are currently receiving a benefit in our identity business from some of our existing customers who are experiencing significantly more traffic as a result of the current environment. But at this point, it is impossible to predict what impact COVID-19 will have on our current customers and our pipeline of potential new customers. These are serious times, and there are large swaths of the economy that are being affected, and our customers are not excluded. Near-term it may be a bumpy road as we weather the economy, but internally we are continuing to focus on execution. We are not pulling back on our investments to grow our business, as we believe identity verification is more important now than ever to companies looking to digitize their businesses. However, we are proceeding cautiously to preserve our business, our bottom line, and our resources. Turning to our deposit solutions, if there ever was a time when mobile check deposit was essential, it is now. As the economic impact payment checks begin to circulate, consumers will use mobile check deposits, many for the very first time. This use case may even be a catalyst for digital or mobile banking adoption. Thanks for investing significant resources to enable their customers through mobile and digital channels, and as they do this, mobile check deposit continues to increase. We remain the clear leader in this regard with over 7,000 financial organizations using our products. We are proud of our mobile deposit offering and its ability to assist people in this time of need. As I noted last quarter, USAA filed two lawsuits in Texas against Wells Fargo for patent infringement related to remote deposit systems, and the juries in those cases returned verdicts in favor of USAA. The court is still considering post-trial motions in those cases that could overturn the verdicts or result in new trials. In the event Wells Fargo is unsuccessful in overturning the verdicts or obtaining new trials, the two cases will be subject to appeal to the U.S. Court of Appeals for the Federal Circuit. In addition, the U.S. Patent Office is currently reviewing the validity of several of the patents issued in the Wells Fargo cases. Final resolution of those issues may be over a year away. Also, as I noted last quarter, Mitek filed an action in California seeking declaratory relief that Mitek products do not infringe the patents issued in Wells Fargo's first lawsuit. In January, USAA filed a motion to dismiss or transfer our actions to the Eastern District of Texas, and we oppose that motion. Recently, the California Court ruled that this action should be heard in the Eastern District of Texas. As such, we intend to vigorously prosecute our case in this new venue, as Mitek invented all of its core technology, and we believe our products do not infringe on any USAA patents. Today, we also filed a petition with the U.S. Patent Office challenging the validity of the only patent that issued in the first Wells Fargo lawsuit that is not already subject to a challenge filed by Wells Fargo. We expect a preliminary decision on whether this challenge will be instituted in about six months. In closing, we are pleased with our results, which include record revenue and significantly improved profitability. I'm proud to lead the Mitek workforce, who have rallied without question to deliver the technology products and services that our customers need and value during these extraordinary times. This is a seminal moment that Mitek has been created to enable. We have the team, the vision, the technology, and a market need for a solution that Mitek is uniquely positioned to deliver. Together, this amounts to a significant opportunity for our employees and shareholders. Now I'll turn the call over to Jeff to discuss the financial results in more detail. Following Jeff's remarks, we'll open the call up to questions. Jeff, please go ahead.

Thanks, Max, and thank you everyone for joining us this afternoon. Let's start with the Q2 revenue and operating results. For the second quarter of fiscal 2020, Mitek generated record Q2 revenue of $23.2 million, a 16% increase year-over-year. Software and hardware revenue was $11.5 million, an increase of 8% year-over-year. Services and other revenue, which includes transactional SaaS revenue, maintenance, and consulting services, was $11.7 million for the quarter, an increase of 25% over Q2 last year. This increase is due to growth in transactional SaaS revenue, which increased 38% year-over-year to $7.4 million. For Q2, deposits revenue increased 13% to $14.6 million, and revenue for identity verification increased 21% to $8.6 million. We delivered strong software and hardware gross margins of 92% for the quarter. Gross margin on services and other revenue was 80% for the quarter, up from 78% in Q2 last year. Total gross margin for the quarter was 86%, up from 85% last year. Total GAAP operating expenses including cost of revenue were $22.1 million, compared to $21.6 million in Q2 last year. This increase is primarily due to investments in operations to grow our business and increase litigation costs. These increases were partially offset by lower expenses in our Paris operations as a result of the restructuring announced in July 2019 and a decline in acquisition-related costs in expenses. Sales and marketing expenses for the quarter were $7.4 million compared to $6.8 million a year ago. R&D expenses were $4.8 million compared to $5.3 million last year, and our G&A expenses were $5.2 million compared to $4.8 million a year ago. GAAP net income for the quarter was $900,000, or $0.02 per diluted share. Our diluted share count was 42 million shares compared to 38.9 million shares a year ago. As a reminder, our earnings release includes reconciliation between GAAP and non-GAAP net income. We believe non-GAAP net income provides a useful measure of the Company's operating results by excluding acquisition-related costs and expenses, stock compensation expense, litigation expenses, and the related tax impacts of these items. Non-GAAP net income for Q2 increased to $5.4 million, or $0.13 per diluted share, compared to $2.7 million, or $0.07 a year ago. Our non-GAAP adjustments include $2.3 million of stock compensation expense, $1.6 million of acquisition-related costs and expenses, and $561,000 of litigation expenses for the quarter. Turning to the balance sheet, we generated $3.2 million in cash flow from operations during the quarter, bringing our total cash and investments to $42.5 million on March 31st. Our accounts receivable balance of $13.7 million represents a days sales outstanding (DSO) of 52 days. As part of the share buyback program we announced in December, we repurchased approximately 137,000 shares during the quarter at an average purchase price of $7.33 per share. This leaves roughly $9 million remaining of the $10 million buyback program which runs through December 2020. Given the current global pandemic, our board has opted to put the repurchase activity on hold for the time being. Now moving to guidance for the remainder of fiscal 2020, Mitek is withdrawing its previously provided guidance for this fiscal year ending September 30, 2020 due to the uncertainty of the full impact of the COVID-19 pandemic on the economy, our customers, and our business. In closing, we are pleased with our results for the second quarter, which include record revenue and significantly improved profitability, and we look forward to continuing to deliver the essential services to Mitek devices.

Thank you. Our first question is from Mike Grondahl with Northland Securities. Please go ahead.

Could you talk a little bit about the new customer funnel for mobile ID and kind of what we've seen there in this environment?

Mike, it's Max. Thanks for the positive comments. Yes, I think we've been building that pipeline for the six quarters I've been with the business. We've been retooling a number of things within the organization and the go-to-market is a big part of that, both our messaging and how we position and then the sales motions. The pipeline has grown really nicely, and of course, the last three or four quarters as those efforts have taken root. You've made a lot of additions to the team, powerful additions to the team by way of personnel. We brought in our new sales leader at the beginning of the calendar year this year, for the identity U.S. business, really made some big strides in Europe, but half of our identity business comes from the EU. So in that regard, I feel good about the opportunity to think about the unknown. One of the other things you heard in Jeff's remarks is just the impact of the pandemic and the shutdown and the slowdown in overall consumer spending, and the big unemployment numbers that we’re seeing. What does this mean for those opportunities and, more importantly, for the businesses that we have with those opportunities? I don’t know if that provides the color you're looking for, but that's probably as smart as we are this far into it.

Got it. And in the mobile ID business, how much of that would you say is online? And what piece of it is sort of offline at a physical location? Have you broken that out before?

I'm not sure I understand the question because you pull on that a little bit.

Sure. With your mobile ID product, how much of it could be done from someone's living room versus maybe someone has to go into a physical store and use that mobile ID product?

Okay, thanks for clarifying it. Well, it could be 100% done remotely, right. From a mobile device, whether that's a phone, iPad or a computer. We do have use cases, it's an easy example, a bank, a retail bank location branch, where when you set up an account typically, you provide your documents and they take your documents and make a copy of them. We've got use cases where we do some of that, but that's a very, very small part of our business. The overwhelming majority of use cases, both the current transaction volumes that we're seeing, as well as the pipeline we just talked about, over 95% of those use cases are wrapped around the idea that you're doing that remotely.

And our next question is from Bhavan Suri with William Blair. Please go ahead.

Hey guys can you hear me, okay?

Yes.

Great, thanks for taking my question and a nice job. I guess I just want to touch a little bit on the current environment. We've obviously seen, through conversations with CIOs that it's going to accelerate, especially coming out of it, the idea of digital transformation, and things like that, but you're kind of at the forefront of some of this, right. So think about mobile check deposits and the idea of doing this remotely. You think about ID verification now and sort of being able to validate that remotely for all sorts of processes, whether it's stuff with DocuSign or things like that. I guess I'd love to understand sort of how those conversations are progressing. You talked a little bit about pipeline, but a little more color in terms of sort of what you think this is going to drive confirmation in your go-to-market especially with the new SUV sales?

Yes, we are trying to find a balance regarding your point, Bhavan. In today's environment, if a bank cannot onboard new customers digitally or via mobile, it is nearly impossible to expect them to visit a branch. I mentioned a few examples while considering the significant declines in GDP, rising unemployment claims, and the overall economic situation. We need to evaluate how this affects individuals, particularly regarding short-term credit card usage and remote purchasing. For instance, just a month ago, Italy was at the heart of the crisis, and we have banking customers in Milan who were in the midst of onboarding. Our customers and their implementation partners urged us to expedite the process since the lockdown was so strict that it was impossible for customers in Italy to go to a branch. As a result, using mobile verification to confirm someone's identity became crucial, even for existing customers with banks like Buddy Bank. For transactions exceeding 1,000 euros, they had to revalidate using government-issued identity cards. This is one example of how we have accelerated our processes during this challenging period. Jeff, do you have anything to add?

All I'd add is the way I view this longer term is just really reinforces the need and for us opportunity for identification services for every business that needs to transact digitally. So longer term this is all beneficial to what Mitek is trying to do. Near-term, obviously, there's going to be bumps, as you know companies whether they were in our pipeline or looking to do something, figure out the impact of the pandemic on their business and what kind of projects they're able to take forward. The great thing is everything we're delivering, well, most everything we deliver, I think, is towards helping companies get more revenue and sign up more customers. So it's important for businesses to be able to do that, so all good things in favor of identity verification.

Let me ask a more direct question, Jeff. I'm surprised there hasn't been an acceleration in the business, given that people are receiving stimulus checks—some deposited directly and others being issued by mail. There's also an increase in electronic signatures and online transactions. Can you help me understand this? I know decisions are being made slowly, but you're connected with over 3,000 banks that are seeing more check deposits. Additionally, your recurring business is growing well, yet you've pulled guidance. Can you help clarify this for me?

So, I'll take on the identity and then I'll let Jeff talk about the deposits a little bit the way we check model works there. I think everything you just said, Bhavan is 100% correct, but I think that's a great hypothesis and now it's just a matter of when does that hypothesis play out. Does that take 30 days? Does that take three months? Does that take nine months for us to get to that place? We're bullish and optimistic that it will be sooner than later. But in the last 45 days, it's completely mind-boggling to see the rate of change without actual zero visibility to what was happening. On the identity side, yes, we're watching these projects accelerate. Some examples I just used, we can come back and let Jeff talk about the deposits, but you're also doing that into the teeth of huge unemployment claims and the bottom falling out of the economy at least for some period of time. I think we're trying to balance being responsible with the optimism we have for the longer-term wind in the sale that this ultimately helps accelerate. Jeff, why don't you talk about the deposits a little bit?

Yes, we definitely anticipate an increase in deposit volume due to the government checks being issued. This will positively impact our network. However, it's important to remember that our customers typically purchase large blocks upfront, so the increased usage will need to go through that process. I expect some customers will return to make repurchases sooner, which would be beneficial for our business. While we hope this is a one-time occurrence tied to the government checks, we will certainly benefit from it. On the other hand, in this economic environment, there might be a decline in the number of checks written as people have less money and there are fewer payroll checks due to unemployment. So, while we expect positive growth in deposit usage, there are other factors to consider as well.

Got it, that's really helpful. One last one from me, just on a quick update on the ruling, you've said, you're expecting a ruling on the declaratory judgment could say Northern California and Texas. Just love to understand how that's going or when would we expect the update? Has a timeline for legal stuff been extended because of COVID and kind of maybe not the milestones? So I know that there's some questions buried in there, but sort of an update of the process with COVID extended and then sort of milestones that investors should be looking for through the process? Thank you.

Yes. So, the next milestone, obviously, is this CJ action that's now going to be contended in the Eastern District. From a timing perspective, I think it's natural to have expected that, of course, in the last 45 to 60 days. The wheels of justice that normally grind along continue to grind along. It's probably a little slower just because of everything we've already talked about and that we're all experiencing personally, but it hasn't stopped. So, the timeline remains largely the same.

And next question comes from Mark Schappel with Benchmark. Please go ahead.

Hi, thank you for taking my question. Max, starting with you, I apologize. I jumped on the call a little bit late, so you may have covered this in your earlier prepared remarks. I was wondering if you could just review what the Company is doing or what steps are being taken on the cost containment front just to manage through the COVID disruptions?

Hey, Mark. Yes, you missed the best part of the call at the front end. From a cost containment perspective, I think we're being conservative. It's one of the reasons that we pulled the guidance here just because we don't know what to expect in the course of the next month or two or three. But from a spending perspective, I think we're being judicious and we've hopefully established our reputations as good stewards of the business and being disciplined in the way that we make these investments. We're not pulling anything back. We were able to, as we said at the beginning of the call, we are a modern digital business; everything that we run is in the cloud, all our employees have laptops, we've been in a highly secured VPN environment. We've been readying customers for a long time. Literally, the day that we announced work from home, the next day, people put their laptops, the things they needed from their work areas, Jeff and I included, went home and the next day got up and went to work at my kitchen table. So, I think we're going to continue to be judicious and continue to be conservative both in the projections we make and also how we run the business, but we're not pulling back. We continue to invest and we continue to grow both sides of this. Jeff, anything you'd add to that?

I would just add that we have continued to hire and onboard people in this work-from-home environment.

Okay, great. Thank you. And then national ID business with respect to the sales organization in ID, has there been a shift in focus from generating new customers to maybe just getting your existing customers to buy more of your product or more of your solutions?

Yes, I wouldn't refer to that as a shift in focus. I think we actually have a dual focus at the beginning of our fiscal year, October 2019. We split the team; we basically took what had been an all-purpose go-to-market team and separated kind of new business from expansion within the hundreds of customers that we have on the identity side. I think that was a natural outgrowth of just continuing to get bigger and more mature and wanting to have unique focus, typically on the Tier 1 and Tier 2 existing customers. Then be able to create its own unique focus around those target accounts we had in the select segments of the market for new identity that we've been after in those segments are the financial services, fintech, and in the marketplace, gig economy customers. So, it's a natural progression for us, a natural evolution for us.

Okay, great, and then Jeff, bringing in here. Despite your operating margins being up significantly year-over-year, our cash flow from operations was down this quarter. I was wondering if you could run through some of the puts and takes in cash flow this quarter?

Sure. I guess the most unusual thing in the quarter for cash is we spent about $1 million in stock repurchase. But other than that, the changes affecting the cash flow from operations remember are really just accounts receivable, a little higher at the end of the quarter, and we paid down payables. So, nothing going on in there other than just some minor working capital changes, really. And then that stock buyback, which I don't know if you caught that on the call.

And our next question comes from Allen Klee with National Securities Corporation. Please go ahead.

My first question is I just wasn't sure if I caught something right. When you talked about what the revenue growth rates were for identity verification and then for deposit imaging, I thought I heard 21% and 13%. Were those the numbers?

Yes, that's correct. Deposit was up 13% and ID is up 21%.

Okay, wonderful. Then do you have a general sense of what percentage of revenue you get from segments that are kind of what you pointed to like hospitality and travel and any other areas that are kind of the obvious ones that might get impacted?

We don't publicly break that out. I would say our exposure to travel and hospitality is on the lower side. We have a couple of customers that are of nice size; we don't have numerous customers in travel and hospitality. We've spoken to you before about Airbnb being a customer of ours, and as you can imagine, their business took a pretty big slowdown during the pandemic. I'm not sure when that bounces back, but that would have probably been the biggest impact for us there.

I think, Allen, just to add on to what Jeff is saying, we did that acquisition of ICAR 3 to 4 years ago. That's that hardware line you see in our income statement. Most of that hardware are actual scanners that are used by hotels and resorts in the Mediterranean, and I don't know those numbers off the top of my head, but they're not immaterial, but they're also not massive either.

Right, yes, there is exposure there as well. They're used in hotels.

Thank you. And then if you look at your business of like how it's been doing in April compared to March. What can you tell us?

Let's call it to our Q2 results, and I don't think we're going to sit here and try to pontificate or provide information around what's happening in April; we'll do that in our Q3 earnings.

Got it.

I actually have really no idea on that. We don't get, you know, all the reporting we get is the number of checks used or deposited, so we don't really see the payroll checks, or if they’re small business or if they're large business, any of those things. I really couldn't answer that one for you.

And our next question comes from Darren Aftahi with Roth Capital Partners. Please go ahead.

Hey guys, good afternoon and thanks for taking my questions. A couple of things from me on the check volume side. Could you anecdotally talk about some of the puts and takes, but what's sort of the trend line you've seen in terms of checks deposited across your network, maybe in April versus March? Is that trend still increasing? Second question, is that a massive shift to everything e-commerce? I'm curious, based on your conversations you're having with the bigger financial institutions, are there going to be more conversations on the need for solutions now in terms of opening up accounts and then doing everything remotely as opposed to seeing the ATM as a channel for transacting? Thanks.

Jeff, do you want to take on the check trends first?

Sure. Today is April 30th, so we don't yet have a full month of check reporting. I can't comment on April specifically. For the checks reported in Q2, usage is where we expected it to be in the low teens, as we've mentioned before. It's difficult to predict how many government checks will be issued as checks versus direct deposits. Our team has collaborated with the Federal Reserve to ensure that the check format they are using will work well with mobile deposit. We're eager to see the results, but I can’t make any forecasts at this stage. Additionally, I cannot provide any details as of April. Regarding ATMs, I'm not sure they play a significant role in this context unless we're considering their effect on identity. Most of our discussions indicate that people prefer not to visit branches or use ATMs, so mobile deposit is the best option. This situation could encourage more users to adopt mobile banking and deposit services. We believe this will lead to increased consumer adoption of mobile deposits. However, it's challenging to make predictions so early in the process, especially only six weeks into the pandemic. That said, we anticipate a positive impact on the mobile deposit business.

Likewise, if I pick upon the questions that are more identity related. I think, Darren, right now, what we've seen kind of since the middle of March, maybe even a little earlier in March is that the more of the reaction to this crisis was started as a health crisis, which now has turned into a global economic crisis. And the things that we're seeing or volumes are really going up are exactly that, right. The shopping, the shopping providers you mentioned, mobile phones and assurance, a big customer for us, making phone claims if your phone is destroyed or not working or maybe you lose your phone, that kind of thing. We're seeing those volumes increase. We got a European customer that basically does identity verification for the UK government for government services such as unemployment filing. And so, what's another example in the financial services is all those PPP loans and we process thousands of transactions from small mom and pop shops. They didn't have merchant banking services while they were filing for PPP loans, which we're now seeing the second wave of that start to spark up based on the increased funding in that program, the SBA. Those are the kinds of examples we've seen so far. And I would refer to that as a reaction stage. Hopefully, optimistically, over the course of the next month or two. Hopefully, we start to get to a place where we start to see recovery mode. I think that’s factored in to some of the questions that we're asked by some of your colleagues and where you were alluding to for e-commerce and digitization. Who wants to go down to a bank and apply for a credit card or apply for a new account? That's a dirty place with a lot of germs and potentially having viruses. I think, where I use the example of Italian banks, but we're seeing that across the board, where the folks that had these digital automation programs are accelerating those and that's what we expect to happen. I think we should expect that to happen broadly, not just a matter of how long that takes some and how serious folks are on that. Am I missing anything in there, Jeff?

No, I don't think so.

Can you give us the number of new ID customers in the quarter?

Okay, I think we track that now with the resellers for some of the ICAR solutions that we have. I mean, those numbers are dozens and dozens of customers. I think that the devil is always in the details as to, you mentioned some of our bigger customers in your question. And that's taking those dozens and dozens and shifting out who's going to be the next big customer, who's going to have those really big volumes. So, I think tracking that number is just not that valuable and limitless is helpful.

And there are no further questions at this time. I would like to turn it back over to Mr. Todd Kehrli for closing remarks.

Thank you, operator, and thank you everyone for joining us today. We look forward to updating you again next quarter. Our call has concluded. Have a wonderful day.

This concludes today's call. Thank you for your participation. You may now disconnect.