Mitek Systems Inc Q2 FY2023 Earnings Call

Good day, and welcome to the Mitek Fiscal 2023 Second Quarter Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Todd Kehrli of MKR Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, and welcome to Mitek's fiscal 2023 second quarter and first six months earnings conference call. With me on today's call are Mitek's CEO, Max Carnecchia; and Interim CFO, Fuad Ahmad. Before I turn the call over to Max and Fuad, I'd like to cover a few quick items. This afternoon, Mitek issued a press release announcing its fiscal 2023 financial results for its second quarter and first six months. This release is available on the company's website at miteksystems.com. This call is being broadcast live over the Internet for all interested parties, 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 this call are made as of today, September 14, 2023, 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'll 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, and thank you for joining us today. We're excited to share our fiscal 2023 second quarter and first six months results. We expect to file our 10-Q for the second quarter soon and plan to file our 10-Q for the third quarter before the NASDAQ extension deadline of October 13. With this filing, we will be current with our SEC filings. Before going over the second quarter results, I want to acknowledge the Mitek team for their hard work, which led to a strong quarter. Despite the challenges of the audit process, your resilience has been commendable. Thank you for your dedication to building a stronger Mitek. Now, regarding our fiscal 2023 second quarter, we achieved record revenue of $45.3 million, marking a 35% increase year-over-year. Our GAAP net income for the second quarter was $4.4 million, with a non-GAAP net income of $13.1 million. Additionally, we generated $6.3 million in cash flow from operations during the quarter. These exceptional Q2 results, along with our strong first quarter performance, highlight significant achievements in the first half of fiscal 2023, including being first to market with a multimodal biometric solution to combat increasing fraud. Beyond the record revenue and earnings in the first six months of the fiscal year, we have established ourselves as a key player in the fight against fraud. Now, let’s delve into our two lines of business, beginning with Deposits. Our two main products, Mobile Deposit and Check Fraud Defender, continue to drive robust revenue growth, with deposits revenue rising by 35% year-over-year. Mobile Deposit is becoming increasingly popular among consumers for its convenience, and the adoption of our Check Fraud Defender product is gaining momentum as bank losses from check fraud escalate. Check Fraud Defender offers a secure, cloud-based solution that enhances existing fraud prevention measures for financial institutions by using proprietary image analysis to gather data from stolen checks, account screens, and identification documents sold in illicit markets to alert banks to potentially compromised accounts. This consortium-based system ensures that relevant data is shared among participating banks, enhancing its effectiveness. We believe that Check Fraud Defender will sustain its growth trajectory and continue to be a significant contributor to our Deposits business for years to come. Before moving on to our Identity business, I’d like to update you on the USAA litigation situation. While Mitek is not involved in the USAA lawsuits, we are actively seeking a declaratory judgment against USAA to demonstrate that our products do not infringe on the four auto capture patents involved in the lawsuits, supporting our banking clients. Our action is currently under appeal to the U.S. Court of Appeals for the Federal Circuit, following the District Court's finding that it lacked jurisdiction to hear our claims. We expect oral arguments on our appeal late this year or early next year. In our favor, there have been positive developments with the U.S. Patent Trial and Appeal Board, which has invalidated five USAA patents related to the lawsuits, two of which pertain to auto capture. We anticipate further invalidations of USAA patents in the coming months as additional patents undergo review, including another auto capture patent. We remain committed to vigorously pursuing our case, as Mitek developed all its core technology and we believe our products do not infringe on any USAA patents. Now turning to our Identity line of business, we are pleased to report a strong 35% year-over-year growth in Identity revenue, an impressive feat given the challenging macroeconomic environment. This performance highlights the growing necessity of identity verification in today's digital landscape. As digital transformation continues, organizations strive to provide seamless and secure online experiences for their customers. Identity verification has become essential in every customer interaction and is critical for ensuring compliance, preventing impersonation fraud, and improving customer onboarding success rates with minimal friction. We have strategically positioned ourselves to meet these growing demands, whether during initial onboarding or returning customer verifications. Our leading identity verification solution, MiVIP, utilizes AI and multimodal biometrics to provide consumers with optimal convenience and the highest security levels to cater to the demands of today’s digital-savvy users. Mitek's Verified Identity Platform, MiVIP, integrates our intellectual property in biometrics, capture, computer vision, and data intelligence, offering a low-code implementation platform for customers. In the first half of fiscal 2023, we introduced MiPass, the industry's first multimodal biometric solution for continuous identity authentication. MiPass combines voice and face recognition with advanced live detection technology, defending against real-time digital and deep fake attacks. Given the rise of machine-driven fraud, using both voice and face biometrics together significantly enhances security beyond face recognition systems currently in use. MiPass also mitigates risks associated with stored on-device biometrics that are vulnerable to compromise, sharing, or overwriting. MiPass is easily incorporated into various customer use cases via Mitek's developer-friendly SDK, catering to tasks like account information updates, password resets, device rebinding, and high-risk financial transactions. Experts estimate that stolen passwords or credentials are involved in over 80% of hacking breaches, costing large companies millions yearly. Transitioning to a more secure password-less digital account authentication approach can foster customer loyalty and reduce the risk of identity theft and account takeover. Focusing on account takeover, Gartner predicts that 20% of successful attacks in 2023 will be facilitated by seat base. Mitek's recent innovation, IDLive Face Plus, addresses the significant security threats posed by deep fakes and digital injection attacks. This product can detect when fraudsters use software and hardware hacks to replace a biometric capture with a fake image. It is the first product to ensure accurate selfie capture on both desktop and mobile devices while minimizing user frustration from complicated security checks. With the escalating realism and accessibility of deep fakes, injection attacks are becoming a more prevalent means to spoof biometrics. The unique strategy employed by IDLive Face Plus to combat this issue will help our customers tackle these growing challenges. In the first half of the fiscal year, we also received a patent for a new method developed by Mitek's ID R&D subsidiary that secures virtual assistant and chatbot sessions on mobile devices. This method gathers multiple biometrics throughout the chat session without additional user prompts, enabling intelligent chatbots to continuously verify a person's identity while maintaining a smooth user experience. This timing aligns with the popularity of Chat GPT, highlighting advancements in conversational intelligence. Our identity verification solutions facilitate smooth and secure interactions for both new and returning consumers, from multinational banks to government agencies. Our customer, Virgin Money, a digital-first bank with the goal of changing the traditional banking landscape, emphasizes the importance of delivering world-class digital experiences. They aim to empower customers and rely on Mitek to streamline their KYC processes, highlighting areas where traditional checks have fallen short. Mitek takes pride in the positive differences we are making and remains dedicated to advancing our technologies and enhancing value for our customers in the battle against digital identity fraud. In the first half of the year, we focused on building brand momentum through increased digital presence and participation in global events, leading to significant customer engagements. Our sales and marketing teams prioritize building relationships and crafting customized solutions, distinguishing Mitek and forming an essential part of our future-oriented strategy. As we innovate and adapt to the changing digital landscape, our Identity business remains vital to our success. We are committed to delivering solutions that consistently meet or exceed our customers' expectations in this interconnected and security-focused world. Looking forward, I want to acknowledge the tough macroeconomic conditions affecting new enterprise spending. Despite achieving notable growth in the first half of the fiscal year, we do not anticipate the same growth rate in the latter half due to the timing of large deals. Like many enterprise software companies, we observe that our customers are extending sales cycles and postponing new purchases as they manage expenses in this challenging landscape. While this trend persists, we expect slower growth moving forward, yet we remain well-positioned to leverage our new business pipeline and exploit significant market opportunities as conditions improve. In light of these challenges, we are reaffirming our annual guidance, projecting revenue growth of 18% year-over-year at the midpoint and a non-GAAP operating margin of 30% to 31% for the full fiscal year. Now, I will turn the call over to Fuad for a more detailed discussion of the financial results.

Thanks, Max, and thank you, everyone for joining us this afternoon. I'll start with our Q2 of fiscal 2023 revenue and operating results. For the second quarter of fiscal '23, Mitek generated $45.3 million of revenue, a 35% increase year-over-year. Software and hardware revenue was $25.3 million, up 39% year-over-year. The increase in software and hardware revenue is primarily due to the growing contribution of ID R&D and continuing mobile deposit reorders. As we have previously noted, ID R&D is transactional in nature and is part of our Identity business. However, since it is offered on-premise, we put that revenue into the software line for accounting purposes. Services and other revenue, which includes transactional SaaS revenue, maintenance, and professional services was $20.1 million for the quarter, up 31% year-over-year. Moreover, our transactional SaaS revenue increased 33% year-over-year to $13.9 million, driving this growth in the transactional SaaS strategy was increased Mobile Verify volume as well as the addition of HooYu revenue. Deposits revenue for the second quarter increased 35% year-over-year to $28.8 million, driven by mobile deposit reorders. Identity revenue also increased 35% year-over-year to $16.6 million, driven by the addition of HooYu SaaS revenue and strong contribution from ID R&D and Mobile Verify products. We delivered software and hardware gross margin up 99% for the quarter. Gross margin on services and other revenue was 72%, and total gross margin for the quarter was 87%, consistent with gross margins in last year's second quarter. Total GAAP operating expenses, including concept revenues were $37.4 million compared to $30.8 million in Q2 of last year. This increase is due to the investments to grow our Identity business and additional costs associated with the acquisition of HooYu, as well as higher G&A expenses related to enhancing our back office systems and teams. Sales and marketing expenses for the quarter were $9.6 million compared to $9.2 million a year ago. R&D expenses were $7.5 million compared to $7.1 million last year, and our G&A expenses were $10.1 million compared to $6.1 million a year ago. The increase in G&A expenses was primarily a result of increased one-time fees associated with our delayed filings, additional resources to our corporate services team to accommodate a rapidly scaling business, and certain one-time restructuring and executive separation expenses. GAAP net income for the quarter was $4.4 million or income of $0.10 per diluted share. Our diluted share count was 45.6 million compared to 46.1 million a year ago. Turning to non-GAAP results. Non-GAAP net income for Q2 of fiscal '23 was $13.1 million or $0.29 per diluted share compared to a non-GAAP net income of $9.7 million or $0.21 per share for the same period last year. We believe non-GAAP net income provides a useful measure of the company's operating profitability and cash flow by excluding amortization and acquisition-related costs, stock compensation expense, one-time or non-recurring litigation expenses, amortization of debt discounts and issuance costs, restructuring costs and the related tax impact of those items. A reconciliation of GAAP to non-GAAP presentation is provided in our press release issued earlier today. Now turning to the balance sheet. We generated $6.3 million in cash flow from operations during the second quarter, bringing our total cash and investments to $114.5 million as of March 31, 2023. For the first six months of fiscal 2023, which includes the record first quarter results we reported earlier this month, we report $91 million of revenue, a 38% increase year-over-year. Deposits revenue for the first six months increased 47% year-over-year to $59 million, driven by solid mobile deposit reorders and signing of a large multiyear contract in the first quarter that has locked in favorable pricing for us over four years. Due to the unique terms of this contract, we recognized additional license revenue related to the future periods of approximately $7 million in the first quarter. Identity revenue for the first six months increased 24% year-over-year to $32 million, driven by the addition of HooYu revenue and strong contribution from ID R&D and Mobile Verify products. Moving on to guidance. As Max noted, we are reiterating the fiscal 2023 guidance we provided earlier this month. We expect revenue for the fiscal year ending September 30, 2023, to be in the range of $169 million to $171 million, an increase of approximately 18% year-over-year from the midpoint of the guidance range. In addition, we expect full year fiscal 2023 non-GAAP operating margin to be in the range of 30% to 31%. In closing, we are pleased with the second quarter results, which included a record second quarter revenue, as well as solid operating margins. Operator, that concludes our prepared remarks. Please open the line for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Jake Roberge with William Blair. Please go ahead.

Hey. Thanks for taking the questions and congrats on the results. I know the check business is lumpy and you expect growth to decelerate through the year just given the timing of deals, but growth in that segment has been very durable. If you had to stack rank growth drivers, what could be the highest contributors between the conversion of more checks to mobile deposit, Check Fraud Defender layering deeper into the model or are price increases starting to be more meaningful? Just would love to kind of really understand what's driving growth in that segment this year?

Sure, Jake. I would stack rank from highest impact to lowest impact, mobile check deposit adoption, so the online banking apps on your phone and use of that for depositing checks instead of going down to the branch, number one. Number two, Check Fraud Defender, and number three, price increases, in that order. I think over time, Check Fraud Defender, as it becomes a more significant part of our business certainly has an opportunity to move up that leadership table.

Okay. Helpful. And then given these results for the quarter ended March, could you talk more about when you started to really feel the impact from the macro on those transactional volumes? Did you actually see any headwinds in Q2 or did that become a lot more pronounced in Q3 and Q4? And then from your comments, it seems like ID verification may be getting more impacted than Mobile Deposit, but would love to kind of hear the puts and takes that you're seeing in each business as it relates to the macro.

I believe we started noticing trends as far back as November and December of last year. While you may not see it reflected in the revenue numbers, the variation in how revenue is generated and the differences in our businesses can create a delay in how some contracts are processed. This makes the impact less obvious. However, these points help explain the situation for both lines of business.

Great. Sounds good. Thanks for taking my questions.

Our next question comes from Mike Grondahl with Northland Securities. Please go ahead.

Hey, guys. Thanks. Mobile ID and Mobile Deposits both grew 35%. Is there really anything to call out for either of those high growth rates, sort of what drove it or anything one-time?

I wouldn't say there's anything one-time. It seems like Q2 FY '23 was the quarter of 35% growth in both lines of business and overall for the company. In the mobile identity business, particularly with Mobile Verify, we definitely saw a significant impact on revenue from long-time existing customers who increased their volumes and usage. This was definitely a contributing factor. Additionally, some banks ran very successful marketing campaigns to attract new customers. As for Mobile Deposit, while I wouldn't term it an outlier, we did secure a couple of large contracts. However, every quarter, the team has done an excellent job of smoothing out the impact of those big contracts.

Got it. And then going back to the March quarter, you had that contract extension with a large reseller, and they got a four-year price lock. Can you talk about the price increase that you got there? And are there other large retailers where you think you could get a similar price increase?

I'd like to remind you, Mike, that we've been taking a principled approach to pricing. If we look back four years, when the team started this effort, we mainly sold the Mobile Deposit solution through resellers. The relationships we had were quite inconsistent, making it difficult to understand our pricing structure. As we've modified our pricing and renegotiated contracts, we've done so with a more principled strategy, which has often allowed us to raise prices. What you saw in the Q1 results and what Fuad mentioned today in the prepared remarks relates to a significant contract we secured, which involved reworking an older contract that wasn't one of our best. I won't go into the specifics, but we aligned their pricing with what we see as the general market for our product and resellers. This is beneficial for the market, our partners, and certainly for Mitek and our shareholders.

Got it. Are there other large retailers, you got to play catch up on?

We're four years into this. There may be one or two left, but I don't think you should expect anything as extreme as what we saw in the Q1 results.

Got it. And lastly, Max, now that you're almost caught up with your filing, what two things are you going to be most focused on?

I’m going to Disney World. Just kidding around there, Mike. Yes, certainly, we’re coming up on the end of our fiscal year. So not only do we want to get current, but we want to finish our FY ‘23 strong. So focused on that, focused on getting our annual operating plan in place. And then we’re going to be focused on kicking off, right, getting everybody armed, aimed and excited about the opportunity that’s before us and the adjustments and the improvements that we have to make for FY ‘24.

Got it. Okay. Hey, thanks, guys.

Next question comes from Allen Klee with Maxim Group. Please go ahead.

Yes. Good afternoon. In Identity, there is strong growth. I'm trying to understand the extent of this growth. I recall that a year or two ago, there was a quarter when a bank's marketing campaign ended, which had some impact. Is there any possibility that this strength might not be recurring due to a shorter-term contract that could be ending, or do you believe that there's just some caution regarding the overall macroeconomic situation? Thank you.

Sure, Allen. I believe there are two key points to address. First, the example you mentioned occurred over a year ago. One of our partners was working with a gaming customer in the online gaming sector who launched a new game that required age verification. This situation illustrated the fluctuating transaction volumes in our Identity business. The game became very popular, necessitating players to confirm they were over 13 years old, resulting in over 1 million registrations for the game, which generated significant revenue for us. However, it’s unlikely we will see similar results in the next quarter without another major game launch. Regarding the banking sector, I haven't observed any particular issues to highlight. We experienced strong transaction volumes with the banks, as I mentioned earlier. Additionally, it’s important to note that the HooYu acquisition has provided us with advantages, and we've had HooYu with us for nearly a full quarter for year-over-year comparisons.

That's helpful. And then for your full biometric solution, can you give us an update of kind of where it stands in terms of where you are going to the market? And how we can think about maybe the sales process and what the size of those deals could potentially be compared to what you've been doing before? Thank you.

No problem. MiPass is a new multimodal biometric solution that uses both face and voice recognition to provide a secure and seamless way of authenticating users. This technology ensures that the individual on the other side of the device is a real person and not an AI, bot, or recorded playback. We introduced it at Money 2020 last year, and it is now fully operational. We have a few customers already, and others are currently testing it to see how they can integrate it into their systems. It's challenging for me to estimate the average deal size given our current data, but there is a wide range of potential value we can offer. We could find smaller opportunities with mid-sized businesses where we might manage the service for around $50,000 per year. On the other hand, there are larger opportunities that could generate hundreds of thousands or even millions of dollars annually, leaning more towards a subscription model rather than transaction-based pricing. I hope that answers your question, Allen.

That's great. Thanks. My last question, it sounds like you're doing great on the patent side. What should we, from the outside, be kind of looking for over the next six to 12 months of news flow related to what's going on?

Yeah. The two things I would keep an eye open for. The first is the ongoing PTAB rulings. So having that patent trade office rule on the patents that are out there that USAA is using to try to campaign against the banking industry. So more news there. Obviously, we're not involved in that, but we're following that very closely. And then as we indicated in the prepared remarks, we still have our declaratory judgment action that's on appeal. And we do expect over the course of the next six months to hear something in that matter.

Okay. Great. Congratulations. Thank you.

Thanks.

Our next question comes from Scott Buck with H.C. Wainwright. Please go ahead.

Hi. Good afternoon, everyone. Thank you for answering my questions. Max, regarding the macro situation, is it simply a matter of people gaining a clearer understanding of the Federal Reserve's plans and interest rates, or are there other factors that could help ease customer concerns?

I appreciate the compliment, Scott, but I'm not sure I'm quite the global economist here. From what we hear, our customers are experiencing a slowdown. As a B2B company, we primarily interact with banking institutions and partners, who are the ones witnessing changes like loan growth, mortgage refinancing, and increases in credit card delinquencies. That's where the slowdown is occurring. A significant part of our business involves assisting these customers in expanding their portfolios and increasing their revenue. Additionally, when the economy slows, we see a rise in fraud, which creates a cycle where the negative impacts may seem to outweigh the positive aspects by a significant margin.

No, that's fair. I appreciate that information. Secondly, could we discuss capital allocation? You're building up a significant amount of cash on the balance sheet. What are your thoughts on potential uses for this cash? Are mergers and acquisitions back on the agenda, or are you considering paying down some debt? What are your thoughts?

I can address that, and I'll ask Max to add his insights. At this stage, our main priority is to ensure that we are fully up to date with our filings. Before we consider any potential mergers and acquisitions or stock buybacks, we need to be current with these filings. As Max mentioned in his prepared statements, we aim to achieve this before our commitment to NASDAQ on October 13. This is our top priority right now. Once we are in good standing with our filings, we can explore other opportunities. In terms of capital allocation, my focus is on internal investments, ensuring that we invest wisely and efficiently to maximize our business growth. We will be careful to allocate our available capital prudently and efficiently. For now, our focus is inward, and we will delay any outward initiatives until we have our filings up to date.

I believe the only point I would add is that due to the very favorable terms of the convertible debt, I find it difficult to envision a scenario where we would prepay or reduce that debt ahead of schedule. While it's not out of the question that certain circumstances could lead us to consider it, given the current situation, it doesn’t seem sensible.

Yes. That makes sense, guys. I appreciate the color. That's it for me. Congrats again on the results.

Thanks, Scott.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Todd Kehrli for any 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.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.