Mitek’s (NASDAQ:MITK) results really disappointed shareholders. Specifically, the ID R&D business acquired in 2021 has been the source of disappointments, where business that had previously been baked into expectations instead was pushed out, possibly closing over a year from now, or was not going to materialise at any point. In our last coverage a couple of years ago, we acknowledged that there were still favourable revenue developments. Indeed, its revenue is disappointing now, and therefore revenue is going to be the main driver of the stock in the medium term. There’s always been a decent value case for Mitek that we have acknowledged in all our past coverage, probably related to the legal overhangs, but we’ve seen situations like this before. There are typically more poor developments coming to light as Mitek sees a change of guard and takes a bit of a bath, with the unusual candour of the executives reflecting that situation. Particularly problematic might be the fact that some investors will hold out hope of timing issues seeing a reversal, where some executive comments indicate that might not happen.
Latest earnings
There were definitely some positives in the quarter as well. In particular, Mitek is winning larger customers for its check deposit business. More importantly, some of that revenue is for the Check Fraud Defender (a.k.a. CFD) businesses, which have a shared system for dealing with check fraud that works across banks and benefits from network effects.
…a top five bank went live on Check Fraud Defender during the third quarter. Importantly, three of the top five banks are already using a prior on-premise generation of CFD. These stand-alone implementations provide the banks with protection for only their individual institutions.
Scott Carter, Interim CEO of Mitek
Mitek, being well ensconced in the financial services markets with its check deposit businesses, also has already existing but older generation CFD business with some of the larger banks that would be likely to upgrade to the later generation system which benefits from this network effect.
Software and hardware revenue grew 6% in the Q3, driven by the check deposit businesses (growing around 18%), and instead pressured by what was expected to be a more dynamic general ID and fraud detection business that is not growing as much as planned. The services and other revenue grew 3% YoY as it benefited from a grown recurring revenue base.
Discussing the disappointment in some of the newer and inorganically acquired businesses, the CEO had the following to say:
a number of promising 6 and 7-figure opportunities, which were anticipated to close in the second half of our fiscal 2024. However, upon review, these deals proved to be more complex than anticipated. These are deals with large multinational corporations for disruptive new applications of our biometrics technology. Dealing with customers of this size and complexity often leads to longer sales cycles.
Scott Carter, Interim CEO
Essentially, Mitek works off a more antiquated business model where they sell licenses, not subscriptions, and instead the recurring revenue comes in the form of maintenance of on-premises hardware but also software and billed consulting engagements to properly run the software. The need to keep up the momentum of closing license sale deals is important for results, as the revenue profile is less smoothed out than for a subscription business.
Large contracts were not recognised in revenue in the current quarter. While that might be easy to discount at first, the concern is that the management quite candidly admitted that some of these contracts are not likely to ever close, and the closing prospects were worse than before the management shakeup which was quite recent and followed a tough period for Mitek including with reporting issues and delisting risks. The ones that could close may take years to do so. This has led to a significant shortfall in revenue that was expected to be picking up at this point.
Candidly, they could close in the short term or they could close in the next 18 months. That’s kind of the range of prospects there.
David Lyle, CFO
It’s not all bad. The company does expect some renewed momentum, for example from the launch of a new deepfake protection product, happening imminently. It is a rapidly growing issue, very new and very alarming, so we expect some success here. Also, around a third of the growth in operating expenses, which are up around 8%, is coming from a Russia cost that appears non-recurring.
Bottom Line
Things aren’t terrible, but they’re not great either. There are a lot of outstanding dilution effects, enough to almost double share counts related to convertibles, warrants and other options. We would look out for those convertibles, though. They explain more than a third of the outstanding possible dilution, and those notes are coming due in 2026. They are, of course, way below par given the coupon, and the lack of vigour in the stock in the interim will actually play in Mitek shareholder’s favour for now. The conversion price is $20.85. It only exceeded those levels for a brief time in 2021. Given the slow sales cycles being demonstrated in ID R&D, we’d be happy about the fact that at least those convertibles are probably not coming in clutch for those bondholders. 18 month delays have probably slowed down sales prospects enough to stop the MITK price from getting ahead of $20 in by 2026.
The deepfake product is another positive. But it’s strange that the mobile ID business didn’t gain the traction that it was supposed to. We’d be cautious, as the management candour lately may be the beginning of a longer process of getting real with shareholders about the reality of the growth expectations and the secular hopes. Not unappealing, but also not a slam dunk.
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