MITK

Business Context and Reporting Period

This Form 10-Q covers Mitek Systems, Inc. for the quarterly period ended December 31, 2002. The company provides character recognition technology and software solutions, including the CheckQuest, QuickStrokes, CheckScript, and Doctus product lines. As of January 31, 2003, there were 11,138,772 shares of Common Stock outstanding.

Key Financial Metrics

Note: Cost of sales margin improved to 78% (Cost of sales was 22% of net sales) compared to 74% in the prior year.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased by 12% ($388,000) compared to Q4 2001. This was primarily driven by a 28% decline in revenue from recognition engines, partially offset by increased maintenance revenue and demand for the Doctus product.
• Profitability Compression: Net income dropped significantly to $60,511 from $380,017 in the prior year. Operating income fell to $63,430 from $377,278.
• Expense Increases: Despite lower revenue, several expense categories increased:
  • Operations: Up 13% due to staff additions in customer support and increased depreciation/rent.
  • Selling and Marketing: Up 10% due to additional marketing expenses.
  • R&D: Up 24% due to three additional employees focused on the CheckQuest product line.
• Cost of Sales Efficiency: Cost of sales decreased by 26% to $640,019, improving the gross margin percentage. This was attributed to fewer high-cost hardware installations of the CheckQuest product line.
• Balance Sheet Strength: Cash increased by $443,934 during the quarter. Accounts receivable decreased by $644,000 due to strong collections. Total liabilities decreased by $182,000.

Guidance, Outlook, and Risks

Strategy and Outlook: Management's strategy for fiscal 2003 focuses on growing markets for new products and enhancing character recognition technology. Specific goals include expanding the installed base of the CheckQuest product line while maintaining growth in QuickStrokes and CheckScript. The company believes it has sufficient liquidity to finance operations for the next twelve months using existing cash, operating cash flow, and its line of credit.

Liquidity and Credit: The company maintains a $750,000 revolving line of credit expiring August 27, 2003. There were no borrowings outstanding at period end, though $360,000 was borrowed and repaid during the quarter. The credit line requires a net worth covenant of $4,000,000; the company's net worth was $5,091,585 at December 31, 2002.

Risks and Contingencies:

• Forward-Looking Risks: Risks include adverse economic conditions, decreased demand, intense competition, regulatory changes, inability to maintain the credit line, and loss of key executives.
• Accounting Policies: The company adopted SFAS No. 142 (Goodwill) and SFAS No. 144 (Impairment of Long-Lived Assets) effective October 1, 2002. No material impact was expected. SFAS No. 148 regarding stock-based compensation disclosures will be effective for the second quarter of 2003.
• Valuation Allowance: The company maintains a valuation allowance against deferred tax assets due to uncertainty regarding future realization based on historical taxable income.

Investor Verification Checklist

• Revenue Mix Shift: Verify the sustainability of the 28% decline in recognition engine revenue and the offsetting growth in maintenance/Doctus revenue.
• Expense Leverage: Assess whether the 10-24% increases in Operations, Marketing, and R&D expenses will yield proportional revenue growth in future quarters.
• Credit Line Renewal: Confirm the status of the $750,000 credit line renewal, which expires in August 2003, and ensure continued compliance with the $4M net worth covenant.
• Accounts Receivable Quality: Monitor the allowance for doubtful accounts ($125,028) given the company's reliance on collections for liquidity.
• Stock-Based Compensation: Review upcoming disclosures under SFAS No. 148 regarding the impact of stock-based compensation on reported results starting Q2 2003.