UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
x           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2010
 
or
 
o           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________ to ___________.
 
Commission File Number 0-15235
 
MITEK SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
(State of Incorporation)
87-0418827
(I.R.S. Employer Identification No.)
 
8911 Balboa Ave., Suite B
San Diego, California
(Address of principal executive offices)
92123
(Zip Code)
 
Registrant's telephone number: (858) 503-7810
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No  ¨
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act Check one):
 
 
Large Accelerated Filer o
  
Accelerated Filer o
  
 
Non-Accelerated Filer o
  
Smaller Reporting Company x
  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  x
 
There were 16,766,137 shares outstanding of the registrant's common stock as of May 12, 2010.
 
MITEK SYSTEMS, INC.
 
FORM 10-Q
 
For the quarterly period ended March 31, 2010
 
Special Note About Forward–Looking Statements
            (ii)
     
PART I - FINANCIAL INFORMATION
   
 
ITEM 1.
  Financial Statements
             1
     
ITEM 2.
  Management's Discussion and Analysis of Financial Condition and Results of Operations
           11
   
 
ITEM 3.
  Quantitative and Qualitative Disclosures About Market Risk
           17
     
ITEM 4.
  Controls and Procedures
           17
     
PART I I - OTHER INFORMATION
     
ITEM 1.
  Legal Proceedings
           17
     
ITEM 1A.
  Risk Factors
           17
     
ITEM 2.
  Unregistered Sales of Equity Securities and Use of Proceeds
           18
     
ITEM 3.
  Defaults Upon Senior Securities
           18
     
ITEM 4.
  (Removed and Reserved)
           18
     
ITEM 5.
  Other Information
           18
     
ITEM 6.
  Exhibits
           19
     
Signatures
  
           20
 
(i)
 
Part I I - Other Information
 
 
Special Note About Forward-Looking Statements
 
We make forward-looking statements in this report, particularly in Part I, Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and in the documents that are incorporated by reference into this report, if any.  These forward-looking statements relate to Mitek's outlook or expectations for earnings, revenues, expenses, asset quality or other future financial or business performance, strategies or expectations, or the impact of legal, regulatory or supervisory matters on Mitek's business, results of operations or financial condition.  Specifically, forward looking statements used in this report may include statements relating to future business prospects, revenue, income and financial condition of Mitek.
 
Forward-looking statements can be identified by the use of words such as "estimate," "may," "plan," "project," "forecast," "intend," "expect," "anticipate," "believe," "seek," "target" or similar expressions.  These statements reflect Mitek's judgment based on currently available information and involve a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.
 
In addition to those factors discussed under the heading "Risk Factors" in Part II, Item 1A of this report, and in Mitek's other public filings with the Securities and Exchange Commission, important factors could cause actual results to differ materially from our expectations.  These factors include, but are not limited to:
 
·      
adverse economic conditions;
·      
general decreases in demand for Mitek products and services;
·      
intense competition (including entry of new competitors), including among competitors with substantially greater resources than Mitek;
·      
loss of key customers or contracts;
·      
increased or adverse federal, state and local government regulation;
·      
inadequate capital;
·      
unexpected costs;
·      
lower revenues and net income than forecast;
·      
the risk of litigation and administrative proceedings;
·      
the possible fluctuation and volatility of operating results and financial condition;
·      
adverse publicity and news coverage;
·      
inability to carry out marketing and sales plans; and
·      
loss of key employees and executives.

You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date hereof, or in the case of a document incorporated by reference, as of the date of that document.  Except as required by law, we undertake no obligation to publicly update or release any revisions to these forward-looking statements to reflect any events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.
 
The above list is not intended to be exhaustive and there may be other factors that would preclude us from realizing the predictions made in the forward-looking statement.  We operate in a continually changing business environment and new factors emerge from time to time.  We cannot predict such factors or assess the impact, if any, of such factors on their respective financial positions or results of operations.
 
In this report, unless the context indicates otherwise, the terms "Mitek," "Company," "we," "us," and "our" refer to Mitek Systems, Inc., a Delaware corporation.
 
(ii)
PART I   - FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
MITEK SYSTEMS, INC
  
BALANCE SHEETS
  
             
   
March 31,
    
September 30,
  
   
2010
    
2009
  
   
(Unaudited)
        
ASSETS
            
    CURRENT ASSETS:
            
    Cash and cash equivalents
   $ 1,414,847     $ 674,115  
    Accounts receivable including related party of $2,612 and $10,003,
     1,003,882       360,817  
        respectively, net of allowance of $6,003 and $24,268, respectively
                
    Deferred maintenance fees
     143,868       60,683  
    Inventory, prepaid expenses and other current assets
     96,652       49,910  
        Total current assets
     2,659,249       1,145,525  
                 
    PROPERTY AND EQUIPMENT-net
     43,999       60,367  
    SOFTWARE DEVELOPMENT COSTS-net
     297,175       365,753  
    OTHER LONG-TERM ASSETS
     60,829       29,465  
                 
TOTAL ASSETS
   $ 3,061,252     $ 1,601,110  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                
                 
    CURRENT LIABILITIES:
                
    Accounts payable
   $ 535,041     $ 356,305  
    Accrued payroll and related taxes
     265,371       206,197  
    Deferred revenue
     897,271       700,714  
    Deferred rent, current
     9,193       118,732  
    Other accrued liabilities
     48,433       44,023  
        Total current liabilities
     1,755,309       1,425,971  
                 
    LONG-TERM LIABILITIES:
                
    Convertible debt
     496,049       -  
    Deferred rent, non-current
     44,983       49,374  
        Total long-term liabilities
     541,032       49,374  
                 
TOTAL LIABILITIES
     2,296,341       1,475,345  
                 
STOCKHOLDERS' EQUITY:
                
    Preferred stock, $0.001 par value, 1,000,000 shares authorized,
                
       none issued and outstanding
     -       -  
    Common stock, $0.001 par value; 40,000,000 shares authorized,
                
       16,766,137 and 16,751,137 issued and outstanding, respectively
     16,766       16,751  
    Additional paid-in capital
     15,776,103       14,920,999  
    Accumulated deficit
     (15,027,958 )     (14,811,985 )
       Total stockholders' equity
     764,911       125,765  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
   $ 3,061,252     $ 1,601,110  
                 
The accompanying notes form an integral part of these financial statements.
 
-1-
MITEK SYSTEMS, INC
STATEMENTS OF OPERATIONS
(Unaudited)
                         
   
Three Months Ended
    
Six Months Ended
  
    March 31,    
March 31,
   
2010
    
2009
    
2010
    
2009
  
                         
SALES:
                        
   Software
   $ 1,027,363     $ 431,433     $ 1,703,436     $ 928,091  
   Professional services
     489,602       456,850       972,540       971,640  
      1,516,965       888,283       2,675,976       1,899,731  
                                 
COSTS AND EXPENSES:
                                
   Cost of sales-software
     130,267       82,951       422,376       220,800  
   Cost of sales-professional services
     51,845       52,106       112,902       109,836  
   Operations
     -       6,516       -       29,840  
   Selling and marketing
     231,275       190,017       395,839       551,057  
   Research and development
     507,370       431,192       1,013,824       1,003,685  
   General and administrative
     498,622       362,230       831,786       892,105  
     Total costs and expenses
     1,419,379       1,125,012       2,776,727       2,807,323  
                                 
OPERATING INCOME (LOSS)
     97,586       (236,729 )     (100,751 )     (907,592 )
                                 
OTHER (EXPENSE) INCOME:
                                
   Interest and other expense
     (90,839 )     (2,154 )     (113,555 )     (2,434 )
   Interest income
     226       772       671       3,799  
     Total other (expense) income - net
     (90,613 )     (1,382 )     (112,884 )     1,365  
                                 
INCOME (LOSS) BEFORE INCOME TAXES
     6,973       (238,111 )     (213,635 )     (906,227 )
                                 
PROVISION FOR INCOME TAXES
     -       (1,800 )     (2,338 )     (1,800 )
                                 
NET INCOME (LOSS)
   $ 6,973     $ (239,911 )   $ (215,973 )   $ (908,027 )
                                 
NET INCOME (LOSS) PER SHARE - BASIC
   $ 0.00     $ (0.01 )   $ (0.01 )   $ (0.05 )
                                 
WEIGHTED AVERAGE NUMBER OF
                                
COMMON SHARES AND COMMON SHARE
                                
EQUIVALENTS OUTSTANDING - BASIC
     16,756,804       16,751,137       16,753,939       16,751,137  
                                 
NET INCOME (LOSS) PER SHARE - DILUTED
   $ 0.00     $ (0.01 )   $ (0.01 )   $ (0.05 )
                                 
WEIGHTED AVERAGE NUMBER OF
                                
COMMON SHARES AND COMMON SHARE
                                
EQUIVALENTS OUTSTANDING - DILUTED
     17,476,183       16,751,137       16,753,939       16,751,137  
                                 
The accompanying notes form an integral part of these financial statements.
 
-2-
MITEK SYSTEMS, INC
  
STATEMENTS OF CASH FLOWS
  
(Unaudited)
  
             
   
For the six months ended
  
   
March 31,
  
   
2010
    
2009
  
OPERATING ACTIVITIES
            
Net loss
   $ (215,973 )   $ (908,027 )
Adjustments to reconcile net loss to net cash
                
used in operating activities:
                
Stock-based compensation expense
     216,684       68,750  
Accretion of discount on convertible debt
     111,135       -  
Depreciation and amortization
     87,110       19,262  
Amortization of capitalized debt issuance costs
     13,800       -  
Provision for bad debts
     (18,265 )     2,229  
Loss on disposal of property and equipment
     -       1,767  
Changes in assets and liabilities:
                
Accounts receivable
     (624,800 )     128,568  
Deferred maintenance fees
     (83,185 )     -  
Inventory, prepaid expenses, and other current assets
     (1,579 )     (32,460 )
Accounts payable
     178,736       159,989  
Accrued payroll and related taxes
     59,174       (103,220 )
Deferred revenue
     196,557       157,109  
Deferred rent
     (113,930 )     (1,593 )
Other accrued liabilities
     4,410       55,374  
Net cash used in operating activities
     (190,126 )     (452,252 )
                 
INVESTING ACTIVITIES
                
Purchases of property and equipment
     (2,165 )     (9,050 )
Investment in software development costs
     -       (63,735 )
Proceeds from sale of property and equipment
     -       70  
Net cash used in investing activities
     (2,165 )     (72,715 )
                 
FINANCING ACTIVITIES
                
Proceeds from the issuance of convertible debt-net
     922,223       -  
Proceeds from exercise of stock options
     10,800       -  
Net cash cash provided by financing activities
     933,023       -  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
     740,732       (524,967 )
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
     674,115       1,300,281  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
   $ 1,414,847     $ 775,314  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
                
Cash paid for interest
   $ 2,055     $ 667  
Cash paid for income taxes
   $ 2,338     $ 1,800  
                 
NON-CASH FINANCING ACTIVITIES
                
Debt discount on convertible note due to warrants
   $ 226,068     $ -  
Beneficial conversion feature related to convertible debt issued
   $ 401,568     $ -  
Other assets funded by issuance of convertible note
   $ 90,328     $ -  
                 
The accompanying notes form an integral part of these financial statements.
  
 
-3-
MITEK SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)

1.         Basis of Presentation

The accompanying unaudited financial statements as of March 31, 2010 of Mitek Systems, Inc. (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X and accordingly, they do not include all information and footnote disclosures required by accounting principles generally accepted in the United States of America.  Refer to the Company’s financial statements on Form 10-K for the year ended September 30, 2009 for additional information.  The financial statements do, however, reflect all adjustments (solely of a normal recurring nature) which are, in the opinion of management, necessary for a fair statement of the results of the interim periods presented.

Results for the three and six months ended March 31, 2010 are not necessarily indicative of results which may be reported for any other interim period or for the year as a whole.

Going Concern
 
The Company reported net income of approximately $7,000 in the three months ended March 31, 2010, compared to a net loss of approximately $240,000 in the three months ended March 31, 2009.  In the six months ended March 31, 2010 and 2009, the Company incurred net losses of approximately $216,000 and $908,000, respectively, and has an accumulated deficit of approximately $15.0 million as of March 31, 2010.  Net cash used in operating activities decreased from approximately $452,000 in the second quarter of fiscal 2009 to approximately $190,000 in the second quarter of fiscal 2010.  Net cash used in investing activities was approximately $2,000 in the six months ended March 31, 2010, compared to approximately $73,000 in the six months ended March 31, 2009.  The Company’s cash balance was approximately $1,415,000 as of March 31, 2010.
 
In January 2009, the Company implemented a plan to decrease its operating expenses by reducing its workforce in light of the economic contraction of the financial services market into which the Company primarily sells its products.  The staff reduction included general and administrative, sales and marketing and technical staff.  The Company has diligently maintained key resources to adequately pursue new sales opportunities and support its operations.  The Company's management does not believe that such reductions have impaired the Company’s ability to develop its ImageNet Mobile Deposit application and other mobile capture products, or to provide technical support to its current and prospective customers.

In December 2009, the Company raised approximately $922,000, net of transaction costs and expenses, from the private placement of debentures and warrants.  This private placement is discussed in greater detail in Note 4 to our financial statements in this report.

Based on its current operating plan, the Company’s existing working capital may not be sufficient to meet the cash requirements to fund its planned operating expenses, capital expenditures, and working capital requirements for the next twelve months without additional sources of cash and/or the deferral, reduction or elimination of significant planned expenditures.  The Company may need to raise significant additional funds to continue its operations.  Although the Company had positive cash flows during the three months ended March 31, 2010, in the absence of continued positive cash flows from operations sufficient to cover operating expenses, the Company may be dependent on its ability to secure additional funding through the issuance of debt or equity instruments.  If adequate funds are not available, the Company may be forced to significantly curtail its operations or to obtain funds through entering into additional collaborative agreements or other arrangements that may be on unfavorable terms, if attainable at all.
 
These factors raise substantial doubt about the Company’s ability to continue as a going concern.  The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  This basis of accounting contemplates the recovery of the Company’s assets and the satisfaction of liabilities in the normal course of business.  In addition, these financial statements do not include any adjustments to the specific amounts and classifications of assets and liabilities, which might be necessary should the Company be unable to continue as a going concern.  The Company is taking expense reduction measures to conserve cash.
 
-4-
Earnings per share
 
The computation of basic and diluted earnings per share is as follows:
 
   
Three months ended
    
Six months ended
  
   
March 31,
    
March 31,
  
   
2010
    
2009
    
2010
    
2009
  
Net income (loss)
   $ 6,973     $ (239,911 )   $ (215,973 )   $ (908,027 )
                                 
Weighted-average common shares and share equivalents outstanding - basic
     16,756,804       16,751,137       16,753,939       16,751,137  
                                 
Effect of dilutive stock options
     719,379       -       -       -  
                                 
Weighted-average common shares and share equivalents outstanding - diluted
     17,476,183       16,751,137       16,753,939       16,751,137  
                                 
Earnings per share:
                                
Basic
   $ -     $ (0.01 )   $ (0.01 )   $ (0.05 )
Diluted
   $ -     $ (0.01 )   $ (0.01 )   $ (0.05 )
 

2.         Recently Issued Accounting Pronouncements
 
During June 2008, the FASB issued an update to ASC Topic 815, Derivatives and Hedging, (“ASC 815”), which is effective for fiscal years beginning after December 15, 2008. ASC 815 addresses the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock.  If an instrument (or an embedded feature) that has the characteristics of a derivative instrument under ASC 815 is indexed to an entity’s own stock, it is still necessary to evaluate whether it is classified in stockholders’ equity (or would be classified in stockholders’ equity if it were a freestanding instrument).  The Company has determined that ASC 815 did not materially affect its financial statements during the six months ended March 31, 2010.

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition: Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”), which amends ASC Topic 605, Revenue Recognition.  ASU 2009-13 revises the current accounting treatment to specifically address how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting.  This guidance is applicable to revenue arrangements entered into or materially modified during the first fiscal year that begins after June 15, 2010.  The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively.  The Company does not anticipate the adoption of this guidance will have a material impact on the financial statements.
 
In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”), which amends ASC Topic 985, Software.  ASU 2009-14 amends the ASC to change the accounting model for revenue arrangements that include both tangible products and software elements, such that tangible products containing both software and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of software revenue guidance.  The changes to the ASC as a result of this update are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.  The Company does not anticipate the adoption of this guidance will have a material impact on the financial statements.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASU 2010-06”), which amends ASC Topic 820, Fair Value Measurements and Disclosures, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures.  ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010; although, early adoption is permitted.  The Company is currently evaluating the impact of adopting ASU 2010-06 on its financial statements.

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events – Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”) that amends ASC Subtopic 855-10, Subsequent Events – Overall.  ASU 2010-09 requires an SEC filer to evaluate subsequent events through the date that the financial statements are issued but removed the requirement to disclose this date in the notes to the entity’s financial statements.  The amendments are effective upon issuance of the final update and accordingly, the Company has adopted the provisions of ASU 2010-09.  The Company has determined that adoption of ASU 2010-09 did not materially affect its financial statements.

-5-
In April 2010, the FASB issued ASU No. 2010-17, Milestone Method of Revenue Recognition ("ASU 2010-17") to (i) limit the scope of this ASU to research or development arrangements and (ii) require that guidance in this ASU be met for an entity to apply the milestone method (record the milestone payment in its entirety in the period received).  However, the FASB clarified that, even if the requirements in ASU 2010-17 are met, entities would not be precluded from making an accounting policy election to apply another appropriate accounting policy that results in the deferral of some portion of the arrangement consideration.  ASU 2010-17 will apply to milestones in both single-deliverable and multiple-deliverable arrangements involving research or development transactions.  ASU 2010-17 will be effective for fiscal years (and interim periods within those fiscal years) beginning on or after June 15, 2010; although, early adoption is permitted.  Entities can apply this guidance prospectively to milestones achieved after adoption; however, retrospective application to all prior periods is also permitted.  The Company is currently evaluating the impact, if any, that adoption of ASU 2010-17 will have on its financial statements.

3.         Capitalized Software Development Costs

The Company has developed Mobile Capture software, a software solution that captures and reads data from mobile devices using proprietary technology.  The Company has completed all of the planning, designing, coding, and testing activities necessary to establish technological feasibility of the product and has determined that the product can be produced to meet its design specifications including functions, features, and technical performance requirements.
 
Costs of internally developed software are expensed until the technological feasibility of the software product has been established.  Thereafter, software development costs, to the extent that management expects such costs to be recoverable against future revenues, are capitalized until the product's general availability to customers in accordance with FASB ASC Topic 985-20, Costs of Software to Be Sold, Leased, or Marketed ("ASC 985-20").
 
The Company evaluates its capitalized software development costs at each balance sheet date to determine if the unamortized balance related to any given product exceeds the estimated net realizable value of that product.  Any such excess is written off through accelerated amortization in the quarter it is identified.  Determining net realizable value, as defined by ASC 985-20, requires making estimates and judgments in quantifying the appropriate amount to write off, if any.  Actual amounts realized from the software products could differ from those estimates.  Also, any future changes to the Company's product portfolio could result in significant increases to its cost of license revenue as a result of the write-off of capitalized software development costs.  The Company completed its first production general release of ImageNet Mobile DepositTM on October 31, 2008, and entered into an agreement with a major financial institution on November 4, 2008 to conduct a performance evaluation of the product.  In accordance with ASC 985-20, the Company ceased capitalizing software development costs related to this product on the date that it completed its first production general release.
 
  In June 2009, the Company began to recognize revenue from the sale of ImageNet Mobile DepositTM, at which time it started amortizing the capitalized software development costs associated with the product in accordance with ASC 985-20.  Under ASC 985-20, the annual amortization shall be the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or (b) the straight-line method over the remaining estimated economic life of the product including the period being reported on.  The Company determined it was appropriate to amortize the related capitalized software development costs over the remaining economic life of the product, estimated to be three years.  The Company recorded amortization of software development costs of approximately $34,000 and $69,000 in the three and six months ended March 31, 2010, respectively.  There was no amortization of software development costs recorded in the three and six months ended March 31, 2009 as the software product was still in the development phase and not yet marketable to customers.
 
4.         Convertible Debt

On December 10, 2009, the Company entered into a securities purchase agreement with accredited investors pursuant to which the Company agreed to issue in exchange for aggregate consideration of approximately $1.0 million the following securities: (i) 5% senior secured convertible debentures in the principal amount of approximately $1.0 million, and (ii) warrants to purchase an aggregate of 337,501 shares of the Company’s common stock with an exercise price of $0.91 per share.  Each investor received a warrant to purchase that number of shares of the Company’s common stock that equals 25% of the quotient obtained by dividing such investor’s aggregate subscription amount by $0.75.  The transaction resulted in proceeds to the Company of approximately $922,000, net of transaction costs and expenses.

-6-
Interest is payable in cash or stock at the rate of 5% per annum on each conversion date (as to the principal amount being converted), on each early redemption date (as to the principal amount being redeemed) and on the maturity date.  The principal amount of the debentures, if not paid earlier, is due and payable on December 10, 2011.  The Company has the right to redeem all or a portion of the debentures before maturity by payment in cash of the outstanding principal amount plus accrued and unpaid interest being redeemed.  The Company agreed to honor any notices of conversion that it receives from the holder before the date the Company pays off the debentures.  The debentures are convertible into shares of the Company’s common stock at any time at the discretion of the holder at a conversion price per share of $0.75, subject to adjustment for stock splits, stock dividends and the like.  The Company has the right to force conversion of the debentures if (i) the closing price of its common stock exceeds 200% of the then effective conversion price for 20 trading days out of a consecutive 30 trading day period or (ii) the average daily trading volume for its common stock exceeds 100,000 shares per trading day for 20 trading days out of a consecutive 30 trading day period and the closing price of its common stock exceeds 100% of the then effective conversion price for 20 trading days out of a consecutive 30 trading day period.  The debentures impose certain covenants on the Company including restrictions against paying cash dividends or distributions on shares of its outstanding common stock.  The debentures are secured by all of the Company’s assets under the terms of a security agreement it entered into with the investors dated December 10, 2009.

In evaluating the accounting for the convertible note, the Company considered whether the conversion option related to the convertible note required bifurcation and separate accounting as a liability at fair value.  Because the conversion option entitles the holder to convert to a fixed number of shares at a fixed price, the Company believes it is not required to bifurcate the conversion option and the related debt host.  Similarly, the warrant contract entitles the holder to convert to a fixed number of shares at a fixed price and is therefore recorded in stockholders’ equity.

Of the gross proceeds, approximately $786,000 was allocated to the debentures and approximately $226,000 to the warrants.  The value of the warrants was estimated using a Black-Scholes option valuation model. The amount allocated to the warrants was recorded as a discount on the debentures and is being amortized to interest expense over the term of the debentures.  In addition, based on the conversion price of $0.75 and relative value of the debentures, a beneficial conversion feature of approximately $402,000 was recorded as an additional discount on the debentures and is being amortized to interest expense in the accompanying statements of operations over the term of the debentures.
 
The following represents the principal amount of the liability component, the unamortized discount, and the net carrying amount of the debentures at March 31, 2010:
 
Principal, including accrued interest of $15,700
   $ 1,028,250  
Unamortized discount
     (532,201 )
Net carrying amount
   $ 496,049  
 
5.         Income Taxes

At September 30, 2009, the Company had net deferred tax assets of approximately $7.24 million.  The deferred tax assets are primarily comprised of federal and state net operating loss carryforwards (approximately 79% of the net deferred tax assets at October 1, 2009).  Such carryforwards began to expire in 2008 and will continue to expire through 2023.  Under the Tax Reform Act of 1986, the amount of and the benefit from net operating losses that can be carried forward may be limited in certain circumstances.  The Company carries a deferred tax valuation allowance equal to 100% of total net deferred assets.  In recording this allowance, management has considered a number of factors, but chiefly, the Company's recent history of sustained operating losses.  Management has concluded that a valuation allowance is required for 100% of the total deferred tax assets as it is more likely than not that the deferred tax assets will not be realized.
 
The Company has not determined the amount of the annual limitation on operating loss carryforwards that can be utilized in a taxable year.  Any operating loss carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance.  Based on the 100% valuation allowance on the deferred tax assets, the Company does not anticipate that future changes in the Company's unrecognized tax benefits will impact its effective tax rate.
 
The Company's policy is to classify interest and penalties related to income tax matters as income tax expense.  The Company had no accrual for interest or penalties as of September 30, 2009 or March 31, 2010, and has not recognized interest and/or penalties in the statement of operations for the three and six month periods ended March 31, 2010.

-7-

6.         Stockholders' Equity

Warrants
 
Historically, the Company has granted warrants to purchase its common stock to service providers and investors.  As of September 30, 2009, the Company had warrants to purchase 1,381,428 shares of its common stock outstanding with exercise prices ranging from $0.70 to $0.92 per share, subject to adjustment per the terms of the agreements.  These warrants expire from June 2011 to May 2012.
 
Included in the warrants discussed above, are warrants to purchase, in the aggregate, 321,428 shares of the Company’s common stock at an exercise price of $0.70 per share, subject to adjustment per the terms of the agreement the Company granted to John H. Harland Company, a related party.  These warrants expire from February 2012 to May 2012.
 
In connection with the issuance of the convertible debentures in December 2009, the Company issued warrants to purchase an aggregate of 337,501 shares of the Company’s common stock with an exercise price of $0.91 per share as discussed in greater detail in Note 4 to our financial statements in this report.
 
The fair value of the vested warrants was estimated on the grant date using the Black-Scholes option valuation model with the following assumptions:
 
Risk-free interest rate
2.19%
Expected term (in years)
5.0
Stock price volatility
2.07
Expected dividend yield
0%
 
The following table summarizes warrant activity in the six months ended March 31, 2010:
   
 
    
 
  
   
Number
of warrants
    
Weighted-average
exercise price
  
Oustanding and exercisable at September 30, 2009
     1,381,428     $ 0.80  
   Issued
     337,501     $ 0.91  
   Exercised for cash
     -       -  
   Expired
     -       -  
Oustanding and exercisable at March 31, 2010
     1,718,929     $ 0.82  
                 
 
There were no exercises of warrants during the six months ended March 31, 2010 and 2009.
 
Stock-based Compensation

The Company adopted the fair value recognition provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, Compensation-Stock Compensation (“ASC 718”).
 
The fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model.  The Black-Scholes model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.  The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior.  The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the expected life of the grant effective as of the date of the grant.  The expected volatility is based on the historical volatility of the Company's stock price.  These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.
 
The value of stock-based compensation is based on the single option valuation approach under ASC 718.  It is assumed no dividends will be declared.  The estimated fair value of stock-based compensation awards to employees is amortized using the straight-line method over the vesting period of the options.  The estimated expected remaining contractual life of stock option grants at March 31, 2010 was approximately 1.8 years on grants to directors and 6.9 years on grants to employees.
 
-8-
The fair value calculations for stock-based compensation awards to employees for the six month periods ended March 31, 2010 and 2009 were based on the following assumptions:
 
   
2010
  
2009
         
Risk-free interst rate
  
0.35% - 2.48%
  
0.44% - 2.29%
Expected life (years)
  
5.21
  
5.29
Expected volatility
  
219%
  
192%
Expected dividends
  
None
  
None
 
ASC 718 requires the cash flows resulting from the tax benefits ensuing from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows.  Due to the Company's valuation allowance from losses in the previous years, there was no such tax benefits during the three and six months ended March 31, 2010.  Prior to the adoption of ASC 718 those benefits would have been reported as operating cash flows had the Company received any tax benefits related to stock option exercises.
 
There were 925,500 stock options granted during the three months ended March 31, 2010.
 
The following table summarizes stock-based compensation expense related to stock options under ASC 718 for the three and six months ended March 31, 2010 and 2009, which was allocated as follows:
 
   
Three Months Ended
    
Six Months Ended
  
   
March 31,
    
March 31,
  
   
2010
    
2009
    
2010
    
2009
  
Research and development
   $ 23,755     $ 8,828     $ 33,690     $ 17,569  
Sales and marketing
     7,223       2,503       9,573       8,723  
General and administrative
     160,291       26,198       173,421       42,458  
                                 
Stock-based compensation expense related to employee stock options included in operating expenses
   $ 191,269     $ 37,529     $ 216,684     $ 68,750  
                                 
 
The following table summarizes vested and unvested options, fair value per share weighted average remaining term and aggregate intrinsic value at March 31, 2010:
 
   
Number of Shares
    
Weighted Average Grant Date Fair Value Per Share
    
Weighted Average Remaining Contractual Life (in Years)
    
Aggregate Intrinsic Value
  
                         
Vested
     2,957,877      
0.39
 
    
4.97
     $ 450,445  
Unvested
     1,385,123      
0.49
      
9.29
       274,345  
Total
     4,343,000      
0.42
      
6.35
     $ 724,790  
                                 
 
As of March 31, 2010, the Company had $650,129 of unrecognized compensation expense expected to be recognized over a weighted average period of approximately 1.0 year.
 
-9-
A summary of option activity under the Company’s stock equity plans during the six months ended March 31, 2010 is as follows:
 
         
 Weighted
    
Weighted Average
  
         
 Average
    
Remaining
  
   
Number of
    
Exercise Price Per
    
Contractual Term
  
   
Shares
    
Share
    
(in Years)
  
Oustanding, September 30, 2009
     3,533,000     $ 0.56       6.10  
                         
   Granted:
                        
      Board of Directors
     150,000     $ 0.79       2.91  
      Executive Officers
     250,000     $ 0.79       9.91  
      Employees
     525,500     $ 0.79       9.58  
    Exercised
     (15,000 )   $ 0.72       -  
    Cancelled
     (100,500 )   $ 0.80       -  
                         
Oustanding, March 31, 2010
     4,343,000     $ 0.60       6.35  
 
The following table summarizes significant ranges of outstanding and exercisable options as of March 31, 2009:
 
   
Weighted
    
Weighted
  
   
Average
    
Average
  
 
 Number of
Remaining
Weighted
 Number of
Exercise Price of
 Number of
Range of
 Options
Contractual Life
Average
 Exercisable
Exercisable
 Unvested
Exercise Prices
 Outstanding
(in Years)
Exercise Price
 Options
Options
 Options
$0.07 - $0.69
       2,300,500
6.35
$0.29
       1,674,198
$0.33
         626,302
$0.70 - $0.92
       1,271,500
7.82
$0.79
          512,679
$0.80
         758,821
$1.06 - $1.68
          725,000
4.07
$1.11
          725,000
$1.11
                  -
$2.13 - $2.68
            38,500
1.90
$2.28
            38,500
$2.28
                  -
$3.25 to $12.37
              7,500
0.14
$6.87
              7,500
$6.87
                  -
 
       4,343,000
6.35
$0.60
       2,957,877
$0.65
      1,385,123
 
On June 10, 2009, the Company’s 1999 Stock Option Plan expired in accordance with the terms of the plan.  Options granted under the plan that were outstanding at such date remain in effect until such options are exercised, forfeited or expire in accordance with the plan.  As of March 31, 2010, options to purchase 684,250 shares of the Company’s common stock were outstanding under the plan and no options were available for future grants.
 
7.  Product Revenue and Sales Concentrations

Product Revenues
 
During the three and six months ended March 31, 2010 and 2009, the Company’s revenues were derived primarily from its Character Recognition Product line.
 
Below is a summary of revenues:
 
   
Three Months Ended March 31,
    
Six Months Ended March 31,
  
   
2010
    
2009
    
2010
    
2009
  
Revenue
                        
   Software licenses
   $ 1,027,363     $ 431,433     $ 1,703,436     $ 928,091  
   Maintenance and professional services
     489,602       456,850       972,540       971,640  
Total Revenue
   $ 1,516,965     $ 888,283     $ 2,675,976     $ 1,899,731  
 
-10-
Sales Concentration
 
The Company sells its products primarily to original equipment manufacturers, system integrators and resellers who ultimately sell to depository institutions.  For the three and six months ended March 31, 2010 and 2009, the Company had the following sales concentrations:
 
 
Three Months Ended
  
Six Months Ended
 
March 31,
  
March 31,
Customers to which sales were in excess of 10% of
2010
  
2009
  
2010
  
2009
total sales:
              
  Number of customers
2
  
2
  
3
  
2
  Aggregate percentage of sales
47.0%
  
31.3%
  
44.0%
  
27.9%
 
Sales to customers in excess of 10% of total sales were approximately $713,000 and $1,177,000 for the three and six months ended March 31, 2010, respectively, compared to approximately $278,000 and $531,000 for the three and six months ended March 31, 2009, respectively.  The balance of accounts receivable from customers with sales in excess of 10% of total sales was approximately $415,000 and $522,000 as of March 31, 2010 and 2009, respectively.

8.   Related Parties
 
John H. Harland Company ("JHH Co.") made investments in the Company in February and May 2005.  JHH Co. acquired a total of 2,142,856 shares of unregistered common stock for an aggregate purchase price of $1,500,000 or $0.70 per share.  As part of the acquisition of shares, JHH Co. received warrants to purchase 321,428 additional shares of common stock at $0.70 per share.  This transaction resulted in JHH Co. and its subsidiary, Harland Financial Solutions (collectively "John Harland"), being considered related parties of the Company due to the amount of the Company's common stock beneficially owned by John Harland.  John Harland is not involved in the management decisions of the Company and does not participate in any board meetings, unless invited.
 
The Company recognized revenues from John Harland of approximately $14,000 and $15,000 for the three months ended March 31, 2010 and 2009, respectively, for professional services, including software maintenance.  Revenue recognized from John Harland for professional services was approximately $31,000 in both the six months ended March 31, 2010 and 2009.  There was an outstanding accounts receivable balance due from John Harland of approximately $3,000 and $10,000 at March 31, 2010 and 2009, respectively.

9.   Commitments and Contingencies
 
The Company’s principal executive office, as well as its research and development facility, is located in an office building in San Diego, California that the Company leases under a non-cancelable operating lease.  The lease costs are expensed on a straight-line basis over the lease term.  The lease on this facility commenced in December 2005 and expires in December 2012.  On February 1, 2009, the lease was amended to allow the Company to defer the payment of 50% of the basic rent due for the months of February through September 2009.  The Company began repaying the deferred rent with interest at an annual rate of 6% in equal monthly installments on October 1, 2009.  The Company paid the final installment on March 1, 2010.  In addition, in connection with the February 2009 amendment, the Company waived its right to exercise an early termination option.  On September 13, 2009, the lease was amended to reduce the amount of office space subject to the lease by approximately 1,722 square feet to approximately 14,205 square feet, which reduced the Company’s basic rent proportionately starting in December 2009.
 
 
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Special Note Regarding Forward-Looking Statements
 
To the extent that this management’s discussion and analysis of financial condition and results of operations contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that our actual financial condition, operating results and business performance may differ materially from those projected or estimated by us in forward-looking statements.  We have attempted to identify certain of the factors that we currently believe may cause actual future experiences and results to differ from our current expectations.  Please see "Note About Forward–Looking Statements" at the beginning of this report.  Please consider our forward-looking statements in light of those risks as you read this report.
 
-11-
Business
 
Our business develops and markets intelligent character recognition and document capture products and services deployed primarily in the financial services markets.  Our technology is currently used to process checks by banks and is used in other markets for specialized applications.
 
During the past fiscal year, we have leveraged our technology and industry customer relationships to enter the rapidly growing market for smartphone mobile business applications.  Branded “Oomph” for Office on My Phone, our new mobile applications use our proprietary technology to capture and read data from photos of documents taken using camera-equipped smartphones.
 
We have developed and deployed a software application that allows users to remotely deposit a check using their smartphone camera.  Additionally, we have developed and deployed a receipt archival application and a mobile document faxing application using our proprietary technology.
 
Application of Critical Accounting Policies

Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America, or GAAP.  Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses.  These estimates by management are affected by management's application of accounting policies are subjective and may differ from actual results.  Our critical accounting policies include revenue recognition, allowance for accounts receivable, fair value of equity instruments and accounting for income taxes.
 
Revenue Recognition

We enter into contractual arrangements with integrators, resellers and end users that may include licensing of our software products, product support and maintenance services, consulting services, resale of third-party hardware, or various combinations thereof, including the sale of such products or services separately.  Our accounting policies regarding the recognition of revenue for these contractual arrangements is fully described in the accompanying Notes to the Financial Statements included in this report.

We consider many factors when applying GAAP to revenue recognition.  These factors include, but are not limited to:

·     
the actual contractual terms, such as payment terms, delivery dates, and pricing of the various product and service elements of a contract;
·     
time period over which services are to be performed;
·     
creditworthiness of the customer;
·     
the complexity of customizations to our software required by service contracts;
·     
the sales channel through which the sale is made (direct, VAR, distributor, etc.);
·     
discounts given for each element of a contract; and
·     
any commitments made as to installation or implementation “go live” dates.

Each of the relevant factors is analyzed to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer.  Management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards.  Any misjudgment or error by management in its evaluation of the factors and the application of the standards, especially with respect to complex or new types of transactions, could have a material adverse effect on our future revenues and operating results.

Accounts Receivable

We constantly monitor collections from our customers and maintain a provision for estimated credit losses that is based on historical experience and on specific customer collection issues.  While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.  Since our revenue recognition policy requires customers to be deemed creditworthy, our accounts receivable are based on customers whose payment is reasonably assured.

-12-
Fair Value of Equity Instruments

The valuation of certain items, including valuation of warrants, beneficial conversion feature related to debentures and compensation expense related to stock options granted, involve significant estimations with underlying assumptions judgmentally determined.  The valuation of warrants and stock options are based upon a Black Scholes valuation model, which involve estimates of stock volatility, expected life of the instruments and other assumptions.

Deferred Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  We maintain a valuation allowance against the deferred tax asset due to uncertainty regarding the future realization based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences.  Until such time as we can demonstrate that we will no longer incur losses or if we are unable to generate sufficient future taxable income we could be required to maintain the valuation allowance against our deferred tax assets.
 
Capitalized Software Development Costs
 
Research and development costs are charged to expense as incurred.  However, the costs incurred for the development of computer software that will be sold, leased, or otherwise marketed are capitalized when technological feasibility has been established.  These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in hardware and software technologies.  Costs that are capitalized include direct labor and related overhead.
 
Amortization of capitalized software development costs begins when product sales commence.  Amortization is provided on a product-by-product basis on either the straight-line method over periods not exceeding three years or the sales ratio method.  Unamortized capitalized software development costs determined to be in excess of net realizable value of the product are expensed immediately.
 
Analysis of Financial Condition and Results of Operations

Comparison of the Three Months Ended March 31, 2010 and 2009

Sales
 
Sales were approximately $1,517,000 and $888,000 for three months ended March 31, 2010 and 2009, respectively, an increase of approximately $629,000, or 71%.  Sales of software licenses increased by approximately $596,000 or 138% to approximately $1,027,000 in the three months ended March 31, 2010 from approximately $431,000 in the three months ended March 31, 2009.  The increase in software license sales primarily relates to the one-time sale of a $524,000 license of one of our core products to an existing key customer.  Sales of maintenance and professional services increased by approximately $33,000 or 7% to $490,000 in the current fiscal quarter, compared to approximately $457,000 in the same period last year, primarily due to the timing of the renewals of maintenance contracts.
 
We recognized no revenue from Harland Financial Solutions, a subsidiary of John H. Harland Company (collectively “John Harland”), from the sale of software licenses in the three months ended March 31, 2010 and 2009.  Revenue from John Harland from the sale of maintenance and professional services was approximately $14,000 in the three months ended March 31, 2010, compared to approximately $15,000 in the three months ended March 31, 2009.  John Harland is a related party as discussed in greater detail in Note 8 to our financial statements included in this report.
 
Cost of Sales
 
Cost of sales was approximately $182,000 in the three months ended March 31, 2010, compared to approximately $135,000 in the three months ended March 31, 2009, an increase of approximately $47,000 or 35%, primarily the result of the increased sales in the current fiscal period.  Stated as a percentage of sales, cost of sales was 12% for the three months ended March 31, 2010, compared to 15% for the three months ended March 31, 2009.
 
-13-
Operations Expenses
 
Operations expenses include payroll, employee benefits, and other personnel-related costs associated with purchasing, shipping and receiving.  Due to the workforce reduction implemented in January 2009, we eliminated our operations department.  Other costs previously included in this department have been reallocated to the other departments.  As a result, there were no operations expenses for the three months ended March 31, 2010 compared to approximately $7,000 for the three months ended March 31, 2009.  Stated as a percentage of sales, operations expenses were 0% and less than 1% in the three months ended March 31, 2010 and 2009, respectively.
 
Selling and Marketing Expenses
 
Selling and marketing expenses include payroll, employee benefits, and other headcount-related costs associated with sales and marketing personnel and advertising, promotions, trade shows, seminars, and other programs.  In the three months ended March 31, 2010 and 2009, selling and marketing expenses were approximately $231,000 and $190,000, respectively, an increase of approximately $41,000 or 22%.  The increase in the current three-month period primarily relates to an increase in outside services, travel and other direct operating expenses, as well as an increase in product promotion costs.  Stated as a percentage of sales, selling and marketing expenses for the three months ended March 31, 2010 were 15%, compared to 21% in the three months ended March 31, 2009.
 
Research and Development Expenses
 
Research and development expenses include payroll, employee benefits, consultant expenses and other headcount-related costs associated with product development.  These costs are incurred to maintain and enhance existing products.  We retain what we believe to be sufficient staff to sustain our existing product lines, including development of new, more feature-rich versions of our existing product, as we determine the marketplace demands.  We also employ research personnel, whose efforts are instrumental in ensuring product paths from current technologies to anticipated future generations of products within our area of business.
 
Research and development expenses for the three months ended March 31, 2010 were approximately $507,000, compared to approximately $431,000 for the three months ended March 31, 2009, an increase of approximately $76,000 or 18%.  The increase in the current three month period primarily relates to increases in outside services, stock-based compensation expense and other direct operating expenses.  Stated as a percentage of sales, research and development expenses were 33% and 49% in the three months ended March 31, 2010 and 2009, respectively.
 
General and Administrative Expenses
 
General and administrative expenses include payroll, employee benefits, and other personnel-related costs associated with the finance, facilities, and legal, accounting and other administrative fees.  General and administrative expenses were approximately $499,000 in the three months ended March 31, 2010 compared to approximately $362,000 in the three months ended March 31, 2009, an increase of approximately $137,000 or 38%.  The increase in the current three month period primarily relates to increased stock-based compensation expense and other direct operating expenses.  Stated as a percentage of sales, general and administrative expenses were 33% for the three months ended March 31, 2010, compared to 41% for the three months ended March 31, 2009.
 
Other (Expense) Income
 
Interest and other expense increased by approximately $89,000 for the three months ended March 31, 2010 to approximately $91,000, compared to approximately $2,000 for the same period last fiscal year.  The increase in the current period primarily relates to accretion of the discount on the debentures issued in December 2009 and accrued interest on the principal amount of the debentures.  Interest income for the three months ended March 31, 2010 was a negligible amount, compared to approximately $1,000 for the three months ended March 31, 2009.
 
Comparison of the Six Months Ended March 31, 2010 and 2009

Sales
 
Sales in the six months ended March 31, 2010 were approximately $2,676,000, compared to approximately $1,900,000 in the six months ended March 31, 2009, an increase of approximately $776,000 or 41%.  Sales of software licenses increased by approximately $775,000 or 84% to approximately $1,703,000 in the six months ended March 31, 2010 from approximately $928,000 in the six months ended March 31, 2009.  The increase in software license sales primarily relates to the one-time sale of a $524,000 license of one of our core products to an existing key customer.  Sales of maintenance and professional services were approximately $973,000 and $972,000 in the six months ended March 31, 2010 and 2009.
 
-14-
We recognized no revenue from John Harland from the sale of software licenses in the six months ended March 31, 2010 and 2009.  Revenue from John Harland from the sale of maintenance and professional services was approximately $31,000 in both the six months ended March 31, 2010 and the six months ended March 31, 2009.
 
Cost of Sales
 
Cost of sales was approximately $535,000 in the six months ended March 31, 2010, compared to approximately $331,000 in the six months ended March 31, 2009, an increase of approximately $204,000 or 62%, primarily the result of the increase in sales and the decreased margin on significant sales of our core product in the current six month period.  Stated as a percentage of sales, cost of sales was 20% for the six months ended March 31, 2010, compared to 17% for the six months ended March 31, 2009.
 
Operations Expenses
 
As a result of the workforce reduction in January 2009 and the elimination of the operations department, there were no operations expenses for the six months ended March 31, 2010 compared to approximately $30,000 for the six months ended March 31, 2009, which included payroll, employee benefits, and other personnel-related costs associated with purchasing, shipping and receiving.  Stated as a percentage of sales, operations expenses were 0% and 2% in the six months ended March 31, 2010 and 2009, respectively.
 
Selling and Marketing Expenses
 
Selling and marketing expenses decreased by approximately $155,000 or 28% to $396,000 in the six months ended March 31, 2010, down from approximately $551,000 in the same period last year.  The decrease in the current six month period primarily relates to a decrease in personnel costs due to the workforce reduction implemented in January 2009 and decreases in other direct operating expenses and product promotion costs, partially offset by an increase in outside services.  Stated as a percentage of sales, selling and marketing expenses for the six months ended March 31, 2010 were 15%, compared to 29% in the six months ended March 31, 2009.
 
Research and Development Expenses
 
Research and development expenses for the six months ended March 31, 2010 were approximately $1,014,000, compared to approximately $1,004,000 for the six months ended March 31, 2009, a decrease of approximately $10,000 or 1%.  The increase in the current six month period primarily relates to increases in outside services, stock-based compensation expense and other direct operating expenses, partially offset by decreases in personnel costs due to the workforce reduction implemented in January 2009.  Stated as a percentage of sales, research and development expenses were 38% and 53% in the six months ended March 31, 2010 and 2009, respectively.
 
General and Administrative Expenses
 
General and administrative expenses were approximately $832,000 in the six months ended March 31, 2010 compared to approximately $892,000 in the six months ended March 31, 2009, a decrease of approximately $60,000 or 7%.  The decrease in the current six month period primarily relates to decreased personnel costs due to the workforce reduction implemented in January 2009 and decreases in accounting and legal fees, outside services and other direct operating expenses, partially offset by increased stock-based compensation expense.  Stated as a percentage of sales, general and administrative expenses were 31% for the six months ended March 31, 2010, compared to 47% for the six months ended March 31, 2009.
 
Other (Expense) Income
 
Interest and other expense increased by approximately $112,000 for the six months ended March 31, 2010 to approximately $114,000, compared to approximately $2,000 for the same period last fiscal year.  The increase in the current period primarily relates to accretion of the discount on the debentures issued in December 2009 and accrued interest on the principal amount of the debentures.  Interest income was approximately $1,000 and $4,000 for the six months ended March 31, 2010 and 2009, respectively.
 
-15-
Liquidity and Capital Resources
 
On March 31, 2010, we had approximately $1,415,000 in cash and cash equivalents compared to approximately $674,000 on September 30, 2009, an increase of approximately $741,000, or 110%, primarily related to the proceeds from the issuance of the debentures in December 2009.  See Note 4 to our financial statements included in this report.  The balance of accounts receivable at March 31, 2010 was approximately $1,004,000, an increase of approximately $643,000 or 178% from the September 30, 2009 balance of approximately $361,000.  The increase in accounts receivable was primarily due to increased sales and the timing of customer billings and the receipt of payments.
 
Deferred revenue, which consists of maintenance and support service fees that are deferred and recognized as income over the contract period on a straight-line basis, was approximately $897,000 and $701,000 at March 31, 2010 and September 30, 2009, respectively.  We believe that as the installed base of our products grows and as customers purchase additional complementary products, the maintenance and support service fees that are deferred, as well as those recognized as income over the contract term, will increase.
 
In addition to the issuance of the convertible debentures in December 2009, we financed our cash needs during the six months ended March 31, 2010 from collections of accounts receivable and existing cash and cash equivalents.  Prior to the December 2009 financing, we financed our cash needs from the collection of accounts receivable and existing cash and cash equivalents.
 
Net cash used in operating activities during the six months ended March 31, 2010 was approximately $190,000, compared to approximately $452,000 during the six months ended March 31, 2009, a decrease of approximately $262,000 or 58%.  The primary uses of cash from operating activities during the six months ended March 31, 2010 included the net loss of approximately $216,000, an increase in accounts receivable of approximately $643,000, an increase in deferred maintenance fees of approximately $83,000 and a decrease in deferred rent of approximately $114,000, partially offset by an increase in accounts payable and other accruals of approximately $242,000.  Net cash used in operating activities in the current six-month period also included non-cash stock-based compensation of approximately $217,000, accretion of the discount on the debentures of approximately $111,000, amortization of software development costs of approximately $69,000, depreciation and amortization of fixed assets of approximately $19,000 and amortization of debt issuance costs of approximately $14,000.
 
Net cash used in investing activities was approximately $2,000 during the six months ended March 31, 2010, compared to approximately $73,000 during the six months ended March 31, 2009.  The decrease in cash used in investing activities in the current period is primarily due to a decrease of approximately $64,000 in software development costs related to our Mobile Capture software application, which costs we ceased capitalizing when we completed our first production general release in November 2008, and a reduction of approximately $7,000 in purchases of property and equipment.  We do not have any significant capital expenditures planned for the foreseeable future.
 
Cash generated from financing activities during the six months ended March 31, 2010, included: (i) 5% senior secured convertible debentures in the principal amount of approximately $1.0 million, and (ii) warrants to purchase an aggregate of 337,501 shares of our common stock with an exercise price of $0.91 per share issued in December 2009.  The debentures are convertible into shares of our common stock at any time at the discretion of the holder at a conversion price per share of $0.75, subject to adjustment for stock splits, stock dividends and the like.  The transaction resulted in proceeds to us of approximately $922,000, net of transaction costs and expenses.
 
We had working capital of approximately $904,000 and a 1.52 current ratio at March 31, 2010, compared to negative working capital of approximately $280,000 and a 0.80 current ratio at September 30, 2009.  On March 31, 2010, our total liability to equity ratio was 3.00 to 1 compared to 11.73 to 1 on September 30, 2009.  Although our working capital has increased in the current period as a result of the December 2009 financing, we continue to experience a significant decline in working capital in the long term.  We do not currently have any credit facilities in place, or any arrangement that we can draw upon for additional capital.
 
In January 2009, we implemented a plan to decrease our operating expenses by reducing our workforce in light of the economic contraction of the financial services market into which we primarily sell our products.  The staff reduction included general and administrative, sales and marketing and technical staff.  We have diligently maintained key resources to adequately pursue new sales opportunities and support our operations.
 
Based on our current operating plan, our existing working capital may not be sufficient to fund our planned operating expenses, capital expenditures, and working capital requirements for the next twelve months without additional sources of cash and/or the deferral, reduction or elimination of significant planned expenditures.  A shortfall from projected sales levels could have a material adverse effect on our ability to continue operations at current levels.  If this were to occur, we would be forced to liquidate certain assets where possible, and/or to suspend or curtail certain of our operations.  Any of these actions could harm our business, results of operations and future prospects.  To guard against this risk, we intend to seek debt, equity or equity-based financing, as we did in December 2009.  We can give no assurance that we will be able to obtain additional financing on favorable terms or at all.  If we raise additional funds by selling additional shares of our capital stock, or securities convertible into shares of our capital stock, the ownership interest of our existing shareholders may be diluted.  The amount of dilution could be increased by the issuance of warrants or securities with other dilutive characteristics, such as anti-dilution clauses or price resets.  If we need additional funding for operations and we are unable to raise it, we may be forced to liquidate assets and/or curtail or cease operations or to obtain funds through entering into additional collaborative agreements or other arrangements that may be on unfavorable terms.  These factors raise substantial doubt about our ability to continue as a going concern.
 
-16-
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Disclosure not required as a result of the Company's status as a smaller reporting company.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures

As of the end of the period covered by this report, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2010, our disclosure controls and procedures were designed and functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) accumulated and communicated to management including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
 
Changes in Internal Controls over Financial Reporting

There have not been any changes in our internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d - 15(f) under the Exchange Act) during the quarter ended March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
 
 
PART II – OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 
We are not aware of any legal proceedings or claims that we believe may have, individually or in the aggregate, a material adverse effect on our business, financial condition, operating results, cash flow or liquidity.
 
RISK FACTORS.
 
In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Part I. Item 1—Description of Business—Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009.  These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects.  As of the date of this report, other than the risk factors set forth below, we do not believe that there have been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009.
 
We have a history of losses and we may not achieve profitability in the future.
 
Our operations resulted in net income of approximately $7,000 in the three months ended March 31, 2010 and a net loss of approximately $216,000 for the six months ended March 31, 2010.  In the three and six months ended March 31, 2009, we incurred losses of approximately $240,000 and $908,000, respectively.  In addition, as a public company, we incur significant legal, accounting, and other expenses related to being a public company.  As a result of these expenditures, we will have to generate and sustain increased revenue to achieve and maintain future profitability.  We may not achieve sufficient revenue to achieve or maintain profitability.  We have incurred and may continue to incur significant losses in the future for a number of reasons, including due to the other risks described in this report, and we may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors.  Accordingly, we may not be able to achieve or maintain profitability and we may continue to incur significant losses for the foreseeable future.
 
-17-
Our common stock price has been volatile.  You may not be able to sell your shares of our common stock for an amount equal to or greater than the price at which you acquire your shares of common stock.
 
The market price of our common stock has been, and is likely to continue to be, highly volatile.  Future announcements concerning us or our competitors, quarterly variations in operating results, announcements of technological innovations, the introduction of new products or changes in our product pricing policies or those of our competitors, claims of infringement of proprietary rights or other litigation, changes in earnings estimates by analysts or other factors could cause the market price of our common stock to fluctuate substantially.  In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies and that have often been unrelated to the operating performance of particular companies.  These broad market fluctuations may adversely affect the market price of our common stock.  During the fiscal year ended September 30, 2009, the closing price of our common stock ranged from $0.05 to $1.01.  During the first six months of fiscal 2010, the closing price our common stock price ranged from $0.60 to $1.04.
 
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
None.
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.
 
None.
 
ITEM 4.
(REMOVED AND RESERVED).
 
ITEM 5.
OTHER INFORMATION.
 
Submission of Matters to a Vote of Security Holders
 
Our annual meeting of stockholders was held on Wednesday, February 24, 2010, for the following purposes:
 
1.     
To elect a board of seven directors;
 
2.     
To adopt the Mitek Systems, Inc. 2010 Stock Option Plan; and
 
3.     
To ratify the appointment of Mayer Hoffman McCann, P.C. as our independent registered public accounting firm for our 2010 fiscal year.
 
There were a total of 16,751,137 shares of our common stock outstanding and entitled to vote at the meeting, and 15,322,859, or approximately 91%, of those shares were represented at the meeting, either in person or by proxy.
 
With respect to the election of directors, the votes were cast for each of the following nominees as follows:
 
NOMINEE
  
 FOR
  
 WITHHELD
         
John M. Thornton
  
         10,385,644
  
              606,500
James B. DeBello
  
         10,291,238
  
              700,906
Michael W. Bealmear
  
         10,965,684
  
                26,460
Vinton P. Cunningham
  
         10,965,684
  
                26,460
Gerald I. Farmer
  
         10,291,538
  
              700,606
Sally B. Thornton
  
         10,385,094
  
              607,050
William P. Tudor
  
         10,965,584
  
                26,560
 
Based on the voting of the stockholders at the annual meeting, each of the nominees listed above was duly elected as directors of Mitek.
 
-18-
With respect to the adoption of the Mitek Systems, Inc. 2010 Stock Option Plan, the votes were cast as follows:
 
FOR
  
AGAINST
  
WITHHELD
  
BROKER NON-VOTES
9,833,096
  
1,112,426
  
46,622
  
4,330,715
           
Based on the voting of the stockholders at the annual meeting, the adoption of the Mitek Systems, Inc. 2010 Stock Option Plan was adopted by our shareholders.
 
With respect to the ratification of the appointment of Mayer Hoffman McCann, P.C. as our independent registered public accounting firm for the 2010 fiscal year, the votes were cast as follows:
 
FOR
  
AGAINST
  
WITHHELD
  
BROKER NON-VOTES
15,176,858
  
138,374
  
7,627
  
 - 0 -
 
Based on the voting of the stockholders at the annual meeting, the appointment of Mayer Hoffman McCann, P.C. as our independent registered public accounting firm for the 2010 fiscal year was ratified.
 
ITEM 6.
EXHIBITS
 
See the exhibit index immediately following signature page to this report.
 
-19-
SIGNATURES
 
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
May 17, 2010
MITEK SYSTEMS, INC.
 
 
By:          /s/ James B. De Bello                              
James B. DeBello
President, Chief Executive Officer, and
Chief Financial Officer
 

-20-
 

 
EXHIBIT INDEX
 

 
Exhibit No.
  
Exhibit Title
31.1
  
Certification of Periodic Report by the Chief Executive Officer Pursuant to Rules 13a-14(a) of the Securities Exchange Act of 1934
31.2
  
Certification of Periodic Report by the Chief Financial Officer Pursuant to Rules 13a-14(a) of the Securities Exchange Act of 1934
32.1*
  
Certification of Periodic Report by the Chief Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
32.2*
  
Certification of Periodic Report by the Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
     
* Furnished herewith
 
-21-