System1, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Unless otherwise indicated or the context otherwise requires, references in this section to "the Company," "System1," "we," "us," "our" and other similar terms refer to System1, Inc and its subsidiaries. The following discussion and analysis of the financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ending December 31, 2024. In addition to historical information, the following discussion and analysis contains forward-looking statements. Our actual results may differ significantly from those projected in such forward-looking statements. Factors that might cause future results to differ materially from those projected in such forward-looking statements include, but are not limited to, those discussed in the sections entitled "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements." included in our Annual Report on Form 10-K. Company Overview We operate an omnichannel customer acquisition platform, delivering high-intent customers to brands, advertisers and publishers . We provide our omnichannel customer acquisition platform services through our proprietary responsive acquisition marketing platform ("RAMP"). Operating seamlessly across major advertising networks and advertising category verticals to acquire end-users, RAMP allows us to monetize these acquired end users through our relationships with third party advertisers and advertising networks ("Advertising Partners"). RAMP operates across our network of owned and operated websites, allowing us to monetize user traffic that we source from various acquisition marketing channels, including Google, Meta, Outbrain, and TikTok. RAMP also allows third party advertising platforms and publishers ("Network Partners") to send user traffic to, and monetize end-user traffic on, our owned and operated websites or through our monetization agreements. Through RAMP, we process daily advertising campaign optimizations across approximately 40 advertising vertical categories as of March 31, 2025 . We are able to efficiently monetize user intent by linking data on consumer engagement, such as first party search data like traffic sources, device type and search queries, with data on monetization rates and advertising spend. This context-enriched data, combined with our proprietary and data science driven algorithms, creates a closed-loop system that is not reliant on personally identifiable information or information obtained through third-party cookies, but which allows RAMP to efficiently match consumer demand with the appropriate advertiser or advertising experience across advertising category verticals. We monetize user traffic acquired by our Network Partners. Since launching, this business has expanded to support additional advertising formats across multiple advertising platforms, and has acquired several leading websites, enabling it to control the entire flow of the user acquisition experience, while monetizing user traffic through our network of owned and operated websites. As of March 31, 2025 , we own and operate approximately 40 websites, including leading search engines like info.com and Startpage.com , and digital media publishing websites and internet utilities, such as HowStuffWorks , MapQuest , CouponFollow and ActiveBeat . Our primary operations are in the United States, and we also have operations in Canada and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems as well as various political and economic environments. Among the risks are changes in existing tax laws, changes in the regulatory framework in foreign jurisdictions, data privacy laws, possible limitations on foreign investment and income repatriation, government foreign exchange controls, exposure to currency exchange fluctuations and employment laws impacting foreign employees. We do not engage in hedging activities to mitigate our exposure to fluctuations in foreign currency exchange rates. 15 On August 1, 2024, we undertook a corporate reorganization, the result of which was that all of the assets and business operations of the company are now held by System1 Holdings, LLC ("System1 Holdings"), a newly formed intermediate holding company of which we maintain the controlling interest and in which the non-controlling interest is owned by the holders of our Class C common stock. Following the corporate reorganization, (a) System1 Holdings now owns 100% of S1 Holdco, the previous intermediate holding company with the non-controlling interests, and 100% of S1 Media, LLC (“S1 Media”), another new subsidiary formed in connection with the corporate reorganization, (b) S1 Media holds the assets and business operations associated with our owned and operated products businesses, which include NextGen Shopping, Inc. ("CouponFollow"), Startpage and Mapquest, and (c) S1 Holdco holds our remaining assets and business operations associated with our digital advertising businesses, including our proprietary RAMP platform. S1 Holdco and its subsidiaries remain obligors and guarantors under our Term Loan and 2022 Revolving Facility, and System1 Holdings and S1 Media are not parties thereto. Components of Our Results of Operations Revenue We earn revenue by directly acquiring traffic to our owned and operated websites and utilizing our RAMP platform and additional services to monetize end-users for our Advertising Partners. For this revenue stream, we are the principal in the transaction and report revenue on a gross basis for the amounts received from Advertising Partners. We have determined that we are the principal since we direct the use of our owned and operating websites, and as such have risk of loss on the user-traffic that we are acquiring for monetization with our Advertising Partners. Additionally, we maintain the website, provide the content and bear the cost and risk of loss associated with the digital online inventory available on our website. Revenue is also earned from revenue-sharing arrangements with our Network Partners related to the use of our RAMP platform and additional services provided to them in order to direct advertising by our Advertising Partners to their digital online inventory. We have determined that we are the agent in these transactions and therefore report revenue on a net basis, because our network partner runs the campaign to acquire user-traffic including managing traffic acquisition cost. We report the revenue generated under our revenue-sharing arrangements on a net basis, based on the difference between amounts received by us from our Advertising Partners, less amounts remitted to the Network Partners based on the underlying revenue-sharing agreements. We recognize revenue as we deliver user-traffic to our Advertising Partners based on a cost-per-click, cost-per-action or cost-per-thousand impression basis. The payment terms with our Advertising Partners are typically 30 days. Revenue may fluctuate from period to period due to a number of factors including seasonality and the shift in mix of user acquisition sources from Advertising Partners. We have two reportable segments: • Owned and Operated Advertising ("O&O"); and • Partner Network Operating Expenses To conform to the current period’s presentation, depreciation and amortization expense was reclassified to cost of revenue and selling, general, and administrative in the prior period condensed consolidated statements of operations. We classify our operating expenses into the following categories: 16 Cost of revenue . Cost of revenue primarily consists of traffic acquisition costs, which are the costs to place advertisements to acquire customers to our websites and services, domain name registration costs, licensing costs to provide mapping services to Mapquest.com and amortization related to our RAMP platform. We do not pre-pay any traffic acquisition costs, and therefore, such costs are expensed as incurred. Amortization related to our RAMP platform is recognized over the estimated useful life of the intangible asset. Salaries and benefits . Salaries and benefits expenses include salaries, bonuses, stock-based compensation, and employee benefits costs. Selling, general, and administrative . Selling, general, and administrative expenses consist of depreciation and non-internally developed software platform amortization, fees for software services, professional services, occupancy costs and travel and entertainment. Depreciation and non-internally developed software platform amortization expense are primarily attributable to our capital investment(s) and consist of property and equipment depreciation and amortization of intangible assets with finite lives. Other Expenses or Incomes: Other expenses or incomes consist of the following: Interest expense, net . Interest expense consists of interest on our debt and the amortization of deferred financing costs and debt discount. Gain on extinguishment of debt . The recognition of the gain from the repurchase of a portion of our Term Loan at a discount. See Item 1, "Financial Statements —Note 5, Debt, Net" for additional information. Change in fair value of warrant liabilities . The mark to market of our liability-classified Warrants. Income tax benefit During 2023 and through July 31, 2024, we were the sole managing member of S1 Holdco and, as a result, consolidated the financial results of S1 Holdco . S1 Holdco was treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, S1 Holdco was not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by S1 Holdco was passed through to and included in the taxable income or loss of its members, including us, on a pro rata basis. We were subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income or loss of S1 Holdco, as well as any stand-alone income or loss generated by us. As of August 1, 2024, we are the sole managing member of System1 Holdings and, as a result, consolidate the financial results of System1 Holdings. System1 Holdings is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, System1 Holdings is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by System1 Holdings is passed through to and included in the taxable income or loss of its members, including us, on a pro rata basis. We are subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income or loss of System1 Holdings, as well as any stand-alone income or loss generated by us. Results of Operations The following table sets forth our consolidated results of operations and our consolidated results of operations as a percentage of revenue for the periods presented (in thousands). 17 Three Months Ended March 31, Change 2025 % of Revenue 2024 % of Revenue ($) (%)* Revenue $ 74,513 100 % $ 84,917 100 % $ (10,404) (12) % Operating expenses: Cost of revenue 46,077 62 % 66,318 78 % (20,241) (31) % Salaries and benefits 24,988 34 % 24,483 29 % 505 2 % Selling, general, and administrative 16,574 22 % 19,912 23 % (3,338) (17) % Total operating expenses 87,639 118 % 110,713 130 % (23,074) (21) % Operating loss (13,126) (18) % (25,796) (30) % 12,670 (49) % Other expense (income): Interest expense, net 7,085 10 % 7,970 9 % (885) (11) % Gain on extinguishment of debt — — % (19,676) (23) % 19,676 (100) % Change in fair value of warrant liabilities 32 — % (251) — % 283 (113) % Total other expense (income), net 7,117 10 % (11,957) (14) % 19,074 (160) % Loss before income tax (20,243) (27) % (13,839) (16) % (6,404) 46 % Income tax benefit (387) (1) % (48) — % (339) 706 % Net loss (19,856) (27) % (13,791) (16) % (6,065) 44 % Less: Net loss attributable to non-controlling interest (3,973) (5) % (3,254) (4) % (719) 22 % Net loss attributable to System1, Inc. $ (15,883) (21) % $ (10,537) (12) % $ (5,346) 51 % * Percentages may not sum due to rounding Revenue and Cost Metrics The key non-financial performance metrics we use to evaluate our business, track the effectiveness of our operations and measure our performance are total advertising spend, number of Owned & Operated Advertising sessions ("O&O sessions"), number of Partner Network sessions ("Network sessions"), Owned & Operated Advertising revenue-per-session ("O&O RPS"), Owned & Operated Advertising cost-per-session ("O&O CPS") and Partner Network revenue-per-session ("Network RPS") to track our operations. We define total advertising spend as the amount of advertising that is spent by us to acquire traffic to our owned and operated websites. We believe total advertising spend is a relevant measure to gauge the effectiveness of our Company to deploy capital to acquire monetizable traffic to our Owned & Operated websites, which is a key driver of our Owned & Operated Advertising reportable segment. We define O&O sessions as the total number of monetizable user visits to our Owned & Operated Advertising websites. We define Network sessions as the number of monetizable user visits delivered by our Network Partners to RAMP. Monetizable visits exclude those visits identified by our Advertising Partners as spam, bot, or other invalid traffic. We define O&O RPS as O&O revenue divided by O&O sessions. We define Network RPS as Network Partner revenue divided by Network sessions. We believe both O&O RPS and Network RPS are key measures to evaluate our effectiveness in converting monetizable traffic into revenue. 18 We define O&O CPS as advertising spend divided by O&O sessions. We believe O&O CPS is a relevant measure to gauge the efficiency of operations and processes in deploying advertising spend, especially when evaluated in combination with total advertising spend. Revenue The following table presents our revenue by reportable segment (in thousands): Three Months Ended March 31, Change 2025 2024 ($) (%) Owned and Operated Advertising $ 57,921 $ 69,030 $ (11,109) (16)% Partner Network 16,592 15,887 705 4% Total revenue $ 74,513 $ 84,917 $ (10,404) (12)% Owned and Operated Advertising Owned and Operated Advertising revenue decreased by $11.1 million, or 16%, compared to the prior comparative period, primarily due to a mix shift towards traffic with a lower RPS, slightly offset by an increase in the number of acquired sessions. For the three months ended March 31, 2025, compared to the prior year comparative period, O&O sessions increased by approximately 0.1 billion to 1.3 billion from 1.2 billion and O&O RPS decreased by approximately $0.01 to $0.05 from $0.06. Partner Network Partner Network revenue increased $0.7 million, or 4%, compared to the prior comparative period, primarily due to the reversal of the majority of a contra revenue liability related to previously withheld payments to certain Network Partners related to validity of traffic those partners had sent to the Company’s platform last year. It was determined that at least a portion of this traffic was invalid. A comprehensive review of the remaining traffic remains ongoing. For the three months ended March 31, 2025, compared to prior year comparative period, sessions increased by approximately 0.2 billion to 1.7 billion from 1.5 billion, and Network RPS was $0.01, a decline of 6% compared to the prior year comparative period. Cost of revenue Cost of revenue decreased $20.2 million, or 31%, pri marily due to our Owned & Operated advertising spend decreasing $16.4 million and our Partner Network agency fees decreasing $3.3 million, which was directionally consistent with the decrease in revenue. For the three months ended March 31, 2025, compared to prior year, our O&O CPS decreased $0.02 to $0.02 from $0.04, due to a mix shift towards lower CPS traffic, which corresponds to the lower RPS realized in our revenue. Amortization expense for our RAMP platform increased $0.4 million, or 3% compared to the prior comparative period primarily due to increased am ortization for our continued investment in developed technology and internally developed software. Our chief operating decision maker measures and evaluates reportable segments based on segment operating revenue and segment adjusted gross profit. We define and calculate segment adjusted gross profit as revenue less traffic acquisition costs incurred to acquire users. The remaining cost of revenue consists of non-advertising expenses such as set-up costs, royalties, fees and amortization related to our RAMP platform. We exclude the following items from segment adjusted gross profit: other cost of revenue (total cost of revenue excluding traffic acquisition cost), salaries and benefits, selling, general and administrative expenses and, at times, certain other transactions or adjustments. 19 The following table presents our segment adjusted gross profit by reportable segment (in thousands): Three Months Ended March 31, Change 2025 2024 ($) (%) Owned and Operated Advertising $ 27,778 $ 22,462 $ 5,316 24 % Partner Network 14,963 10,919 4,044 37 % See the Revenue and Cost of revenue discussions above. Salaries and benefits Salaries and benefits expense increased $0.5 million, or 2.0% compared to the prior comparative period. The increase was primarily due to $0.8 million in severance related expenses due to a reduction in workforce in the period and $0.6 million in bonus incentive related expenses. This was partially offset by a $1.3 million decrease in stock-based compensation primarily due to Replacement Award vesting between the comparative periods. Selling, general, and administrative Selling, general, and administrative expense decreased $3.3 million, or 17.0% compared to the prior comparative period. The decrease was primarily due to a $2.7 million decrease in professional and consulting fees and receipt of a $0.5 million legal settlement. Other expense (income): Interest expense, net Interest expense, net decreased $0.9 million, or 11.0% compared to the prior comparative period primarily due to a lower outstanding debt balance. Gain on extinguishment of debt Gain on extinguishment of debt decreased $19.7 million compared to the prior comparative period due to the repurchase of our principal debt balances via a Dutch auction in the first quarter of 2024. There was no repurchase in the first quarter of 2025. Change in fair value of warrant liabilities Change in fair value of warrant liabilities decreased $0.3 million compared to the prior comparative period. Income tax benefit The difference between the effective tax rates for the periods presented above and the federal statutory tax rate of 21% was primarily due to the exclusion of non-controlling income (loss), nondeductible expenses, valuation allowance and outside basis adjustments. 20 Liquidity and Capital Resources We expect existing cash and cash equivalents and cash flows from operating and financing activities to continue to be sufficient to fund our operating and cash commitments for investing and financing activities for at least the next twelve months. Our principal sources of liquidity have historically been from cash received from the sale of Total Security Limited (formerly known as Protected. net Group Limited), indebtedness available under our credit facilities, other indebtedness and cash flows from operations. Our principal sources of liquidity are expected to be from cash on hand and cash flows from operating and financing activities. Our ability to fund future operating expenses and capital expenditures, and our ability to meet our future debt service obligations, will depend on our ability to execute on our operational strategy and may be affected by our profitability, as well as general economic, financial and other factors which are beyond our control. We continue to develop and implement plans to improve our liquidity. Our main focus is executing on our operational strategy, which includes continued focus on expanding the number of advertising partners that are utilizing or integrated with RAMP by continuing to attract and monetize users with commercial intent on our owned and operated web properties and on behalf of our Network Partners as well as optimizing bids and driving higher returns on advertising spend. Additionally, we are focused on our current cost structure by reducing our cash operating expenses and debt service obligations. Adverse macroeconomic conditions have affected, and may in the future affect, the demand for advertising, resulting in fluctuations in the amounts our advertisers spend on advertising, which could have a negative impact on our financial condition and operating results. As of March 31, 2025, we had unrestricted cash and cash equivalents of $43.9 million and $50.0 million available to borrow on our 2022 Revolving Facility. For the three months ended March 31, 2025, we had cash outflows of $22.8 million. The principal drivers of our cash outflows were $15.9 million related to net change in operations, which included $13.2 million in outflows related to the payment of an earnout obligation for the CouponFollow acquisition, $5.0 million principal repayment of our Term Loan, $1.2 million of capitalized software development costs, and $0.3 million of other items. Our revenue is dependent on two key Advertising Partners, Google and Microsoft. See our concentration with customers discussion at Item 1 "Financi al Statements — Note 2, Summary of Significant Accounting Policies " for additional information. Credit Facilities See Item 1, "Financial Statements - Note 5, Debt, Net" of this Quarterly Report on Form 10-Q. Cash Flows The following table summarizes our cash flows for the periods presented (in thousands): Three Months Ended March 31, 2025 2024 Net cash used in operating activities $ (15,949) $ (15,987) Net cash used in investing activities $ (1,548) $ (1,622) Net cash used in financing activities $ (5,304) $ (48,158) Operating Activities Our cash flows from operating activities are primarily impacted by growth in our operations, timing of collections from our partners and related payments to our suppliers for advertising inventory and data. We typically pay suppliers in advance of collections from our clients and our collection and payment cycles can vary from period 21 to period. In addition, seasonality may impact cash flows from operating activities on a sequential quarterly basis during the year. In the three months ended March 31, 2025, cash used in operating activities of $15.9 million. The principal drivers of our cash outflow from operations were $13.2 million in outflows related to the payment of earnout obligations for the CouponFollow acquisition, and $4.3 million in net interest paid on our Term Loan. In the three months ended March 31, 2024, cash used in operating activities were $16.0 million. The principal driv ers of our cash outflow from operations were cash bonus payments of $7.2 million primarily related to 2023 annual employee performance bonuses, $1.8 million of audit fees, $2.4 million of consulting fees, and interest paid on our Term Loan of $8.2 million. Investing Activities Our primary investing activities consisted of costs capitalized for internally developed software. In the three months ended March 31, 2025 and 2024, cash used in investing activities of $1.5 million and $1.6 million resulted primarily from costs capitalized for internally developed software, respectively. Financing Activities Our financing activities consisted primarily of borrowings and repayments of our indebtedness under our credit facilities. In the three months ended March 31, 2025, cash used in financing activities of $5.3 million was primarily related to the repayment of the 2022 Term Loan. In the three months ended March 31, 2024, cash used in financing activities of $48.2 million was primarily related to the repurchase of the 2022 Term Note via a Dutch auction in the amount of $46.1 million. Off-Balance Sheet Arrangements We do not have any relationships with entities often referred to as structured finance or special purpose entities that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We did not have any other off-balance sheet arrangements during the periods presented other than the indemnification agreements. Contractual Obligations and Known Future Cash Requirements Service Agreements In June 2021, we entered into a multi-year agreement with a service provider whereby we are contractually obligated to spend $5.0 million annually between July 2023 and June 2026 . As of March 31, 2025 , we remain contractually obligated to spend a remaining $5.0 million towards this commitment. Contingencies From time to time, we are subject to contingencies that arise in the ordinary course of business. We record an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We do not currently believe the resolution of any such contingencies will have a material adverse effect upon our condensed consolidated financial statements. 22 Critical Accounting Policies and Estimates We prepare our financial statements in accordance with GAAP. Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. The critical accounting estimates, assumptions, and judgments that we believe to have the most significant impact on our condensed consolidated financial statements are valuation of goodwill, stock-based compensation and income taxes. There have been no material changes to our critical accounting policies and estimates as described in our Annual Report on Form 10-K filed with the SEC on March 10, 2025. Recently Issued Accounting Pronouncements For information regarding recent accounting pronouncements, refer to Item 1, "Financial Statements - Note 2, Summary of Significant Accounting Policies . " Item 3. Quantitative and Qualitative Disclosure about Market Risk As a "smaller reporting company", as defined by Rule 10(f)(1) of Regulation S-K, we are not required to provide this information.