System1, Inc. 10-K

Item 8. Financial Statements and Supplementary Data Index to Consolidated Financial Statements Reports of Independent Registered Public Accounting Firm (PCAOB ID 238 ) 78 Consolidated Balance Sheets 80 Consolidated Statements of Operations 81 Consolidated Statements of Comprehensive Income (Loss) 82 Consolidated Statements of Stockholders’ Equity 83 Consolidated Statements of Members’ Deficit 84 Consolidated Statements of Cash Flows 85 Notes to Consolidated Financial Statements 87 77 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of System1, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of S1 Holdco, LLC and its subsidiaries (Predecessor) (the “Company”) as of December 31, 2021, and the related consolidated statements of operations, comprehensive income (loss), changes in members’ deficit, and cash flows for the period from January 1, 2022 through January 26, 2022 and for the year ended December 31, 2021, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021, and the results of its operations and its cash flows for the period from January 1, 2022 through January 26, 2022 and for the year ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Substantial Doubt about the Company’s Ability to Continue as a Going Concern The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has violated a covenant which resulted in the outstanding principal balances under the Company’s Term Loan and Revolving Facility with Bank of America being callable at the request of, or with the consent of, the required majority lenders and has insufficient liquidity to settle the outstanding principal balances of the Term Loan and Revolving Facility that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Los Angeles, California June 5, 2023 We have served as the Company’s auditor since 2020. 78 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of System1, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of System1, Inc. and its subsidiaries (Successor) (the “Company”) as of December 31, 2022, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for the period from January 27, 2022 through December 31, 2022, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022, and the results of its operations and its cash flows for the period from January 27, 2022 through December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Substantial Doubt about the Company’s Ability to Continue as a Going Concern The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has violated a covenant which resulted in the outstanding principal balances under the Company’s Term Loan and Revolving Facility with Bank of America being callable at the request of, or with the consent of, the required majority lenders and has insufficient liquidity to settle the outstanding principal balances of the Term Loan and Revolving Facility that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Los Angeles, California June 5, 2023 We have served as the Company’s auditor since 2020. 79 System1, Inc. and Subsidiaries Consolidated Balance Sheets (In thousands, except for par values) Successor Predecessor December 31, 2022 December 31, 2021 ASSETS Current assets: Cash and cash equivalents $ 24,606 $ 47,896 Restricted cash, current 9,074 — Accounts receivable 80,927 90,203 Prepaid expenses and other current assets 11,901 7,689 Total current assets 126,508 145,788 Restricted cash, non-current 5,395 743 Property and equipment, net 4,022 830 Internal-use software development costs, net 6,948 11,213 Intangible assets, net 492,686 50,368 Goodwill 515,591 44,820 Operating lease right-of-use assets 6,484 — Other non-current assets 2,822 3,149 Total assets $ 1,160,456 $ 256,911 LIABILITIES AND STOCKHOLDERS’ EQUITY/ MEMBERS’ DEFICIT Current liabilities: Accounts payable 12,068 72,846 Accrued expenses and other current liabilities 95,447 31,284 Protected.net incentive plan liability, current 15,436 — Deferred revenue 70,164 1,971 Operating lease liabilities, current 2,149 — Debt, net 15,021 170,453 Total current liabilities 210,285 276,554 Operating lease liabilities, non-current 5,875 — Long-term debt, net 399,504 — Warrant liability 7,798 — Deferred tax liability 43,355 7,789 Protected.net incentive plan liability, non-current 15,824 — Other liabilities 5,027 969 Total liabilities 687,668 285,312 Commitments and contingencies (Note 11) STOCKHOLDERS’ EQUITY / MEMBERS’ DEFICIT Class A common stock - $ 0.0001 par value; 500,000 shares authorized, 91,674 Class A shares issued and outstanding as of December 31, 2022 9 — Class C common stock - $ 0.0001 par value; 25,000 shares authorized, 21,747 Class C shares issued and outstanding as of December 31, 2022 2 — Additional paid-in capital 829,687 — Accumulated deficit ( 445,301 ) — Members’ deficit — ( 28,829 ) Accumulated other comprehensive income (loss) ( 417 ) 428 Total stockholders’ equity/members’ deficit attributable to System1, Inc. 383,980 ( 28,401 ) Non-controlling interest 88,808 — Total stockholders’ equity/members’ deficit 472,788 ( 28,401 ) Total liabilities and stockholders’ equity/members’ deficit $ 1,160,456 $ 256,911 See notes to consolidated financial statements. 80 System1, Inc. and Subsidiaries Consolidated Statements of Operations (In thousands, except for per share and per unit data) Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Revenue $ 773,940 $ 52,712 $ 688,389 Operating costs and expenses: Cost of revenues (excluding depreciation and amortization) 538,779 41,507 521,113 Salaries and benefits 194,976 31,181 66,747 Selling, general, and administrative 63,478 15,665 35,813 Depreciation and amortization 118,652 1,000 13,885 Impairment of goodwill 366,309 — — Total operating costs and expenses 1,282,194 89,353 637,558 Operating income (loss) ( 508,254 ) ( 36,641 ) 50,831 Other expense: Interest expense 32,050 1,049 16,870 Change in fair value of warrant liabilities 3,751 — — Total other expense 35,801 1,049 16,870 Income (loss) before income tax ( 544,055 ) ( 37,690 ) 33,961 Income tax (benefit) provision ( 101,976 ) ( 629 ) 965 Net income (loss) $ ( 442,079 ) $ ( 37,061 ) $ 32,996 Net loss attributable to non-controlling interest ( 105,682 ) — — Net income (loss) attributable to System1, Inc. $ ( 336,397 ) $ ( 37,061 ) $ 32,996 Basic and diluted net loss per share $ ( 3.77 ) n/a n/a Weighted average number of shares outstanding - basic and diluted 89,251 n/a n/a Basic and diluted net income (loss) per unit n/a $ ( 1.81 ) $ 1.61 Weighted average units outstanding - basic and diluted n/a 20,488 20,488 See notes to consolidated financial statements. 81 System1, Inc. and Subsidiaries Consolidated Statements of Comprehensive Income (Loss) (In thousands) Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Net income (loss) $ ( 442,079 ) $ ( 37,061 ) $ 32,996 Other comprehensive income (loss) Foreign currency translation income (loss) ( 723 ) 87 771 Comprehensive income (loss) ( 442,802 ) ( 36,974 ) 33,767 Comprehensive loss attributable to non-controlling interest ( 105,762 ) — — Comprehensive income (loss) attributable to System1, Inc. $ ( 337,040 ) $ ( 36,974 ) $ 33,767 See notes to consolidated financial statements. 82 System1, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity (In thousands) Class A Common Stock Class C Common Stock Class D Common Stock Shares Amount Shares Amount Shares Amount Additional Paid-In-Capital Accumulated Deficit Accumulated Other Comprehensive Income Non-Controlling Interest Total Stockholders’ Equity Successor: For the period from January 27, 2022 to December 31, 2022 BALANCE—January 26, 2022 51,750 $ 5 — $ — — $ — $ 574,003 $ ( 107,797 ) $ — $ — $ 466,211 Effect of the Merger 29,017 3 22,077 2 1,450 — 148,359 — — 198,691 347,055 BALANCE—January 27, 2022 80,767 8 22,077 2 1,450 — 722,362 ( 107,797 ) — 198,691 813,266 Net loss — — — — — — — ( 336,397 ) — ( 105,682 ) ( 442,079 ) Exercise of warrants 3,969 — — — — — 27,989 — — — 27,989 Issuance of restricted stock, net of forfeitures and shares withheld for taxes 968 — — — — — ( 2,089 ) — — — ( 2,089 ) Issuance of common stock in connection with the Merger, net of offering costs, underwriting discounts and commissions 930 — — — — — 661 — — — 661 Issuance of common stock in connection with the acquisition of business 2,000 — — — — — 25,500 — — — 25,500 Issuance of market-based restricted stock units — — — — 1,450 — — — — — Conversion of Class D shares to Class A shares 2,900 1 — — ( 2,900 ) — — — — — 1 Conversion of Class C shares to Class A shares 330 — ( 330 ) — — — 2,714 — — ( 2,714 ) — Establishment of liabilities under tax receivable agreement and related changes to deferred tax assets associated with increases in tax basis — — — — — — ( 41 ) — — — ( 41 ) Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC — — — — — — ( 2,596 ) — — — ( 2,596 ) Other comprehensive income — — — — — — — — ( 417 ) 24 ( 393 ) Stock-based compensation — — — — — — 55,187 — — — 55,187 Distribution to members — — — — — — — — — ( 1,511 ) ( 1,511 ) Class A common stock repurchases ( 190 ) — — — — — — ( 1,107 ) — — ( 1,107 ) BALANCE—December 31, 2022 91,674 $ 9 21,747 $ 2 — $ — $ 829,687 $ ( 445,301 ) $ ( 417 ) $ 88,808 $ 472,788 See notes to consolidated financial statements. 83 System1, Inc. and Subsidiaries Consolidated Statements of Changes in Members’ Deficit (In thousands) Members’ Deficit Accumulated Other Comprehensive Income (Loss) Total Members’ Deficit Predecessor: For the period January 1, 2022 to January 26, 2022 BALANCE—January 1, 2022 $ ( 28,829 ) $ 428 $ ( 28,401 ) Net loss ( 37,061 ) — ( 37,061 ) Accumulated other comprehensive income — 87 87 Stock-based compensation expense 23,705 — 23,705 BALANCE—January 26, 2022 $ ( 42,185 ) $ 515 $ ( 41,670 ) Members’ Deficit Accumulated Other Comprehensive Income (Loss) Total Members’ Deficit Predecessor: For the period January 1, 2021 to December 31, 2021 BALANCE—January 1, 2021 $ ( 47,886 ) $ ( 343 ) $ ( 48,229 ) Net income 32,996 — 32,996 Accumulated other comprehensive income — 771 771 Stock-based compensation expense 413 — 413 Distribution to Court Square Capital Partners ( 8,257 ) — ( 8,257 ) Contribution from OpenMail 227 — 227 Distribution to OpenMail ( 6,322 ) — ( 6,322 ) BALANCE—December 31, 2021 $ ( 28,829 ) $ 428 $ ( 28,401 ) See notes to consolidated financial statements. 84 System1, Inc. and Subsidiaries Consolidated Statements of Cash Flows (In thousands) 85 Successor Predecessor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Cash flows from Operating Activities: Net income (loss) $ ( 442,079 ) $ ( 37,061 ) $ 32,996 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 118,652 1,000 13,885 Stock-based compensation 106,943 23,705 413 Impairment of goodwill 366,309 — — Amortization of debt issuance costs 4,836 — 2,261 Noncash lease expense 1,532 115 — Change in fair value of contingent consideration and CEO equity profit interest — ( 9 ) 7,054 Change in fair value of warrants 3,751 — — Deferred tax benefits ( 107,798 ) ( 816 ) ( 981 ) Other 661 — — Changes in operating assets and liabilities Accounts receivable 4,602 11,118 ( 19,064 ) Due from related party — — — Prepaids and other assets ( 3,348 ) 1,069 ( 4,968 ) Accounts payable 2,121 ( 67,600 ) 20,756 Accrued expenses and other liabilities ( 13,478 ) 57,488 12,113 Protected.net incentive plan liability ( 20,000 ) — — Deferred revenue 9,008 311 82 Other long-term liabilities ( 28,395 ) 77 ( 3,842 ) Net cash provided by (used in) operating activities 3,317 ( 10,603 ) 60,705 Cash flows from Investing Activities: Purchases of property and equipment ( 3,546 ) — ( 49 ) Capitalized software development costs ( 6,389 ) ( 441 ) ( 6,486 ) Acquisition of businesses, net of cash acquired ( 444,074 ) — — Net cash (used in) investing activities ( 454,009 ) ( 441 ) ( 6,535 ) Cash flows from Financing Activities: Proceeds from term loan and line of credit 450,000 — — Repayment of term loan ( 187,488 ) — ( 11,636 ) Member capital contributions — — 227 Payments for financing costs ( 24,845 ) — ( 382 ) Payments for earnouts ( 1,715 ) — — Taxes paid related to net settlement of restricted stock awards ( 2,090 ) — — Redemptions of Class A common stock ( 510,469 ) — — Proceeds from warrant exercises 5,027 — — Purchases of treasury stock ( 1,122 ) — — Cash received from the Backstop 246,484 — — Payments on contingent consideration from purchase of companies — — ( 6,715 ) Related party loan — — ( 1,500 ) Distributions to members ( 1,511 ) — ( 14,579 ) Net cash (used in) financing activities ( 27,729 ) — ( 34,585 ) Effect of exchange rate changes in cash, cash equivalent and restricted cash ( 57 ) ( 19 ) 41 Net increase (decrease) in cash, cash equivalents and restricted cash ( 478,478 ) ( 11,063 ) 19,626 Cash and cash equivalents and restricted cash, beginning of the period 517,553 48,639 29,013 Cash and cash equivalents and restricted cash, end of the period $ 39,075 $ 37,576 $ 48,639 Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets: Cash and cash equivalents $ 24,606 $ 36,833 $ 47,896 Restricted cash 14,469 743 743 Total cash, cash equivalents and restricted cash $ 39,075 $ 37,576 $ 48,639 Supplemental cash flow information: Cash paid for income taxes $ 8,298 241 $ 2,750 Cash paid for interest $ 25,993 932 $ 14,740 Cash paid for operating lease liabilities $ 2,199 175 $ — Operating lease assets obtained in exchange for operating lease liabilities $ 2,064 7,987 $ — Tenant improvements paid by lessor $ 636 — $ — Stock-based compensation included in capitalized software development costs $ 817 — $ — Equity issuance to settle intercompany loan $ — 941 $ — Deferred consideration for acquisition $ 6,850 — $ — See notes to consolidated financial statements. 86 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) 1. ORGANIZATION AND DESCRIPTION OF BUSINESS System1, Inc. and subsidiaries (“System1” or the “Company”) operates an omnichannel customer acquisition platform, delivering high-intent customers to advertisers and sells antivirus software packages to end user customers. The Company provides its omnichannel customer acquisition platform services through its proprietary responsive acquisition marketing platform (“RAMP”) . Operating seamlessly across major advertising networks and advertising category verticals to acquire users, RAMP allows the Company to monetize such users through its relationships with third party advertisers and advertising networks (“A dvertising Partners ”) . RAMP also allows third party advertising platforms and publishers (“ Network Partners ”) , to send user traffic to, and monetize user traffic on, the Company’s owned and operated websites. RAMP operates across the Company’s network of owned and operated websites and related products, allowing it to monetize user traffic that it sources from various acquisition marketing channels, including Google, Facebook, Taboola and Zemanta. The Company, through its wholly owned subsidiary Protected.net Group Limited, incorporated in England and Wales (“Protected.net ” ), also provides antivirus software solutions, offering its customers a single packaged solution that provides protection and reporting to the end user. The Company delivers its antivirus software solutions directly to end-user customers across the world. The antivirus software solutions product offering comprises a core security package with varying levels of extra protection based on a customer's specific needs. The Company’s primary operations are in the United States; and the Company also has operations in Canada, the United Kingdom, and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems and various political and economic environments. Among these risks are changes in existing tax laws, possible limitations on foreign investment and income repatriation, government foreign exchange controls, and exposure to currency exchange fluctuations. The Company does not engage in hedging activities to mitigate its exposure to fluctuations in foreign currency exchange rates. For the purposes of the consolidated financial statements, periods on or before January 26, 2022 reflect the financial position, results of operations and cash flows of S1 Holdco ("S1 Holdco") and its consolidated subsidiaries prior to the Merger (as defined in Note 3—MERGER ), referred to herein as the “Predecessor,” and periods beginning on or after January 27, 2022 reflect the financial position, results of operations and cash flows of the Company and its consolidated subsidiaries as a result of the Merger, referred to herein as the “Successor”. Going Concern As of June 1, 2023, the Company had not delivered audited financial statements for the fiscal year ended December 31, 2022 to Bank of America as required by the covenants of the Term Loan (refer to Note 12 – DEBT, NET). The failure to timely deliver the audited financial statements is an event of default under the Term Loan and provides Bank of America the ability to immediately call the outstanding principal balances of the Term Loan and Revolving Facility of $ 430,000 , as of the date of this filing, at the request of, or with the consent of, the required majority of lenders until such time that the audited financial statements are delivered to Bank of America. The Company does not have sufficient liquidity to settle the outstanding principal balances should they be called, nor has the Company identified sufficient alternative sources of capital. As a result, this matter raises substantial doubt about the Company’s ability to continue as a going concern. Upon delivery of the audited financial statements by the Company, the event of default will be remediated and, once remediated, Bank of America will no longer have the ability to call the outstanding principal balances on the Term Loan and Revolving Facility. Separate from the default under the Term Loan and Revolving Facility , in the third and fourth quarters of 2022, the Company experienced declining cash flows and financial performance as a result of deteriorating macroeconomic conditions, resulting in reductions in both advertiser and overall consumer demand for our marketing services. As of December 31, 2022, the Company had cash on hand of $ 24,606 . The declining cash flows and financial performance also raised substantial doubt regarding the Company's ability to continue as a going concern for a period of one year following the date that the consolidated financial statements are issued. In response to the declining cash flows, the 87 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Company implemented a plan to raise additional financing. On April 10, 2023, the Company entered into an incremental revolver note (“2023 Revolving Note”) with related parties for $ 20,000 (refer to Note 12—DEBT, NET for additional information regarding the 2023 Revolving Note). As of the date of this filing, the available balance under the 2023 Revolving Note was $ 15,000 . The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Accordingly, the consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation The Company was a special purpose acquisition company originally incorporated as a Cayman Islands exempted company on February 11, 2020 under the name Trebia Acquisition Corp. (“Trebia”). The Company was formed for the purpose of effecting a merger, share exchange, asset acquisition, share purchase, reorganization or similar business combination with one or more businesses. On January 27, 2022, the Company consummated a business combination (the "Merger"), which resulted in the acquisition of S1 Holdco and System1 SS Protect Holdings, Inc. (“Protected”). Per the Merger, System1, LLC, a wholly-owned operating subsidiary of S1 Holdco, and Protected.net, a wholly-owned operating subsidiary of Protected, became subsidiaries of Trebia. As a result of the Merger, the results of operations, financial position and cash flows of the Predecessor and Successor are not directly comparable. The Company was deemed the accounting acquirer in the Merger based on an analysis of the criteria outlined in Accounting Standards Codification (“ASC”) 805, Business Combinations, and S1 Holdco was deemed to be the predecessor entity. Accordingly, the historical financial statements of S1 Holdco became the historical financial statements of the Company, upon the consummation of the Merger. As a result, the financial statements included in this report reflect (i) the historical operating results of S1 Holdco prior to the Merger and (ii) the combined results of the Company, including S1 Holdco and Protected following the closing of the Merger. The accompanying financial statements include a Predecessor period, which includes the period through January 26, 2022 concurrent with the Merger, and a Successor period from January 27, 2022. A black-line between the Successor and Predecessor periods has been placed in the consolidated financial statements and in the tables to the notes to the consolidated financial statements to highlight the lack of comparability between these two periods as the Merger resulted in a new basis of accounting for S1 Holdco. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The accompanying consolidated financial statements include the accounts of System1, Inc. and its subsidiaries for the Successor period, and S1 Holdco for the Predecessor periods. All intercompany accounts and transactions have been eliminated in the consolidation of the financial statements. ASC 842 Adoption On January 1, 2022, the Company adopted ASC 842, Leases ("ASC 842"), under the modified transition approach. This accounting standard provides several optional practical expedients in transition. The Company elected the “package of practical expedients,” which permits the Company to not reassess its prior conclusions about lease identification, lease classification and initial direct costs. ASC 842 also provides practical expedients for an entity’s ongoing accounting. The Company elected the short-term lease recognition exemption. Accordingly, for those leases that qualify, the Company did not recognize an operating lease asset or operating lease liability for existing short-term leases in transition. The Company also elected the practical expedient to not separate lease and non-lease components for all leases. The adoption of ASC 842 did not have any effect on the Company's previously reported consolidated statements of operations and did not result in a cumulative catch-up adjustment to the opening balance 88 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) of accumulated deficit on the accompanying consolidated balance sheet. The Company recorded $ 6,786 of operating lease assets, $ 7,987 of lease liabilities and reclassified $ 1,201 of deferr ed rent liabilities as a reduction to the beginning operating lease assets upon implementation of ASC 842. See Note 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Leases and Note 7—LEASES for additional details. Risk and Concentrations The Company is subject to certain business and operational risks, including competition from alternative technologies, as well as dependence on key Advertising Partners, key employees, key contracts, and growth to achieve its business and operational objectives. Concentrations The following table illustrates the concentration as a percentage of total revenues for the Company's key Advertising Partners: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Google 68 % 88 % 84 % Microsoft 3 % 4 % 5 % As of December 31, 2022, the Company had (i) two paid search advertising partnership agreements with Google, and (ii) one paid search advertising partnership agreement with Microsoft. The Google agreements are in effect through February 28, 2025, and July 31, 2023, respectively. The agreement with Microsoft is in effect through June 30, 2025. Under certain circumstances, each of these agreements may be terminated by either the Company or the respective Advertising Partner immediately, or with minimal notice. Accounts receivable are primarily derived from Advertising Partners located within the United States. As of December 31, 2022 (Successor), Google and Yahoo, represented 68 % and 11 %, respectively, of the Company’s accounts receivables balance. As of December 31, 2021 (Predecessor), these two Advertising Partners represented 72 % and 10 %, respectively, of the Company’s accounts receivables balance. Use of Estimates The preparation of the accompanying consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the accompanying consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions reflected in these consolidated financial statements include, but are not limited to: (1) valuation of goodwill, acquired intangible assets and long-lived assets, (2) valuation and recognition of the Company's stock-based compensation awards, (3) income taxes, (4) contingent consideration and (5) determination of the fair value of the warrant liabilities. Significant estimates affecting the accompanying consolidated financial statements have been prepared on the basis of the most current and best available information, including historical experience, known trends and other market-specific or other relevant factors that the Company believes to be reasonable. Management evaluates its estimates, as there are changes in circumstances, facts and experience. Changes in estimates are recorded in periods which they become known. However, actual results from the resolution of such estimates and assumptions may vary from those used in the preparation of the accompanying consolidated financial statements. Cash and Cash Equivalents 89 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Cash and cash equivalents consist of amounts held as bank deposits. Cash is deposited with high-credit-quality financial institutions and, at times, such balances with any one financial institution may exceed the insurance limits of the prevailing regulatory body. Historically, the Company has not experienced any losses related to these cash balances and believes that there is minimal risk of expected future losses. However, there can be no assurance that there will not be losses on these deposits. Accounts Receivable Accounts receivable primarily represents amounts due from Advertising Partners, and these accounts receivable are stated at the amount the Company expects to collect from outstanding balances and do not bear interest. The Company does not require collateral for its accounts receivable. The Company considers the following factors when determining the collectability of specific customer accounts: past transaction history with the customer and current economic industry trends. These accounts receivables have historically been paid on a timely basis. Due to the nature of the accounts receivable balance, no allowance for doubtful accounts was necessary as of December 31, 2022 (Successor) and December 31, 2021 (Predecessor). The payment terms for the Company's accounts receivable are typically 30 days. Foreign Currency The functional currency of two of the Company's wholly-owned subsidiaries is the currency of the primary economic environment in which they operate. The assets and liabilities of these wholly-owned subsidiaries are translated at the prevailing rate of exchange at the balance sheet date, while the results of operations are translated at the average exchange rate in effect for the period. The translation adjustments resulting from translating the functional currency into U.S. dollars have been deferred as a component of accumulated other comprehensive income (loss) in stockholders' equity. The functional currency of the Company's other wholly-owned non-U.S. subsidiaries is the U.S. dollar and accordingly, nonmonetary balance sheet accounts are remeasured with the appropriate historical rates. All other balance sheet accounts are translated at the prevailing rate of exchange at the balance sheet date, while the results of operations are translated at the average exchange rate in effect for the period. The gains and losses resulting from this remeasurement are reflected in the determination of net income (loss). Warrant Liability The Company accounts for the Public Warrants and Private Placement Warrants (collectively, the “Warrants”; which are discussed in further detail in Note 13—WARRANTS and Note 14—FAIR VALUE MEASUREMENT ) in accordance with ASC 815-40 under which the Warrants do not meet the criteria for equity classification, and therefore must be recorded as liabilities measured at fair value each balance sheet date, with changes in fair value recorded in Change in fair value of warrant liabilities in the consolidated statements of operations. The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. The fair value of the Private Placement Warrants was estimated using the fair value of the Public Warrants. Fair Value of Financial Instruments The provisions of ASC 820, Fair Value Measurements and Disclosures ( "ASC 820") , relate to financial and nonfinancial assets and liabilities, as well as other assets and liabilities carried at fair value on a recurring basis. ASC 820 provides a single authoritative definition of fair value, sets out a framework for measuring fair value, and expands on required disclosures about fair value measurement. The Company measures fair value based on a three-level hierarchy of inputs, maximizing the use of observable inputs, where available, and minimizing the use of unobservable inputs when measuring fair value. A financial instrument’s level within the three-level hierarchy is based on the lowest level of input that is significant to the fair value measurement. 90 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The three-level hierarchy of inputs is as follows: Level 1 : Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date; Level 2 : Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3 : Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs are based on the Company’s own assumptions about current market conditions and require significant management judgment or estimation. Financial instruments consist of cash, cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities, and warrant liabilities. Cash equivalents and restricted cash are stated at fair value on a recurring basis. Accounts receivable, accounts payable and accrued liabilities are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment date. As of December 31, 2022 and 2021, the Company's outstanding debt included a Term Loan, of which its fair value was estimated using an observable market quotation (Level 2). The Company’s liabilities measured at fair value relate to the Public Warrant liabilities (Level 1), Private Placement Warrant liabilities (Level 2), the former CEO of S1 Holdco's equity profits interest liability (Level 3), and contingent consideration (Level 3). Certain assets, including goodwill, intangible assets and other long-lived assets, are also subject to measurement at fair value on a nonrecurring basis if they are deemed to be impaired as a result of an impairment review. The Company determines the fair value by applying Level 3 unobservable inputs. For further information on the fair value assessment of goodwill and impairment charge recorded in 2022, refer to Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET — Valuation of Goodwill . Restricted Cash The Company’s restricted cash as of December 31, 2022 (Successor) primarily consists of the following items: (i) cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office, (ii) funds held by the Company's credit card processors to cover potential charge backs initiated by the Company's customers, (iii) the escrow account balance related to the portion of unvested equity awards as of the closing of the Merger that will be cash settled as the service requirement is completed, (iv) the escrow account balance related to the indemnification obligations related to its RoadWarrior acquisition and (v) the escrow account balance related to the postcombination compensation arrangement related to the CouponFollow acquisition. The amount of restricted cash as of December 31, 2021 (Predecessor) relates to cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office. Property and Equipment, net 91 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Repairs and maintenance are charged to expense as incurred, while improvements are capitalized. Upon the sale or retirement of property and equipment, the accounts are relieved of the cost and the related accumulated depreciation, and any resulting gain or loss is included in selling, general, and administrative expense on the accompanying consolidated statements of operations. The estimated useful lives of the Company’s property and equipment for purposes of computing depreciation are as follows: (Years) Computer equipment 3 Office equipment 3 Furniture, fixtures and equipment 3 - 7 Motor vehicles 4 Leasehold improvements Shorter of the remaining lease term or estimated useful life for leasehold improvements. I nternal-use Software Development Costs, net Internal-use software development costs are stated at cost, less accumulated amortization. The Company capitalizes certain internal-use software development costs associated with creating and enhancing internally developed software related to the Company’s technology infrastructure, including continuing to develop and deploy its RAMP platform. Deployment activities focus on enhancement of our customer acquisition capabilities, including website enhancements and tools for marketing support, and upgrades of dashboards and reporting tools. These costs are comprised of personnel costs, which include salaries, bonuses, stock-based compensation and employee benefits’ expenses for employees who are directly associated with, and who devote significant time to, software projects, as well as external direct costs of materials and services consumed in developing or obtaining the software. Internal-use software development costs that do not meet the qualification for capitalization are expensed as incurred, and are recorded in Salaries and benefits expense on the accompanying consolidated statement of operations. Internal-use software development activities generally consist of three stages: (i) the planning stage, (ii) the application and infrastructure development stage, and (iii) the post-implementation stage. Costs incurred in the planning and post-implementation stages of software development, including costs associated with the post configuration training and repairs and maintenance of the developed technologies, are expensed as incurred. Costs incurred in the application and infrastructure development stage, including significant enhancements and upgrades, are capitalized once the preliminary project stage is completed, management has authorized further funding for the completion of the project, and it is probable that the project will be completed and the software will perform as intended. Capitalization ends once a project is substantially complete, and the software and technologies are ready for their intended purpose(s). Internal-use software development costs are amortized using a straight-line method over an estimated useful life of three ( 3 ) years, commencing when the software is ready for its intended use. The straight-line recognition method approximates the manner in which the expected benefit will be derived. The Company does not transfer ownership of its software or lease its software to third parties. Intangible Assets Intangible assets primarily consist of acquired technology, customer relationships and trade names/trademarks. The Company determines the appropriate useful life based on management’s estimate of the applicable intangible asset’s remaining economic useful life at the time of acquisition. Intangible assets are generally amortized over their estimated economic useful lives using a straight-line method, which approximates the pattern in which the economic 92 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) benefits are consumed. Certain customer relationship intangibles are amortized on an accelerated basis based upon the expected timing of economic benefits which are derived from an analysis of customer attrition rates over the expected life. The fair value of the intangible assets acquired are determined using either the income or market methodologies. The estimated useful lives of the Company’s intangible assets are as follows: Useful Life (Years) Developed technology 4 Customer relationships 3 - 5 Trademarks and trade names 10 Other intangibles 4 Impairment of Long-Lived Assets The Company assesses the recoverability of its long-lived assets when events or changes in circumstances indicate that their carrying value may not be recoverable. Such events or changes in circumstances may include a significant adverse change in the extent or manner in which a long-lived asset is being used; significant adverse changes in legal factors or in the business climate that could affect the value of a long-lived asset; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of a long-lived asset; current or future operating or cash flow losses that demonstrate continuing losses associated with the use of a long-lived asset; or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The Company performs impairment testing at the asset group level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The Company assesses recoverability of its long-lived assets by determining whether the carrying value of the asset group can be recovered through projected undiscounted cash flows over their remaining useful lives. If the carrying value of the asset group exceeds the forecasted undiscounted cash flows, an impairment loss is recognized and measured as the amount by which the carrying amount exceeds the estimated fair value. An impairment loss is charged to operations in the period in which management determines such impairment has occurred. During 2022, in conjunction with the Company's testing for impairment of goodwill, the Company performed an impairment assessment of its long-lived asset groups by comparing undiscounted cash flows with carrying values. The undiscounted cash flows exceeded the carrying value, and accordingly, the Company did not record any impairments of long-lived assets. Refer to Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET — Goodwill Impairment for additional information. Business Combinations The results of a business acquired in a business combination are included in the Company’s consolidated financial statements from the date of acquisition. The Company allocates the purchase price, which is the sum of the consideration provided which may consist of cash, equity, or a combination of the two, paid in a business combination for the identifiable assets and liabilities of the acquired business at their acquisition-date fair values. Any excess amount paid over the identifiable net assets is recorded as goodwill. The process for estimating the fair values of the acquired business involves the use of significant estimates and assumptions, including estimating average industry multiples, customer and service attrition rate, forecasted revenue and revenue growth rates, discount rates, technology migration rates, royalty rates and estimating future cash flows. The Company estimates the fair value based on assumptions which the Company's management believes to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, the Company may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. At the conclusion of the 93 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) measurement period, any subsequent adjustments are reflected in the Company’s consolidated statements of operations. Transaction costs associated with business combinations are expensed as incurred and are included in selling, general and administrative expenses on the Company’s consolidated statements of operations. When purchase consideration includes contingent consideration, the Company records the fair value of the contingent consideration as of the date of acquisition, and subsequently remeasures the contingent consideration at fair value as of each reporting date through the Company’s consolidated statements of operations. Goodwill Goodwill represents the excess of the purchase price over the fair value of net assets acquired and identifiable intangibles in a business combination. The Company accounts for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other , which requires the Company to test goodwill at the reporting unit level for impairment at least annually, or if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company performs its annual goodwill impairment test on December 31. The Company has the option (i) to assess goodwill for possible impairment by performing a qualitative analysis to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount or (ii) to perform the quantitative impairment test. The quantitative impairment test involves comparing the estimated fair value of a reporting unit with its respective carrying amount, including goodwill. If the estimated fair value exceeds carrying amount, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than carrying amount, an impairment loss is recognized in an amount equal to the excess, not to exceed the carrying amount of goodwill. The determination of fair value(s) requires the Company to make significant estimates and assumptions. These estimates include, but are not limited to, future expected cash flows from a market participant perspective, discount rates and industry data. Unanticipated events or circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results. Refer to Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET regarding impairment of goodwill in fiscal 2022 . Leases On January 1, 2022, the Company adopted ASC 842 , Leases , and recognized operating lease assets and operating lease liabilities on its consolidated balance sheet. A contract is or contains a lease when, (1) the contract contains an identified asset and (2) the customer obtains substantially all of the economic benefits from the use of that underlying asset and directs how and for what purpose the asset is used during the term of the contract in exchange for consideration. The Company assesses whether an arrangement is or contains a lease at inception of the contract. For all leases, other than those that qualify for the short-term recognition exemption, the Company recognizes as of the lease commencement date, on the balance sheet a liability for its obligation related to the lease and a corresponding asset representing the Company’s right to use the underlying asset over the period of use. The Company’s operating leases are included in operating lease assets and operating lease liabilities on the Company’s consolidated balance sheet as of December 31, 2022 (Successor). Operating lease assets and operating lease liabilities are initially recorded based on the present value of lease payments over the lease term, which may include options to extend or terminate the lease when it is reasonably certain at the commencement date that such options will be exercised. As the rate implicit for each of the Company’s leases is not readily determinable, the incremental borrowing rate ("IBR") based on the information available on the 94 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) commencement date of the lease is used to determine the present value of lease payments. The IBR is estimated by calculating a discount rate based on available adjusted market data. Operating lease assets include any lease incentives. Lease agreements with lease and non-lease components are accounted for as a single lease component. Lease expense is recognized on a straight-line basis over the term of the lease. Operating lease expenses are included in selling, general, and administrative expenses on the accompanying consolidated statements of operations. See Note 7—LEASES for additional details. Revenue Recognition The Company recognizes revenue when control of the promised services is transferred to the Company’s customers, in an amount that reflects the consideration it expects to be entitled to in exchange for those services. The Company determines revenue recognition through the following steps: • Identification of a contract with a customer, • Identification of the performance obligations in the contract, • Determination of the transaction price, • Allocation of the transaction price to the performance obligations in the contract, and • Recognition of revenue when or as the performance obligations are satisfied. The Company’s revenue is principally derived from the following areas: Advertising and Other Revenue The Company earns revenue by directly acquiring traffic to its owned and operated websites and utilizing its RAMP platform and related services to connect its Advertising Partners to its owned and operated websites. For this revenue stream, the Company is the principal in the transaction and reports revenue on a gross basis for the amounts received from its Advertising Partners. For this revenue, the Company has determined that it is the principal since it has a risk of loss on the traffic that it is acquiring for monetization with its Advertising Partners, and, in the case of its owned and operated websites, the Company maintains the website, provides the content and bears the cost and risk of loss associated with its websites’ advertising space. Revenue is also earned from revenue-sharing arrangements with the Company’s Network Partners for the use of its RAMP platform and related services that enable them to direct advertising provided by Advertising Partners to their advertising inventory. The Company has determined it is the agent in these transactions and reports revenue on a net basis, because (a) the Company does not control the underlying advertising space, (b) the Company does not acquire the traffic and does not have risk of loss in connection therewith and (c) the pricing is in the form of a substantively fixed-percentage revenue-sharing arrangement. The Company reports this revenue on a net basis with respect to the amount retained under its revenue-sharing arrangements, which represents the difference between amounts received by the Company from the Advertising Partners, less amounts remitted to the Network Partners based on underlying contracts. The Company recognizes revenue upon delivering traffic to its Advertising Partners based on a cost-per-click or cost-per-thousand impression basis. Subscription Revenue In connection with the Merger and acquisition of Protected.net discussed in Note 3—MERGER , the Company is also engaged in selling antivirus, adblock, and safe browsing software as a service subscription ("SaaS") to customers. The subscription business provides real-time antivirus protection, a safe-browsing feature, adblocking, blocking of malicious websites and data breach monitoring. Subscription revenue is primarily derived from the (i) delivery of the antivirus software and (ii) delivery of the additional add-on service(s), which all are provided on a fixed-price 95 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) basis. The performance obligations related to subscription, maintenance and support are satisfied over the term of the customer contract and the associated subscription revenue is recognized over the contract term on a ratable basis, which is consistent with transfer of control. The Company’s services rendered to customers are generally paid for in advance with cash receipts recorded as deferred revenue, which represents a liability under a noncancellable contract. Cost of Revenues Cost of revenues primarily consists of traffic acquisition costs, which are the costs to place advertisements to acquire customers to the Company’s websites and subscription services, as well as content, publishing, domain name registration costs, licensing costs to provide mapping services to Mapquest.com, credit card processing fees, and licensing costs related to the antivirus and other software available via APIs for sale and distribution of its SaaS products to end customers. The Company does not pre-pay any traffic acquisition costs, and therefore, expenses such costs as incurred. Salaries and Benefits Salaries and benefits expenses include salaries, bonuses, stock-based compensation, non-capitalized personnel costs incurred in the internal use software development, and employee benefits costs. Stock-Based Compensation Compensation cost related to stock-based payments is measured based on the fair value of the units issued and recognized in salaries and benefits expenses on the company’s consolidated statement of operations. The Company has elected to treat stock-based payment awards with time-based service condition(s) only as a single award, with the related compensation expense recognized on a straight-line basis. The assumptions used in the Black-Scholes model to value equity in the Predecessor period are based upon the following: • Fair Value of common stock: S1 Holdco’s equity was not publicly traded, therefore the fair value was determined by S1 Holdco’s Board of Directors, with input from management and contemporaneous valuation reports prepared by a third-party valuation specialist. • Expected Term: The expected term of the award is estimated by considering the contractual term and vesting period of the award, the employees’ expected exercise behavior and the post-vesting employee turnover rate. For non-employees, the expected life equals the contractual term of the award. • Risk-free Interest Rate: The risk-free interest rate is based on published U.S. Treasury Department interest rates for the expected term of the underlying award. • Volatility: The volatility was based on the expected unit price volatility of the underlying units over the expected term of the award which is based upon historical share price data of an index of comparable publicly traded companies. Replacement Awards Pursuant to the Merger, the Company was required to replace certain profits interests awards, the value creation units ("VCU") and Class F Units ("F Units"), with a combination of a restricted stock unit (“RSU”) in System1 and a cash award (collectively, the "Replacement Awards”). The fair value of the Replacement Awards was derived utilizing the transaction closing price of $ 10.00 . The Merger triggered a liquidating event, therefore, the portion of the Replacement Awards issued in connection with the Merger that was associated with services rendered through the date of the Merger are included in the total consideration transferred, with the exception of the unvested awards subject to service vesting conditions where the service condition has not been completed. With regards to the remaining unvested portion of the Replacement Awards, the Company continues to recognize compensation expense on a straight-line basis over the original requisite service period and recognizes forfeitures as they occur. For VCU 96 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Replacement Awards forfeited prior to vesting, the Company recognizes accelerated compensation expense for the remaining unvested shares, as a share of the Company’s Class A Common Stock becomes issuable to the previous investors for each VCU Replacement Award forfeited. For Cash Replacement Awards forfeited prior to vesting, the Company recognizes accelerated compensation expense for the unpaid amount, as that cash amount becomes payable to the previous investors. Post-Combination Awards For awards granted subsequent to the Merger, the Company’s fair value of the related restricted stock units was derived from the market price of its Class A common stock, which is traded on the NYSE. As these awards are subject only to time-based service conditions, the Company recognizes compensation expense for these awards on a straight-line basis over the requisite service period for each award, and recognizes forfeitures as they occur. Liability Awards In connection with the Merger and acquisition of Protected.net described in Note 3—MERGER , the Company effected an incentive plan for eligible recipients which is payable in a fixed value of fully-vested shares of the Company’s Class A common stock upon the satisfaction of certain performance and service conditions (the “ Protected.net Incentive Plan ” ). In connection with the acquisition of CouponFollow described in Note 4—ACQUISITIONS the Company effected an incentive plan for eligible recipients, which, at the Company’s option, is payable in cash or fully-vested shares of the Company’s Class A common stock upon the satisfaction of certain performance and service conditions (the “ CouponFollow Incentive Plan ” ). The Company recognizes compensation cost for these liability awards with performance and service conditions if and when it is deemed probable that the performance condition will be achieved. The probability of vesting is evaluated at each reporting period taking into consideration actual results to-date and forecasts and compensation cost adjusted to reflect the completed portion of the service period with a graded vesting attribution . Refer to Note 19—STOCK-BASED COMPENSATION for additional information . Repurchased Shares Repurchased shares of the Company's common stock are retired, and the cost of the retired shares in excess of par value, including any direct and incremental costs associated with the repurchase, is recorded as a decrease in retained earnings. Selling, General, and Administrative Expenses Selling, general, and administrative expenses consist of fees for professional services, occupancy costs, travel and entertainment. These costs are expensed as incurred. Depreciation and Amortization Depreciation and amortization expenses are primarily attributable to the Company’s capital investments and consist of property and equipment depreciation and amortization of intangible assets with finite lives. Income Taxes The Company is the sole managing member of S1 Holdco and, as a result, consolidates the financial results of S1 Holdco. S1 Holdco is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, S1 Holdco is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by S1 Holdco is passed through to and included in the taxable income or loss of its members, including the Company, on a pro rata basis. The Company is subject to U.S. federal income taxes, in 97 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) 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 the Company. Various subsidiaries of the Company are subject to income tax in the United States and in other countries. The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities (“DTAs” and “DTLs”, as applicable) for the expected future tax consequences of events that have been included in the financial statements. Under this method, the Company determines DTAs and DTLs on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period that includes the enactment date. The Company recognizes DTAs to the extent that it believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, carryback potential if permitted under the tax law, and results of operations. If the Company determines that it would not be able to realize its DTAs in the future in excess of their net recorded amount, it would make an adjustment to the DTA valuation allowance, which would increase the provision for income taxes. The Company records uncertain tax positions in accordance with ASC 740, Income Taxes, on the basis of a two-step process in which (1) it determines whether it is more likely than not that the tax positions will be sustained on the basis of its technical merits and (2) for those tax positions that meet the more-likely-than-not recognition threshold, it recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes both accrued interest and penalties, when appropriate, in the provision for income taxes on the accompanying consolidated statements of operations. Non-Controlling Interest The Company reports a non-controlling interest representing the economic interest in S1 Holdco held by certain individuals and entities other than the Company. The non-controlling interest is comprised of certain selling equity holders of S1 Holdco that retained an economic interest in S1 Holdco through their ownership of Class B units in S1 Holdco as of the closing of the Merger, along with the same number of corresponding shares of Class C common stock in the Company. The non-controlling interest holders may, from time to time, require the Company to convert all or a portion of their economic interest via a redemption of their Class B units in S1 Holdco together with surrendering their corresponding shares of Class C common stock in the Company in exchange for shares of Class A common stock on a one -for-one basis. The Company's Board of Directors may elect to redeem the non-controlling interest holder's Class B units in cash. As future redemptions occur, this will result in a change in ownership and reduce the amount recorded as non-controlling interest and a corresponding increase in additional paid-in capital. As additional shares of Class A common stock are issued by the Company, Class A units in S1 Holdco are issued to the Company to maintain a one-to-one ratio of Class A common stock outstanding to the Company's Class A units in S1 Holdco. During the quarter ended September 30, 2022, certain shareholders converted 330 Class C shares into Class A shares. As a result, the Company reduced the non-controlling interest balance in equity by $ 2,714 and increased the additional paid-in capital balance by the same amount. The following table summarizes the ownership interest in S1 Holdco as of December 31, 2022 (Successor). Units Ownership % Class A units of S1 Holdco 91,674 81 % Class B units of S1 Holdco 21,747 19 % Recent Accounting Pronouncements 98 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, including subsequent amendments, Measurement of Credit Losses on Financial Instruments (Topic 326), which modifies the accounting methodology for most financial instruments. The guidance requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. This guidance is effective for the Company for annual periods beginning after December 15, 2022, and early adoption is permitted. The adoption of this update on January 1, 2023 did not have a material effect on its consolidated financial statements. 3. MERGER On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022) (the “Business Combination Agreement” or "BCA"), by and among S1 Holdco, Trebia, and Protected (collectively, the “Companies”). On January 26, 2022 (the “Closing Date”), the Company consummated the business combination (the "Merger") pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company is organized via an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected. Additionally, Trebia’s ordinary shares and public warrants ceased trading on the New York Stock Exchange ("NYSE"), and System1 Inc.'s Class A common stock and the Public Warrants began trading on the NYSE on January 28, 2022 under the symbols “SST” and “SST.WS,” respectively. The consideration paid to the existing equity holders of S1 Holdco and Protected in connection with the Merger consisted of the following: • Cash; • Class A common stock; • Class C common stock; • Replacement Awards. The aggregate cash consideration was $ 440,155 . The aggregate equity consideration paid and/or retained for S1 Holdco Class B Units was $ 610,144 , consisting of (a) the aggregate equity consideration payable under the Business Combination Agreement, consisting of shares of Class A common stock and Replacement Awards, and (b) the aggregate Class B Units in S1 Holdco retained by S1 Holdco equity holders at the Closing. The fair value of the Class A common stock was determined by utilizing the transaction closing price per share per the BCA of $ 10.00 and a discount of 10 %, as the shares were not immediately available for sale upon issuance and this restriction is viewed to be a function of the security characteristics. Additionally, the aggregate Class B units in S1 Holdco retained by S1 Holdco equity holders at the Closing Date resulted in a non-controlling interest. The 22,077 Class B units in S1 Holdco and the corresponding Class C common stock in the Company were determined to have an estimated value of $ 198,691 . As the Class B units in S1 Holdco together with the corresponding shares of the Company's Class C common stock are exchangeable for shares of Class A common stock on a one-for-one basis, the fair value was determined using the same method as for the shares of Class A common stock, utilizing the transaction closing price of $ 10.00 and a discount of 10 % (as the units and the corresponding shares of Class C common stock were not immediately available for sale upon issuance and this restriction is viewed to be a function of the security characteristics). The fair value of $ 198,691 was included in non-controlling interest on the accompanying consolidated balance sheet and consolidated statements of changes in stockholders' equity. In connection with the Merger, System1 and Cannae Holdings, Inc. (“Cannae”), an investor in the Sponsor of Trebia, entered into a backstop agreement (the “Backstop Agreement”) on June 28, 2021, as amended on January 99 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) 10, 2022, whereby Cannae agreed, to subscribe for up to 25,000 shares of Trebia Class A common stock in order to fund up to $ 250,000 of redemptions by shareholders of Trebia. See discussion below regarding the Amended and Restated Sponsor Agreement, which was amended in conjunction with the Backstop Agreement. As a result of shareholder redemptions, Cannae provided $ 246,484 of the cash used to fund the Closing Cash Consideration pursuant to its obligations under the Backstop Agreement and in exchange received 24,648 shares of Class A common stock ("Backstop shares"). Additionally, pursuant to the Backstop Agreement, the Selling Shareholders (i.e., certain shareholders of S1 Holdco and Protected prior to the Merger) agreed that, in the event shareholders of Trebia requested redemption of Trebia outstanding equity immediately prior to the Merger in excess of a certain dollar value threshold, certain equity holders of S1 Holdco and Protected would reduce their cash consideration and proportionally increase their equity consideration for the Merger, which is referred to as the “Seller Backstop Election”. In the event that the Seller Backstop Election was made, the Sponsors would forfeit their shares to allow the Company to then issue shares to the Selling Shareholders. The Seller Backstop Election was triggered and, as a result, the Sponsors forfeited 930 shares of Trebia Class B ordinary shares which were converted at time of Merger, at a one-to-one ratio, into shares of Class A common stock of System1 and delivered to the various selling shareholders of S1 Holdco, collectively referred to as the “Sponsor Promote Shares”. The total consideration amount, in a combination of cash and equity consideration, did not change from the amount agreed in the Business Combination Agreement due to this Seller Backstop Election. The Company recorded $ 7,706 in Salaries and benefits expense and $ 661 in S elling, general and administrative expense for Sponsor Promote Shares during the period January 27, 2022 through March 31, 2022 (Successor). In connection with the execution of the Business Combination Agreement and the Backstop Agreement, on June 28, 2021, as amended on January 10, 2022, the sponsors of Trebia entered into the Amended and Restated Sponsor Agreement whereby the sponsors agreed to forfeit up to 2,600 shares of Trebia Class B common stock in order for the Company to then issue the shares to Cannae (“Backstop forfeiture shares”), in exchange for Cannae entering into the Backstop Agreement. On January 27, 2022, based upon the final backstop funding provided by Cannae, the sponsors forfeited 2,533 shares of Trebia Class B shares, after which the Company then issued 2,533 shares of Class A common stock to Cannae. Trebia recorded a forward purchase liability of $ 25,336 immediately prior to the Merger, representing the fair value of the Backstop shares and the Backstop forfeiture shares. In accordance with the Amended and Restated Sponsor Agreement entered into concurrently with the Business Combination Agreement, the Company issued 1,450 Class D shares to the Trebia sponsors in exchange for 1,450 Trebia Class B shares ("Sponsor RSA's"). The difference in the fair value of the two was treated as a capital contribution. The founders of S1 Holdco and Protected were also issued 1,450 Class D shares ("Seller RSUs"). Further, in connection with the Merger, the Company also effected an incentive plan for Protected business. Refer to Note 19—STOCK-BASED COMPENSATION for additional information on the Seller RSU's and the Protected Incentive Plan. Concurrently with the consummation of the Merger, System1 entered into a tax receivable agreement with the minority holders of S1 Holdco, (the “Tax Receivable Agreement” or "TRA"), pursuant to which, among other things, the parties to the Tax Receivable Agreement have agreed to the allocation and payment of 85 % of the actual savings, if any, in U.S. federal, state and local income tax that System1 may realize as a result of certain tax benefits (if any) related to the transactions contemplated by the Business Combination Agreement and future exchanges of Class B Units in S1 Holdco (together with the corresponding shares of the Company’s shares of Class C common stock) in exchange for shares of the Company’s Class A common stock. As of the Closing Date, the fair value of obligations under the TRA were determined to be zero as any tax savings were uncertain. The TRA is contingent consideration and subsequent changes in fair value of the contingent liability are recognized in earnings. Refer to TRA discussion in Note 10—INCOME TAXES. The Company adopted ASU No. 2021-08, Business Combinations: Contract Assets & Liabilities on January 1, 2022 and accordingly, has recorded contract assets and contract liabilities acquired as part of the Merger based on what the Company would have recorded under ASC 606, Revenue from Contracts with Customers, as of the acquisition 100 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) date, as if the Company had entered into the original contract at the same date and on the same terms as S1 Holdco and Protected. The Merger has been accounted for as a business combination using the acquisition method of accounting. The total purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The purchase consideration was allocated to the following assets and liabilities: Amount Tangible assets acquired and liabilities assumed: Cash and marketable securities $ 68,748 Accounts receivable 79,086 Prepaid expenses 7,807 Income tax receivable 4,566 Property, plant & equipment, net 1,551 Other assets 6,950 Accounts payable ( 9,798 ) Deferred revenue ( 60,768 ) Accrued expenses and other current liabilities ( 110,004 ) Income tax payable ( 2,091 ) Notes payable ( 172,038 ) Deferred tax liabilities ( 138,613 ) Other liabilities ( 8,474 ) Total tangible assets acquired and liabilities assumed ( 333,078 ) Intangible assets 562,100 Goodwill 821,277 Net assets acquired $ 1,050,299 Consideration: Cash $ 440,155 Equity 411,453 Total consideration attributable to System1 851,608 Total consideration attributable to non-controlling interest 198,691 Total consideration $ 1,050,299 The intangible assets as of the closing date of the acquisition included: Amount Weighted Average Useful Life (in Years) Trademarks $ 246,400 10 Customer relationships 119,700 4 Technology 196,000 4 Total $ 562,100 The fair value of the intangible assets acquired was determined using income-based approach methodologies. Intangible assets are amortized over their estimated economic useful lives using a straight-line method, which approximates the pattern in which the economic benefits are consumed. Customer relationships are amortized on an 101 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) accelerated basis. To determine the amortization period for each of the customer relationships assets and to evaluate the pattern of usage of economic benefits, the Company performed a customer attrition analysis of the Company's customer relationships to estimate the attrition rate and consequently the life expectancy for the existing customer relationships. Key assumptions used in the valuation of intangible assets are below: Trademarks – The Company valued trademarks using the relief-from-royalty method under the income-based approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademarks, and a discount rate. Customer relationships – The Company valued customer relationships using an excess-earnings method utilizing distributor inputs. Key assumptions include customer attrition rate, revenue growth rate, existing customer revenue, deferred revenue, and a discount rate. Technology – The Company valued technology using the excess-earnings method utilizing company-specific inputs. Key assumptions include forecasted revenue, technology migration rate and a discount rate. The goodwill arising from the acquisition consists largely of the expected synergies from combining operations as well as the value of the workforce. Goodwill is not deductible for tax purposes. Unaudited Pro Forma Information The following unaudited pro forma information reflects adjustments for additional amortization resulting from the fair value adjustments to assets acquired and liabilities assumed, adjustments for alignment of accounting policies, adjustments for transaction expenses, adjustments for certain stock-based compensation and equity related expenses incurred as a result of the transactions and the resulting tax effects, as if the Merger and acquisitions of Answers, CouponFollow and RoadWarrior (each as defined in Note 4—ACQUISITIONS) occurred January 1, 2021. The pro forma results do not include any anticipated cost synergies or other effects of the merged companies. Accordingly, pro forma amounts are not necessarily indicative of the results that actually would have occurred had the acquisitions been completed on the dates indicated, nor is it indicative of the future operating results of the combined company. Year ended December 31, 2022 December 31, 2021 Pro forma revenue $ 843,872 $ 880,789 Pro forma net (loss) $ ( 360,022 ) $ ( 211,904 ) 4. ACQUISITIONS Answers Holdings, Inc. On May 4, 2022, the Company acquired the assets of Answers Holdings, Inc. and its subsidiaries, collectively ("Answers") for total cash consideration of $ 4,632 . The acquisition of Answers constitutes a business combination under ASC 805, Business Combinations . This acquisition expands the Company's portfolio of Owned & Operated Advertising publishing sites and search destinations to include a destination for higher education and lifelong learning content. The amounts of revenue and income before income taxes for the period from May 4, 2022 to December 31, 2022 were $ 1,891 and $ 479 , respectively. The operating results of Answers are reported within the Owned and Operated Advertising segment. The purchase consideration was allocated to the following assets and liabilities: 102 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Amount Assets acquired and liabilities assumed: Working capital $ 32 Trademark - 10 years weighted average useful life 1,100 Goodwill 3,500 Net assets acquired $ 4,632 Total consideration: Cash $ 4,632 The goodwill arising from the acquisition consists largely of the expected synergies from combining operations, and is deductible for tax purposes over 15 years. The Company incurred $ 93 in transaction costs related to the acquisition. Trademark – The Company valued the trademark using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademark and a discount rate. NextGen Shopping, Inc. On March 4, 2022, the Company acquired NextGen Shopping, Inc. (d/b/a “CouponFollow”) for total cash consideration of $ 75,087 , of which $ 16,446 was deferred, $ 5,600 was held-back, and $ 25,500 related to the fair value of 2,000 shares of Class A common stock issued. The fair value of the shares of Class A common stock was determined by utilizing the closing price per share of the Company's Class A common stock listed on the NYSE as of March 3, 2022, and a discount rate of 7.5 %, as the shares were not immediately available for sale upon issuance, and this restriction was deemed to be a function of the security characteristics. The deferred consideration of $ 16,446 was paid subsequent to the acquisition. The held-back consideration amount will become payable eighteen months subsequent to the acquisition date, subject to the Company's satisfaction of any potential post-closing purchase price adjustments and indemnification claims. The cash payment included the transaction costs of $ 3,129 that the Company paid on behalf of CouponFollow in connection with the closing of the transaction. The acquisition of CouponFollow constitutes a business combination under ASC 805. In conjunction with this acquisition, the Company also committed to pay postcombination compensation of $ 8,500 , which is payable in cash and subject to continued services from certain individuals of CouponFollow. Separately, in conjunction with the acquisition, the Company entered into the CouponFollow Incentive Plan, providing up to $ 10,000 of postcombination compensation which is payable in stock or cash at the option of the Company, and subject to continued service from certain individuals, and up to $ 25,000 which is payable in stock or cash at the option of the Company contingent upon achieving certain financial thresholds and the continued employment of certain key individuals of CouponFollow. Refer to Note 19—STOCK-BASED COMPENSATION for additional information. This acquisition leverages CouponFollow’s reputation, software and large organic traffic to vertically integrate with the Company’s RAMP platform and generate paid traffic for shopping-related products. The results of CouponFollow’s operations from the date of acquisition have been included in the Company’s consolidated financial statements. The amounts of revenue and income before income taxes for the period from March 4, 2022 to December 31, 2022 (Successor) were $ 17,948 and $ 2,839 , respectively. The operating results of CouponFollow are reported within the Owned and Operated Advertising segment. The total purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The purchase consideration was allocated to the following assets and liabilities: 103 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Amount Cash and cash equivalents $ 21,232 Accounts receivable 5,860 Other current assets 446 Accounts payable ( 116 ) Accrued expenses and other current liabilities ( 118 ) Income tax payable ( 197 ) Deferred tax liabilities ( 10,895 ) Trademark - 10 years weighted average useful life 38,100 Software - 4 years weighted average useful life 4,100 Goodwill 42,175 Net assets acquired $ 100,587 Consideration: Cash $ 75,087 Equity 25,500 Total consideration $ 100,587 The goodwill arising from the acquisition consists largely of the expected synergies from combining operations as well as the value of the workforce. The goodwill is not deductible for tax purposes. The Company incurred $ 813 in transaction costs related to the acquisition. Trademark – The Company valued the trademark using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademarks and a discount rate. Software – Acquired software technology was valued using the excess-earnings method utilizing company-specific inputs. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the software and a discount rate. RoadWarrior, LLC On February 9, 2022, the Company acquired the assets of RoadWarrior, LLC (“RoadWarrior”) for total cash consideration of $ 19,636 . The acquisition of RoadWarrior constitutes a business combination under ASC 805. The acquisition expands the Company’s Mapquest.com website technology, and provides additional functionality for customers centered around route planning for delivery drivers and teams. The results of RoadWarrior’s operations as of and after the date of acquisition have been included in the Company’s consolidated financial statements from February 9, 2022 to December 31, 2022 (Successor) . The amounts of revenue and income before income taxes for the period from February 9, 2022 to December 31, 2022 (Successor) were $ 4,579 and $ 3,022 , respectively. The operating results of RoadWarrior are reported within the Owned and Operated Advertising segment prospectively from the date of acquisition. The total purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The purchase consideration was allocated to the following assets and liabilities: 104 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Amount Working capital $ 155 Trademark - 10 years weighted average useful life 2,200 Software - 4 years weighted average useful life 1,000 Customer relationships - 3 years weighted average useful life 1,300 Goodwill 14,981 Net assets acquired $ 19,636 Total consideration Cash $ 19,636 The goodwill arising from the acquisition consists largely of the expected synergies from combining operations as well as the value of the workforce. The goodwill is deductible for tax purposes over 15 years. The Company incurred $ 308 in transaction costs related to the acquisition. Trademark – The Company valued the trademark using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademarks and a discount rate. Software – Acquired software technology was valued using the excess-earnings method utilizing company-specific inputs. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the software and a discount rate. Customer relationships – The Company valued customer relationships using an excess-earnings method utilizing distributor inputs. Key assumptions include customer attrition rate, revenue growth rate, existing customer revenue, deferred revenue, and a discount rate. Refer to Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET — Impairment for additional information. 5. PROPERTY AND EQUIPMENT, NET Property and equipment, net consisted of the following: As of December 31, 2022 2021 Computer equipment $ 793 $ 415 Motor vehicles 234 — Furniture and equipment 958 475 Leasehold improvements 2,750 976 Property and equipment—gross 4,735 1,866 Less accumulated depreciation ( 713 ) ( 1,036 ) Property and equipment—net $ 4,022 $ 830 Total depreciation expense on property and equipment was as follows: 105 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Depreciation expense $ 786 $ 16 $ 310 6. GOODWILL, INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET Goodwill The changes to goodwill by reportable segments were as follows: Owned and Operated Advertising Partner Network Subscription Total Goodwill at January 27, 2022 $ — $ — $ — $ — Additions 355,316 93,400 433,184 881,900 Impairment ( 355,316 ) ( 10,993 ) — ( 366,309 ) Goodwill at December 31, 2022 $ — $ 82,407 $ 433,184 $ 515,591 Additions to Goodwill were from the acquisitions of S1 Holdco, Protected.net, CouponFollow, RoadWarrior and Answers in 2022. See discussion below regarding impairment of goodwill. There was no Goodwill activity for the year ended December 31, 2021 and the period from January 1, 2021 through January 26, 2022 (Predecessor). Goodwill by reportable segments as of December 31, 2021 was as follows: Owned and Operated Advertising Partner Network Total Goodwill at December 31, 2021 $ 24,403 $ 20,417 $ 44,820 Goodwill Impairment The Company assesses goodwill for impairment annually as of December 31 or more frequently if events or changes in circumstances indicate the asset might be impaired. Prior to the fourth quarter of 2022, the Company had four reporting units, as follows: i. Publishing and Lead Generation - within Owned and Operated Advertising reportable segment ii. Search and Applications - within Owned and Operated Advertising reportable segment iii. Partner Network – reportable segment and reporting unit iv. Subscription – reportable segment and reporting unit The Company has experienced adverse macroeconomic impacts as a result of changes in market conditions and increases in interest rates, which contributed to reduced forecasted revenues and reduced expectations for future cash flows. In response to these ongoing macroeconomic conditions and a broad weakening of consumer demand during the third quarter of 2022, the Company reduced its earnings forecasts for the Owned and Operated Advertising & Partner Network reportable segments. Given these adverse impacts, the Company performed an interim quantitative goodwill impairment analysis for all its reporting units as of September 30, 2022. 106 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Based on the Company’s quantitative impairment analysis as of September 30, 2022: • the fair value of the Subscription reporting unit exceeded its carrying amount by 13 %. • the fair value of the Search and Applications reporting unit exceeded its carrying amount by 2 %. • the fair value of the Publishing and Lead Generation reporting unit was substantially less than its carrying amount. As a result, the Company impaired all the goodwill attributable to this reporting unit of $ 329,133 . • the fair value of the Partner Network reporting unit was less than its carrying amount, resulting in a $ 10,976 impairment of goodwill attributable to this reporting unit. During the quarter ended December 31, 2022, the Company realigned its reporting structure due to changes in management such that the Search and Applications reporting unit became part of the Publishing and Lead Generation reporting unit and the new reporting unit was renamed Owned and Operated Advertising. Based on the Company’s December 31, 2022 annual impairment analysis: • the fair value of the Subscription reporting unit exceeded its carrying amount by 18 %. • the fair value of the Owned and Operated Advertising reporting unit was substantially less than its carrying amount. As a result, the Company impaired all the goodwill attributable to this reporting unit of $ 26,200 . • the fair value of the Partner Network reporting unit exceeded the carrying amount by 9 %, as the Partner Network reporting unit experienced improved results during the fourth quarter of 2022. The fair values of the Company’s reporting units as of September 30, 2022 and December 31, 2022 were computed by weighting a discounted cash flow model and a reference transaction model which included inputs developed using both internal and market-based data. The Company's key assumptions in the discounted cash flow model included, but were not limited to, the weighted average cost of capital, revenue growth rates (including long-term growth rates), and operating margins. The weighted average cost of capital reflected the increases in market interest rates. The Company's reference transaction model derives indications of value based on mergers and acquisition transactions in the digital advertising industry. Key assumptions in this model include, but were not limited to, selection of comparable transactions, revenue and EBITDA multiples and EBITDA margins from those transactions. Any deviation in actual financial results compared to the forecasted financial results or valuation assumptions, a decline in equity valuations, or increases in interest rates, among other factors, could have a material adverse effect to the fair value of the reporting units and could result in a future impairment charge. There can be no assurance that the Company’s future asset impairment testing will not result in a material charge to earnings. Internal-use software development costs and intangible assets Internal-use software development costs and intangible assets consisted of the following: December 31, 2022 (Successor) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Total internal-use software development costs $ 7,206 $ ( 258 ) $ 6,948 Intangibles: Developed technology $ 196,128 $ ( 45,322 ) $ 150,806 Trademarks and trade names 287,857 ( 26,241 ) 261,616 Software 5,100 ( 1,066 ) 4,034 Customer relationships 121,000 ( 44,770 ) 76,230 Total intangible costs $ 610,085 $ ( 117,399 ) $ 492,686 107 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) December 31, 2021 (Predecessor) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Total internal-use software development costs $ 21,274 $ ( 10,061 ) $ 11,213 Intangibles: Developed technology $ 8,398 $ ( 7,242 ) $ 1,156 Trademarks and trade names 69,007 ( 21,375 ) 47,632 Professional service agreement 3,100 ( 2,359 ) 741 Customer relationships 1,500 ( 661 ) 839 Total intangible costs $ 82,005 $ ( 31,637 ) $ 50,368 The internal-use software development costs include capitalized costs not ready for its internal use of $ 4,955 and $ 2,540 as of December 31, 2022 and 2021, respectively. Amortization expense for internal-use software development costs and intangible assets were as follows: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Amortization expense for internal-use software development $ 467 $ 355 $ 4,934 Amortization expense for intangible assets $ 117,399 $ 629 $ 8,641 No impairment of internal-use software development cost or intangible assets was identified for the periods presented in this report. As of December 31, 2022, the expected amortization expense associated with the Company’s intangible assets and internal-use software development costs was as follows: Amortization Expense 2023 $ 111,177 2024 102,167 2025 95,217 2026 43,903 2027 29,258 Thereafter 117,912 Total amortization expense $ 499,634 As of December 31, 2022, the weighted average amortization period for all intangible assets was 7 years. 7. LEASES The Company leases office facilities under noncancelable operating lease agreements. During the period from January 1, 2022 through January 26, 2022 (Predecessor) and January 27, 2022 through December 31, 2022 (Successor), the Company had leases for office facilities in Marina del Rey, California; Bellevue, Washington; and Guelph, Canada. 108 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The components of lease expense were as follows: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Operating lease expense $ 1,923 $ 142 Short-term lease expense 840 12 Variable lease expense 310 — Total lease expense $ 3,073 $ 154 Supplemental information related to leases was as follows: Successor As of December 31, 2022 Weighted average remaining lease terms (in years): 6.9 Weighted average discount rate 5.2 % Maturities of lease liabilities by fiscal year for the Company's operating leases are as follows: Successor As of December 31, 2022 2023 $ 2,512 2024 2,583 2025 2,238 2026 272 2027 276 Thereafter 1,234 Total lease payments $ 9,115 Less: Imputed interest ( 1,091 ) Present value of operating lease liabilities $ 8,024 Rent expense was $ 2,221 for the year ended December 31, 2021 (Predecessor), which was included in selling, general, and administrative expenses on the accompanying consolidated statements of operations. As of December 31, 2021, the expected future operating lease obligations were as follows: 109 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Year ending December 31, Amount 2022 $ 1,957 2023 $ 1,950 2024 $ 1,950 2025 $ 1,663 8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Successor Predecessor December 31, 2022 December 31, 2021 Payable to employees $ 12,890 $ 10,091 Accrued marketing expenses 38,911 144 Accrued professional fees 2,706 6,242 VAT tax liability 4,343 — Accrued tax liability 1,176 361 Acquisition holdback liability 6,885 — Accrued revenue share 1 16,921 — Contingent consideration — 1,682 Former CEO profit interest — 11,132 Other liabilities 11,615 1,632 Accrued expenses and other current liabilities $ 95,447 $ 31,284 1 Revenue share payables of $ 9,475 were included in accounts payable on the accompanying consolidated balance sheet as of December 31, 2021 due to the timing of the receipt of invoices. No revenue share was accrued as of December 31, 2021. Ian Weingarten was hired as CEO of S1 Holdco on April 10, 2019. He was entitled to a cash-settled profits interest of 5 % of the value of S1 Holdco, which was contingent upon (i) a participation threshold of $ 300,000 (which was subject to adjustment as set forth in the S1 Holdco operating agreement) and (ii) on a four-year vesting term, or if a qualifying change in control transaction occurs. In February 2021, Mr. Weingarten's employment with S1 Holdco was terminated and the parties entered into a separation agreement. In connection with the separation agreement, S1 Holdco agreed to payment of separation pay benefits consistent with the terms of Mr. Weingarten’s employment agreement, including the payment of the liability accrued for the cash-settled profits interest of 5 % of S1 Holdco, which was deemed vested as to a 3.75 % profits interest and forfeited as to the remaining 1.25 % profits interest above the applicable adjusted threshold amount (subject to further increase to a 2.5 % profits interest in the event that the Merger was not consummated). S1 Holdco recorded a liability for this arrangement of $ 11,132 as of December 31, 2021 (Predecessor). In January 2022, in conjunction with the consummation of the Merger, S1 Holdco settled the profits interest liability pursuant to the separation agreement with Mr. Weingarten. 9. DEFERRED REVENUE Deferred revenue activities were as follows for the periods presented: 110 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Deferred Revenue January 1, 2021 (Predecessor) $ 1,889 Additions 5,116 Revenue recognized ( 5,034 ) December 31, 2021 (Predecessor) $ 1,971 Deferred Revenue January 1, 2022 (Predecessor) $ 1,971 Additions 620 Revenue recognized ( 309 ) January 26, 2022 (Predecessor) $ 2,282 Deferred Revenue January 27, 2022 (Successor) $ — Additions 1 237,568 Revenue recognized ( 167,404 ) December 31, 2022 (Successor) $ 70,164 1 Includes $ 61,156 from the 2022 acquisitions. We expect to recognize revenue related to the remaining performance obligations as of December 31, 2022 within the next twelve months. 10. INCOME TAXES The Company is the sole managing member of S1 Holdco and, as a result, consolidates the financial results of S1 Holdco. S1 Holdco is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, S1 Holdco is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by S1 Holdco is passed through to and included in the taxable income or loss of its members, including the Company, on a pro rata basis. The Company is 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 the Company . Domestic and foreign components of the Company’s income (loss) before income taxes were as follows: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Domestic $ ( 480,672 ) $ ( 38,068 ) $ 30,521 Foreign ( 63,383 ) 378 3,440 Income (loss) before income taxes $ ( 544,055 ) $ ( 37,690 ) $ 33,961 111 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The components of the income tax provision (benefit) were as follows: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Current: — — Federal $ 79 $ — $ — State 426 17 55 Foreign 5,317 170 1,882 Total current provision $ 5,822 $ 187 $ 1,937 Deferred: Federal $ ( 89,997 ) $ — $ — State ( 8,769 ) — — Foreign ( 9,032 ) ( 816 ) ( 972 ) Total deferred (benefit) $ ( 107,798 ) $ ( 816 ) $ ( 972 ) Income tax (benefit) provision $ ( 101,976 ) $ ( 629 ) $ 965 112 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) A reconciliation of the statutory tax rate to the effective income tax rate for the periods presented was as follows: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Amount % Amount % Amount % Income tax (benefit) provision at statutory tax rate $ ( 114,252 ) 21.0 % $ ( 7,915 ) 21.0 % $ 7,132 21.0 % State tax, net of federal ( 5,470 ) 1.0 15 — 55 0.2 Non-Controlling interests 19,205 ( 3.5 ) — — — — Effect of flow-through entity — — 7,994 ( 21.2 ) ( 6,409 ) ( 18.9 ) Changes in unrecognized tax benefits 8,940 ( 1.6 ) — — — — Foreign income taxes at different statutory rate 1,152 ( 0.2 ) 18 — 88 0.3 Investment in partnership basis adjustments ( 13,491 ) 2.4 — — — — Other 1,940 ( 0.4 ) ( 741 ) 1.9 99 0.2 Effective income tax rate $ ( 101,976 ) 18.7 % $ ( 629 ) 1.7 % $ 965 2.8 % The aggregate amount of gross unrecognized tax benefits related to uncertain tax positions were as follows: Gross Unrecognized Tax Benefits January 1, 2021 (Predecessor) $ — Increases based on tax positions related to prior periods — Increases based on tax positions related to current periods — December 31, 2021 (Predecessor) $ — Gross Unrecognized Tax Benefits January 1, 2022 (Predecessor) $ — Increases based on tax positions related to prior periods — Increases based on tax positions related to current periods — January 26, 2022 (Predecessor) $ — Gross Unrecognized Tax Benefits January 27, 2022 (Successor) $ — Increases based on tax positions related to prior periods 221 Increases based on tax positions related to current periods 11,061 December 31, 2022 (Successor) $ 11,282 113 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Interest and penalties related to the Company's unrecognized tax benefits are recorded as components of the provision for income taxes. Interest or penalties accrued for the years ended December 31, 2022 and 2021 were not material. The total amount of unrecognized benefits that, if recognized, would favorably affect the effective tax rate was $ 9,200 (net of Federal benefit) at December 31, 2022. The Company is not currently under examination in any jurisdiction. It is reasonably possible that, within the next twelve months, statutes of limitation will expire which could have the effect of reducing the balance of unrecognized tax benefits by $ 29 . 114 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The earliest tax years that remain subject to examination in the major tax jurisdictions in which the Company operates were as follows: Jurisdiction Tax Year United States 2019 California 2018 United Kingdom 2021 Netherlands 2016 The components of the deferred income taxes were as follows: Successor Predecessor December 31, 2022 December 31, 2021 Deferred tax assets: Net operating losses $ 16,053 $ — Interest expense 1,196 165 Other 1,920 5 Total deferred tax assets 19,169 170 Valuation allowance ( 1,087 ) ( 170 ) Total net deferred tax assets $ 18,082 $ — Deferred tax liabilities: Investment in partnerships $ 21,144 $ — Intangibles 40,112 7,789 Other 171 — Total deferred tax liabilities $ 61,427 $ 7,789 Net deferred tax liabilities $ 43,345 $ 7,789 The Company assesses available positive and negative evidence to estimate if it is more likely than not to use certain jurisdiction-based deferred tax assets including net operating loss carryovers. On the basis of this assessment, a valuation allowance was recorded during the year ended December 31, 2022. As of December 31, 2022, the Company had U.S. federal net operating loss carryovers (“NOLs”) of $ 9,911 that may be used indefinitely and various state NOLs that will expire at different times. The Company also has United Kingdom NOLs of $ 70,873 that may be used indefinitely. Uncertainties that may affect the utilization of our tax attributes include future operating results, tax law changes, rulings by taxing authorities regarding whether certain transactions are taxable or deductible and expiration of carryforward periods. The Company had an ownership change and as a result certain federal and state NOLs were limited pursuant to Section 382 of the Code. This limitation has been accounted for in calculating the Company's available NOL carryforwards. The change in the valuation allowance was comprised of the following: 115 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Valuation Allowance January 1, 2021 (Predecessor) $ 170 Increases in valuation allowance recorded through earnings — December 31, 2021 (Predecessor) $ 170 Valuation Allowance January 1, 2022 (Predecessor) $ 170 Increases in valuation allowance recorded through earnings — January 26, 2022 (Predecessor) $ 170 Valuation Allowance January 27, 2022 (Successor) $ 170 Increases in valuation allowance recorded through earnings 917 December 31, 2022 (Successor) $ 1,087 Tax Receivable Agreement Pursuant to the Company's election under Section 754 of the Internal Revenue Code (the “Code”), the Company expects to obtain an increase in its share of the tax basis in the net assets of S1 Holdco when LLC Interests are redeemed or exchanged by the other members of S1 Holdco. The Company intends to treat any redemptions and exchanges of LLC Interests as direct purchases of LLC Interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that would otherwise be paid in the future to various tax authorities. On January 27, 2022, the Company entered into a Tax Receivable Agreement with certain of the then-existing members of S1 Holdco that provides for the payment by the Company of 85 % of the amount of any tax benefits that are actually realized, or in some cases are deemed to realize, as a result of (i) increases in the Company's share of the tax basis in the net assets of S1 Holdco resulting from any redemptions or exchanges of LLC Interests, (ii) tax basis increases attributable to payments made under the Tax Receivable Agreement, and (iii) deductions attributable to imputed interest pursuant to the Tax Receivable Agreement (the “TRA Payments”). The Company expects to benefit from the remaining 15 % of any tax benefits that may actually realize. As of December 31, 2022, the Company acquired an aggregate of 330 LLC Interests in connection with the redemption of LLC Interests, which resulted in an increase in the tax basis of its investment in S1 Holdco subject to the provisions of the Tax Receivable Agreement. The Company recognized a liability in the amount of $ 1,036 for the TRA Payments due to the redeeming members, representing 85 % of the aggregate tax benefits the Company expects to realize from the tax basis increases related to the redemption of LLC Interests, after concluding it was probable that such TRA Payments would be paid based on estimates of future taxable income. During the year ended December 31, 2022, inclusive of interest, no payments were made to the parties to the Tax Receivable Agreement. As of December 31, 2022, the total amount of TRA Payments due under the Tax Receivable Agreement, was $ 1,036 . 11. COMMITMENTS AND CONTINGENCIES In June 2021, S1 Holdco entered into a multi-year agreement with a service provider whereby the Company is contractually obligated to spend $ 8,000 between July 2022 and June 2023. As of December 31, 2022 (Successor), t he Company remains contractually obligated to spend $ 4,115 towards this commitment. 116 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) As of December 31, 2022, the Company had various non-cancelable operating lease commitments for office space which have been recorded as Operating lease liabilities. Refer to Note 7—LEASES for additional information regarding lease commitments. Litigation The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company believes the ultimate liability, if any, with respect to these actions will not materially affect the consolidated financial position, results of operations, or cash flows reflected in the consolidated financial statements. There can be no assurance, however, that the ultimate resolution of such actions will not materially or adversely affect the Company’s consolidated financial position, results of operations, or cash flows. The Company accrues for losses when the loss is deemed probable and the liability can reasonably be estimated. In July 2021, System1 OpCo (f/k/a System1, LLC) received initial correspondence from counsel for a United Kingdom-based marketing research company and its United States subsidiary (collectively, the “Demanding Group”) alleging trademark infringement (i) based on its use of the “SYSTEM1” trade name and mark in the United States, and (ii) subsequently based on its use of the “SYSTEM1” trade name and mark in the United Kingdom. The correspondence demanded that System1 OpCo cease and desist from using the “SYSTEM1” name and mark, and made reference to potential legal action if System1 OpCo did not comply with that demand. While System1 OpCo was engaged in active discussions and correspondence with the Demanding Group to attempt to resolve the matter, the Demanding Group filed a lawsuit in the United States District Court for the Southern District of New York in September 2021 (the “Infringement Suit”), alleging (i) trademark infringement, (ii) false designation of origin, (iii) unfair competition and (iv) certain violations of New York business laws, seeking, among other things, an injunction, disgorgement of profits, actual damages and attorneys’ fees and costs. The Company believes that the Demanding Group’s infringement and other allegations and claims set forth in the Infringement Suit may be subject to a laches defense, among other defenses, and the Company intends to vigorously defend its rights and position in the Infringement Suit. System1 OpCo filed a motion to dismiss the Infringement Suit in November 2021, which was granted in part (without prejudice) and denied in part. As a result of the court’s ruling on the motion to dismiss, the Demanding Group filed an Amended Complaint in October 2022, which matter remains pending. Even though the Company received similar correspondence from the Demanding Group regarding its alleged infringing use of the SYSTEM1 trade name and mark in the United Kingdom, no lawsuit has been filed in the United Kingdom. The Company does not believe that its activities infringe any rights of the Demanding Group in the United Kingdom because, among other defenses, the Company does not actively offer services to customers using the SYSTEM1 trade name and mark in the United Kingdom. The Company’s counsel has informed the Demanding Group’s UK counsel of these circumstances, and the Demanding Group’s UK counsel confirmed receipt of this correspondence, and the parties have not shared any further meaningful correspondence with respect to the Demanding Group’s allegations of infringing use in the United Kingdom. The parties to the Infringement Suit have been negotiating a mediated settlement and co-existence agreement, which is still in process as of the date of the filing of this Form 10-K and the terms of which have yet to be finalized, while the matter remains outstanding. Amounts accrued as of December 31, 2022 for any potential losses have been immaterial to-date. In March 2023, the Company received a letter from counsel for Alta Partners, LLC (“Alta”), which purports to be a holder of certain Public Warrants of the Company (“Demand Letter”). The Demand Letter alleges that the Company breached the terms of the Warrant Agreement, and that Alta is entitled to approximately $ 5.7 million in damages, plus prejudgment interest, as a result. On April 20, 2023, counsel for the Company responded to the Demand Letter, denying that any breach occurred or that Alta is entitled to any damages (“Response Letter”). The Company continues to deny liability and will defend vigorously against any claims. The Company has not accrued a loss for this matter, as a loss is not probable and a loss, or range of loss, is not reasonably estimable. Indemnifications In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, investors, directors, officers, employees, and other parties with respect to certain 117 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement claims made by third parties. These indemnifications may survive termination of the underlying agreement and the maximum potential amount of future payments the Company could be required to make under these indemnification provisions may not be subject to claims related to these indemnifications. As a result, the Company believes the estimated fair value of these agreements was immaterial . Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2022 (Successor) or December 31, 2021 (Predecessor), respectively. 12. DEBT, NET Predecessor Debt As of December 31, 2021 (Predecessor), S1 Holdco had principal of $ 172,038 outstanding under a term loan secured from Cerberus Business Finance, LLC. Amortization payments of $ 1,750 were due quarterly and, upon delivery of the prior year’s audited consolidated financial statements, S1 Holdco was required to make a payment of 50 % of excess free cash flow, as defined. S1 Holdco also had a $ 20,000 revolving line of credit, and no amounts were outstanding as of December 31, 2021. Interest payments on the secured financing were due monthly at London InterBank Offered Rate (“LIBOR”), plus 7 % with a LIBOR floor of 1 %. Maturity for the secured financing was August 22, 2022. Successor Debt In connection with the Merger, Orchid Merger Sub II LLC (a subsidiary of S1 Holdco) entered into a new loan (“Term Loan”) and revolving facility (“Revolving Facility”) with Bank of America, N.A., on January 27, 2022, providing for a 5.5 year term loan with a principal balance of $ 400,000 and with the net proceeds of $ 376,000 , of which a portion of the proceeds were used by S1 Holdco, to settle the outstanding debt of $ 172,038 with Cerberus Business Finance, LLC. The Revolving Facility provided for borrowing availability of up to $ 50,000 . As of December 31, 2022, $ 50,000 was outstanding on the Revolving Facility and principal of $ 385,000 was outstanding on the Term Loan. Through December 31, 2025, $ 5,000 of the Term Loan is payable quarterly. From March 31, 2026, $ 7,500 of the Term Loan is payable quarterly. The Term Loan matures in 2027. For every interest period, the interest rate on the Term Loan is the adjusted Term Secured Overnight Financing Rate (“Term SOFR”) plus 4.75 %. The Term Loan is amortized in quarterly installments on each scheduled payment date. The Term Loan comes with a leverage covenant, which goes into effect only if the utilization on the Revolving Facility exceeds 35 % of the $ 50,000 Revolving Facility at each quarter-end starting from the first full quarter after the effective date of the Merger, such that the first lien leverage ratio (as defined in the credit agreement) should not exceed 5.40 . The facility has certain financial and nonfinancial covenants, including a leverage ratio. The facility also requires that the Company delivers its audited consolidated financial statements to its lender within 120 days of its fiscal year end, December 31. Should the Company fail to distribute the financial statements to its lender within 120 days, it is allowed an additional 30 days to cure. As of June 1, 2023, the Company had not delivered audited financial statements for the fiscal year ended December 31, 2022 to Bank of America as required by the covenants of the Term Loan. The failure to timely deliver the audited financial statements is an event of default under the Term Loan and provides Bank of America the ability to immediately call the outstanding principal balances of the Term Loan and Revolving Facility of $ 430,000 , as of the date of this filing, at the request of, or with the consent of, the required majority of lenders until such time that the audited financial statements are delivered to Bank of America. The Company does not have sufficient liquidity to settle the outstanding principal balances should they be called, nor has the Company identified sufficient alternative sources of capital. As a result, this matter raises substantial doubt about the Company’s ability to continue as a going concern. Upon delivery of the audited financial statements by the Company, the event of default will be remediated and, once remediated, Bank of America will no longer have the ability to call the outstanding principal balances on the Term Loan and Revolving Facility. 118 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The Revolving Facility matures in January 2027, and accordingly, it is classified within long-term debt, net on the consolidated balance sheet as of December 31, 2022. The interest rate on the Revolving Facility is the adjusted Term SOFR plus 2.5 % with an adjusted Term SOFR floor of 0 %. In March 2022, the Company borrowed $ 49,000 under its Revolving Facility, to fund a portion of the purchase price related to its CouponFollow acquisition. In October 2022, the Company borrowed the remaining $ 1,000 available. As of December 31, 2022 (Successor), $ 50,000 was outstanding on the Revolving Facility. As of December 31, 2022, future minimum principal payments on long-term debt were as follows: Successor 2023 $ 20,000 2024 20,000 2025 20,000 2026 30,000 2027 345,000 Total future minimum principal payment $ 435,000 Less: current portion ( 20,000 ) Long-term portion $ 415,000 As of December 31, 2022 loan fees amounting to $ 1,061 for the Term Loan have been recorded as a reduction of the carrying amount of the debt and are amortized to interest expense using the effective interest method. The carrying value and estimated fair value of the Term Loan were $ 364,525 and $ 336,900 , respectively, as of December 31, 2022. 13. WARRANTS In June 2020, the Company issued Public Warrants and Private Placement Warrants in conjunction with the initial public offering of Trebia. Public Warrants may only be exercised for a whole number of shares. No fractional shares will be issued upon exercise of the Public Warrants. The Public Warrants became exercisable on April 18, 2022, when the S-1/A registration statement, which was required to be filed under the terms of the Warrant Agreement and the BCA, was declared effective. The Public Warrants will expire five years from the completion of the Merger, or earlier upon redemption or liquidation. The Company is not obligated to deliver any shares of Class A common stock pursuant to the exercise of a Public Warrant and has no obligation to settle such Public Warrants exercises unless a registration statement under the Securities Act with respect to the Class A common stock underlying the Public Warrants is then effective and a prospectus relating thereto is current, subject to the Company satisfying its obligations with respect to registration, or a valid exemption from registration is available. Warrants are exercisable and the Company is obligated to issue a share of Class A common stock upon exercise of each Warrant, as the Warrants have been registered with the SEC. The Company is obligated to use its commercially reasonable efforts to maintain the effectiveness of a registration statement for the registration, under the Securities Act, of the Class A common stock issuable upon exercise of the Warrants, and a current prospectus relating thereto, until the expiration or redemption of the Warrants in accordance with the provisions of the Warrant Agreement. If the effectiveness of a registration statement covering the issuance of the shares of Class A common stock issuable upon exercise of the Warrants is not maintained, Warrant holders may exercise Warrants on a “cashless basis” in accordance with Section 3(a)(9) of the Securities Act or another exemption. In addition, if the Company's Class A common stock is, at the time of any exercise of a Warrant, not listed on a national securities exchange such that it satisfies the definition of a “covered security” under Section 18(b)(1) of the Securities Act, the Company may, at its option, require holders of the Public Warrants who exercise their warrants to do so on a “cashless basis” in accordance with Section 3(a)(9) of the Securities Act and, in the 119 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) event the Company elects to do so, the Company will not be required to file or maintain in effect a registration statement, but it will use its best efforts to register or qualify the shares under applicable blue sky laws to the extent an exemption is not available. In such event, each holder would pay the exercise price by surrendering the Public Warrants for that number of shares of Class A common stock equal to the lesser of (A) the quotient obtained by dividing (x) the product of the number of shares of Class A common stock underlying the Public Warrants, multiplied the excess of the “fair market value” less the exercise price of the Public Warrants by (y) the fair market value and (B) 0.361 . The “fair market value” shall mean the volume weighted average price of the Class A common stock for the 10 trading days ending on the trading day prior to the date on which the notice of exercise is received by the warrant agent. Redemption of Warrants when the Price per Class A common stock equals or exceeds $ 18.00 —The Company may redeem the outstanding Public Warrants: ● in whole and not in part; ● at a price of $ 0.01 per Public Warrant; ● upon not less than 30 days’ prior written notice of redemption to each warrant holder and ● if, and only if, the last reported sale price of the Class A common stock for any 20 trading days within a 30 -trading day period ending three business days before sending the notice of redemption to warrant holders (the “Reference Value”) equals or exceeds $ 18.00 per share (as adjusted for share splits, share capitalizations, reorganizations, recapitalizations and the like). If and when the Warrants become redeemable by the Company, the Company may exercise its redemption right even if it is unable to register or qualify the underlying securities for sale under all applicable state securities laws. However, the Company will not redeem the Warrants unless an effective registration statement under the Securities Act covering the underlying shares of Class A common stock issuable upon exercise of the Warrants is effective and a current prospectus relating to those shares of Class A common stock is available throughout the 30 -day redemption period. Redemption of Warrants When the Price per Class A common stock equals or exceeds $ 10.00 —Once the Warrants become exercisable, the Company may redeem the outstanding Warrants: ● in whole and not in part; ● at $ 0.10 per warrant upon a minimum of 30 days’ prior written notice of redemption provided that holders will be able to exercise their Warrants on a cashless basis prior to redemption and receive that number of shares determined by reference to the exhibit in the report on Form 10-K for the year ended December 31, 2021 filed on March 31, 2022, based on the redemption date and the “fair market value” of the Class A common stock; ● if, and only if, the Reference Value (as defined above under “Redemption of Warrants When the Price per Class A common stock Equals or Exceeds $ 18.00 ”) equals or exceeds $ 10.00 per share (as adjusted for share splits, share dividends, reorganizations, recapitalizations and the like); and ● if the Reference Value is less than $ 18.00 per share (as adjusted for share splits, share dividends, reorganizations, recapitalizations and the like) the Private Placement Warrants must also be concurrently -called for redemption on the same terms as the outstanding Public Warrants, as described above. The exercise price and number of common stock issuable upon exercise of the Public Warrants may be adjusted in certain circumstances including in the event of a share dividend, extraordinary dividend or recapitalization, reorganization, merger or consolidation. However, except as described below, the Public Warrants will not be 120 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) adjusted for issuances of common stock at a price below its exercise price. Additionally, in no event will the Company be required to net cash settle the Public Warrants. The Private Placement Warrants were identical to the Public Warrants underlying the units sold in the initial public offering of Trebia, except that (x) the Private Placement Warrants and the shares of Class A common stock issuable upon the exercise of the Private Placement Warrants were not transferable, assignable or salable until 30 days after the completion of the Merger, subject to certain limited exceptions, and (y) the Private Placement Warrants were exercisable on a cashless basis. The Public and Private Placement Warrants are accounted for as liabilities and marked-to-market at each reporting period, with changes in fair value included as change in fair value of warrant liabilities on the consolidated statements of operations. In April 2022, the Private Placement Warrant holders exercised their Warrants on a cashless basis in exchange for 3,532 shares of the Company's Class A common stock. There are no outstanding Private Placement Warrants as of December 31, 2022 (Successor). Additionally, during the year ended December 31, 2022, Public Warrant holders exercised 437 warrants for cash resulting in total proceeds paid to the Company of $ 5,027 . The total outstanding Public Warrants as of December 31, 2022 was 16,813 . 14. FAIR VALUE MEASUREMENT Financial Liabilities Measured at Fair Value on a Recurring Basis The following tables present the Company’s fair value hierarchy for liabilities measured at fair value on a recurring basis as of December 31, 2022 (Successor) and December 31, 2021 (Predecessor): December 31, 2022 (Successor) Level 1 Public warrants $ 7,798 December 31, 2021 (Predecessor) Level 3 Former CEO equity interest 11,132 Contingent consideration 1,682 Total $ 12,814 The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. The fair value of the Private Placement Warrants was estimated using the Public Warrants’ quoted market price. All Private Placement Warrants were exercised in April 2022. The fair value of the former CEO of S1 Holdco's equity profits interest was determined with an option pricing model and utilizing significant unobservable inputs for a discount for lack of marketability and projected financial information. The fair value contingent consideration was determined with an option pricing model and contains significant unobservable inputs for projected financial information. Changes in estimated fair value of Level 1, 2 and 3 financial liabilities for the period from January 1, 2022 through January 26, 2022 (Predecessor), the period from January 27, 2022 through December 31, 2022 (Successor), and for the year ended December 31, 2021 (Predecessor), respectively, are as follows: 121 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Former CEO equity profits interest* Contingent consideration Warrant liability Fair value of liabilities at December 31, 2020 (Predecessor) $ 4,236 $ 8,240 Settlements — ( 6,715 ) Change in fair value 6,896 157 Fair value of liabilities at December 31, 2021 (Predecessor) and January 26, 2022 (Predecessor) $ 11,132 $ 1,682 Fair value of liabilities at January 27, 2022 (Successor) $ 1,682 $ 27,012 Additions 28 — Settlements ( 1,715 ) ( 22,965 ) Change in fair value 5 3,751 Fair value of liabilities at December 31, 2022 (Successor) $ — $ 7,798 * Former CEO equity profits interest as further described in executive compensation Note 8—ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES . The total impact of the changes in fair values related to contingent consideration and the former CEO's equity profits interest in S1 Holdco are included in selling, general and administrative expenses, and salaries, other compensation and benefits expenses, respectively on the accompanying consolidated statements of operations. There were no transfers in or out of levels during the period January 1, 2022 through January 26, 2022 (Predecessor), the period January 27, 2022 through December 31, 2022 (Successor), or for the year ended December 31, 2021 (Predecessor). Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis For further information on the fair value assessment of goodwill and impairment charge recorded in the year ended December 31, 2022, refer to Note 6 — GOODWILL, INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET — Goodwill Impairment . 15. NET INCOME (LOSS) PER SHARE For the period from January 1, 2022 through January 26, 2022 (Predecessor), and for the year ended December 31, 2021 (Predecessor), the basic net income (loss) per unit attributable to members was calculated by dividing the net income (loss) attributable to common equity holders by the weighted-average number of membership units. For the period from January 27, 2022 through December 31, 2022 (Successor), the basic net loss per share was calculated by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. Basic and diluted net income (loss) per share was calculated as follows: 122 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Basic and diluted net loss per share $ ( 3.77 ) n/a n/a Numerator: Net loss attributable to System1, Inc. $ ( 336,397 ) n/a n/a Denominator: Weighted-average common shares outstanding used in computing basic net loss per share (shares in thousands) 89,251 n/a n/a Basic and diluted net income (loss) per unit n/a $ ( 1.81 ) $ 1.61 Numerator: Net income (loss) n/a $ ( 37,061 ) $ 32,996 Denominator: Weighted-average membership units outstanding - basic and diluted (units in thousands) n/a 20,488 20,488 Shares of Class C common stock, RSUs and Public Warrants outstanding for the period January 27, 2022 through December 31, 2022 (Successor) are considered potentially dilutive of the shares of Class A common stock and are included in the computation of diluted loss per share, except when the effect would be anti-dilutive. For the periods presented in the table above, a total of 16,813 Public Warrants were excluded from the computation of net loss per share as the impact was anti-dilutive. 16. SEGMENT REPORTING ASC 280-10, Segment Reporting, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), in deciding how to allocate resources and assess performance. The Company’s Chief Executive Officer, who is considered to be its CODM, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance. The CODM measures and evaluates reportable segments based on segment operating revenues as well as adjusted gross profit and other measures. The Company defines and calculates adjusted gross profit as revenue less advertising expense to acquire users. The remaining cost of revenues consists of non-advertising expenses such as set-up costs, royalties and fees. The Company excludes the following items from segment adjusted gross profit: depreciation and amortization of property, equipment and leasehold improvements, amortization of intangible assets and, at times, certain other transactions or adjustments, that the CODM does not consider for the purposes of making decisions to allocate resources among segments or to assess segment performance. Although these amounts are excluded from segment adjusted gross profit, they are included in reported consolidated net income from operations before income tax and are included in the reconciliation that follows. The Company’s computation of segment adjusted gross profit may not be comparable to other similarly-titled measures computed by other companies because all companies do not calculate segment adjusted gross profit in the same fashion. Operating segments do not sell products and services across segments, and, accordingly, there are no intersegment revenues to be reported. The accounting policies for segment reporting are the same as for System1 as a whole. 123 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) The CODM of the Company reviews operating results, assesses performance and makes decisions by operating segment. Management views each of the Company’s business lines as an operating segment. The Company has three business lines, operating segments and reportable segments: Owned and Operated Advertising, Partner Network, and Subscription. R efer to Note 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES for additional information regarding our revenue generating activities. The following table summarizes revenue by reportable segments: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Owned and Operated Advertising $ 556,303 $ 49,249 $ 652,884 Partner Network 55,926 3,463 35,505 Subscription 161,711 — — Total revenue $ 773,940 $ 52,712 $ 688,389 The following table summarizes adjusted gross profit by reportable segments: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Owned and Operated Advertising $ 138,560 $ 8,768 $ 143,284 Partner Network 42,291 3,012 35,505 Subscription 78,220 — — Adjusted gross profit $ 259,071 $ 11,780 $ 178,789 Other cost of revenues 23,910 575 11,513 Salaries and benefits 194,976 31,181 66,747 Selling, general, and administrative 63,478 15,665 35,813 Depreciation and amortization 118,652 1,000 13,885 Impairment of goodwill 366,309 — — Interest expense 32,050 1,049 16,870 Change in fair value of warrant liabilities 3,751 — — Income (loss) before income tax $ ( 544,055 ) $ ( 37,690 ) $ 33,961 The following table summarizes revenue by geographic region: 124 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Successor Predecessor Geographic Region Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 United States $ 593,527 $ 51,701 $ 652,622 United Kingdom 162,019 — 543 Other countries 18,394 1,011 35,224 Total revenue $ 773,940 $ 52,712 $ 688,389 The following table summarizes property and equipment, net and operating lease right-of-use assets by reportable segments: Successor Predecessor December 31, 2022 December 31, 2021 Owned and Operated Advertising $ 9,646 $ 830 Subscription 860 — Total $ 10,506 $ 830 The following table summarizes property and equipment, net and operating lease right-of-use assets by geographic region: Successor Predecessor December 31, 2022 December 31, 2021 United States $ 5,473 $ 718 Canada 3,730 78 Other countries $ 1,303 $ 34 Total $ 10,506 $ 830 17. RELATED-PARTY TRANSACTIONS On October 16, 2018, S1 Holdco and its subsidiaries purchased a 50.1 % interest in Protected for $ 55,000 . At the time of the transaction, an investment vehicle known as Lone Investment Holdings ("LIH") was a shareholder and creditor of Protected. LIH owned 7.7 % of the equity of Protected, and also was a creditor for $ 10,500 , with respect to shareholder loans for which Protected was the obligor. LIH’s shareholders primarily consist of members of the Company’s management team. As a result of the Merger, LIH’s shareholder loan to Protected was repaid, with interest, and LIH also received $ 1,158 in proceeds from the sale of its equity. Additionally, during 2021, S1 Holdco extended a loan of $ 1,500 to its former CEO in connection with his separation agreement. In January 2022, in conjunction with the consummation of the Merger, the loan was repaid in full. Protected.net utilizes multiple payment processors in order to process credit card payments from its subscription customers, including Paysafe Financial Services Limited (“Paysafe”). In March 2021 Paysafe completed a merger with Foley Trasimene Acquisition Corp. II (“Foley Trasimene”), a special purpose acquisition company sponsored by entities affiliated with William Foley, who was also a sponsor of Trebia Acquisition Corp. and is a member of the Company’s Board of Directors. Protected.net’s payment processing agreement with Paysafe was negotiated before the announcements of both (i) the Merger as well as (ii) the business combination between Paysafe and Foley 125 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Trasimene. The amount due from Paysafe was $ 2,447 as of December 31, 2022 (Successor). Payment processing fees related to Paysafe incurred subsequent to the Merger of $ 2,767 are included in cost of revenues (excluding depreciation and amortization) on the accompanying consolidated statements of operations. The Company has agreements with JDI Property Holdings Limited (“JDI”), an entity controlled by a director of the Company, which allows for the Company to occupy desks at JDI’s property in such a place as JDI specifies from time to time in exchange for GBP 52 per month. The agreements with JDI expire on October 31, 2026. Additionally, the Company utilizes a JDI credit card and the Company reimburses JDI monthly. The amount owed to JDI was immaterial as of December 31, 2022 (Successor). On August 30, 2022, the Company, Protected.net and Just Develop It Limited (“JDIL”), an entity controlled by a director of the Company, entered into a Conditional Consent, Waiver and Acknowledgement (the “Waiver”) pursuant to which JDIL agreed to waive its right to the Year 3 Stock Bonus Pool (as such term is defined in the BCA), consisting of $ 50,000 of Class A common stock payable in January 2024 and as set forth in Section 12.11(a) of the BCA dated June 28, 2021 (as amended), by and among S1 Holdco, Protected and the other parties signatory thereto in exchange for $ 40,000 in cash payable in four ( 4 ) quarterly installments of $ 10,000 each, commencing on August 30, 2022 and on each three ( 3 ) month anniversary thereafter. In connection with entering into the Waiver, the Company entered into one ( 1 ) year contractual lockup agreements with each of Christopher Phillips, a member of the Board of Directors of the Company and the controlling shareholder of JDIL (on behalf of himself and JDIL), pursuant to which Mr. Phillips and JDIL agreed not to sell each their shares of Class A common stock for one year from September 1, 2022 through August 30, 2023 (the “Lockup Period”); provided that Mr. Phillips and JDIL may sell Class A common stock, among other exceptions, at any time during the Lockup Period at prices equal to or in excess of $ 11.00 per share. On April 10, 2023, Orchid Merger Sub II, LLC (“Orchid Sub”), a wholly-owned subsidiary of the Company, entered into a $ 20,000 Revolving Note (the “2023 Revolving Note”) with certain trusts that were established for the benefit of the Company's co-founders. R efer to Note 20 — SUBSEQUENT EVENTS for additional discussion. 18. CAPITALIZATION Class A Common Stock Voting rights. Except as provided in the Company's Charter or as required by applicable law, holders of Class A Common Stock will be entitled to one vote per share on all matters to be voted on by its Stockholders generally. At annual and extraordinary general meetings of the Company's Stockholders, the holders of Class A Common Stock and Class C Common Stock will vote together as a single class on any matters submitted to a vote of its Stockholders, or, holders of Preferred Stock, if any, are entitled to vote together with the holders of Class A Common Stock or Class C Common Stock, as a single class with the holders of Preferred Stock. Generally, unless a different voting standard applies under the Company's Organizational Documents or applicable law, all matters to be voted on by shareholders must be approved by a majority of the votes cast (except for the election of directors, which will be decided based on a plurality of the votes cast by stockholders present in person or represented by proxy at the applicable meeting and entitled to vote on the election of such directors). Reservation of Shares. Under the Company's Charter, the Company will have at all times, authorized and unissued shares of Class A Common Stock for the purposes of effecting any redemptions or exchanges under the New S1 Holdco Agreement. Class C Common Stock Voting rights. Except as provided in the Company's Charter or as required by applicable law, holders of Class C Common Stock will be entitled to one vote per share on all matters to be voted on by its Stockholders generally. At any annual and extraordinary general meeting of the Company's Stockholders, the holders of Class A Common 126 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) Stock and Class C Common Stock will vote together as a single class on any matters submitted to a vote of its Stockholders, or, holders of Preferred Stock, if any, are entitled to vote together with the holders of Class A Common Stock or Class C Common Stock, as a single class with the holders of Preferred Stock. Holders of Class C Common Stock have no economic rights, only voting rights. Generally, unless a different voting standard applies under the Company's Organizational Documents or applicable law, all matters to be voted on by stockholders must be approved by a majority of the votes cast (except for the election of directors, which will be decided based on a plurality of the votes cast by stockholders present in person or represented by proxy at the applicable meeting and entitled to vote on the election of such directors). Future Issuances. Under the Company's Charter, System1 is not permitted to issue additional shares of Class C Common Stock after the adoption of the Company's Charter, other than in connection with the valid issuance S1 Holdco Common Units under the New S1 Holdco Operating Agreement. Restriction on Transfer. Under the Company's Charter, holders of Class C Common Stock may only transfer their Class C Common Stock to certain permitted transferees, while also simultaneously transferring an equal number of such holder’s S1 Holdco Common Units. Class D Common Stock Voting Rights. Except as provided in the Company's Charter or as required by applicable law, holders of Class D Common Stock are not entitled to any voting rights. Notwithstanding the preceding sentence, under the Company's Charter, any vote that changes the terms of the Class D Common Stock requires the separate approval of a majority of the holders of Class D Common Stock. Restriction on Transfer. Under the Company's Charter, holders of Class D Common Stock may only transfer their Class D Common Stock to certain permitted transfers. Conversion. Class D Common Stock automatically converted into Class A Common Stock on a one -for-one basis, following the consummation of the Merger, once the volume-weighted average price ("VWAP") of the Post-Closing Company exceeded $ 12.50 per share (adjusted for share splits, share capitalizations, reorganizations, recapitalizations and the like) for any twenty ( 20 ) trading days within a period of thirty ( 30 ) consecutive trading days before the fifth anniversary of the consummation of the Merger. All shares of Class D Common Stock converted to Class A Common Stock in the period ended March 31, 2022. Repurchase Program In August 2022, the Company's Board of Directors authorized up to $ 25,000 for the repurchase of the Company's Class A common stock and Public Warrants (the “ 2022 Repurchase Program ” ). During the year ended December 31, 2022 the Company repurchased 190 shares for an aggregate purchase price of $ 1,122 under the 2022 Repurchase Program. As of December 31, 2022, all repurchased shares were constructively retired. 19. STOCK-BASED COMPENSATION As described in Note 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES , the Replacement Awards continue to vest over the original vesting schedule of the original underlying awards. The Company recognized a total stock-based compensation expense of $ 23,705 upon the consummation of the Merger during the period January 1, 2022 through January 26, 2022 (Predecessor). The Company recognized stock-based compensation expense of $ 21,290 under these awards during the period January 27, 2022 through December 31, 2022 (Successor). The unrecognized stock-based compensation expense associated with these unvested Replacement Awards was $ 13,025 a s of December 31, 2022. When the VWAP of the Company’s common stock price exceeded the threshold in March 2022 the Sponsor RSAs and Sponsor RSUs vested, and the Company recorded their conversion from Class D common stock to Class A 127 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) common stock on its Consolidated Statements of Changes in Stockholders' Equity. The Company also recorded $ 12,745 in stock-based compensation expense associated with the vesting of the Sponsor RSUs during the period January 27, 2022 through March 31, 2022 (Successor). Since these Sponsor RSAs and Sponsor RSUs had a market condition to vest, the Company estimated the fair values of these market-based RSAs and RSUs using a Monte Carlo simulation. The key assumptions used to determine the fair value of these market-based RSUs and RSAs were as follows: Risk-free interest rate 1.6 % Expected price volatility 50.0 % Cost of equity 23.6 % Expected term (years) 5 Fair value of Class A Common stock $ 10.00 The Company recorded $ 7,706 in stock-based compensation expense for Sponsor Promote Shares during the period January 27, 2022 through March 31, 2022 (Successor). The Company recorded the following total stock-based compensation expense: Successor Predecessor Period from January 27, 2022 through December 31, 2022 Period from January 1, 2022 through January 26, 2022 Year Ended December 31, 2021 Stock-based compensation expense $ 106,943 $ 23,705 $ 413 RSUs generally vest over three years , subject to the holder's continued service through the vesting date. The following summarizes RSU activity: Shares Weighted-Average Grant Date Fair Value per Share Unvested as of January 27, 2022 — $ — Granted 7,488 * $ 9.94 Vested ( 1,221 ) * $ 10.31 Forfeited ( 804 ) $ 10.13 Unvested as of December 31, 2022 5,463 $ 9.83 ____________________ *Excludes the 2,900 market-based RSUs and RSAs discussed above. At December 31, 2022, the Company had unrecognized stock-based compensation relating to restricted stock of approximately $ 35,272 , which is expected to be recognized over a weighted-average period of 1.6 years. On April 27, 2022, the Company filed a registration statement on Form S-8 covering the shares and awards issued and granted under the System1, Inc. 2022 Incentive Award Plan ("Award Plan”). On May 10, 2022, the Company’s Board of Directors authorized the issuance of 1,900 replacement RSUs in connection with S1 Holdco unvested value creation units outstanding at the time of the Merger, pursuant to the terms of the BCA and an additional 4,900 RSUs from the authorized Award Plan pool of shares. Protected.net Incentive Plan 128 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) In connection with the Merger and acquisition of Protected.net described in Note 3—MERGER , which was consummated on January 27, 2022, the Company effected an incentive plan for eligible recipients as defined in the BCA (see Note 3—MERGER ), which may include employees and non-employees, including the Protected.net CEO, totaling up to $ 100,000 payable in fully-vested shares of the Company’s Class A common stock. If the last twelve months ("LTM") Cash EBITDA (as defined in the BCA) of the Protected.net business exceeds $ 55,000 on or prior to December 31, 2023, a bonus pool of $ 50,000 payable in fully-vested shares of the Company’s Class A common stock (the “2023 Award”) shall be allocated to eligible recipients as of December 31, 2023. Shares under the 2023 Award will be issued to eligible recipients within 30 days of December 31, 2023. Further, if the LTM Cash EBITDA of the Protected.net business exceeds $ 65,000 on or prior to December 31, 2024, an additional bonus pool of $ 50,000 also payable in fully-vested shares of the Company’s Class A common stock (the “2024 Award ” ) shall be allocated to eligible recipients as of December 31, 2024. Shares under the 2024 Award will be issued to eligible recipients within 30 days of December 31, 2024. The number of shares payable under the 2023 Award and the 2024 Award will be determined based on the volume-weighted average price of the Company’s Class A common stock over the 20 consecutive trading days preceding the 5 trading days prior to the applicable settlement dates. The distribution of shares to eligible recipients for both the 2023 Award and the 2024 Award shall be at the sole discretion of the Protected.net CEO, or the System1, Inc. Board if the Protected.net CEO is no longer employed by the Company. On August 30, 2022, the Company modified the 2023 Award to change this award from a bonus payable in fully-vested shares of the Company's Class A common stock to a $ 40,000 cash payment settleable in four equal quarterly cash installments beginning upon the modification of the 2023 Award. During the year ended December 31, 2022, the Company recognized $ 35,436 for the 2023 Award, within Salaries and benefits expenses on the accompanying consolidated statements of operations. On June 1, 2023, the Company further modified the 2023 Award, deferring the last quarterly cash installment of $ 10,000 such that $ 5,000 was due on May 30, 2023, $ 5,000 is due on July 1, 2023, and providing additional cash bonus payments of up to $ 10,000 , $ 6,000 due on October 1, 2023 (the "October Payment") and $ 1,000 due on the first of each month of November 2023 through February 2024 (together the "Remaining Payments"). All of the payments due under this modification are conditioned upon the members of the Protected senior management (i) entering into employment agreements that include certain protective covenants in favor of Protected and (ii) remaining employed by Protected (other than as a result of a termination without cause) through all applicable payment dates. The October Payment and the Remaining Payments are conditioned upon the Protected business (x) not exceeding certain trailing three-month customer acquisition marketing spending caps or (y) achieving certain monthly (or trailing twelve-month) minimum EBITDA thresholds. Although the LTM Cash EBITDA target for the 2024 Award has not been met, the Company determined that it was probable of achievement, and accordingly, it recorded pro rata portions of the $ 50,000 payable for this award. or $ 15,824 , within salaries and benefits expenses on the accompanying consolidated statements of operations for the year ended December 31, 2022. As of December 31, 2022, stock-based compensation has been recorded as current and non-current Protected.net Incentive Plan liabilities within the consolidated balance sheet . The remaining liability for the modified 2023 Award will be recorded over the remaining service period with graded vesting attribution for each quarterly installm ent. The remaining liability for the 2024 Award will be recorded over the remaining service period to the extent that management determines that the achievement of the LTM Cash EBITDA target and issuance of the Series A common stock is considered probable. CouponFollow Incentive Plan In connection with the acquisition of CouponFollow described in Note 4—ACQUISITIONS , which was consummated on March 4, 2022, the Company approved and adopted the CouponFollow Incentive Plan, which includes CouponFollow’s key employees, including CouponFollow’s founder (“Principal Participant” and together collectively the “Participants”). The CouponFollow Incentive Plan provides for total payments of $ 35,000 payable at the Company’s option in cash or in fully-vested shares of the Company’s Class A common stock, consisting of a fixed amount of $ 10,000 and contingent amounts of $ 25,000 , which can be earned over a three calendar year period 129 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) between each January 1 to December 31 of 2022, 2023 and 2024 (each a “Performance Period” and collectively, the “Performance Periods”). In order to receive any payments under the CouponFollow Incentive Plan, the Participants must maintain continuous employment through the last day of each Performance Period to be eligible for the following earnout payment amounts (with the exception of the Principal Participant who is still eligible if terminated without cause or if he terminates his employment for good reason) in the amounts and at the times set forth below: • Fixed Amount. Over the course of the Performance Periods, the Company shall pay to each of the employed eligible Participants a total of $ 10,000 (the “Fixed Amount”) in three substantially equal pro rata installment payments (as set forth in each Participant’s applicable award agreement) within 60 days of the end of each Performance Period. • Tier 1 Target. If, during any of the Performance Periods, the CouponFollow business achieves the first tier TTM EBITDA (as defined in the CouponFollow Incentive Plan) for the first time (the “Tier 1 Target”), the Company will pay a total of $ 10,000 (the “Tier 1 Amount”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below. • Tier 2 Target. If, during any of the Performance Periods, the CouponFollow business achieves the second tier TTM EBITDA for the first time (the “Tier 2 Target”), the Company will pay an additional $ 7,500 (the “Tier 2 Amount”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below. • Tier 3 Target. If, during any of the Performance Periods, the CouponFollow business achieves the third tier TTM EBITDA for the first time (the “Tier 3 Target” and together with the Tier 1 Target and Tier 2 Target, collectively the “Targets”), the Company will pay an additional $ 7,500 (the “Tier 3 Amount” and together with the Tier 1 Amount and the Tier 2 Amount, collectively the “Tier Amounts”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below. Performance Period* Fixed Amount Tier 1 Amount** Tier 2 Amount** Tier 3 Amount** Total Maximum Payment per Performance Period Dec. 31, 2022 $ 3,333 $ 3,333 $ — $ — $ 6,666 Dec. 31, 2023 3,333 3,333 3,750 — 10,416 Dec. 31, 2024 3,334 3,334 3,750 7,500 17,918 $ 10,000 $ 10,000 $ 7,500 $ 7,500 $ 35,000 *Payments for each applicable Performance Period are paid within 60 calendar days of the end of the applicable Performance Period. **If the Tier 1 Amount is not achieved in the first Performance Period but is achieved in the second Performance Period, the Tier 1 Amount for the first Performance Period shall be paid out at the end of the second Performance Period and if achieved in the third Performance period the full amount will be paid at the end of the third Performance Period. If the Tier 2 Amount is not achieved in the second Performance Period but is achieved in the third Performance Period, the Tier 2 Amount will be paid at the end of the third Performance Period. If the Tier 2 Amount or the Tier 3 Amount is achieved in the first Performance Period, such Tier Amounts shall be paid as noted in the table above. If a Participant’s continued employment is terminated prior to applicable payment date(s), with the exception of the Principal Participant as discussed above, the Company will reverse all prior liabilities for their pro rata share of any Tier Amounts associated with that Participant. If the Company elects to settle the payment obligations with respect to any Tier Amount in shares of the Company’s Class A common stock, the number of shares payable under the CouponFollow Incentive Plan will be determined based on the VWAP of the Company’s Class A common stock 130 System1, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollars, number of shares and number of units in thousands, except for per share or per unit amounts) over the 30 trading day period immediately preceding the respective settlement date, but in any event, shall be capped at 4,667 shares of the Company’s Class A common stock in the aggregate. Any amount over the maximum number of shares is to be settled in cash. As of December 31, 2022, the Company has determined that it was not probable that the CouponFollow business would achieve any of the Targets during the Performance Periods, and accordingly, it did not record a liability for any of the Tier Amounts set forth in the CouponFollow Incentive Plan. During the year ended December 31, 2022, the Company recognized $ 3,333 for the Fixed Amount, within Salaries and benefits expenses on the accompanying consolidated statements of operations, which was settled in shares during 2023. Stock-Based Award Plan The Company is authorized to issue restricted stock, restricted stock units, stock options, stock appreciation rights, and other stock-based and cash-based awards under its 2022 Incentive Award Plan. The number of shares authorized for grant is subject to increase each year on January 1, equal to the lesser of (a) a number of shares equal to 2.5 % of the aggregate number of common stock outstanding on the final day of the immediately preceding calendar year and (b) such smaller number of shares as is determined by the board of directors. On January 1, 2023, the number of shares authorized for grant under the Company’s 2016 Incentive Award Plan was increased by 2.8 million shares in accordance with plan provisions. 20. SUBSEQUENT EVENTS On April 10, 2023, Orchid Sub, a wholly-owned subsidiary of the Company, entered into a $ 20,000 Revolving Note (the “2023 Revolving Note”) with Lone Star Friends Trust (acting by and through its trustee, Stanley Blend, “Lone Star”) and CEE Holding Trust (acting by and through its trustee, Jackson Hole Trust Company, “CEE”, and together with Lone Star, collectively, the “Lenders” and each, a “Lender”), which are trusts established for the benefit of Michael Blend (Chief Executive Officer, co-founder and stockholder) and Charles Ursini (co-founder and stockholder), respectively, in a private transaction approved by the independent and non-interested members of the Company’s Board of Directors (the “Board”). Each Lender provided a $ 10,000 commitment for an aggregate principal of $ 20,000 under the 2023 Revolving Note to Orchid Sub on a several but not joint basis (each, a “Commitment” and, collectively, the “Commitments”). As of the date of this filing, the outstanding principal balance on the 2023 Revolving Note was $ 5,000 and the available balance was $ 15,000 . Any borrowed loan amounts outstanding under the 2023 Revolving Note accrue interest at the rate per annum equal to the Secured Overnight Financing Rate (“SOFR”) as administered by the Federal Reserve Bank of New York plus 3.15 %. Orchid Sub may borrow amounts under the 2023 Revolving Note in increments of $ 100 , and may prepay any amounts borrowed at any time without penalty or interest (other than applicable breakage costs, if any). The Company may borrow up to its commitment amount, and may reuse the loan again after the balance has been paid down. The final maturity date under the 2023 Revolving Note is July 10, 2024. The Lenders are also entitled to (i) an unused commitment fee equal to 1.0 % per annum of the actual daily amount of total unfunded Commitments under the 2023 Revolving Note during the period from the closing date to the maturity date, payable quarterly in arrears and (ii) a closing fee equal to 12.0 % of each Lender’s Commitment under the 2023 Revolving Note, payable within 180 days of April 10, 2023. In addition, Orchid Sub agreed to reimburse the Lenders for their reasonable and documented costs expenses incurred in connection with the negotiation, documentation and execution of the 2023 Revolving Note. As of the date of this filing, the available balance under the 2023 Revolving Note was $ 15,000 . Refer to NOTE 19 - STOCK-BASED COMPENSATION for details of modifications made to the Protected Incentive Plan on June 1, 2023. 131 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 132