System1, Inc.

System One's business and financial results are our co-founder and CEO, Michael Bland, and our chief financial officer, Tritivesh Kadambi. A recording of this conference call will be available on our investor relations website shortly after this call has ended. I'd like to take this opportunity to remind you that during the call, we will be making forward-looking statements. This includes statements relating to the operating performance of our business, future financial results and guidance, strategy, long-term growth, and overall future prospects. may also make statements regarding regulatory or compliance matters these statements are subject to known and unknown risks and uncertainties that could cause our actual results to differ materially from those projected or implied during this call in particular those described in our risk factors included in our registration statement on form s1 filed on april 13 2022 in our form 10k for the fiscal year 2022 filed on june 6 2023 and in our Form 10Q for the third quarter of 2023, filed on November 9th, 2023, as well as the current uncertainty and unpredictability in our business, the markets, and the global economy generally. You should not rely on forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as the date hereof, and System 1 disclaims any obligation to update any forward-looking statements except as required by law. Our discussion today will include non-GAAP financial measures, including adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. Historical performance and future estimates provided during this call exclude results from total security. Information regarding our non-GAAP financial results, including a reconciliation of our historical GAAP to non-GAAP results, may be found on our investor relations website. I would now like to turn the conference call over to System 1's co-founder and chief executive officer, Michael Blund.

Thanks, Kyle. Good afternoon, everyone, and thanks for joining us on our Q3 System 1 earnings call. Our biggest news by far is our recently announced sale of our total security subscription business. The transaction was valued at approximately $340 million, including $240 million in cash. As part of this transaction, approximately 25% of our total outstanding shares were transferred back to the company. We completed this deal for two primary reasons. First, we are confident System 1 will be more successful focused exclusively on our advertising business. While there have been headwinds in digital marketing over the last year, We believe the overall market has been stabilizing in the back half of 2023, and we have continued confidence in our Ramp platform and our team. Our advertising business is positioned for nice growth in 2024, and this deal helps us better execute against our vision. For the second reason, the total security transaction improved our balance sheet and capital structure overall. The cash provides immediate and long-term financial flexibility and will support our continued investment in our advertising platform. Additionally, with a reduced share count, as our advertising business starts scaling again, the benefits from that growth are going to be spread across a much smaller shareholder base. Operationally, we don't expect any disruption to our advertising business as a result of this transaction. The subscription business was primarily a standalone business, is easily separable from our technology stack, and is located in a separate office in the UK. We wish the best of luck to the total security team and its new owners. Now let's talk about third quarter performance. System 1 delivered $88 million of revenue and $37 million of gross profit. Adjusted EBITDA was $8.1 million, which is up 33% quarter over quarter. The adjusted EBITDA growth was a result of lower operating expenses impacted by cost-cutting measures we have taken throughout the year. The operating expense savings offset a sequential decrease in gross profit. We continue to face some headwinds in our owned and operated business, which is impacting our ability to profitably deploy advertising spend. Owned and operated revenue was $66 million, down 14% from Q2, driven by a 15% sequential decline in advertising spend. We generated over 900 million sessions, up more than 100 million versus Q3, with a spread of over 2.5 cents per session. Our network advertising business generated $22 million for revenue and gross profit of $15 million, up 3% quarter over quarter. The network business continues to benefit from ramp platform upgrades made this year that have positioned us very well in the marketplace. We signed 90 new partners in Q3 with 40 of those going live within the quarter. Over the last 12 months, we have signed 275 new partners, including five of the top 10 highest grossing partners currently on our platform. As we continue to add new partners and expand revenue from our existing base, We expect the network advertising business to deliver solid growth and be a key part of our strategic plan going forward. Now, along with the sale of total security, our business highlights in the quarter include new partnerships for search monetization with Ecosha, which is one of the largest independent search engines. We also signed a confidential agreement to monetize Search for a large browser company, which we anticipate will be a nice contributor in 2024. On the product side, we announced key feature improvements in our Road Warrior Driving Direction app, and CouponFollow launched its Partner Network, whereby we will be providing our promo code technology to third parties. We also continue integrating AI throughout our Ramp platform and business processes. As I mentioned on our last earnings call, AI is enabling us to scale our advertising campaigns at a pace we haven't seen before. And it feels like we are just scratching the surface with our uses of AI. Looking back at the last 12 months, 2023 definitely was a challenging year for System 1. We dealt with an uncertain advertising market. We had liquidity challenges related to our high debt burden. And we spent several months evaluating the sale of our subscription business. In response to these challenges, I think we made the right decisions to set up our company for long-term success. We narrowed our business focus to our core competency in advertising. We made substantial reductions to our operating expenses. We continued to invest in our rent platform. And the total security sale brought in a large injection of cash to our balance sheet. Looking forward to 2024 and beyond, I believe System One is a rejuvenated company set up to return to solid growth. We have excellent technology, strong relationships with our network and advertising partners, and we are solidly profitable. And most importantly, we have a focused and highly motivated team all moving in the same direction. That said, While we are optimistic about 2024, I don't have a crystal ball about what the overall economic environment is going to look like. And after a very rocky 2023, I don't want to promise performance that we aren't confident we can meet or exceed. I encourage our shareholders to look at System 1 as a long-term investment and judge our success on an annual basis. I know that's what we do. What I can tell you is that, except for the last 18-month blip, your System 1 team has a long history of producing results that have generated great returns for our shareholders. And as I like to state, every quarter, management is highly aligned with you. We put in our own capital this year to provide the company with extra liquidity, and we currently own almost 40% of System 1 after the retirement of the 29 million shares. As a leaner and hyper-focused advertising business, we are ready for the next chapter of System 1. I'll now hand things off to Triti to discuss the quarterly results in more detail, as well as provide Q4 guidance. Take it away, Triti.

Thanks, Michael. Thank you, everyone, for joining us today. I wanted to start by echoing Michael's comments on the total security transaction. The transaction sets us up both for greater success now and in the future. We received $240 million of gross cash in the deal, and since the close of the deal on November 30th, we have used a portion of that cash to repay all of our unsecured and related party debts, and have also paid down the entire balance of our $50 million secured revolver, 100% of which remains available to us if needed. In addition to ensuring that our liquidity and working capital needs are addressed, the primary use of the remaining cash will be to de-labor the company in the most effective way possible. And we will and are exploring all available options to do so, including accretive M&A. Outside of the cash proceeds, the buyers are assuming approximately $67 million of intercompany debt owed by System 1 to Total Security. And the transaction also included a waiver of $60 million in potential earn-out payments due to the Total Security management team. And the transfer of approximately 29.1 million shares of System 1's Class A common stock back to the company. which was then subsequently retired. Those shares transferred to System 1 represented approximately 25% of the company's shares outstanding. In addition to the reasons Michael mentioned, earlier around focusing on the advertising business and simplifying the overall business the liquidity provided by the transaction affords us the opportunity to continue to make investments into the core business and our ramp platform we will continue to be focused on investments that benefit both the owned and operated and the network advertising businesses while continuing to maintain our historical discipline and measured approach to investment and capital allocation decisions. Before moving on to a discussion of our Q3 results and guidance, I wanted to remind you that I will be speaking to results with respect to the remaining business only, excluding results from total security. Now on to Q3 results. Q3 revenue was $88 million as compared to $177 million last year, a 44% decrease year-over-year. The year-over-year decrease was driven by the owned and operated advertising business, which was down 54%, while network advertising revenue was up 63%. Adjusted growth profit was $37 million, down 18% year-over-year. Revenue-less advertising spend for the owned and operated advertising segment declined 36% to $24 million. Network revenue less agency fees was up 49% to $15.3 million versus $10.3 million last year. Continuing a trend that we have been seeing throughout the year, both cost per session CPS and revenue per session RPS were down sequentially. In Q3, RPS was down $0.02 sequentially to $0.07 per session, while CPS was down a penny to $0.05 versus $0.07 last quarter. Our spread between revenue per session and cost per session was a little under $0.03. On the network advertising business, RPS remained flat at $0.03 per session. Operating expenses net of add-backs were $29.1 million, down 3% year-over-year, which reflects the impact from cost reductions we have made throughout the year. As a reminder, while we have been making changes throughout the year, the most significant of the cost-cutting measures we undertook occurred in early September. Q4 will be the first period in which we see a full quarter of those reductions in the quarter. Adjusted EBITDA was $8.1 million versus $15.8 million last year, down 49% year-over-year and representing a 22% margin on gross profit. Now on to Q4 guidance. We expect to see a continuation of the RPS and CPS trends we have seen all year, with RPS and CPS either flat or declining in tandem, and RAMP maintaining our spread around $0.03 on a per session basis. We expect our network advertising business to continue to deliver significant year-over-year growth in Q4, with gross profit up approximately 29% versus last year. We are estimating Q4 revenue to come in between $93 million and $96 million, representing a 33% year-over-year decline at the midpoint. We are estimating gross profit to come in between $35 million and $37 million, representing a 16% decline year-over-year at the midpoint. We are estimating adjusted EBITDA to come in between $7.5 million and $9.5 million. Our EBITDA guidance reflects a 5% sequential growth at the midpoint quarter-over-quarter, as well as the fourth consecutive quarter of EBITDA growth for the business. With respect to liquidity, as of today, we have approximately $140 million of cash and $370 million of debt under our secure term loan. While our recent financial performance has been negatively impacted by market conditions, we continue to feel bullish about the future and the future opportunities that come along with it. With the recent investments we have made in the platform, cost-saving measures taken this year, and those to come in the future, primarily in the OPEX areas, specifically G&A as a result of our smaller footprint from the total security disposition, as well as the overall financial flexibility created from the total security transaction, We believe we are set up for success.

Thank you for joining us today.

Thank you, Trudy. We're now going to open the line for some questions. The first question comes from Dan Kernos with Benchmark. Dan?

Great, thanks. Michael, Trudy, good to see you guys again. Nice for you guys to be out there. Nice to see you, Dan. So, Michael, look, we're smaller, leaner, and meaner. We're back to our roots here after the transaction. And a couple of things I want to drill down on. So first, I would just ask you, number one, obviously, we've had this shift in focus recently, network versus O&O, right? Obviously, network's been growing pretty rapidly. You did mention in your prepared remarks some of the features and improvements we're seeing with Road Warrior and Coupon Follow. And I would think the latter with the explosion of retail media probably has a long runway. So maybe you can just to start with help us think through how we should kind of see the expected balance of focus going forward now that you're back to your roots here, number one. And then within that, like, you know,

scaling back up how aggressive do you think you need to be and sort of you know reinvigorating either of the the base ono or network platforms you know post software yeah yeah thanks dan thanks for the question so uh network versus ono first of all network's growing really well um as i mentioned our our new ramp product which we uh released last this year earlier this year has been Really well regarded in the marketplace. So we expect our network partners to continue piling on, keep scaling with us. So we're feeling pretty good about that. O&O is really where we're hoping to get a lot more scale out of next year. It was a pretty rough year for us in 2023, kind of starting in late 2022. Pretty optimistic about the ability to scale O&O next year. Primarily a few things, really. The first one being, and this is just kind of more subjective than anything, the focus of the company now. 2023 was pretty difficult year overall for System 1. Digital marketing on a macro level was pretty choppy. We had a lot of focus on completing our total security transaction the last few months. and um and so i think the focus of the company uh on ono is is there but more specifically uh our ramp platform uh when we started incorporating ai into it um we're starting to see some really interesting things in our ability to scale in terms of the ability potential ability to put advertising dollars to work and specifically i've kind of talked about what ai is starting to enable us to do When you look at our platform and the way that we operate, we're a bit different than most advertisers out there in market. So if you look at an advertiser like a Geico or American Express, they've got a pretty straightforward way of advertising their product. They've got a few different creatives that might make sense for people looking for credit cards. In the case of American Express, they've got a few different channels that they operate in. Typically, they'll be heavy on SEM and the search engines, maybe on Facebook, and then maybe a little bit on the native networks. We're pretty different at System 1 in that we advertise across hundreds of different verticals. So we'll be in everything from healthcare, and in healthcare, we might be in 50 different verticals in healthcare. We'll be in auto, travel, finance, really everything you can speak of. and when you combine those hundreds of different verticals with all the different marketing channels we're in you know everything from native advertising on taboola and outbrain to facebook to tick tock to google to wherever you can spend spend money profitably you know we're going to be in thousands of different campaigns at once and so that makes us a somewhat unique advertiser in the marketplace And what AI is allowing us to do is really automate those campaigns. And what I mean by that is when you think about what an advertising campaign is composed of, it'll be a lot of different images. So images designed to appeal to consumers. It might be a call to action. So come get a discount on this, or we've got great deals on this, or whatever that might be when you're speaking to a consumer. It may be a video. It's a lot of different kinds of creatives. And it's actually somewhat difficult when you get across hundreds and thousands of campaigns to keep up with those creatives and automate new creatives. What AI is starting to allow us to do is roll those out and literally press a button with some editorial oversight and iterate on creatives over and over again. And that's on the front end. And then on the back end, we're enabled to automate our bidding processes. So as a campaign is working or not working, we're scaling up our advertising buy up or down to adjust for how much we're making off that campaign. And so as I'm looking at 2024, I think as we've done a pretty good job over the last couple, I'd say quarters, and specifically the last quarter, integrating the new capabilities of AI into the platform. As I'm looking forward to 2024, the thing that gives me a pretty good amount of comfort in our ability to scale O&O are the new capabilities that we're rolling onto that.

Got it. That's super helpful. Yeah. You know, I kind of want to dig a little bit deeper into that, Michael, like next year's could be a year of, pretty big upheaval, right? You know, we'll see if Google ever does actually get rid of the cookie. Maybe, probably. But, you know, and as you also, as you know, Michael, having done this for a long time, you know, the publishers are always like, it's, if it ain't broke, don't fix it. So we'll see how many guys are scrambling when, you know, the changes actually happen. So but for you, like, as you look at the marketplace, I know you guys don't do any CTV because the pricing's been kind of out of whack or the return hasn't been there. It'd be interesting when Amazon comes on now and we get more inventory in the market. Sounds like there's some downward pressure there. But what are you seeing by channel and from your sort of data ingestion set, right? How confident do you feel that you'll be able to maintain spreads throughout the year, whatever disruption, which disruption is usually good for you guys, but whatever disruption could occur in the marketplace?

I mean, spread is relatively straightforward for us to maintain because, remember, we can adjust pricing on the buy side to accommodate what we're making on the sell side. So it's much more our ability to put more marketing spend to use maintaining that spread. So we're feeling pretty good about what the market's looking like right now. We got a lot of questions because we're in market at scale on both the buy and sell side about what the digital marketing marketplace looks like. I can tell you Q4 is looking okay. It's not looking like last year's Q4, where the bottom kind of dropped out in November and December. It's not looking like as, you know, typical year where you would see, you know, a huge amount of scale, but it's looking okay. so as we're kind of looking forward to next year um we're anticipating a return to kind of normalcy in the market we're not anticipating a big downturn um in digital advertising market in terms of where we're expecting to see scale we're starting to see you mentioned ctv we're not you know as you mentioned we're not in ctv right now but where we are starting to see quite some some nice pockets of opportunity video related um particularly like we're seeing tick tock open up for us um you know it more scale than we've seen in the past we expect that is going to translate pretty directly over into reels um and youtube as well so for for our you know Our outlook on the market is where we haven't seen big scale in the past is on the video side, but we are starting to get traction there. And I would expect that's going to be a pretty big pocket of opportunity for us and a pretty big pocket of growth in 24.

And maybe we can just talk a little bit about some of the O&O initiatives, right? I mean, you mentioned Road Warrior. You mentioned the opening up of Coupon Follow to 3P, which I love, right? I mean, it feels like pretty easy to just kind of dump in their API and go or whatever, however you guys want to connect. So I guess from your perspective, you know, How should we think about like what other properties where you have other initiatives or opportunities that we should be anticipating? And I'm not asking necessarily for specifics because you don't want to give your playbook out, but just how should we be thinking about that? And are there any categories or verticals where you guys feel you have maybe a competitive advantage where you come out with a new product or feature tool that can really drive accelerated growth in ONO?

Yeah, we do. So again, thanks for the question. So similar to what we do with our network partners leveraging RAMP, we do feel like we've got some specific products out there that are market leading that we would like to build more partnerships on. partnerships with. Coupon Follow is one that I mentioned briefly. I can give you a little bit more detail on that. So with Coupon Follow, think of it as a promo code database, which is hard to put together. And this is a promo code related to a lot of different e-commerce companies out there. And then we've also got what we essentially product, which is a product that kind of in an automated way will enter promo codes into into your shopping cart as you're shopping. And so those those two products are both ones that we're looking to take to market and provide white label solutions for third parties. And we have signed deals and are getting those to market. Startpage is another one that I mentioned. In Startpage, we've got one of the leading private search engines in the world. And millions of happy customers that use it every single day. And it turns out there's a lot of people, a lot of other companies that want to be able to offer StartPage to their consumers. So we're going out there and market and offering up StartPage and partnership opportunities there as well. So on our MapQuest side of the business, we've got a nice mapping product and we do offer a mapping API. to third parties where we developed a pretty decent business in there, offering up mapping to third parties as well. So any product we have in our portfolio where we can go to market in a partnership basis, we're going to do that. So you'll keep seeing more of that in 24.

Cool. And if I can just squeeze one more, and I know I've gone on a little bit, but I don't want Trini to feel left out here. So you've got the injection of capital or cash, I guess you say, from the sale. You've taken some cost actions. I just want to get a sense from you where we think or how we should be thinking about just broader leverage both on the margin side in 2024, like You know, how much is an element of scale? How much is an element of cost? How much is an element of investment? Right. And then I'm sure you're very aware of where your debt is trading treaty. So to the extent that we should think about, you know, open market, if it's available or other forms of debt reduction, that would also be accretive to shareholders. Just curious on your thought process of putting the capital you have to use.

thanks thanks for the question dan you know as i mentioned in the in the prepared remarks um you know we did take a slug of the capital that we brought in from the total transaction a total security disposition and pay down some of our you know kind of related party on secure debt some of the the shorter term financing that we did earlier this year and also paid down the revolver uh to create flexibility for us um from a capital perspective And, you know, again, the main intention of that debt is going to be to delever the company from a leverage component. So, you know, if you look at kind of the midpoint of guidance that we provided, you know, pro forma for some of the expense reductions that we took earlier this year, it would put leverage, you know, above kind of six times, which is not where we would look to be as a company. You know, I think we've said before, we'd like to get down closer to three. And, you know, I think given some of the uncertainty in the ad markets that Michael mentioned, even with a clear path of execution, I think getting to that target level of leverage is probably late 24, early 25. And so as a result of that, again, we're going to take a holistic look at how to deleverage the company with what's available to us. It includes potentially M&A if it's accretive. But I think most importantly for us was to, you know, have the debt, essentially give ourselves a breathing room from a liquidity perspective, you know, against our financial covenants, etc. And just put ourselves in a place where we can really focus on operating the business and executing against their core initiatives.

And Triti, given that statement, you know, I mean, I can back into the math because leverage calculation kind of gives some other, you know, pieces of the puzzle, shall we say. But, you know, just in terms of scaling the actual business from a margin, EBITDA margin and cash flow perspective, just thinking about kind of the components of scale, rescaling the O&O business versus cost initiatives, assuming the underlying macro is just stable, doesn't change.

Yeah, I think that's right. And, you know, I think it's fair to, we would expect to, you know, see some growth in gross profit. And, you know, the way our model works, that gross profit growth should, you know, almost dollar for dollar go down to EBITDA. And we would expect to, you know, for the most part, be able to keep OpEx kind of where it is in terms of the implied guidance in Q4 through next year. I think there's still potentially some savings to go get just maybe around services and just our infrastructure, given we're a little bit smaller now. with the disposition of total security uh but in terms of you know organizationally our footprint how we're structured um to go after the initiatives um and the opportunities that you know ramp gives us access to i think we're in a good place right now with the current with the current team yeah we feel like the team we've got in place um you know after you know we did a fair amount of restructuring 23 uh slim down the team i would feel like we can scale the business back up without you know significant headcount increase

Perfect. Sorry for monopolizing the call. It's been so long, guys. I wanted to get all that out there.

So great to see you guys. Good to see you, Dan. Thanks for the question. Good to see you. Thank you.

There are no further questions. We're going to turn it back to Michael Glenn for closing remarks.

OK, well, thanks, everybody, for joining us. Been a little bit of time since we were able to hop on a call with all of you. look forward to seeing you we're going to start hitting the conference circuit again um now that our transaction is behind us so if you can make any of the conferences we're going to be at we'd like to meet you in person but until the next time happy holidays everybody thank you thanks everyone