System1, Inc.

Hello, my name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the System 1 Q1 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session, and instructions will be provided at that time. I would now like to turn the conference over to Kyle Ostgaard, Vice President of Finance. You may begin.

Thank you for standing by. and welcome to the first quarter of 2024 conference call for System 1. Joining me today to discuss System 1's business and financial results are our co-founder and CEO, Michael Lund, and our Chief Financial Officer, Tritesh Kadabi. 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 certain 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. We 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, including our annual report on Form 10-K for the fiscal year 2023, filed on March 15th, as well as the current uncertainty and unpredictability in our business, the markets, and the global economy generally. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on management's assumptions and beliefs as of the day 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 and adjusted gross profit, 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 measures, including a reconciliation of our non-GAAP financial measures to our most comparable historical GAAP financial measures, 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 Huynh.

Thanks, Kyle. Good afternoon, everyone, and thanks for joining us on our Q1 System 1 earnings call. Let's get right into our quarterly performance. I'm happy to announce that System 1 was able to deliver financial results which exceeded our earlier guidance. System 1 delivered $85 million of revenue and $31 million of gross profit. Adjusted EBITDA was $423,000. Owned and operated revenue was $69 million, down 35% year-over-year and down 13% from last quarter. This was driven by a 12% sequential decline in advertising spend. We generated over 1.2 billion sessions, an 18% year-over-year increase, and a 14% quarter-over-quarter increase. Spread was approximately 2 cents per session. International revenue continued to remain a highlight with international revenue representing approximately 29% of owned and operated revenue. This was up from 25% of owned and operated revenue in Q4 of 2023. Now, overall, Q1 was somewhat choppy, but ended on a positive note. The overall advertising marketplace started off a bit weak in January and improved as the quarter progressed. This pattern was expected to match what we see in a typical Q1. Our Q1 volatility was driven primarily by our Google relationship, which as a reminder is our largest revenue source. We saw significant volatility from Google during the quarter. Their sell side pricing moved around more than typical. And the Google product team introduced new features at a very rapid pace with minimal advance notice to us. Longer term, this is a good thing for System 1. We work closely with Google to integrate new features into our tech stack, and the product improvements almost always lead to increased revenues for System 1. In the short term, however, the rapid fire of Google changes caused quite a bit of volatility in the overall Google partner ecosystem. Unfortunately, things have begun to stabilize with Google. The last couple weeks of Q1 were particularly strong, and these favorable trends have continued through the early weeks of Q2. If Google pricing and product rollout stay consistent, we expect all of our marketing-driven businesses lines to benefit. Partner network revenue was $16 million, and gross profit was $11 million. Revenue increased 5% year over year, but was down 5% sequentially, as we expected due to typical seasonality. Sessions were 1 billion up 134% year-over-year and 32% sequentially as traffic from existing partners increased along with new partners joining the network. Partner network RPS declined 55% year-over-year and 28% quarter-over-quarter driven by the same marketplace headwinds that impacted our owned and operated business. The marketplace headwinds we faced in our O and O business namely narrowing RPS spreads and volatility in sell-side pricing, were shared by our partners as well. But notwithstanding that, our partner network business continued to perform through solid execution as well as what we believe is the attractiveness of our RANT platform. Key metrics evidencing this include in Q1 of 24, total active partners grew 5% from Q4 to over 250 total partners. Average revenue per partner decreased sequentially by 9% due to Q1 seasonality and choppiness in the marketplace. Remember, when partners join our ramp platform, there's a timeframe during which they begin to scale up with us. This is a function of the partner getting more familiar with our platform, as well as our constant evaluation and monitoring of their traffic quality. We consider a platform partner to be a scaled partner. when they're generating at least $50,000 of revenue per quarter on-ramp. At the end of Q1, we had 57 scale partners compared to 50 scale partners in Q1 of 23, representing a 14% growth rate. Moreover, as I mentioned previously, our partners are using us more and for more sessions. It is our hope that as the advertising market continues to improve, the combination of our growth in number of scale partners and the increase in the number of sessions will accelerate the growth of our partner network business. Moving to our organic businesses, they had a good quarter on several fronts. First, we saw a significant increase in organic traffic to MapQuest and Coupon Follow that began in March and should continue through Q2. These increases were driven primarily by favorable changes in the Google search algorithms. We've been working very hard to improve the customer experience on these sites in the hope our Google rankings would improve. Unfortunately, our efforts have begun paying off with increased traffic that directly drives corresponding increases in revenue. We also saw the launch of several key business development partnerships with our Star Page and Coupon Follower properties that we expect to begin paying dividends as the year progresses. Going forward, we are focused in a few key areas. First, we are continuing to invest in our RAMP platform. AI has materially improved our ability to scale our buy-side capabilities, and we plan to open up our buy-side to partners who currently use us primarily for sell-side monetization. Second, our organic properties will keep focusing on their on-site experiences, we'll be launching new and improved apps, and we'll be integrating additional distribution partnerships. Third, we're planning to start expanding our subscription business by rolling out more internally developed subscription products. And finally, we have been back to exploring the M&A market again as the digital market stabilized and pricing has started to get a bit more rational. Overall, I'm very pleased with our execution in Q1, especially with respect to product enhancements on RAMP focused on AI-driven automation. We're executing with focus and we are shipping products faster than ever. Our execution is starting to show up in our performance, and I'm increasingly confident we are moving back into growth mode. I also am happy to have Chuck Orsini rejoin System Wayne in an official capacity as our president and COO. Chuck and I co-founded System Wayne, and Chuck was our original CEO. He has driven much of our execution in the last year, and I'm happy to have him back in an official capacity. As I mentioned, every quarter, System 1 management has much of our network worth in System 1 shares. We're highly aligned with our longer-term shareholders. Management is in this for the long haul, and we welcome investors who want to come along for the ride. I'll now hand things off to Triti to discuss our quarterly results in more detail, as well as our Q2 guidance.

Take it away, Triti. Thanks, Michael.

As Michael mentioned, there were market-related challenges in Q1. especially early in the quarter. But we remain bullish given that March came in not just above the first two months of the quarter, but also above expectations. And we delivered results above the high end of the guidance range for revenue, gross profit, and for adjusted EBITDA. As I discussed to you on results, I want to highlight that year-over-year comparisons continue to be a challenge, as we haven't yet rebounded to the levels of advertising demand we saw in the first half of 2023. due to continued macro declines in the advertising market through the first three quarters of last year. And in Q1 of last year, our owned and operated SEM business still contributed $6 million of gross profit as compared to approximately $2 million of gross profit a quarter starting in Q2 of 2023 and continuing through last quarter. Also, we typically expect a sequential decline in Q1 versus a seasonally strong Q4. Now onto our operating results. Q1 revenue was 84.9 million, representing a 30% year-over-year decline and sequential decline of 12%. That was good for 900K above the top end of our Q1 revenue guidance range that we provided in March. Own and operated advertising revenue was 69 million, representing a 35% year-over-year decline and sequential decline of 13%. Network advertising revenue was 15.9 million, up 5% year-over-year and down 5% sequentially. Adjusted gross profit was 31.2 million, down 18% year-over-year and 17% sequentially, and that was above the high end of guidance by $1.2 million. Revenue less advertising spend for our own and operated advertising segment declined 16% sequentially to $22.5 million. Network revenue less agency fees was down 17% to 10.9 million versus the prior quarter. Own and operated cost per session and revenue per session were both down 1 cent sequentially to 4 cents and 6 cents respectively, with the spread down slightly to approximately 2 cents. On the network advertising business, revenue per session was 2 cents per session. Most importantly, total sessions processed by RAMP in the most recent quarter was 2.26 billion, up 22% sequentially and 53% year-over-year. Adjusted EBITDA impacting operating expenses, which are net of add-backs, were 30.8 million, down 7% year-over-year. As a reminder, we expect Q1 to be the high-water mark for OpEx, driven by FY23 audit costs. Adjusted EBITDA was $422,000 versus $5.2 million last year, which came in above the high end of the Q1 guidance range by $1.4 million. With respect to liquidity, we ended the quarter with $69.9 million of unrestricted cash in our balance sheet. and a term loan balance of $296 million. Our net leverage at quarter end was approximately 9.19 times. I want to reiterate my comments from our last earnings call with respect to capital structure. We remain comfortable that our current liquidity, including the $50 million of availability on our revolver, provide ample cushion for all of our short and medium-term liquidity needs. We remain highly focused on maximizing equity value for our shareholders, while remaining focused on continuing to de-lever the business. And we will continue to be opportunistic on debt re-purchases. For example, we extinguished an additional $1.2 million of term debt for $720,000 of cash on April 30th. And per Michael's comments, we will continue to explore a creative M&A where we have a track record of execution of success. Most importantly, we'll continue to prioritize investment and execution to drive organic growth in our core advertising business. Although we have recently seen more stability in the market through the first several weeks of Q2, there's still quite a bit of uncertainty in the online advertising environment in which we operate, as evidenced by the recent news about Google delaying the deprecation of cookies. So again, we will not be providing full-year guidance for 2024 at this time, other than to say that we expect to deliver year-over-year growth in revenue, adjusted gross profit, and adjusted EBITDA in the second half of 2024. We're estimating Q2 revenue to come in between 88 million and 90 million, representing an 8% year-over-year decline at the midpoint. We're estimating adjusted gross profit to come in between 33 and 35 million dollars, representing a 16% decline at the midpoint. And we estimate Q1 adjusted EBITDA to come in between 5 and 7 million dollars, slightly down year-over-year at the midpoint. We remain cautiously optimistic about the digital advertising market stabilizing this year, and remain extremely bullish about our ability to execute against both near and long-term opportunities.

Thank you. Thank you, Trudi. We are now going to open the line for some questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. If you wish to withdraw your question, simply press star 1 again. Your first question comes from the line of Dan Kernos with the Benchmark Company. Your line is open.

Great. Thanks. Good afternoon. Good start to the year, guys. Maybe I guess we'll start with what Triti just kind of talked about, kind of high level. Obviously, Google pushing out cookie deprecation until next year. There's a ton of issues around that. We've also had a TikTok ban passed in the house. You know, it seems like kind of the Wild West right now. You know, can you guys just kind of help us think through how your partners are looking at the environment right now and in the confines of, you know, Google probably making a bunch of changes to privacy sandbox and a bunch of other things, just how you're thinking about being able to maintain sort of consistent spread as we go through this volatile period?

Yeah, thanks, Dan. And thanks for joining. Good to hear from you. So specifically related to cookie deprecation, you know, we actually think that's going to be a bit of a tailwind for us. What's going to happen when cookies are deprecated, we're pretty highly confident is that contextual advertising is going to be more effective as some of the third party based average third party cookie based advertising kind of goes away. And so We're not concerned at all about the cookie deprecation. We're in fact a little bit disappointed that they ended up pushing into 2025. We still remain highly confident that some form of that's going to be coming out. Everything we're hearing from Google is that they're talking about a delay rather than kind of reversing their course on cookie deprecation. TikTok specifically, we don't have much exposure there. We do advertise on TikTok through the network. It's been pretty effective for us. Most of our exposure, though, is international. So we don't expect that domestic people from the U.S. will continue to be able to advertise via TikTok in the international market. So we don't really anticipate any problems there. I mean, overall, on kind of a macro level, you know, we're starting to see I would say the overall advertising market, and you've seen this in the people reporting their Q1s, looks like we're starting to see things relatively stable. We're always reluctant to kind of call the stability and call the growth in the back half, but we don't really see anything that's particularly alarming right now to us.

Got it. That's really helpful. And since you brought up international, Michael, I feel like I ask you this every call and, you know, sort of like it's coming, it's coming. You know, you flagged it as a highlight, especially in O&O in Q1 and just kind of curious what sort of opportunity set you're seeing further from here.

I mean, Trudy, you can kind of talk about the numbers specifically, but we definitely remain under indexed. International is starting to tick up.

You want to kind of talk about where we are there, Trudy? Yeah, I think we mentioned in the prepared remarks that international as a percentage of our own and operator revenue was close to 30%, 29% in Q1, up from 25 in Q4. And so, again, you know, I think for our internal efforts, we're doing a good job marching against, you know, getting closer to where we think that should be on a worldwide basis, which is in and around 50%. And so we think we're making good progress overall.

We're a bit under-indexed in the EU, and the EU in particular has had varying – they're rolling out kind of privacy-related things, privacy-related regulation at a pretty rapid pace in the EU. So our owned and operated is under-indexed in the EU, but also our partner network as well is under-indexed in the EU. So we see a lot of opportunity there. Asia, we're doing pretty well. I would say South America, there's opportunity there, although that's not really where the real money is. The real money is going to be international. It's going to be in the EU, kind of UK and Asia. But we think we'll continue growing our overall share internationally.

Without giving away your roadmap, is there anything else you can share with us on either the internal developments as it relates to things you're doing with StartPage or Coupon Follow and how that might be additive to the balance of the year? And Michael, interesting to hear the commentary about internally developed subscription products. Given the history, I'm sure you have plenty of experience now and you certainly had some before. So just love to get some color on how you're thinking about attacking that.

Yeah, I'll kind of answer those sequentially, I think, Dan. So we've mentioned one thing on the coupon follow and MapQuest side specifically. In Q1, kind of in March, Google started, they rolled out one of their core algorithm updates, and we benefited from that algorithm update. So MapQuest and both coupon follow, you know, achieve some better positioning, basically, in the Google rankings. Doing that requires a lot of hard work. You spend some time on the customer experience on your sites, and you can spend six to 12 months improving the customer experience, and it takes a long time for that to pay off in the Google rankings. So we're really pleased to see that roll out and to see us benefit. And that rolled out in March. And so we got some of the benefit in March. I think we'll continue seeing that benefit accrue really through the rest of the year because it's remained at that level that we saw in March. And in some cases, we're continuing to improve in the rankings. We have been making, we're not ready to announce anything right now, but we have been making some pretty good progress. in putting together what we think are going to be some really interesting apps related both on the MapQuest start page and then on the coupon follow side. And so we do intend on rolling those out, you know, most likely in Q2. We could see some slippage into Q3 for one or two of them. And those are going to be a mix, Dan, of both advertising via via our typical advertising tech stack. And we also are going to be getting, and we anticipate getting back into the subscription business. And just as a reminder, Dan, we sold our large subscription business last year. We do have a smaller subscription business that we're still operating. And we think we've got a lot of in-house expertise, both in how to build those subscription products, but also how to market market them. So we're going to leverage that expertise across additional products.

Perfect. Super helpful, guys. I appreciate it. I'll get back in the queue.

Thank you. Thanks, Dan. Thanks for joining.

Your next question comes from the line of Thomas Forte with Maxim Group. Your line is open.

Great. So first off, Michael and Trudy, congrats on the quarter. You sound very optimistic on your business, which is encouraging to hear. One question and one follow-up. So Michael, when I think about your core competency, it's connecting advertisers and consumers with intent. The consumer environment, the consumer spending environment right now is pretty challenging. So I'm wondering how you're navigating those challenges. And then if you've ramped your efforts in travel or some additional categories to perhaps mirror where the discretionary spending is focused today.

Mm-hmm. Yeah, I mean, as we've talked about, you know, over several quarters, so as the as consumer demand is kind of moving up or down, what that generally does is affects pricing on the buy side. So as as the economy shifting around, while we do see the effects of it, we're able to kind of change our pricing to follow consumer demand. What we have seen I can kind of talk to you about some verticals that we're seeing a movement in because we have exposure across really the entire economy because we effectively are chasing the verticals that consumers are looking for. So what we've been seeing is in the health category, health probably stayed pretty steady for a long time. And that really matches the overall U.S. economy. So we're seeing a lot of consistency in the health category, which is around 18% to 20% of overall advertiser spend, something like that. Interestingly, we're starting to see automotive pick up a little bit. That's just in the places where we're advertising. And so obviously as automotive is picking up and we're seeing the dealerships come back in and start spending money again, we're going to be focused on that as well. And then within finance, finance is such a broad category. We're seeing certain areas of finance completely dried up. Mortgage, which used to be a pretty big vertical for us, it's going to be very difficult to get any scale right now in mortgage or particularly in the refinancing space. But on the flip side, some of the areas related to more like higher interest rates going up are good for us. So A lot of things related to banking, getting higher interest rate savings accounts, those things where consumers are starting to perk up to their ability to make some money off of the higher interest rates, we're seeing pop up. In general, I would say we're just not seeing the weak, you pointed to consumer weakness I would say we're not seeing a decline. You know, I'd say that we're starting to see, you know, some relative stability on the consumer side. And while, again, we're not ready to kind of call, you know, a return to normal, we're definitely not feeling the way we were in, you know, call it early 2023. Great.

And then I know you're not giving a full year outlook, but I was hoping that you could just high level the following. So with this being a presidential election year, an expectation that there'll be a large portion of digital advertising going toward that. Historically, has that presented opportunities and challenges? How have you navigated that situation historically?

We haven't seen like in the past, so I guess this will be the either third or fourth presidential cycle that we've been through at System 1. Um, we haven't seen a lot of changes in, in our, in the marketplaces we play in as the elections come around. I suspect you'll see that hit kind of the, uh, the video market a fair amount. Um, we don't play, you know, heavily on the video side. Um, so we are not, we're not projecting anything really kind of, kind of, kind of any tailwinds or headwinds. relating from, you know, that, you know, what will be certainly a burst of activity, you know, the last couple months of the year. Trey, do you want to like kind of follow up on that related to where we're looking for 2024?

Yeah, I mean, I think to that point, just some of the uncertainty that Michael highlighted around how we're thinking about ad markets, you know, we obviously chose not to guide for the full year, but we do think kind of given our current trends, the stability we are seeing, we do expect to see growth in the back half versus our second half of 2023. You start to see that a little bit in our Q2 guidance, specifically around EBITDA. But I think kind of Q3, Q4, we expect to be guiding to and delivering growth across all three of the key financial metrics.

Yeah, we're kind of going to burn off some declines we had in the past. And so looking forward towards the end of the year, we've you know, we would expect, as Trudy said, to move back into growth mode. I would say, Tom, just to kind of follow up, I would say bigger for us, and I would say also bigger for the overall, certainly the digital display market. We do think cookie deprecation, when that comes about, we think that's going to have pretty substantial effects from the testing that we've seen And also looking back historically to an iOS, when a similar change came through in Safari, that had a pretty substantial effect in pricing in the display and programmatic market. So we would suspect that that's going to be, there's going to be some winners and losers when the Chrome cookie deprecation comes about. Every indication we see will be a winner. But I would say if you're looking towards the future and what's going to happen in the overall app market, that would be, for us at least, that would be a much bigger lever than anything related to the presidential election.

Great. Thanks again for taking my question.

Thanks, Tom. Thanks, Tom. Thanks for joining.

Your next question is a follow-up from Dan Kernos. Your line is open.

Thanks. I thought I'd just sneak one more in, Michael. On ramp and scaling the buy side, I just want to get a sense from you. You've kind of talked about it in the past, but a few things, just how you're thinking about the opportunity, how much you have to invest on that side. Obviously, a lot of that's moving towards self-serve, it feels like, and you touched on it in the last response to a degree, but it also theoretically can help open up the opportunity with additional formats, whether it's video or other things in theory. So I'm just kind of curious how you're looking at that opportunity and what it might mean for the penal.

Yeah, sure. So we kind of caught a, I would say we caught a break with the, you know, with with the launch of generative AI. And, and so for us, both across all of our all of our different ad formats, so So for us, we're kind of almost a unique advertiser in the marketplace. When you think about your typical advertiser, I talk about it's going to be someone like a Capital One advertising credit cards or somebody advertising mortgages. And it's pretty straightforward to come up with your advertising copy and your advertising units and what, if you're going to do video advertising, what that's going to look like. There's only so many permutations you can have on an ad for, you know, get a better credit card. When you contrast that with what we do at System 1, you know, we're advertising in hundreds of different verticals. And so the different advertising permutations, you know, if you've got 100 permutation of advertisement across 100 verticals, all of a sudden you're expanding pretty quickly into 10,000 different ad formats. It's actually quite difficult by hand to come up with all those formats in an automated way, recreate different tones and different colors and all the different changes you can make to advertising to pull consumers better. And so AI came along and allowed us to automate a lot of those processes. And so in addition to that, we're using machine learning AI to handle the bid pricing So when you think about not only all the verticals we're in, but all the different places we advertise, so everywhere from Facebook to Google to TikTok to any place you can spend money, all of a sudden you've got a bunch of different advertising channels, multiply that times the number of ad permutations, and the entire system gets pretty complex pretty quickly. So where we are now is we've got the ability to scale our advertising in a much more automated manner as we very quickly have incorporated AI into our platform. And so when doing that, we're one of the biggest advertisers in the world at this point. And so what we're going to be doing going forward is opening up those capabilities on the buy side to people that want to use our platform, which we really haven't done before. We think it's going to really give people using our platform an advantage in the marketplace because they can really dovetail with all the capabilities that we've built ourselves. And if you think about the average partner of ours, you know, they don't have a hundred person engineering team to go develop these buy-side capabilities. You know, our average partner might be everywhere, anywhere from five to, you know, 30 employees. And so by offering up that buy-side scale, we think that we have the ability to you know, turn Ramp into much more of a software-type product, almost a DSP-type product. And we think that, you know, not only is it going to help our owned and operated business scale, and we're already really seeing the effects of that, we think by opening up the buy side, we're going to get a lot more people on the platform, and it's going to be a lot more sticky.

And, Dan, this is Trudy. Just to hop in on kind of the P&L impact, you know, our, as you kind of said, our OpEx base, At the end of last year, we kind of already recalibrated and reorganized how we think about product and development against these specific initiatives and goals. And to Michael's point, really, it's create a platform that we can use end-to-end internally and then think about potentially how that gets syndicated out. And so at least for, I'd say, at least the next 12 months, the team that we have here and the OpEx load that we have here should be sufficient to kind of build out these medium-term initiatives. So the short answer is no increase in the P&L.

Yeah, don't expect a lot of incremental costs going into this. So that's another benefit we've had is a lot of the automation on our platform is allowing us to do more with the same number of people.

That is really helpful. Thanks for the complete answer. Appreciate it, guys.

Appreciate it, Dan. Thank you.

This concludes the question and answer session. I will turn the call to Michael Blend for closing remarks.

Yeah, well, thanks, everybody, for joining us today. You know, if you've been following us at System One closely, you know it's been a choppy few quarters for us, but the team has been really heads down executing, and it feels like we're starting to see all that hard work paying off. I'd say we're getting increasingly optimistic about our trajectory here at the company. And so we look forward to speaking with all of you at our Q2 earnings call. Thank you very much. Thanks for joining.

This concludes today's conference. Thank you for joining. You may now disconnect your lines.