System1, Inc.

Vice President of Finance, you may begin.

Thank you for standing by, and welcome to the second quarter 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 Blend, and our Chief Financial Officer, Tritivesh Kadambi. 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 compliance matters. These statements are subject to known and unknown risks and uncertainties that could cause our actual results to differ materially for those projected or applied during this call. In particular, those described in our risk factors included in our end report on 410K 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 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 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 Blend.

Thanks, Kyle. Good afternoon, everyone, and thanks for joining us on our Q2 2024 System 1 earnings call. We have a positive update for you today. I'm happy to announce that System 1 delivered financial results which exceeded the high end of guidance across our key financial metrics. System 1 delivered $95 million of revenue and $39 million of gross profit. Adjusted EBITDA was $9.9 million, which was 42% higher than the high end of our guidance range. These strong results were driven by the positive returns from the continued investment in our RAND platform, very strong international growth, significant progress in our owned and operated products, and a tight focus on reducing OPEX. Let's get into some of the financial details. I want to start with our owned and operated business. Total owned and operated revenue was $77 million, flat year-over-year and up 12% from last quarter. Adjusted gross profit was $27 million, up 22% from last quarter and flat year-over-year. Our quarterly growth was driven by 7% sequential growth in advertising spend, as well as a 21% quarter-over-quarter uptick in revenue from our owned and operated products. We generated over 2 billion sessions on our owned and operated properties, a 145% year-over-year increase, and a 66% quarter-over-quarter increase. Spread was approximately 1.5 cents per session. Revenue per session was down nearly 60% year-over-year. The decline was driven by lower cost-per-click rates in the United States, as well as a bigger mixed shift towards international markets, which naturally have lower monetization rates in the United States. Now, international growth continues to be a highlight, with international revenue presenting approximately 36% of owned and operated revenue. This is up from 29% in the first quarter. Our continued international growth demonstrates the power of RAMP's use of AI to very efficiently create content and advertising creatives in multiple languages. For example, When we see an opportunity like engineering jobs in India or checking accounts in the UK, we can very quickly move to capitalize on the opportunity. Our owned and operated products had another strong quarter, with continued favorable organic traffic trends on both Coupon Follow and MapQuest. In May, Coupon Follow benefited from a Google search algorithm update. The update was aimed at eliminating spammy coupon and promo code websites from Google search results. This was not only a long overdue and welcome change, but was also great for consumers, as the Google index was becoming polluted with copycat coupon-related sites. Coupon Follow is one of the most useful coupon websites, full of original content and thoroughly vetted promo codes, and Google appropriately gave Coupon Follow a positive boost. As a result, Coupon Follow saw a significant increase in site traffic and corresponding revenue. June organic sessions were up nearly 80% year-over-year, and on some days, Coupon Follow is the most trafficked coupon site in the world. On MapQuest, we saw a similar story, although not as dramatic. Q2 organic visits were up 10% year-over-year. We've been very focused on improving the customer experience on both MapQuest and Coupon Follow, and it's gratifying to see that we're paying dividends with increased users and revenue. StartPage, our private search engine, also had a very productive quarter. We launched our private browser app and have seen over 50,000 downloads with significantly positive user feedback, including over 2,000 five-star ratings to date across our iOS and Android app users. We have high hopes for the browsers for our loyal Startpage users, and we also hope to be able to profitably market them to new users in the coming quarters. Now let's move on to our Partner Network business. Partner Network revenue was $17 million, and adjusted gross profit was $13 million. Revenue decreased 12% year-over-year, but was up 8% sequentially. Adjusted gross profit decreased 9% year-over-year, but was up 24% sequentially. Total sessions were $2 billion, up 203% year-over-year, and up 33% sequentially, as we continued to add partners to the network. Partner network RPS declined 71% year-over-year and 19% quarter-over-quarter. The higher sessions and lower RPS were driven by the same trends that we saw in our owned and operated business. Lower pricing in the United States and a bigger mixed shift to international markets. Despite the decline in revenue, our partner network business continued to show solid demand from the market. In Q2, our total active partners grew 19% from the first quarter to almost 300 partners. Average revenue per partner decreased sequentially by 9% as new partners onboarded this quarter continue to scale up. At the end of Q2, we had 58 scale partners in line with the first quarter. As a reminder, we consider a platform customer to be a scale partner when they are generating at least $50,000 of revenue per quarter on-ramp. Before I hand things off to Triti, I wanted to outline our key initiatives that we expect to drive System One's growth over the next few years. First, we are continuing to invest in our ramp platform in three key areas. Buy-side efficiency is driven by AI. Second is opening up our buy side capabilities to our partners. And third is launching new products. Let me take this opportunity to walk you through each of these in more detail. First, let's talk about AI. As I mentioned in the last couple of quarters, we've been hard at work integrating AI capabilities into RAMP. AI enables us to create advertising campaigns and associated content at a scale, at least an order of magnitude greater than we could have in the past. This scale, combined with our improved bidding and optimization algorithms, has enabled our owned and operated advertising business to reach a size only a handful of other companies can match. Maintaining ramp and constantly adding improvements requires a large engineering and product team, laser-focused on AI integration, machine learning, optimizations, and speed. Traditionally, our network partners have relied on System 1 solely for sell-side monetization. They have their own buy-side capabilities to purchase traffic, and they rely on System 1 to monetize that traffic. This strategy works well for many partners after a certain level, but typically partners cap out in size as their own buy-side capabilities and technology hit certain limitations. Simply put, it is very difficult to buy traffic of the scale System 1 does. It requires a sophisticated buy-side platform, And while our network partners are highly skilled at buying traffic, they typically just don't have a large enough team to scale beyond a certain point. By opening up the system-run buy-side platform to our partners, we expect to enable many of them to scale far beyond what they currently do. In addition to better buying capabilities, we also are integrating new monetization products into RAMP. Each of these products follows a similar pattern. We build the product feature or enhancement into RAMP, We utilize our owned and operated properties and our own team to figure out how to scale the product. And once we have all the kinks worked out, we open it up to partners. Over the last year, our focus has been on launching and scaling a new product offering by Google called Related Search on Content. This product requires sending high quality traffic to content very highly tailored to specific advertising verticals. Google advertising is integrated directly into the content. While similar to Google-related products we've worked with in the past, the new product requires System 1 to develop new technology to ensure we can scale it while maintaining very high quality. It took us some time, but now we're at the point where we are confident we have the technology and processes in place to scale this new product. System 1 is generating over seven figures of monthly revenue from the product. Google is very pleased with the results, and we now are in the process of rolling it out to partners. So we've done what we always do. use our owned and operated scale to explore and then scale a new market, and then offer our new capabilities to our partners. The next two areas we are planning to invest in are two segments we currently are under-indexed, shopping and subscription products. Both of these areas are huge consumer markets where we currently are not scaled. We have slightly different approaches for each of them. For shopping, we likely will partner with large shopping-focused advertising networks, similar to our current approach of partnering with Google, Bing, and Yahoo. We are still exploring these partnerships, but we believe partnering with networks is a better option than attempting to build out our own direct advertising network in commerce. We might take a different approach with subscription. We already operate two successful subscription products associated with MapQuest, and we have shown in the past that we know how to scale subscription into the hundreds of million dollars of revenue. We also already operate businesses in some huge consumer categories that could be ripe for subscription. We operate search engines, we have browsers that we run, we have big mapping services, and we're also big in shopping. So while we will consider partnering with existing subscription businesses, we also are exploring building out our own products. The good thing is that RAMP will support these efforts with only minimal increase in OpEx or R&D. We built RAMP to be very flexible in supporting new buy-side and sell-side capabilities, and plugging in these new products will be pretty straightforward. I also wanted to take a few minutes talking about our organic products specifically. We traditionally have focused our earnings comments on our marketing driven businesses and our ability to scale our overall business by purchasing traffic and marketing can drive very fast scale in our business. But as we saw in 2022 and parts of 23, it can also cause volatility. Now in contrast, our product businesses are comprised of utilities that consumers seek out and use every day. For example, Coupon Follow helps people find promo codes that save them money when they're shopping. Start Page enables its users to search the web in privacy. MapQuest provides mapping for people who prefer it over Google or Apple Maps. And Roll Warrior helps delivery drivers drop off packages more efficiently. And each one of these properties is supported by related products, whether it be our Sently browser extension, which is part of Coupon Follow, our Starpage private browsers, or the MapQuest and Road Warrior mobile apps. Because these products do not require marketing to generate usage, they are distinct from our marketing-driven businesses in two primary ways. First, their revenues are more consistent and less tied to shifts in the overall digital advertising market. Second, they are much higher margin businesses, as we spend a much lower percentage of our revenues on marketing them. The dynamics of these product lines are different enough that we plan to begin presenting them independently from our marketing businesses. Triti will go into more detail about this reporting change in his remarks. Overall, I'm very pleased with our performance in the second quarter. Our System 1 team has been executing very well over the last year, and it's gratifying to see that execution starting to show up in our financial performance. We aren't yet where we want to be, but things are moving in the right direction. To close my section of our call, I would like to once again remind you that management is the largest shareholder group in System 1, and our interests are very highly aligned with yours. We appreciate your overwhelming support of our new equity plan tied to hitting EBITDA targets, and we intend to hit those targets. As our business gets back into growth mode, we're excited to have you along for the ride. I'll now hand things off to Triti to discuss our quarterly results in more detail, as well as our Q3 guidance. Take it away, Triti.

Thanks, Michael. We are pleased with our second quarter performance and sequential growth trends, highlighted by quarter-over-quarter adjusted gross profit growth at 24% and $9.9 million of adjusted EBITDA versus $400,000 in Q1. While the year-over-year metrics remain challenged due to the sequential step-downs we saw in overall advertising demand going from Q2 to Q3 of last year, We significantly narrowed our year-over-year declines across key financial metrics and even grew adjusted EBITDA, which was driven by our cost-cutting initiatives over the past several quarters, with operating expenses down 16% year-over-year. Now on to our specific operating results. Q2 revenue was $94.6 million, representing a 2% year-over-year decline and sequential increase of 11%. Revenue was 4.6M above the top end of our Q2 revenue guidance that we provided in May. Own and operated revenue was 77.4M, flat year-over-year, and up 12% sequentially. Network revenue was $17.2M, down 12% year-over-year, but up 8% sequentially. Adjusted gross profit was $38.8M, down 4% year-over-year, but up 24% sequentially. We significantly narrowed our year-over-year decline, which was 18% in Q1. Adjusted gross profit was above the high end of guidance by $3.8 million. Revenue-less advertising spend for our owned and operated advertising segment grew 22% sequentially to $27.4 million. Network revenue-less agency fees was up 24% to $13.5 million versus the prior quarter. Owned and operated cost per session and revenue per session were both down two cents sequentially to two cents and four cents respectively. On the network advertising business, RPS was one penny per session. Most importantly, total sessions processed by RAMP in the most recent quarter was $4.06 billion, up 47% sequentially and 171% year-over-year. As Michael mentioned during his remarks, these RPS and CPS trends were primarily driven by growth in lower RPS and CPS international traffic sources. I wanted to take some time here to focus on our own and operated products, which today are primarily composed of our Coupon Follow, MapQuest, and Startpage businesses. A key feature of all these businesses is that they are not dependent on paid advertising to drive traffic and revenue, and instead primarily rely on organic traffic, such as direct navigation, unpaid referrals, and search engines. As a result, they provide us with nice diversification versus our paid advertising business and the volatility that comes with it. Also, while they comprise a smaller portion of our revenue, 19% of total revenue and 23% of owned and operated revenue in Q2, they make up a more significant portion of our gross profit. 42% of total adjusted gross profit and 63% of owned and operated adjusted gross profit in Q2. For these businesses, revenue was up 17% and gross profit was up 18% year-over-year in Q2. Sequentially, revenue was up 21% and gross profit was up 26%. We recently reorganized our overall corporate structure to more easily report the performance of our products businesses. Please review the 10Q file earlier today for more information on this structure. Also, starting with our Q3 results, we will provide information on the current and historical performance of these businesses in our supplemental financials. On to operating expenses and adjusted EBITDA. In Q2, operating expenses net of ad backs was $28.9 million, down almost $2 million quarter over quarter, and down 16% year over year. We have been working hard to rationalize our operating expense structure following the total security sale at the end of last year. And year-to-date, we've already reduced operating expenses by $10 million on an annualized basis versus 2023. And we expect to drive even more cost savings in the back half of the year heading into 2025 and beyond. Adjusted EBITDA was $9.9 million versus $6.1 million last year. Adjusted EBITDA came in above the high end of the Q2 guidance range by $2.9 million. With respect to liquidity, we ended the quarter with $75.7 million of unrestricted cash on our balance sheet. and an outstanding balance of $290 million of term loan debt under our credit agreement. Our net leverage on a consolidated basis at quarter end was approximately 7.5 times. Although we have been executing well and haven't seen as much volatility as we saw earlier in the year, there is still quite a bit of uncertainty in the online advertising environment in which we operate. So we will continue to provide quarterly guidance. It is worth noting that historically Q3 has been relatively flat to down versus Q2, while Q4 has typically benefited from seasonal trends, and we expect to see the same this year as well. We're estimating Q3 revenue to come in between $86 million and $88 million, roughly flat year over year at the midpoint. We are estimating adjusted gross profit to come in between $36 million and $38 million, also flat year over year at the midpoint. but also with 150 biffs of gross margin expansion at the midpoint. We estimate Q3 adjusted EBITDA to come in between $8 million and $10 million, up 11% year-over-year at the midpoint. We remain bullish about our ability to execute against both near and long-term opportunities and remain focused on delivering financial results that reflect that execution. Thank you for joining us today.

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

Thank you. The floor is now open for questions. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star 1 again. If you are called upon to ask a question and are listening via loudspeaker on your device, please pick up your handset to ensure that your phone is not on mute when asking your question. Your first question comes from the line of Daniel Kernos of Benchmark Company. Your line is open.

Thanks afternoon guys. Nice progress. There's actually a lot to unpack here, but maybe we'll just start with some simplistic questions and just ask treaty following up on your commentary around historical seasonality. You know, are you guys seeing anything that's giving you pause in the marketplace as you look towards the forward guidance and given all of the initiatives, Michael, that you outlined, you know, what kind of contribution should we be expecting or over what timeframe, whether it's back half of this year or into 25, just help us at least get the framework of how you're thinking about some of the new initiatives contributing to the P&L.

I said that first, Trudy? Hey, Dan, how you doing? This is Trudy. So yeah, I get the easy question there. So short answer is no to your first question. So Q2 was in line with what we thought it would be I think we mentioned in our last commentary back in May that we were seeing kind of the advertising markets behave as we would expect them to behave kind of sequentially coming off of Q1. That held through Q2 and knocking on wood, the first part of Q3 here. And we haven't seen anything that would give us pause or across any specific verticals or anything, even given some of the maybe the macro news that's kind of been around in the last week or so. And I'll turn over to Michael for. Yep.

Thanks, Dan. So in terms of the new initiative, so first of all, when treaty talks about, you know, our Q3 guidance and also expecting the seasonal uptick in Q4, that would anticipate no contribution or very de minimis contribution from any of our new efforts. In terms of opening up the buy side to our partners, that's really ongoing right now. you know, we're going to start letting the first partners on kind of as we speak. We're not modeling in any significant contribution in 2024, but we are highly confident that our buy side platform is an improvement over for most of our partners, if not all of them, and we'll let them scale, you know, substantially beyond where they are now. For shopping, Again, we are just getting into market with one of our new partners there on the kind of commerce side and have really, really, really early results. We're not anticipating scale on that in the second half of the year. If we do see it in Q4, that would be some kind of unanticipated upside for us. And in subscription, we do anticipate having at least one product in market In Q4, you know, one of them, our first one is pretty close to being complete and ready for testing. Again, just to reiterate, not modeling in any substantial contributions on any of these, but we will be a market in all three of those initiatives in the back half of the year.

That is super helpful and comprehensive. I appreciate that. Maybe I'll just follow up quickly. It's probably more of a fun question, Michael, but, you know, now that Google has decided not to deprecate third-party cookies anymore and they have really no alternative solution in place at this point, it feels like the whole industry, I guess, breathes a bit of a sigh of relief. So I'm just kind of curious, you know, how you think that will impact sort of CPMs going forward, what reactions you've seen, if it changes anything now that privacy sandbox is kind of on hold for the foreseeable future?

Yeah, so we're not anticipating much of a change. We were expecting that Q4, if they had fully rolled out the cookie deprecation the way they had talked about, was going to be pretty volatile for a lot of people in market. Obviously, that's not going to happen now. But Dan, I know you and I talked about this in the past. We're not We weren't really surprised to see Google take that stance and kind of indefinitely delay things. We've been hearing rumblings in the market, been hearing a lot of the testing that'd be being done, and they really simply hadn't been able to come up with a replacement that was that competitive with current cookie solutions. What we are hearing and what I think some of the testing is starting to show is that the solution that Google's come up with is starting to get fairly competitive on the monetization side. It's just technically pretty complex to implement. So again, I guess it doesn't really affect our stance and what we think our business is going to do. We do think the industry as a whole, a lot of people were, I think, probably more concerned about the effects than they were letting on, and I'm sure they're breathing a bit of a sigh of relief

Last for me, Michael, step aside. I always ask you about international, and you always tell me it's on the come, and yet you highlight it at this quarter. So just love to hear if there's particular geos you've been able to target, particular verticals in international where you've had success, and how much you think that will be a contributing factor to what should be accelerating growth in the 25s.

Pretty bullish right now, international. We've had a lot of success in programmatic markets over the last couple of quarters. We've been scaling up in particular our relationship with TikTok and Pangle. Pangle is their programmatic network that's attached to the TikTok overall business. And we're seeing that across almost all international markets. We're seeing it in Asia, South America, a bit in Europe as well. So I would say that if current trends continue, we're going to continue to see pretty rapid growth in our international business, continuing to take more and more of a contribution to our overall revenue. And right now, if you ask me, I don't think those trends are going to slow down. We've been tuning our platform to focus more international. There's a lot of idiosyncratic things you have to do to really attack the program out of market, particularly internationally. But we think we've got those things figured out, and, you know, we see a lot of growth ahead of us, and it's starting to kick in already. So not on the come anymore. We're actually seeing it. Yep.

Definitely here. Thanks, guys. Really appreciate the color, and congrats on getting things moving in the right direction.

Thanks, Dan. Thanks for calling in. Thanks for the questions.

There are no further questions at this time. I'll now turn the conference back over to Michael Blinn for closing remarks.

Okay, great. Well, thanks, everybody, for joining us today. You know, as we tried to make clear on our remarks today, things are really starting to move in the right direction here at System 1. Overall, our team is executing really well. Our major customers are pleased, both on our partner side and also on our revenue side. And overall, we're seeing some, you know, decent stability results in the digital advertising market, which is what we've been looking for over here for the last year and a half. So in sum, things are looking pretty good. We're looking forward to having you join us again for Q3 earnings, and we are definitely hoping to have some good news to report for you then as well. So thank you for joining.

This concludes today's conference call. You may now disconnect.