System1, Inc.

Thank you for standing by and welcome to the third 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 chief executive officer, Michael Blend, and our chief financial officer, Trinvesh Kadambi. The 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 in our annual report on Form 10-K for 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 to 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 Q3 2024 System 1 earnings call. Despite a mixed quarter with respect to the overall advertising marketplace, we delivered a strong quarter with many positives, including exceeding the high end of guidance on EBITDA. System 1 delivered almost $89 million of revenue and $38 million of gross profit. Adjusted EBITDA came in at $10.3 million. These results were driven by the continuation of the trends we discussed last quarter. Our owned and operated products continue to perform well, with revenue up 16% sequentially from the second quarter. As a reminder, our owned and operated products are our businesses which have organic users, and they are not heavily reliant on system ones spending marketing dollars for their growth. Our largest owned and operated products are Startpage, our private search engine, MapQuest, our mapping solution that competes with Google and Apple Maps, and Coupon Follow, our promo code website that enables consumers to get great deals while they shop. Now, in contrast to the growth in these products, our marketing-driven business lines continue to see the effects of significant shoppiness with our largest advertising partner, which is Google. Now, while Google's overall advertising business is doing fine, The specific area of Google we partner with, which is called their search partner network, has underperformed the rest of the Google business. Because we are closely tied to the search partner network, choppiness within this business line at Google has translated into underperformance on our marketing-driven businesses. That said, and I'll go into this later, we are optimistic that our businesses tied to Google will return to growth in 2025. On the technology side, we continue to see returns from our continued investment in our Ramp platform as we integrate AI deeply into Ramp. We were able to create and launch new marketing campaigns faster and more efficiently, and our product and engineering teams are moving faster than ever. And on our expense side, our focus on reducing OpEx continues, and we're having a positive impact with OpEx decreasing 5% sequentially. All right, let's get into some of the business details, starting with our owned and operated businesses. Total owned and operated revenue was $71 million, up 7% year-over-year, but down 9% from last quarter. Adjusted gross profit was $26 million, up 11% year-over-year, and down 4% from last quarter. The sequential revenue and gross profit declines were caused by a decrease in advertising spend of approximately $5.5 million. Although advertising spend declined, sessions on our O&O properties were over $2 billion, up 125% year-over-year and up 3% from last quarter. RPS and CPS both decreased from the second quarter, making it the third consecutive quarter of declines in these metrics. This trend is driven by lower cost-per-click rates in the United States, as well as a mixed shift towards international markets, which also have lower monetization rates than the U.S., In Q3, international revenue represented 35% of owned and operated revenue compared to 24% in Q3 of 2023. The spread between RPS and CPS in Q3 was 1.3 cents or 59% compared to 1.4 cents or 55% in Q2. Overall, I am pleased that we have been able to scale our international efforts quite a bit. But unfortunately, this was offset by a decline in our domestic marketing-driven businesses. In Q3, we launched over 12,000 new marketing campaigns and over 50% increase from Q1 of this year. The investments in RAMP are paying off and enabling us to greatly increase our launch throughput with campaign launches increasing every quarter this year. As I mentioned, our O&O products continue to perform really well and in Q3 generated approximately 29% of total O&O revenue and 75% of our O&O gross profit. Coupon Follow has continued to have a strong year following a series of Google search algorithm updates that started in May and that benefited the promo code and couponing sites with the best technology. In Q3, Coupon Follow experienced a 47% sequential and 108% year-over-year increase in organic sessions to its website, and the number of users of our promo code browser extension has more than doubled. StartPage, our private search engine, continues to execute well and grew user sessions 22% year over year. In addition, we recently completed the rollout of our private browser app by launching the Android version, which joins our iOS version we rolled out in Q2. So far, we have seen significant downloads and engagement with more than 200,000 downloads across Android and iOS. And on MapQuest, we saw 15% growth year-over-year in user sessions and recently have seen the highest usage of our MapQuest mapping service since we acquired the business in 2019. I should add a little perspective to this accomplishment. When we acquired MapQuest from Verizon in 2019, it was a 23-year-old brand in serious decline. And on the Internet, it is highly unusual and very difficult to resuscitate a brand and bring it back to life. Our MapQuest team has not only injected new life back into MapQuest, we are seeing record usage days and are rolling out new innovative products such as our new private maps app. Overall, our organic products give us a significant hedge against the recent volatility we've seen in our marketing-driven O&O business. Because this business has been so choppy the last several quarters, I thought it would be useful to get into more detail as to the causes. At the highest level, our marketing-driven businesses are driven by two factors. The cost of buying traffic on our buy side and the amounts we receive for monetizing that traffic with advertisers on our sell side. For the last four quarters or so, our buy side costs at our traffic sources like Meta, Google, and programmatic display networks have been relatively stable and in some cases increasing as the overall advertising market rebounds. Our integration of AI into our Ramp platform has enabled us to scale our campaign launches on the buy side, and our bidding algorithms have become increasingly sophisticated. I'm really pleased with all the work we have done to scale our buy side efforts. Now, in contrast, the sell side has been the root of almost all of our marketing business-related issues. To understand those issues, it's important to remember that much of our sell side revenue is derived from Google, and specifically the Google Search Partner Network I refer to as SPN. The SPN is comprised of non-Google-owned websites and search engines that show Google advertising, and it's distinct from Google.com or YouTube or other Google properties. Google specifically calls out the SPN segment in its earnings. If you look at Google's financial results, which I'm sure many of you do, you will see that SPN has remained largely flat while the rest of the Google business has climbed. System One is a very large participant in the SPN via our publishing network, and much of our marketing revenue is generated by purchasing advertising on ad networks like Meta and sending that traffic to advertisers via the SPN. Our core issue related to the SPN is that we have seen large fluctuations in what Google pays us for traffic we send to the SPN. There are several reasons for this. But the most important one is that Google has been making significant efforts to improve conversions for advertisers who advertise on the SPN. These efforts include policy changes, improved screening of traffic quality, and significant product improvements. The efforts are critical to maintaining the health of the ecosystem because the traffic that flows through SPN has to convert for advertisers who advertise on the network. While Google regularly makes pricing adjustments and product changes to ensure high traffic quality, its efforts have ramped up considerably in the past year. Now, System 1 applauds Google's efforts and is one of Google's largest and highest quality partners. We have been at the forefront of working with Google to improve the quality of the SPN. Unfortunately, as Google rolls out product updates designed to improve the overall network quality, The immediate effect is volatility that impacts all partners, including System 1. Now, as the cadence of the product updates has increased, it has been challenging even for the higher quality partners like System 1 to keep pace and adjust. Now, fortunately, All of these efforts appear to be having the desired effect of increasing traffic quality, which in turn means that advertisers will benefit more, which ultimately will increase advertising rates paid by advertisers in the long term. As the Google Search Partner Network rebounds, we believe System 1 is well-positioned to benefit. We've invested heavily in RAMP, including leveraging AI and machine learning processes for real-time traffic quality detection. In addition, we have always worked closely with our network partners to make sure that we are preserving advertiser trust while maintaining a quality user experience. In short, the more Google focuses on its efforts to maximize value to consumers and advertisers, the more System 1 will benefit. Now, moving on to our partner network business. Partner network revenues was $18 million and adjusted gross profit was $13 million. Revenue decreased 17% year over year, but was up 5% sequentially. Adjusted gross profit decreased 5% year over year and 3% sequentially. Total sessions were $2.3 billion, up 159% year over year, and up 13% sequentially. Partner network RPS declined 68% year over year and 7% quarter over quarter. The higher sessions and lower RPS were driven by the same trends that we saw in our O&O marketing business. lower domestic pricing, and a bigger mix shift to international markets. In Q3, average revenue per partner increased 7% versus the second quarter. Total active partners decreased slightly from Q2 to approximately 290 partners. At the end of Q3, we had 58 scale partners in line with second quarter. We consider platform customer to be a scale partner when they are generating at least $50,000 of revenue per quarter on ramp. Now, like our O&O marketing business, our partner network is dependent on the strength and steadiness of the Google Search Partner Network, and therefore is subject to the same dynamics I outlined above. Similar to our O&O marketing business, as the SPN rebounds and pricing increases, we expect that growth in our partner network will follow. Overall, I'm really pleased with our performance in the third quarter. Our team has been executing well. Certain parts of our business are exceeding our expectations. and we are well positioned for growth in the areas that remain challenged once the ESPN steadies. Our product and engineering teams are executing well, we're doing more with fewer people, and we remain tightly focused on controlling OpEx. We aren't yet where we want to be, but things are moving in the right direction. In light of the ongoing volatility in the marketplace that I highlighted earlier in my comments, we've decided to not provide guidance for Q4 at this time. If we see improvements in stability, we may revisit the possibility of offering guidance later in the quarter. Now, to close my section of the call, as always, I would like to remind you that management is the largest shareholder group in System 1, and our interests are very aligned with yours. As our business gets back into growth mode, we're excited to have you along for the ride. And now I'll hand things off to Triti to discuss our quarterly results in more detail. Thanks a lot, Triti.

Take it away. Thanks, Michael. Overall, we are very pleased with our third quarter financial results, where we came in at or above the high end of our guidance for all of our key financial metrics, with the highlight being our $10.3 million of adjusted EBITDA, representing year-over-year growth of 28% and quarter-over-quarter growth of 4%. Now, on to our operating results. Q3 revenue was $88.8 million, representing a 1% year-over-year increase and sequential decline of 6%. Revenue was $800,000 above the high end of our Q3 revenue guidance range that we provided in August. Owned and operated advertising revenue was $70.8 million, up 7% year-over-year but down 9% sequentially. Our owned and operated results were primarily driven by our products businesses, which generated $20.7 million in revenue, up 31% year-over-year and 16% sequentially. Network revenue was $18 million, down 17% year-over-year but up 5% sequentially. Adjusted gross profit was $37.7 million, up 1% year-over-year and down 3% sequentially. Adjusted gross profit was above the midpoint of guidance by $700,000. Revenue-less advertising spend for our owned and operated advertising segment declined 4% sequentially to $26.4 million. Specifically for our owned and operated product businesses, revenue-less advertising spend was $20 million, up 35% year-over-year and 16% sequentially. Network revenue less agency fees was $13.1 million, down 3% from Q2 and down 15% sequentially. Owned and operated cost per session and revenue per session were both down sequentially to $0.02 and $0.03 respectively. On the network advertising business, RPS was a penny per session. Most importantly, total sessions processed by RAMP in the most recent quarter was $4.4 billion, up 142% year-over-year and 8% sequentially. In general, this quarter made it apparent how the diversity of our business lines are a real asset to the overall business, as the organic nature of our products businesses served as a strong bulwark against the choppiness of the paid advertising markets. While we have seen significant volatility on our marketing-driven businesses, resulting from sell-side product and policy updates, our core product utilities, such as mapping, private search, and coupons and promo codes, provide us the opportunity to sidestep this volatility and continue to attract users that we can then monetize, which also allows our ramp platform to continue to generate gross profit and adjusted EBITDA for the company. On to operating expenses and EBITDA. In Q3, operating expenses net of ad backs were $27.3 million, down $1.5 million quarter-over-quarter and down $1.8 million year-over-year. As I have stated continuously throughout this year, we have been working hard to reduce our operating expense structure over the last year, and we expect to continue to drive sequential cost savings on a quarterly basis for the foreseeable future. Adjusted EBITDA was $10.3 million in Q3 versus $8.1 million in the same quarter last year. Adjusted EBITDA came in above the high end of our Q3 guidance range by $300,000. We are extremely proud of our ability to generate sequential growth in adjusted EBITDA despite a slight sequential decline in adjusted gross profit. With respect to liquidity, we ended the quarter with $69.1 million of unrestricted cash on our balance sheet and an outstanding balance of $285 million of term loan debt under our credit agreement. Our net leverage at quarter end was approximately seven times. Per Michael's earlier comments, given the current volatility in the marketplace, we have decided not to provide financial guidance for the quarter at this time. The uncertainty in market conditions makes it challenging to offer an accurate outlook, especially during the seasonally strong Q4. However, should we observe a stabilization in the overall market environment and pricing dynamics, we may consider issuing guidance at a later time during the quarter. While we remain focused on navigating these conditions in the short term and remain confident in our ability to seize on our long-term opportunities, we are committed to achieving financial outcomes that demonstrate our operational success. Thank you for joining us today.

Thank you, Trudy. We're now going to open the line for some questions. On the line is Tom Forte from Maxim Group. Tom, go ahead with your question.

Great, thanks. So, Michael, you did an amazing job explaining a lot of the things that are going on. So let's start with MapQuest. What have you done that's enabled you to essentially resurrect the brand, and what gives you confidence that you can continue to grow it on a go-forward basis?

Yeah, thanks, Tom, and thanks for joining. So on MapQuest, when we took it over, it must have been more than four or five years ago from Verizon – It was really a brand decline. Verizon wasn't investing in it, wasn't adding features to it, wasn't making the mapping better. All the kind of, you know, nuts and bolts, blocking and tackling you need to keep a consumer brand going. When we took it over, we essentially took over the technology. It took us a couple years to move it onto our technology stack and then really basically just started adding features to it that we thought customers would like. We added a lot more what are called points of interest, so a lot more descriptions about places people are trying to travel to. And we switched technology providers over to here. We've got a lot of other data sources that we've been adding to it. We've been improving the mobile apps that people use, truly all the things that will bring customers on board. And a lot of that has resulted in more direct users coming, but also more people finding us through search engines as well. People are going and typing in addresses and MapQuest is showing up because it's such a well-known brand and such a good experience. Going forward, Tom, we just launched a new private mapping app. So you can now, unlike using things like Google Maps and Apple Maps that gather a lot of your data, you can now drive to the places you want in privacy and no one will know where you're going. But things like that, when we're going to start rolling out subscription products related to MapQuest, you know, and it's all paying off. You know, this quarter we've had a few weeks ago our highest traffic day ever since we acquired the brand from Verizon. So, you know, I guess just to summarize, we're just doing what we always do when we buy companies, which is, you know, make the products better.

Then my next question is, on the industry itself, you did a wonderful job explaining what's going on with kind of a specific – Google product, but does it help you essentially that the digital advertising market, there should be a lot less emphasis now that the election is behind us and that sort of thing. So I know that you're withholding guidance due to a lack of visibility in the ad market, but is it beneficial to you that advertisers essentially focus more on goods and services and less on candidates?

Yeah, so specifically where the election being over should help us is on the buy side. So when we're buying ads on places like Facebook, you know, we're competing with every advertiser out there. And the more, you know, election-focused advertising spin that comes on board, it's just more advertising competition. When that pulls back, it'll kind of look like a more normal marketplace. And so we would expect to, you know, pay a little bit lower price. And we haven't seen it. I haven't looked at the data in the last day or so. So I can't tell you for sure, but I would suspect that we'll see pricing kind of normalize a little bit from the burst over the last, you know, four to six weeks. The specific reason why we're withholding guidance is not really volatility in the overall advertising market, but specifically the next six to seven weeks are really where, you know, you would expect to see a couple things happen. The buy side will go up, so our costs on buying traffic should go up because there's a burst of advertising activity related to, you know, the holiday season. And then on the sell side, so we're pretty confident we'll see some increased costs on the buy side. Typically what would happen is we'll offset that with increased better pricing on the sell side when we're selling to Google. Because the Google search partner network has been pretty volatile, as I outlined in my remarks, we're not, you know, we don't have 100% confidence that we'll see that increase that we would expect. So far, everything looks okay. But, you know, because the next six weeks are so important, we thought it would be more prudent to kind of not promise any numbers until we had a pretty good idea what they were going to be.

All right. So then last one for me, and then I'm going to hand it off to Dan. So RAMP is an amazing technology. You were early in leveraging artificial intelligence. I was curious if you have many adjustments to RAMP. that make it more effective today than maybe it was last quarter or last year?

So the pace of product improvements we're making to ramp is pretty remarkable. I know that a lot of companies have been talking about AI. It's really been the buzzword for the past year, year and a half. As I mentioned, some of the early use cases for AI that have been really, really effective have been in the advertising space. So we talk a lot about being able to create better content using AI, which we have been able to do. We're using it to create our content with editors looking over the results and making sure that what we're publishing is truthful and authentic. But then on the advertising creative side, the ability to produce entertaining, engaging ads that people will click on has gone up dramatically. you know, by at least an order of magnitude on our side in terms of ease of producing those. And, you know, I think it's going to end up being a couple orders of magnitude. So, yeah, to answer your question, since last quarter, yeah, we've been making, you know, continual improvements in the platform. And I expect every quarter over the next, you know, year or two, we're going to see dramatic improvements. So our platform is much better. much more automated, much more scalable. You're not yet seeing in our numbers primarily because of the reasons I outlined in the earlier remarks.

Great. Thanks, Michael. Thanks, Trudy. Good luck in the fourth quarter.

Thank you. Thanks, John. Thanks for joining.

The next question is from Dan Kernels from the Benchmark Company. Dan, go ahead with your question.

I hope you guys can hear me. How you guys doing? Obviously crazy night tonight. So I'm going to try, Michael, to ask my best here and hopefully not go over something you've already said. But a couple of things I wanted to actually follow up on one of Tom's questions. Just given the change in administration, A, I'm curious if you have an opinion on, you know, I know there haven't been remedies yet in the ad tech trial, but I'm curious what you think that might mean for kind of Google and the ecosystem. And then secondarily, you know, I think there's a view that there might be, I don't know, let's call it a reinvigorated lower end of the consumer given the recent change in administration as well. And so what that might mean either for ad spend and or for kind of couponing as we head into the holiday period.

So, okay, a few questions in there, Dan. Thanks for joining. Appreciate it. Always good to talk with you. So I can't really speak – To what would happen, what's going to happen on consumer spending, it's kind of hard to tell. You know, I don't really know. I don't think anybody knows what will happen with the potential change in administration. I've seen a lot of speculation what could happen to interest rates going up or down, you know, but I don't want to speculate anything there. Specifically as related to kind of a lot of the ongoing antitrust trials, The change in administration could have a pretty big effect on that. I'm not an expert in this area, but my understanding is that a lot of the groups which brought the antitrust trials against Google and some of the other large technology companies, potentially you're going to see less focus on antitrust. I know there's been some speculation on that as well. As far as it relates to Google specifically, again, I don't really know what's going on behind the scenes. I don't think anybody does. I guess my understanding was that the new administration has been a little bit antagonistic to Google. So, you know, you might expect that Google won't get a lot of relief there. But on the flip side, you know, for all I know, you know, there could be plans to even drop cases against Google. So I think until that becomes a little bit more clear, it's a little tough to speculate. I would say that with the change administration, it does seem pretty, it doesn't seem like a bad thing for Google on the antitrust front. I'm on the trial side. The one area that you and I have talked about, which I'm wildly curious to see what happens is, um, I believe the tick tock, uh, you know, the tick tock ban is coming up here in like two, three months. And, um, My understanding is that at least within the new administration, there's some conflicting views on whether that should take effect. Now, if I recall correctly, I believe that was a law that's passed, so I don't actually know if, you know, the law could be ignored. But I'll be wildly curious to see what happens really to TikTok because that would have a pretty dramatic effect on the – not really on our business. We don't do a ton of business with TikTok domestically. But on the overall advertising marketplace, if TikTok either stays in or goes out, you're going to see some – pretty dramatic changes.

Yeah, I mean, I just like I know it seems kind of higher level, but I just bring it up because you guys tend to thrive in sort of disrupted marketplaces. And so to the extent like, you know, if we get into December, and all of a sudden, there's just a vacuum because we're post political, and nobody has any idea how much to spend, or what to spend it on. Or if we end up having kind of changes to the ecosystem, I'm just, you know, How ready are you guys to capitalize on that kind of stuff? You know, do you anticipate disruption? And frankly, Michael, I mean, you gave me the good segue to the question I always ask you every call, which is, it's true, you don't do TikTok domestically, but you do do it very well internationally. And we continue to hear kind of a recovery abroad. And so just curious, you know, what you're seeing there and how that's impacting the business.

Yeah, so to your first question, absolutely. When there's disruption in markets, that's where we thrive, and so we would welcome disruption. We'd welcome, you know, advertising spend pullback from the rest of the advertisers. We'll for sure step in and take advantage of that if it happens. On the TikTok side, no, we're seeing continued strength internationally working with them, been impressed with the team that we work with there. And we're a big enough advertiser at this point where we have a large team from TikTok working with us, and we'll do all-day meetings with them. They've been quite responsive on the product side. In some cases, we need some bespoke technology built for us, and they've been great at doing that. So we're seeing continued strength there, and I don't expect that to change internationally via TikTok.

Yeah, and Dan, this is Trey again. Nice to talk to you. International remains a bright spot for us as well. So, you know, Michael mentioned in his remarks, you know, 35% in owned and operated revenue in Q3 versus 24% last year. So, again, to your point, an area of real growth for us, albeit at kind of lower RPSs, just given rates internationally versus domestic.

Yeah. I think, Dan, you mentioned promo codes and couponing. Yeah, we would expect that. As we see every year, holiday season is going to be a strong one for coupon follow. You know, we for sure see a burst of activity that pretty closely mirrors shopping trends domestically where, you know, our strength on coupon follow is domestic.

Yeah, we're hearing about a pull forward and a shift to e-com this year. So I think that would probably benefit you guys. I guess we'll see. how that plays out. I guess I'll probably leave it there. I would love to ask you guys about new product launches and what they're going to contribute to the P&L. But since we don't have Q4 guide, I don't think I'll get much of an answer at this point. So I appreciate it. Thanks for all the color guys. And good luck. And good job on Q3.

Thanks for joining. Appreciate it. Always good to talk with you.

We know we're now going to turn it back to Michael blend for closing remarks.

Okay, thanks, Kyle. Thanks, everybody for joining. I'm happy that we had a quarter in which we could fulfill our guidance for all the investors out there. Thanks for following us, and we look forward to speaking with you next quarter. Thanks again.