System1, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. The 2022 merger created predecessor and successor reporting periods, so some year-over-year comparisons are not directly comparable.
Business context and reporting period
System1 operates an advertising customer-acquisition platform (RAMP), including owned websites and a partner network, and sells antivirus and related subscriptions through Protected. It reported three segments: Owned and Operated Advertising, Partner Network, and Subscription. Protected had approximately 2.8 million active subscribers at quarter-end.
Financial performance and liquidity
| Metric | Q2 2023 | Comparable Q2 2022 |
|---|---|---|
| Revenue | $147.2 million | $219.8 million |
| Operating loss | $36.4 million | $31.1 million |
| Net loss | $44.2 million | $33.8 million |
| Net loss attributable to System1 | $35.2 million | $25.7 million |
| Basic and diluted loss per share | $0.38 | $0.29 basic; $0.33 diluted |
| Adjusted gross profit | $60.3 million | $73.6 million |
Revenue fell 33% year over year. Cost of revenue was 64% of revenue, compared with 69% a year earlier; adjusted gross profit was about 41% of revenue, versus 33%. Operating loss was about 25% of revenue, versus 14%. Interest expense increased 69% to $12.3 million, primarily due to higher interest rates.
Revenue by segment: Owned and Operated Advertising fell 51% to $77.3 million; Partner Network rose 3% to $19.6 million; Subscription rose 18% to $50.3 million. Owned and Operated Advertising’s decline reflected weaker advertiser and consumer demand, fewer sessions, and lower revenue per session. Subscription growth reflected subscriber growth, renewals, and higher prices.
For the six months, revenue was $315.1 million, down 28% against the combined 2022 predecessor and successor periods. Net loss was $87.3 million. Operating cash flow was positive $1.4 million, compared with $8.3 million used in the 2022 successor period; the merger makes historical comparisons less straightforward.
At June 30, cash and cash equivalents were $8.6 million, with an additional $17.6 million of restricted cash. Current assets were $95.1 million and current liabilities $209.9 million. Debt carrying value, net of discounts and issuance costs, was $407.0 million; principal outstanding was $375 million on the term loan and $50 million on the revolving facility. The company also reported a $5.0 million related-party loan. Quarterly principal and interest payments were approximately $15 million.
Material changes, outlook, and risks
- Management reported that worsening macroeconomic conditions had reduced advertiser and consumer demand. After quarter-end, increased customer-acquisition costs and the loss of a Network Partner further weakened cash forecasts and could affect leverage-covenant compliance in the second half of 2023.
- The filing states that these conditions raise substantial doubt about the company’s ability to continue as a going concern for the twelve months following issuance. Cost reductions were underway and management was considering strategic alternatives, including new equity or debt and incremental financing, but had no definitive plans or agreements. The company warned that, without improved performance or successful financing and other measures, it could lack cash to fund operations by year-end.
- As of the filing date, $10 million remained available under a $20 million related-party revolving note. The note carries interest at SOFR plus 3.15% and matures in July 2024, subject to automatic extensions.
- The company said it was in covenant compliance when it filed. Separately, it had missed the deadline to deliver audited 2022 financial statements, resulting in an event of default on June 1; it delivered the statements on June 5 and cured the default.
- Advertising partner concentration remains significant: Google represented 55% of Q2 revenue and 60% for the first half. Google and Yahoo accounted for 65% and 13%, respectively, of accounts receivable at quarter-end.
- Disclosure controls and procedures were ineffective at June 30 due to unremediated material weaknesses in financial reporting, including weaknesses involving acquisitions, complex instruments, accrued liabilities, goodwill, financial reporting processes, and IT controls. Prior-period restatements and adjustments are described in the filing.
- The company committed to spend $15 million on a multi-year web-services agreement; $14.1 million remained committed at quarter-end. It also settled a trademark lawsuit in June, with a fixed payment over 17 months; the accrued amount was described as immaterial. A warrant holder’s demand alleged approximately $5.7 million in damages; the company denied liability and had not accrued a loss because it was not reasonably estimable.
- No quantitative goodwill impairment assessment was required in the first half of 2023 and no impairment was recorded then. The filing describes substantial goodwill impairments in 2022 and warns that deterioration in assumptions could lead to future impairment.
The filing provides no formal financial guidance. Management’s outlook is qualified by the going-concern uncertainty, weaker demand, higher acquisition costs, partner loss, and potential covenant pressure.
Important facts for investors to verify
- Liquidity runway, planned cost reductions, and whether additional financing or other strategic measures are secured.
- Updated cash forecasts and compliance with the term-loan leverage covenant after the post-quarter customer-acquisition cost increase and Network Partner loss.
- Revenue trends by segment, particularly Owned and Operated Advertising sessions and revenue per session, and Subscription acquisition costs and retention.
- Progress remediating material weaknesses and the reliability of future financial reporting.
- Terms and cash timing of debt service, the related-party note, incentive-plan payments, the web-services commitment, and legal matters.