System1, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. The unaudited statements report the post-merger “Successor.” Comparisons with 2022 are affected by the January 2022 merger and acquisitions; the filing combines separate predecessor and successor periods for certain comparisons, so results are not fully comparable. Dollar amounts below are in millions unless noted.
Business context
System1 operates an omnichannel customer-acquisition and advertising platform and sells antivirus subscriptions, primarily under TotalAV. At quarter-end, Protected.net had more than 2.6 million active subscribers. The company reported three segments: Owned and Operated Advertising, Partner Network, and Subscription.
Financial results and liquidity
| Metric | Q1 2023 | Prior-period context |
|---|---|---|
| Revenue | $167.9 | Down 23% versus the combined 2022 comparison periods |
| Operating loss | $(37.5) | Compared with $(76.1) across the combined 2022 periods |
| Net loss | $(43.1) | Compared with $(80.4) across the combined 2022 periods |
| Net loss attributable to System1, Inc. | $(34.0), or $(0.37) per share | Prior successor period: $(36.1), or $(0.44) per share; periods are not directly comparable |
| Cash used in operating activities | $(5.8) | Prior successor period: $(30.9); not directly comparable |
| Cash and cash equivalents | $8.3 | $24.6 at December 31, 2022 |
| Cash, cash equivalents and restricted cash | $21.7 | $39.1 at December 31, 2022 |
| Debt, net of discounts and costs | $410.8 | $414.5 at December 31, 2022 |
Cost of revenue was $120.4, or 72% of revenue; GAAP gross profit was $47.5. Adjusted gross profit, a company-presented measure, was $54.2, down 13% versus the combined 2022 comparison periods. Operating loss equaled approximately 22% of revenue. Net interest expense increased to $11.5 from $5.8 across the combined 2022 periods, primarily reflecting higher interest rates.
Cash used in investing activities was $2.4, including $1.7 of capitalized software costs; cash used in financing activities was $9.1, including a $5.0 term-loan repayment. Current assets were $97.5 and current liabilities $199.4, leaving negative working capital of approximately $101.8. Deferred revenue was $76.3. The filing does not provide a company-wide revenue or earnings outlook.
Material changes and management commentary
- Owned and Operated Advertising: Revenue fell 40% year over year on the filing’s comparison basis. Sessions increased from 975 million to 1.026 billion, but revenue per session declined from approximately $0.18 to $0.10. Management attributed the decline chiefly to weaker advertiser and consumer demand amid deteriorating macroeconomic conditions.
- Partner Network: Revenue increased 2%; sessions rose from 309 million to 448 million, while revenue per session declined from approximately $0.05 to $0.03.
- Subscription: Revenue increased 68%, reflecting subscriber growth, more renewals, higher prices, and a full quarter of results versus approximately two months in the prior-year comparison period.
- Google represented 64% of revenue and 74% of accounts receivable at March 31; Microsoft represented 2% of revenue. This creates significant partner and collection concentration risk.
- Intangible-asset amortization contributed to depreciation and amortization expense of $29.4, up 28% versus the combined 2022 comparison periods. No goodwill or intangible-asset impairment was recorded in Q1 2023. However, the company disclosed that prior 2022 goodwill impairments were substantial and that further deterioration in assumptions could prompt future impairment.
Guidance, risks, contingencies and unusual items
- Going concern and financing: Management disclosed substantial doubt about the company’s ability to continue as a going concern for the year following issuance, citing declining cash flows and performance. On April 10, 2023, the company entered a $20.0 million revolving note with trusts benefiting its co-founders; $15.0 million remained available as of the filing. Management said this financing, cash on hand and operating cash flows were expected to support operations for 12 months and alleviate the doubt. The note bears interest at SOFR plus 3.15%, includes a 1% annual unused-commitment fee and a 12% closing fee, and matures July 10, 2024.
- Debt covenant default, subsequently cured: The company missed a deadline to deliver 2022 audited financial statements, triggering a default and making $430.0 million of term-loan and revolving-facility principal callable under specified lender rights. It delivered the audit on June 5, 2023, curing the continuing default. The company stated it was in compliance with debt covenants as of the filing.
- Internal controls: Management concluded disclosure controls were not effective at March 31, 2023 because of multiple material weaknesses, including in staffing and segregation of duties, acquisitions, financial reporting, accrued liabilities and equity accounting, goodwill valuation, complex financial instruments and IT controls. The weaknesses had not been remediated; prior-period financial statements had required restatements.
- Legal matters: A trademark dispute was settled in June 2023, with co-existence terms and fixed payments over 17 months; amounts accrued at March 31 were described as immaterial. A warrant-holder demand alleged approximately $5.7 million in damages; the company denied liability and had not accrued a loss because it could not reasonably estimate one.
- The company recognized $7.5 million of Protected.net incentive-plan compensation in Q1. It also disclosed a remaining $2.2 million contractual service-spending commitment at March 31. No share repurchases occurred during the quarter.
Most important facts for investors to verify
- Whether operating cash flow and liquidity improve, and whether the related-party revolving note remains available on the disclosed terms.
- Current debt balances, covenant status, maturity and costs of the revolving note, and any subsequent financing or repayment developments.
- Trends in Owned and Operated Advertising revenue per session and dependence on Google and other major partners.
- Progress in remediating material weaknesses and whether future filings require adjustments or restatements.
- Developments in the warrant-holder claim, trademark settlement payments, and the valuation headroom supporting goodwill and intangible assets.