System1, Inc. — Form 10-Q Summary
Business context and reporting period
System1 operates an omnichannel customer-acquisition and advertising platform (RAMP), owned websites and a subscription antivirus business through Protected.net. The quarter ended March 31, 2022 straddled the January 26, 2022 merger: results through January 26 are reported as “Predecessor” (S1 Holdco), while January 27–March 31 results are “Successor” and include the combined company. Accordingly, the reported periods are not directly comparable. System1 also acquired RoadWarrior and CouponFollow during the quarter.
Key financial metrics
| Metric | Successor period: Jan. 27–Mar. 31, 2022 | Predecessor period: Jan. 1–Jan. 26, 2022 | Q1 2021 comparator |
|---|---|---|---|
| Revenue | $166.1 million | $52.7 million | $147.6 million |
| Operating income (loss) | $(35.8) million | $(40.0) million | $10.9 million |
| Net income (loss) | $(38.1) million | $(40.5) million | $6.7 million |
| Net loss attributable to System1 / per share | $(30.0) million / $(0.36) | Not applicable | Not presented on a comparable share basis |
| Adjusted gross margin | $53.4 million | $12.2 million | $40.3 million |
| Operating cash flow | $(26.2) million | $(10.5) million | $10.1 million |
| Investing cash flow | $(428.9) million | $(0.4) million | $(1.4) million |
| Financing cash flow | $(12.1) million | No cash flow reported | $(6.6) million |
Successor-period revenue comprised $130.3 million Owned and Operated, $8.0 million Partner Network and $27.9 million Subscription. Adjusted gross margin was approximately 32% of Successor-period revenue. Operating and net loss margins were approximately 22% and 23%, respectively. These ratios describe only the post-merger period.
At March 31, 2022, cash and cash equivalents were $42.2 million and restricted cash was $7.9 million. Current assets were $161.5 million versus current liabilities of $225.2 million. Notes payable were $424.6 million on the balance sheet; debt principal excluding fees was $449.0 million, including $49.0 million drawn on the revolving facility. Total liabilities were $831.3 million. The company reported total equity, including non-controlling interest, of $829.7 million.
Material changes versus prior comparable period
- Reported Successor revenue included Protected’s $27.9 million subscription contribution. Management attributed Owned and Operated revenue growth in the relevant comparison to 234 million additional sessions with revenue per session flat. However, merger timing and acquisitions make reported periods non-comparable.
- For the three months ended March 31, 2022, user-acquisition costs were $138.1 million, driving 975 million sessions at $0.14 cost per session; the filing compares this with $107.3 million, 741 million sessions and $0.15 per session in Q1 2021.
- Successor-period costs included substantial merger-related and share-based compensation effects. Share-based compensation was $27.2 million in the Successor period and $27.7 million in the Predecessor period; amortization rose following merger-related intangible-asset recognition.
- The company recorded a $13.8 million non-cash loss from remeasurement of warrant liabilities. The merger and acquisitions also substantially increased goodwill and intangible assets; goodwill was $907.0 million at March 31.
- Unaudited pro forma figures, assuming the merger and specified acquisitions occurred at the start of each comparative period, show revenue of $236.0 million for Q1 2022 versus $193.2 million for Q1 2021, and net loss of $32.8 million versus net income of $88.7 million. Management cautions that these figures are not necessarily indicative of actual or future results.
Outlook, risks, contingencies and unusual items
- No formal revenue, earnings or cash-flow guidance is provided. Management expects salaries, commissions, benefits and general and administrative costs to increase in absolute dollars as the company invests in infrastructure and supports growth.
- Debt carries variable rates: the term loan is priced at adjusted Term SOFR plus 4.75%, and the revolver at adjusted Term SOFR plus 2.75%. Management estimated that a one-percentage-point rate change would alter annual interest expense by approximately $4.5 million. Quarterly principal amortization begins June 30, 2022; a springing leverage covenant applies if revolver utilization exceeds 35%.
- Google and Microsoft accounted for 73% and 3% of Successor-period revenue, respectively. Google contracts extend through February and July 2023; Microsoft’s contract was month-to-month while the parties worked on a longer-term renewal. The partners may terminate under certain circumstances. Google and Yahoo represented 73% and 9% of receivables at quarter end.
- Management states it expects to meet scheduled debt payments, but also says additional financing may be needed if existing resources and sales growth do not fund future needs; additional financing may not be available on favorable terms or at all. Operating cash flow was negative in the Successor period.
- The company identified continuing material weaknesses in internal control over financial reporting and concluded disclosure controls were not effective as of March 31. Weaknesses included staffing and segregation of duties, acquisition accounting and valuation, accrued liabilities, accounting policies and IT general controls. Remediation was ongoing and had not been validated over sustained reporting cycles.
- A U.S. trademark-infringement lawsuit concerning the SYSTEM1 name remained pending; the company said it intended to defend itself. Management said ordinary-course legal matters were not expected to materially affect results, while acknowledging outcomes cannot be assured.
- Other notable items: CouponFollow was acquired for cash and stock, with additional service-conditioned and performance-contingent payments; RoadWarrior was acquired for cash and contingent consideration. The company recorded no Tax Receivable Agreement liability because potential tax savings were uncertain. Subsequent to quarter end, Answers.com was acquired for $4.6 million; warrant exercises also generated $5.0 million of cash proceeds through May 10.
Important facts for investors to verify
- Review the post-merger operating trend using comparable pro forma results, and separate acquired-business contributions from organic growth.
- Track cash conversion, working-capital movements, restricted-cash availability and the funding required for debt service and planned investment.
- Confirm term-loan and revolver balances, variable-rate exposure, covenant headroom and upcoming amortization requirements.
- Monitor renewal or replacement of key advertising-partner agreements and changes in revenue and receivables concentration.
- Assess the progress and independent testing of the disclosed control-remediation plan, including acquisition accounting and IT controls.
- Follow final purchase-price allocations, contingent or service-conditioned acquisition payments, warrant dilution and the pending trademark litigation.