Transcript
Thank you for being here. My name is Joe, and I will be your conference operator today. I would like to welcome everyone to the System1 Second Quarter 2024 Earnings Call. All lines have been muted to avoid background noise. After the speaker's comments, we will have a question-and-answer session. I will now turn the conference over to Kyle Ostgaard, Vice President of Finance. You may begin.
Thank you for standing by, and welcome to the second quarter 2024 conference call for System1. Joining me today to discuss System1's business and financial results are Co-Founder and CEO, Michael Blend; and our Chief Financial Officer, Tridivesh Kidambi. A 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 make 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 included in our annual report on Form 10-K for the fiscal year 2023 filed on March 15 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 System1 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 System1's Co-Founder, Chief Executive Officer, Michael Blend.
Thanks, Kyle. Good afternoon, everyone, and thanks for joining us on our Q2 2024 System1 Earnings Call. We have a positive update for you today. I'm happy to announce that System1 delivered financial results which exceeded the high end of guidance across our key financial metrics. System1 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 RAMP platform, very strong international growth, significant progress in our owned and operated products, and a tight focus on reducing operational expenses. 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. 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 mix shift towards international markets, which naturally have lower monetization rates. Now, international growth continues to be a highlight, with international revenue representing 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 efficiently create content and advertising creatives in multiple languages. For example, when we're seeing an opportunity like engineering jobs in India or checking accounts in the U.K., we can very quickly capitalize on the opportunity. Our owned and operated products had another strong quarter with continued favorable organic traffic trends on both CouponFollow and MapQuest. In May, CouponFollow benefited from a Google search algorithm update aimed at eliminating spamming coupon and promo websites from Google Search results. This was a long overdue and welcome change, greatly benefiting consumers and enhancing CouponFollow's positive boost in site traffic and corresponding revenue. June organic sessions were up nearly 80% year-over-year. While MapQuest saw similar growth, with Q2 organic visits up 10% year-over-year. We've been focused on improving the customer experience in both MapQuest and CouponFollow, and it's gratifying to see the dividends with increased users and revenue. Startpage, our private search engine, also had a productive quarter, launching our private browser app and seeing over 50,000 downloads with significantly positive user feedback, including over 2,000 five-star ratings from our iOS and Android app users. We are optimistic about the browser for loyal Startpage users and hope to market them profitably 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 continue to add partners to the network. Despite the revenue decline, our Partner Network business continued to show solid market demand, with total active partners growing 19% to almost 300 partners. Average revenue per partner decreased sequentially by 9%, as new partners onboarded this quarter continued to scale up. At the end of Q2, we had 58 scale partners in line with the first quarter. Before I hand things off to Tridi, I want to outline our key initiatives to drive System1's growth over the next few years. First, we are continuing to invest in our RAMP platform in three key areas. First, buy-side efficiency driven by AI; second, opening up our buy-side capabilities to our partners; and third, launching new products. I want to walk you through these in detail. First, let's talk about AI. As I mentioned previously, we've been hard at work integrating AI capabilities into RAMP. AI enables us to create advertising campaigns and associated content at a scale greater than we could have in the past. This scale, combined with our enhanced bidding and optimization algorithms, has allowed our advertising business to reach a size that few others can match. Maintaining RAMP and adding improvements requires a large engineering and product team laser-focused on AI integration, machine learning optimizations, and speed. Traditionally, our Network Partners relied on System1 solely for sell-side monetization. They manage their buy-side capabilities to purchase traffic and depend on System1 to monetize that traffic. By opening up our buy-side platform for our partners, we expect to enable many to scale far beyond their current capabilities. Additionally, we are integrating new monetization products into RAMP. Each of these products follows a similar pattern: we build a feature into RAMP, utilize our owned and operated properties to figure out how to scale, and then open it up to partners. Over the last year, our focus has been on launching a new product offering by managing Google-related search on content. This product requires sending high-quality traffic to highly tailored content. Google advertising has been integrated directly into the content. It took time, but now we have confidence that we can scale this new product. System1 is generating over seven figures of monthly revenue from it, and Google is pleased with the results as we roll it out to partners. The next two areas we plan to invest in are shopping and subscription products, which are huge consumer markets where we currently don't have scale. We may partner with large shopping-focused advertising networks, similar to our existing partnerships with Google and Yahoo!. We also operate two successful subscription products associated with MapQuest, and we've demonstrated our ability to scale subscriptions into the hundreds of millions of dollars of revenue. We've built RAMP to be flexible in supporting these new products with minimal increases in operating expenses or R&D. I also want to discuss our organic products specifically. Our earnings comments have traditionally focused on our marketing-driven businesses. While marketing can rapidly scale our business, it can also cause volatility, as seen in 2022 and parts of 2023. In contrast, our product businesses provide utilities that consumers seek out and use daily. For example, CouponFollow helps people find promo codes, Startpage enables private web searches, MapQuest provides alternative mapping services, and RoadWarrior assists delivery drivers. These products don't require marketing to generate usage, resulting in consistent revenues that are less tied to shifts in the overall digital advertising market. We plan to present these product lines independently from our marketing businesses starting with our upcoming reports. Overall, I am very pleased with our Q2 performance. Our team has executed well over the past year, and we are seeing this reflected in our financial performance. We aren't yet where we want to be, but we are heading in the right direction. To close my section, I want to remind you that management is the largest shareholder group in System1, and our interests are highly aligned with yours. We appreciate your support of our new equity plan tied to hitting EBITDA targets, and we are committed to achieving those targets. As our business transitions back to growth mode, we are excited to have you along for the ride. I will now hand it off to Tridi for a more detailed financial overview and our Q3 guidance.
Thanks, Michael. We are pleased with our second quarter performance and sequential growth trends highlighted by quarter-over-quarter adjusted gross profit growth of 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 from Q2 to Q3 of last year, we significantly narrowed our year-over-year declines across key financial metrics and even grew adjusted EBITDA, 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 a sequential increase of 11%. Revenue was $4.6 million above the top end of our Q2 revenue guidance that we provided in May. Owned and operated revenue was $77.4 million, flat year-over-year and up 12% sequentially. Network revenue was $17.2 million, down 12% year-over-year but up 8% sequentially. Adjusted gross profit was $38.8 million, 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 $0.02 sequentially to $0.02 and $0.04, respectively. On the Network Advertising Business, RPS was $0.01 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, these RPS and CPM trends were driven mainly by growth in lower RPS and CPS international traffic sources. I wanted to focus on our owned and operated products, which are primarily composed of CouponFollow, MapQuest, and Startpage. A key feature of these businesses is that they are not dependent on paid advertising for traffic and revenue but instead rely on organic traffic from direct navigation, unpaid referrals, and search engines. This provides diversification versus our paid advertising business. While they account for a smaller portion of our revenue—19% of total revenue and 23% of owned and operated revenue in Q2—they comprise a more significant portion of our gross profit, with 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 reorganized our corporate structure to better report the performance of our product businesses. Please review the 10-Q we filed earlier today for more information on this restructuring. From now on, we will provide information on the current and historical performance of these businesses in our supplemental financials. On operating expenses and adjusted EBITDA, in Q2, operating expenses net of add-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 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. We expect to drive even more cost savings in the second half of the year moving into 2025 and beyond. Adjusted EBITDA was $9.9 million versus $6.1 million last year, coming in above the high end of the Q2 guidance range by $2.9 million. As for 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 was approximately 7.5 times at quarter end. Although we have been executing well and avoided the volatility we experienced earlier in the year, uncertainty remains in the online advertising environment, so we will continue to provide quarterly guidance. Historically, Q3 has been relatively flat to down versus Q2, while Q4 has typically benefited from seasonal trends; we expect to see this pattern again this year. We estimate Q3 revenue between $86 million and $88 million, roughly flat year-over-year at the midpoint. We estimate adjusted gross profit to be between $36 million and $38 million, also flat year-over-year at the midpoint, but expect 150 basis points of gross margin expansion at the midpoint. We estimate Q3 adjusted EBITDA to be between $8 million and $10 million, up 11% year-over-year at the midpoint. We remain optimistic about our ability to execute both near-term and long-term opportunities and focus on delivering positive financial results. Thank you for joining us today.
Thank you, Tridi. We are now going to open the line for some questions.
Thank you. The floor is now open for questions. Your first question comes from the line of Daniel Kurnos of Benchmark Company. Your line is open.
Thanks. Good 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 Tridi following up on your commentary around historical seasonality. 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, what kind of contribution should we be expecting or over what time frame, whether it's back half of this year 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.
Dan, this is Tridi. So yes, I get the easy question there. So the 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 the advertising markets behave as we expected them to, kind of sequentially coming off of Q1 that held through Q2 and is ongoing into the first part of Q3 here. We haven't seen anything that would cause us concern across any specific verticals, even given the recent macro news.
Yes. Thanks, Dan. So in terms of the new initiatives, when Tridi talks about our Q3 guidance and also expecting the seasonal uptick in Q4, that would anticipate no contribution or very minimal contribution from any of our new efforts. The opening up of the buy side to our partners is ongoing, and we’re starting to onboard partners as we speak. We're not modeling in any significant contribution in 2024; however, we are confident that our buy-side platform is an improvement for most, if not all, of our partners, enabling them to scale substantially beyond their current operations. For shopping, we are just getting into market with one of our new partners and have early results that are promising, but we are not anticipating scale in the second half of the year. If it materializes in Q4, that would be an unexpected upside. We do anticipate having at least one subscription product in market in Q4; the first one is close to being complete and ready for testing. Again, to reiterate, we aren't modeling in any substantial contributions from these initiatives, but we will be entering the market with all three in the second 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 now that Google has decided not to deprecate third-party cookies anymore and they have no alternative solution in place at this point, it feels like the whole industry breathes a bit of a sigh of relief. So I'm curious how you think that will impact CPMs going forward, and what reactions you've seen from the industry?
Yes. We're not anticipating much of a change. We were expecting Q4 to be volatile if the cookie deprecation rolled out as planned. Obviously, that is no longer the case. Dan, I know we've discussed this before, and it doesn't surprise us that Google chose to delay this solution indefinitely. We've heard about market testing for some time, and they were unable to create a replacement that was competitive with current cookie solutions. What we're hearing now is that the solution being developed is becoming competitive on monetization but is technically complex to implement. Overall, we believe that the industry was likely more concerned about the effects than they indicated, and they are now feeling some relief.
Last for me, Michael, I'll step aside. I always ask you about international growth, and you highlighted it this quarter. So I'd love to hear if there are particular geographies you’ve been able to target or verticals internationally where you've had success, and how much that might contribute to accelerating growth in '25.
We're quite bullish on international growth. We've found considerable success in programmatic markets over the last couple of quarters. Our relationship with TikTok and their programmatic network, Pengo, is growing, and we're seeing it across nearly all international markets including Asia, South America, and parts of Europe. If current trends continue, we expect to see rapid growth in our international business, contributing more significantly to overall revenue. These trends are not expected to slow down, and we have tuned our platform to focus internationally. There are unique considerations for succeeding in the programmatic market, particularly internationally, but we believe we have those strategies refined and see substantial growth ahead.
There are no further questions at this time. I will now turn the conference back over to Michael Blend for closing remarks.
Okay. Great. Well, thanks, everybody, for joining us today. As we tried to make clear during our remarks, things are really starting to move in the right direction here at System1. Our team is executing well, our major customers are pleased, both on the partner side and on the revenue side, and we’re seeing stability in the digital advertising market, which we’ve aimed for over the last 1.5 years. Looking forward to Q3 earnings, and we are hopeful to share positive news then as well. Thank you for joining.
This concludes today's conference call. You may now disconnect.