Earnings Call Transcript - SST Q4 2024

Operator, Operator

Thank you for standing by. And welcome to the Fourth Quarter 2024 Earnings Conference Call for System1. Joining me today to discuss System1's business and financial results are our Co-Founder and Chief Executive Officer, 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 2024 filed on March 10, 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 and Chief Executive Officer, Michael Blend.

Michael Blend, CEO

Thanks, Kyle. Good afternoon everyone and thank you for joining System1 on our Q4 2024 earnings call. We wrapped up the year with solid execution across the business. For the fourth quarter, System1 delivered $76 million in revenue and $45 million in gross profit. Adjusted EBITDA came in at $17.9 million, which was a 79% year-over-year increase. It is good to see our financial performance starting to reflect all the hard work and progress made by our team over the past year. Although we performed well overall, our strong results were primarily driven by our owned and operated products, with revenue increasing 30% sequentially from Q3 and 60% compared to Q4 last year. Our products like Startpage, MapQuest and CouponFollow show higher engagement benefiting from improvements in SEO, user experience and product expansion. In contrast, our marketing driven businesses continue to be negatively affected by fluctuations in our Google-related business. As I discussed during my remarks last quarter, we continue to see ongoing volatility due to changes enacted by Google in their Search Partner Network. These changes have the longer term goal of improving advertiser conversions and traffic quality. However, in the short-term, they continue to cause significant volatility and lower payments by Google to partners like System1. As Google pays out less for traffic, System1 makes corresponding adjustments to the amount we pay for traffic to ensure our marketing businesses remain profitable. Consequently, lower monetization from Google caused our advertising spend to decline 26% sequentially. Google has been implementing rapid changes to its Search Partner Network products over the last 18 to 24 months, and frankly, keeping up with these changes has been a challenging process for our team. That said, we remain steadfast in our Google partnership. We've continued to invest heavily in our RAMP platform, and we have strategically positioned ourselves for when the Google network ultimately rebounds. On the technology front, our investment in AI powered automation within RAMP has yielded promising results. It's been increasing efficiency and scale across all of our marketing operations. In 2025, we are strengthening our focus on AI integrations across all facets of RAMP and we expect to see continued improved efficiency. Now let's go into more detail on our owned and operated segment, which includes both our marketing driven businesses and our owned and operated properties. Total owned and operated revenue reached $65 million reflecting a 19% year-over-year decline and a 9% sequential decrease. This decline was driven by a 40% year-over-year revenue decline in our marketing businesses, offset by a 60% increase in our owned and operated products. While revenue declined, adjusted gross profit was up at $32 million. This marks a 20% year-over-year increase and a 21% sequential rise from the third quarter. The gross profit expansion despite a revenue decline highlights our ability to drive efficiency and margin growth within this segment as well as the higher gross profit margins of our owned and operated products. Sessions across our owned and operated properties totaled $1.9 billion, down 8% from Q3 due to reduced ad spend, but up 79% year-over-year. Our year-over-year growth reflects the increased scale of campaigns being run on RAMP, as well as growth in our own and operated products. International markets remain a key driver, with international revenue representing 36% of total owned and operated revenue, up from 26% in Q4 2023. In Q4, we launched over 22,000 marketing campaigns, a five-fold year-over-year increase. This significant increase in marketing campaigns simply would not have been possible prior to our embrace of AI. Our medium term goal for scaling marketing campaign launches is $130,000 per quarter, aiming for launching a new marketing campaign every minute of every day. While we are confident in RAMP's ability to scale, we are being limited by fluctuations in the Google SPN performance. One recent change made by Google is worth highlighting as it helps explain how Google's changes directly impact our business. A few weeks ago, System1 was informed by Google that they plan to automatically opt-out advertisers on a rolling basis from participating in their AdSense for Domains product known as AFD beginning later this month. The practical effect of Google's pending change is that AFD monetization is likely to materially decline, making it significantly more difficult to profitably send acquired traffic to AFD powered websites. This AFD change will be both a short-term negative and a medium term positive for System1. In the short-term, both our owned and operated and partnered network lines do substantial AFD related business, and we expect that business to decline as Google rolls out this change. On the flip side, Google is making this change to encourage adoption of its newer related search on content product, known in the industry as RSOC. Our company is well positioned to navigate this transition as we have been allocating significant resources into our RSOC efforts over the last 24 months. System1 is a leading partner with Google on this exciting product. While we believe System1 is among the best positioned in the market to navigate this change, Google's decision to opt out advertisers from AFD will likely cause significant business and product disruption. We are rapidly shifting our remaining owned and operated and partner network AFD businesses over to the newer RSOC product while also keeping pace with rapid changes Google is making to RSOC. Ultimately, we welcome this disruption as it aims to weed out bad actors from the ecosystem and ultimately is going to benefit technology driven companies focused on high quality consumer and advertiser experiences. While we expect the stormy weather will continue for a bit longer, we're looking forward to the sunny days ahead where we can return our focus on scaling our Google business back up. Now, let's move on to some highlights from our products group, which is on a stellar run. First, let's go ahead and start with CouponFollow, our leading coupon and promo code service. CouponFollow had a very strong holiday shopping season and a great fourth quarter, with the site continuing to perform well following Google search algorithm updates in 2024. Our focus on high quality user experience and delivering verified real time promotional codes continues to pay off. Organic sessions rose more than 20% sequentially from Q3, and sessions were up 129% year-over-year. In addition to our growth in site traffic, our browser extension users have more than doubled year-over-year. We have a strong momentum with CouponFollow; as our usage increases, we get better signals on which promo codes are currently effective for users. This enables a higher quality experience for users because the promotional codes that users try actually work. This, in turn, attracts more users and results in more data and so forth. As CouponFollow continues to scale, we are able to secure more direct deals with brands, which improves the accuracy of deals found on the platform. In 2025, we're going to aggressively capitalize on these trends, with a continued focus on improving the experience for both consumers and merchants. Now, I'm going to move on to Startpage, our privacy-focused search engine. Startpage continues to gain traction as global concerns around online privacy and data security show no signs of letting up. As regulations like GDPR in Europe and evolving U.S. privacy laws place greater emphasis on consumer data protection, Startpage is well positioned to provide an alternative to mainstream search engines. Startpage user sessions grew over 20% year-over-year as more users seek private search. Additionally, the private browser apps we launched last year have already garnered more than 200,000 downloads across both Android and iOS. As usage and revenues grow on Startpage, we will focus on adding features users expect when they transition from Google, Bing, or DuckDuckGo. We also intend to integrate AI into Startpage as a major focus in 2025. Lastly, let's talk about MapQuest. I'm pleased to share that MapQuest continues to see strong engagement, with user sessions growing more than 45% year-over-year. The demand for alternative mapping and navigation solutions remains robust, particularly as users seek more privacy-conscious and feature-rich alternatives. Our team has revitalized MapQuest by introducing new functionalities, enhancing our mobile experience, and optimizing local mapping capabilities. Recently, we launched Private Maps, which offers users enhanced control over their location data, and all these efforts are paying off, as the renewed MapQuest recently went viral on social media and received features on CNN and in segments by Stephen Colbert. Now, I'll move on to our Partner Network performance. Partner Network revenue was $11 million, and adjusted gross profit was $14 million, up 10% both year-over-year and sequentially. Our Partner Network results included an accounting revenue adjustment, which lowered both revenue and COGS and had no impact on gross profit. Excluding the adjustment, revenue was $18 million, reflecting an 8% year-over-year increase. In Q4, average revenue per partner decreased by 6% compared to the third quarter, while the number of active and scaled partners increased. Total active partners rose by 6% from Q3 to over 300 partners. At the end of Q4, we had 65 scaled partners, a 12% increase from the third quarter. We consider a platform customer to be a scaled partner when they are generating at least $50,000 of revenue per quarter on RAMP. Similar to our owned and operated business, our Partner Network team has had to navigate the rapidly changing Google landscape. The team has done an excellent job managing the volatility, and we are well positioned as we transition business over to the new Google RSOC product. Looking forward to the rest of 2025, we remain cautiously optimistic. Our owned and operated products continue to demonstrate strong fundamentals, and I am excited to expand on our core platforms in couponing, private search, and mapping. On the marketing side, our investments in AI-driven optimizations are positioning us for future growth, and I’m pleased we made the early decision to invest heavily in the new Google RSOC product. To close, I want to reiterate that System1's leadership team remains fully aligned with our shareholders, and we appreciate your continuous support as we transition back to growth mode and strive to deliver long-term value. With that, I'll hand it over to Tridi to go over our financials and provide Q1 guidance.

Tridivesh Kidambi, CFO

Overall, we are pleased with our fourth quarter financial results, with the highlight being our $17.9 million of adjusted EBITDA, representing year-over-year growth of 79% and quarter-over-quarter growth of 73%. For the year, we generated $38.6 million of adjusted EBITDA, demonstrating our ability to grow through a challenged marketplace. Now let's dive into our operating results. Q4 revenue was $75.6 million, representing a 21% year-over-year decrease and a sequential decline of 15%. Owned and operated advertising revenue was $64.7 million, down 19% year-over-year and 9% sequentially. The decrease in revenue is directly related to an $11.6 million sequential decline in advertising spend within the owned and operated advertising segment. Our O&O products business generated $27.1 million in revenue, up 60% year-over-year and 30% sequentially, as expected in a seasonally strong Q4. Our fourth quarter RPS was $0.03, in line with the third quarter and CPS was $0.017, down 20% from $0.021 in the previous quarter. As we lowered our advertising spend, we shifted towards lower CPS traffic sources. Overall, RPS and CPS were both down significantly year-over-year, as we have culled certain acquisition channels that had higher RPS and higher CPS. RPS was down 55% year-over-year and CPS was down 65%. The spread between RPS and CPS in Q4 was $0.017 or 98% margin, compared to $0.013 or 59% in Q3. Network revenue was $10.9 million, but adjusted for our net revenue adjustment, it was $18 million, reflecting an 8% year-over-year increase and in line with Q3. Total sessions were $1.9 billion, reflecting a 46% year-over-year increase and a sequential decline of 20%. Partner Network RPS, after adjusting for the out of period revenue adjustment, decreased 26% year-over-year but increased 24% quarter-over-quarter. Adjusted gross profit stood at $44.7 million, up 19% year-over-year and sequentially. Revenue less advertising spend for our O&O advertising segment increased 21% sequentially to $32 million. Revenue less advertising spend for our O&O products was $25.6 million, up 62% year-over-year and 27% sequentially. Network revenue less agency fees was $14.4 million, up 10% year-over-year and sequentially. Total sessions processed by RAMP in the most recent quarter were $3.8 billion, up 61% year-over-year and down 14% sequentially. On to operating expenses and EBITDA. In Q4, operating expenses, net of advance, were $26.8 million, down $0.5 million quarter-over-quarter and down $700,000 year-over-year. We continue to focus on reducing OpEx to create operating leverage. Adjusted EBITDA was $17.9 million in Q4, compared to $10 million in the same quarter last year, representing a 79% year-over-year increase. Regarding liquidity, we ended the quarter with $63.6 million of unrestricted cash on our balance sheet and an outstanding balance of $280 million of term loan debt under a credit agreement. Our net consolidated leverage at quarter-end was approximately 5.6 times. Now let's move on to Q1 guidance. We are estimating Q1 revenue to come in between $69 million and $71 million, down 18% year-over-year at the midpoint. Despite the revenue decline guidance, we estimate adjusted gross profit to grow by 25% year-over-year at the midpoint, expecting it to be between $38 million and $40 million. We expect Q1 adjusted EBITDA to range between $9 million and $11 million, representing an increase of over 9.5 million year-over-year at the midpoint. The adjusted EBITDA guidance also assumes a benefit from the reversal of the majority of the prior period partner payment balances related to fraudulent traffic on our network from Q2 of last year. For the reasons articulated by Michael during his remarks, specifically regarding Google volatility, we will not be providing full year guidance at this time. As mentioned during our last earnings call, we have continued to see significant volatility in our marketing-driven businesses due to ongoing sell-side product and policy updates. However, our core product utilities such as private search, mapping, and couponing provide a strong foundation for navigating these challenges effectively. Looking ahead, 2025 presents an opportunity to further scale these products driving consistent user acquisition and engagement. By continuing to attract and retain users through differentiated high-value services, we not only mitigate market fluctuations but also create sustained monetization opportunities. Our RAMP platform remains instrumental in generating gross profit and EBITDA as we refine our AI-driven strategies to optimize traffic quality and advertising yield. AI-driven advancements to our platform and processes will also allow us to optimize our operating expenses throughout the year. Our ability to balance growth in owned and operated segments with a disciplined approach to our marketing businesses will be a key focus in the year ahead. Thank you for joining us today.

Operator, Operator

Thank you, Tridi. We're now going to open the line for some questions. The first question comes from Tom Forte with the Maxim Group. Go ahead, Tom.

Tom Forte, Analyst

Great. So first off, Michael and Tridi, I hope you and your colleagues are okay when it comes to the California wildfires. Second, congrats on the improvement in the adjusted EBITDA for both the fourth quarter and full year. So I have three questions. I'll go one at a time. Michael, as experts on AI and one of the early users of the technology to advance your business, would love your thoughts on DeepSeek and in general your ability to invest in RAMP at much lower CapEx than your tech peers?

Michael Blend, CEO

Thanks, Tom. Thanks for joining and for the questions. Good to see you. So I would say as far as DeepSeek goes, I don't have a specific opinion about what they're doing except that it's been very nice to see that DeepSeek, along with a number of other open source providers, as well as general competition in the AI marketplace, is bringing costs down substantially for us. What we're seeing is that the price of using these tools has been coming down every couple weeks or so. We're also seeing advances in a lot of the code assist tools that we're building where we've been quite heavy users of AI. What we're seeing is that every two weeks, people are leapfrogging the other products, and the pace at which these tools are developing is extraordinary. AI is affecting our business in a couple different ways. First of all, as we've discussed on our last few quarterly earnings calls, AI is perfectly built for a lot of the marketing we do. It's helping us do tactical things like producing better ads and using AI and machine learning to rapidly change bid pricing on advertising, but also to produce better taglines and content. Our entire advertising flow has greatly improved. Recently, we've seen some dramatic changes in our ability to do product and engineering work at System1. As our engineers and product teams adopt these AI tools, we've seen two to four times improvements in efficiency and productivity. We made the decision early on when code assist tools matured to fully embrace them. We're able to do that given the size of our company and how adaptable our engineering and product teams are. We're seeing fantastic efficiency improvements. Moreover, we're encouraging employees from various business segments to adopt these tools. Interestingly, one of our heads from the MapQuest side developed an idea for a fun product one night, built it, and after collaborating with an engineer, launched it within 14 to 15 hours. That product garnered features on Stephen Colbert and CNN. Such rapid development would have been impossible without these tools. AI is increasing our efficiency and productivity as well as unleashing creativity, which is great to see.

Tom Forte, Analyst

Excellent. All right, so then my second question, which I get most often from investors. Can you talk about your balance sheet and your efforts to improve your capital structure, including managing your debt?

Michael Blend, CEO

Sure. It's something we focus on carefully. Tridi, do you want to go ahead and address that?

Tridivesh Kidambi, CFO

Sure. Hi, Tom, how are you doing? Thanks for being here and for the question. Obviously, we think about our balance sheet and capital structure a fair amount. In August of this past year, we undertook some restructuring work that aligned our corporate structure with how we manage our business. That being said, as I mentioned in my prepared remarks, our net leverage at the end of the year was 5.6 times, which is frankly higher than we would prefer. However, we feel very bullish about our business prospects and the ability to grow into a net leverage position we're more comfortable with. We still have about two and a half years left on the term of our credit agreement, and we believe we'll be in a strong position to refinance that when the time comes.

Tom Forte, Analyst

Great. All right, so then my last question — that was very helpful, Tridi, I appreciate that. Michael, can you remind me of how periods of heavy political advertising spending impact your business model? Given the political season is behind us, is it a much easier operating environment for you?

Michael Blend, CEO

Yes, great question, Tom. Our business operates contrary to many advertising firms. In Q4, when political advertising surged, it impacts our buy side and drives pricing up for us when we purchase advertising. Therefore, we are pleased that the political quarter has ended, as the buy side opens up a bit and we expect pricing to decrease. So it's a favorable change for System1.

Operator, Operator

The next question is from Dan Kurnos with Benchmark. Dan, go ahead.

Dan Kurnos, Analyst

Great, thanks. Good afternoon, guys. Michael, there’s a lot to unpack here. Could you discuss at a higher level your positioning regarding the RSOC shift? It sounds like you're ahead of the curve. We’ve been in discussions with other premium publishers and agencies about this transition, and many seem unprepared. Can you elaborate on your readiness and any remaining areas of investment? It will undoubtedly cause market disruptions, similar to the cookie deprecation.

Michael Blend, CEO

Yes, sure, Dan. It's a bit specialized, but worth it since Google is a key part of our revenue. Google has multiple advertising products we leverage to monetize our traffic. Historically, AFD has been one, alongside AFS, and now RSOC. About 18 months ago, Google introduced RSOC, which we decided to invest significantly in. We believe it was a wise decision as Google has informed the market that AFD will likely become less important. We believe we're well positioned as System1 to lead in promoting RSOC. Some bumps may occur as revenue shifts away from AFD, but over the medium to long term, RSOC looks to be favorable for consumers and advertisers, and we expect to navigate this transition effectively.

Dan Kurnos, Analyst

Tridi, could you discuss your guidance for revenue excluding TAC and the potential for growth in this uneven environment? The adjusted gross profit in Q4 was impressive, what's your outlook?

Tridivesh Kidambi, CFO

Yes, we are guiding to some growth this year. Stability in the marketplace is positive for us, as RAMP is designed to capitalize on that stability. Given the third month of the quarter, we feel confident in our guidance. Our execution has driven this confidence.

Michael Blend, CEO

I would reiterate that our organic products are performing well, and we're seeing decent growth there. We would have more confidence about the year ahead if it weren't for the transition happening with Google, so we’re waiting for clarity on that front. However, we're optimistic as we begin 2025, and we believe we have turned the corner.

Dan Kurnos, Analyst

One last quick question for Tridi. You mentioned the adjusted EBITDA margin. What should we expect for this year? Will we see an increase?

Tridivesh Kidambi, CFO

We expect our gross profit increase to largely flow through to adjusted EBITDA. We continue to meticulously assess our OpEx to guarantee a satisfactory ROI. Consequently, we anticipate our adjusted EBITDA margins to rise as a percentage of gross profit.

Michael Blend, CEO

The operational effectiveness of our team, aided by AI-driven products, has been impressive. We expect this momentum to lead to continued leverage as our gross profit expands.

Dan Kurnos, Analyst

Appreciate the insights. It was fun engaging with MapQuest.

Michael Blend, CEO

We're glad you enjoyed it. We had a large number of people on board as well. I believe that concludes our questions. Thank you all for joining us this quarter. We look forward to discussing more next quarter and hope to bring good news then.