System1, Inc 8-K/A, filed Apr 4, 2022
System1, Inc. (SST)
About this 8-K/A
System1, Inc filed this 8-K/A on April 4, 2022, reporting on events of January 27, 2022.
Items reported
- Item 2.01: Completed an acquisition or sale of assets
- Item 4.01: Change of auditor
- Item 9.01: Financial statements and exhibits
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Amendment No. 3)
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation) |
(Commission File Number) |
(I.R.S. Employer Identification No.) |
| (Address of principal executive offices) | (Zip Code) |
(
(Registrant’s telephone number, including area code)
(Former name or former address, if changed since last report)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Trading |
Name of each exchange | ||
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
INTRODUCTORY NOTE
Unless the context otherwise requires, “we,” “us,” “our,” “System1” and the “Company” refer to System1, Inc., a Delaware corporation (f/k/a Trebia Acquisition Corp., a Cayman Islands exempted company), and its consolidated subsidiaries following the closing of the Business Combination. Unless the context otherwise requires, references to “Trebia” refer to Trebia Acquisition Corp., prior to the closing of the Business Combination. All references herein to the “Board” refer to the board of directors of the Company.
The Company is filing this Form 8-K/A (this “Amendment No.3”) to further amend its Current Report on Form 8-K, originally filed with the Securities and Exchange Commission (the “SEC”) on February 2, 2022 and initially amended by Amendment No.1 to its Current Report on Form 8-K/A filed with the SEC on February 3, 2022 and Amendment No.2 to its Current Report on Form 8-K/A filed with the SEC on February 9, 2022 (as so amended, the “Original Form 8-K”), by: (i) amending certain disclosures under Item 2.01 of the Original Form 8-K to provide an update of developments at the Company or its subsidiaries, subsequent to the filing date of the Original Form 8-K; (ii) amending the financial statements provided under Item 9.01(a) in the Original Form 8-K to include: (A) the audited consolidated financial statements of S1 Holdco as of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019; (B) the Management’s Discussion and Analysis of Financial Condition and Results of Operations of S1 Holdco for the year ended December 31, 2021; (C) the audited consolidated financial statements of Protected UK as of and for the years ended December 31, 2021 and 2020; and (D) the Management’s Discussion and Analysis of Financial Condition and Results of Operations of Protected UK for the year ended December 31, 2021; (iii) amending the pro forma financial information provided under Item 9.01(b) in the Original Form 8-K to include the unaudited pro forma condensed combined financial information of the Company as of and for the year ended December 31, 2021; and (iv) adding the exhibits included below under Item 9.01(d).
Except as expressly set forth herein, this Amendment No.3 does not amend, modify or update the disclosures contained in the Original Form 8-K. Terms used in this Amendment No.3 but not defined herein, or for which definitions are not otherwise incorporated by reference herein, shall have the meaning given to such terms in the Original Form 8-K.
Item 2.01 Completion of Acquisition or Disposition of Assets.
BUSINESS
The information set forth in the section of the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2022 (“Form 10-K”) entitled “Business” beginning on page 1 is incorporated herein by reference.
RISK FACTORS
The information set forth in the section of the Form 10-K filed entitled “Risk Factors” beginning on page 9 and in the section of the Company’s amended Registration Statement on Form S-1/A filed with the SEC on April 1, 2022 (the “Form S-1/A”) entitled “Risk Factors” beginning on page 5 is incorporated herein by reference.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The information set forth in Item 4.01 of this Amendment No.3 and Item 4.01 of the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2022 is incorporated herein by reference.
FINANCIAL INFORMATION
The information set forth in sections (a), (b) and (d) of Item 9.01 of this Amendment No.3 is incorporated herein by reference.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information set forth on Exhibits 99.2 and 99.4 to this Amendment No.3 are incorporated herein by reference.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth in the section of the Form 10-K filed entitled “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” beginning on page 65 is incorporated herein by reference.
DIRECTORS AND EXECUTIVE OFFICERS
The information set forth in the section of the Form 10-K filed entitled “Directors, Executive Officers and Corporate Governance” beginning on page 53 is incorporated herein by reference.
EXECUTIVE COMPENSATION
The information set forth in the section of the Form 10-K filed entitled “Executive Compensation” beginning on page 59 is incorporated herein by reference.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth in the section of the Form 10-K filed entitled “Certain Relationships and Related Transactions, and Director Independence Founder Shares” beginning on page 69 is incorporated herein by reference.
LEGAL PROCEEDINGS
The information set forth in the section of the Form 10-K filed entitled “Legal Proceedings” beginning on page 46 is incorporated herein by reference.
DESCRIPTION OF REGISTRANT’S SECURITIES
The information set forth in the section of the Form S-1/A entitled “Description of Capital Stock” beginning on page 139 is incorporated herein by reference.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The information set forth in the section of the Form S-1/A entitled “Description of Capital Stock—Anti-Takeover Effects of the System1 Charter, System1 Bylaws and Certain Provisions of Delaware Law—Limitations on Liability and Indemnification of Officers and Directors” beginning on page 148 and the section of Item 5.02 of the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2022 entitled “Directors and Officers Indemnification and Advancement Agreements” are each incorporated herein by reference.
Item 4.01. Changes in Registrant’s Certifying Accountant.
On February 24, 2022, the Audit Committee of the board of directors of the Company approved management’s recommendation to appoint PricewaterhouseCoopers LLP (“PwC”) as the Company’s independent registered public accounting firm for the Company’s fiscal year ending December 31, 2022 and to dismiss Marcum LLP (“Marcum”) as the Company’s independent registered public accounting firm, effective upon the Company’s filing of its Annual Report on Form 10-K for the fiscal year ended December 31, 2021 and the fiscal period from February 11, 2020 (inception) to December 31, 2020, which consists only of the accounts of the pre-Business Combination special purpose acquisition company, Trebia.
On March 30, 2022, upon the submission of the form 10-K to the SEC, Marcum was dismissed as the Company’s independent registered public accounting firm.
The report of Marcum on Trebia’s consolidated balance sheet as of December 31, 2021 and 2020 and the statements of operations, changes in shareholders’ equity and cash flows for the year ended December 31, 2021, and for the period from February 11, 2020 (inception) to December 31, 2020, did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainties, and audit scope or accounting principles.
During the period from February 11, 2020 (inception) to December 31, 2020, the year ended December 31, 2021 and through March 30, 2022, there were no disagreements between the Company and Marcum on any matter of accounting principles or practices, financial disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Marcum, would have caused it to make reference to the subject matter of the disagreements in its report on Trebia’s financial statements for such period.
During the period from February 11, 2020 (inception) to December 31, 2020, the year ended December 31, 2021, and subsequent interim period through March 30, 2022, there have been no “reportable events” (as defined in Item 304(a)(1)(v) of Regulation S-K), other than the material weaknesses in Trebia’s internal controls identified by management related to complex financial instruments as set forth in Trebia’s form 10-K for the fiscal year ended December 31, 2021 as filed with the SEC on March 31, 2022, and which resulted in the restatement of Trebia’s financial statements as set forth in Trebia’s Form 10-K for the fiscal year ended December 31, 2020 as filed with the SEC on December 1, 2021 and Forms 10-Q for the quarters ended June 30, 2020 and September 30, 2020 as filed with the SEC on August 14, 2020 and November 12, 2020, respectively.
The Company has provided Marcum with a copy of the foregoing disclosures and has requested that Marcum furnish the Company with a letter addressed to the SEC stating whether it agrees with the statements made by the Company set forth above. A copy of Marcum’s letter, dated April 4, 2022, is filed as Exhibit 16.1 to this Amendment No.3.
PwC served as independent registered public accounting firm of S1 Holdco prior to the Business Combination. During the fiscal years ended December 31, 2020, and December 31, 2021, and the subsequent interim period through March 30, 2022, neither the Company nor anyone on its behalf has consulted with PwC regarding (i) the application of accounting principles to a specific transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s financial statements, where either a written report or oral advice was provided to the Company that PwC concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue, (ii) any matter that was the subject of a disagreement within the meaning of Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K or (iii) any reportable event within the meaning of Item 304(a)(1)(v) of Regulation S-K.
Item 9.01 Financial Statements and Exhibits.
(a) Financial statements of businesses acquired.
The (i) audited consolidated financial statements of S1 Holdco as of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019, filed herewith as Exhibit 99.1; (ii) the Management’s Discussion and Analysis of Financial Condition and Results of Operations of S1 Holdco for the year ended December 31, 2021, filed herewith as Exhibit 99.2; (iii) audited consolidated financial statements of Protected UK as of and for the years ended December 31, 2021 and 2020, filed herewith as Exhibit 99.3; and (iv) the Management’s Discussion and Analysis of Financial Condition and Results of Operations of Protected UK for the year ended December 31, 2021, filed herewith as Exhibit 99.4, all of which are incorporated herein by reference.
(b) Pro forma financial information.
The unaudited pro forma condensed combined financial information of the Company as of and for the year ended December 31, 2021 is set forth in Exhibit 99.5 attached hereto and is incorporated herein by reference.
(d) Exhibits.
| 10.10 | Form of Indemnification Agreement | 8-K | 001-39331 | 10.4 | March 2, 2022 | |||||||||||||||||
| 16.1 | Letter of Marcum LLP dated April 4, 2022 | X | ||||||||||||||||||||
| 21.1 | Subsidiaries of the registrant | 10-K | 001-39331 | 21.1 | March 31, 2022 | |||||||||||||||||
| 99.1 | Audited Consolidated Financial Statements of S1 Holdco as of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019. | X | ||||||||||||||||||||
| 99.2 | Management’s Discussion and Analysis of Financial Condition and Results of Operations of S1 Holdco for the year ended December 31, 2021. | X | ||||||||||||||||||||
| 99.3 | Audited Consolidated Financial Statements of Protected UK as of and for the years ended December 31, 2021 and 2020. | X | ||||||||||||||||||||
| 99.4 | Management’s Discussion and Analysis of Financial Condition and Results of Operations of Protected UK for the year ended December 31, 2021. | X | ||||||||||||||||||||
| 99.5 | Unaudited Pro Forma Condensed Combined Financial Information of the Company as of and for the year ended December 31, 2021. | X | ||||||||||||||||||||
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document). | |||||||||||||||||||||
| † | The annexes, schedules, and certain exhibits to this Exhibit have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Registrant hereby agrees to furnish supplementally a copy of any omitted annex, schedule or exhibit to the SEC upon request. |
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| System1, Inc. | ||||||
| Date: April 4, 2022 | By: | /s/ Daniel Weinrot | ||||
| Name: | Daniel Weinrot | |||||
| Title: | General Counsel & Corporate Secretary | |||||
Exhibit 16.1
FORM 8-K ATTACHMENT - CHANGE OF ACCOUNTANTS’ LETTER
April 4, 2022
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549
Commissioners:
We have read the statements made by System1, Inc. (f/k/a Trebia Acquisition Corp.) under Item 4.01 of its Form 8-K dated April 4, 2022. We agree with the statements concerning our Firm in such Form 8-K; we are not in a position to agree or disagree with other statements of System1, Inc. (f/k/a Trebia Acquisition Corp.) contained therein.
Very truly yours,
/s/ Marcum LLP
Marcum LLP
Exhibit 99.1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Members of S1 Holdco, LLC
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of S1 Holdco, LLC and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of operations, of comprehensive income, of changes in members’ deficit and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
April 1, 2022
We have served as the Company’s auditor since 2020.
F-26
S1 Holdco, LLC and Subsidiaries
Consolidated Balance Sheets
(In thousands)
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| ASSETS |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 47,896 | $ | 29,013 | ||||
| Accounts receivable, net of allowance for doubtful accounts |
90,203 | 71,140 | ||||||
| Prepaid expenses and other current assets |
7,689 | 3,016 | ||||||
|
|
|
|
|
|||||
| Total current assets |
145,788 | 103,169 | ||||||
|
|
|
|
|
|||||
| Restricted cash |
743 | — | ||||||
| Property and equipment, net |
830 | 1,057 | ||||||
| Internal-use software development costs, net |
11,213 | 9,660 | ||||||
| Intangible assets, net |
50,368 | 59,009 | ||||||
| Goodwill |
44,820 | 44,820 | ||||||
| Due from related party |
2,469 | 969 | ||||||
| Other non-current assets |
680 | — | ||||||
|
|
|
|
|
|||||
| Total assets |
$ | 256,911 | $ | 218,684 | ||||
|
|
|
|
|
|||||
| LIABILITIES AND MEMBERS’ DEFICIT |
||||||||
| Current liabilities: |
||||||||
| Accounts payable |
$ | 72,846 | $ | 52,104 | ||||
| Accrued expenses and other current liabilities |
33,255 | 19,039 | ||||||
| Notes payable, current |
170,453 | 9,374 | ||||||
|
|
|
|
|
|||||
| Total current liabilities |
276,554 | 80,517 | ||||||
|
|
|
|
|
|||||
| Notes payable, non-current |
— | 170,595 | ||||||
| Other liabilities |
8,758 | 15,801 | ||||||
|
|
|
|
|
|||||
| Total liabilities |
285,312 | 266,913 | ||||||
|
|
|
|
|
|||||
| Commitments and contingencies (Note 11) |
||||||||
| Members deficit: |
||||||||
| Members’ deficit in S1 Holdco |
(28,829 | ) | (47,886 | ) | ||||
| Accumulated other comprehensive income (loss) |
428 | (343 | ) | |||||
|
|
|
|
|
|||||
| Total members’ deficit |
(28,401 | ) | (48,229 | ) | ||||
|
|
|
|
|
|||||
| Total liabilities and members’ deficit |
$ | 256,911 | $ | 218,684 | ||||
|
|
|
|
|
|||||
See notes to consolidated financial statements.
F-27
S1 Holdco, LLC and Subsidiaries
Consolidated Statements of Operations
(In thousands, except for per unit data)
| For the Years Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Revenue |
$ | 688,389 | $ | 475,977 | $ | 407,493 | ||||||
|
|
|
|
|
|
|
|||||||
| Operating costs and expenses: |
||||||||||||
| Cost of revenues (exclusive of depreciation and amortization shown separately below) |
521,113 | 340,996 | 275,770 | |||||||||
| Salaries, commissions, and benefits |
66,747 | 55,548 | 48,389 | |||||||||
| Selling, general, and administrative |
35,813 | 22,979 | 19,960 | |||||||||
| Depreciation and amortization |
13,885 | 13,832 | 11,244 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total operating costs and expenses |
637,558 | 433,355 | 355,363 | |||||||||
|
|
|
|
|
|
|
|||||||
| Operating income |
50,831 | 42,622 | 52,130 | |||||||||
| Interest expense |
16,870 | 24,351 | 26,033 | |||||||||
| Other expense |
— | — | 1,146 | |||||||||
|
|
|
|
|
|
|
|||||||
| Income from continuing operations before income tax |
33,961 | 18,271 | 24,951 | |||||||||
| Income tax expense |
965 | 1,907 | 702 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net income from continuing operations |
32,996 | 16,364 | 24,249 | |||||||||
| Income (loss) from discontinued operations, net of taxes |
— | 47,397 | (15,454 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net income |
$ | 32,996 | $ | 63,761 | $ | 8,795 | ||||||
|
|
|
|
|
|
|
|||||||
| Net income per unit from continuing operations attributable to S1 Holdco, LLC: |
||||||||||||
| Basic and Diluted |
$ | 1.61 | $ | 0.80 | $ | 1.18 | ||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) per unit from discontinued operations attributable to S1 Holdco, LLC: |
||||||||||||
| Basic and Diluted |
$ | — | $ | 2.31 | $ | (0.75 | ) | |||||
|
|
|
|
|
|
|
|||||||
| Weighted average membership units outstanding |
||||||||||||
| Basic and Diluted |
20,488 | 20,488 | 20,488 | |||||||||
|
|
|
|
|
|
|
|||||||
See notes to consolidated financial statements.
F-28
S1 Holdco, LLC and Subsidiaries
Consolidated Statements of Comprehensive Income
(In thousands)
|
For the Years Ended December 31, |
||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Net income |
$ | 32,996 | $ | 63,761 | $ | 8,795 | ||||||
| Other comprehensive income (loss) |
||||||||||||
| Foreign currency translation adjustments |
771 | (224 | ) | (119 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Comprehensive income |
$ | 33,767 | $ | 63,537 | $ | 8,676 | ||||||
|
|
|
|
|
|
|
|||||||
See notes to consolidated financial statements.
F-29
S1 Holdco, LLC and Subsidiaries
Consolidated Statements of Changes in Members’ Deficit
(In thousands)
| Members’ Capital |
Accumulated Other Comprehensive Income (Loss) |
Noncontrolling Interest |
Total Members’ Deficit |
|||||||||||||
| BALANCE—January 1, 2019 |
$ | (77,530 | ) | $ | — | $ | 17,873 | $ | (59,657 | ) | ||||||
| Net income |
8,795 | — | — | 8,795 | ||||||||||||
| Accumulated other comprehensive income |
— | (119 | ) | — | (119 | ) | ||||||||||
| Share-based compensation expense |
1,764 | — | — | 1,764 | ||||||||||||
| Change in non-controlling interest |
— | — | (15,455 | ) | (15,455 | ) | ||||||||||
| Distribution to Court Square Capital Partners |
(1,489 | ) | — | — | (1,489 | ) | ||||||||||
| Contribution from OpenMail |
7,257 | — | — | 7,257 | ||||||||||||
| Distribution to OpenMail |
(7,166 | ) | — | — | (7,166 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| BALANCE—December 31, 2019 |
$ | (68,369 | ) | $ | (119 | ) | $ | 2,418 | $ | (66,070 | ) | |||||
| Net income |
63,761 | — | — | 63,761 | ||||||||||||
| Disposal of noncontrolling interest in Protected |
— | — | (2,418 | ) | (2,418 | ) | ||||||||||
| Distributions to members from sale of Protected |
(28,765 | ) | — | — | (28,765 | ) | ||||||||||
| Share-based compensation expense |
1,012 | — | — | 1,012 | ||||||||||||
| Accumulated other comprehensive income |
— | (224 | ) | — | (224 | ) | ||||||||||
| Distribution to Court Square Capital Partners |
(11,975 | ) | — | — | (11,975 | ) | ||||||||||
| Contribution from OpenMail |
2,255 | — | — | 2,255 | ||||||||||||
| Distribution to OpenMail |
(5,805 | ) | — | — | (5,805 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| BALANCE—December 31, 2020 |
$ | (47,886 | ) | $ | (343 | ) | $ | — | $ | (48,229 | ) | |||||
| Net income |
32,996 | — | — | 32,996 | ||||||||||||
| Share-based compensation expense |
413 | — | — | 413 | ||||||||||||
| Accumulated other comprehensive income |
— | 771 | — | 771 | ||||||||||||
| Distribution to Court Square Capital Partners |
(8,257 | ) | — | — | (8,257 | ) | ||||||||||
| Contribution from OpenMail |
227 | — | — | 227 | ||||||||||||
| Distribution to OpenMail |
(6,322 | ) | — | — | (6,322 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| BALANCE—December 31, 2021 |
$ | (28,829 | ) | $ | 428 | $ | — | $ | (28,401 | ) | ||||||
|
|
|
|
|
|
|
|
|
|||||||||
See notes to consolidated financial statements.
F-30
S1 Holdco, LLC and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
| For the Years Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Cash Flows from Operating Activities: |
||||||||||||
| Net income |
$ | 32,996 | $ | 63,761 | $ | 8,795 | ||||||
| Net income (loss) from discontinued operations |
— | 47,397 | (15,454 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net income from continuing operations |
32,996 | 16,364 | 24,249 | |||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
| Depreciation and amortization |
13,885 | 13,832 | 11,244 | |||||||||
| Share-based compensation |
413 | 1,192 | 1,764 | |||||||||
| Amortization of debt issuance costs |
2,261 | 3,521 | 2,548 | |||||||||
| Write-down of contingent consideration liability |
— | — | (800 | ) | ||||||||
| Change in fair value of contingent consideration and former CEO equity interest |
7,054 | 5,950 | 1,727 | |||||||||
| Deferred tax (benefits) expense |
(981 | ) | 32 | (2,143 | ) | |||||||
| Changes in operating assets and liabilities-net of effect of acquisitions: |
||||||||||||
| Accounts receivable, net of allowance for doubtful accounts |
(19,064 | ) | 6,833 | (10,950 | ) | |||||||
| Due from related party |
— | (28 | ) | — | ||||||||
| Prepaids and other assets |
(4,968 | ) | (1,076 | ) | 516 | |||||||
| Accounts payable |
20,756 | 4,234 | 3,739 | |||||||||
| Accrued expenses and other current liabilities |
12,113 | 1,143 | (3,318 | ) | ||||||||
| Deferred revenue |
82 | 415 | (169 | ) | ||||||||
| Other long-term liabilities |
(3,842 | ) | (5 | ) | 430 | |||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by operating activities of continuing operations |
60,705 | 52,407 | 28,837 | |||||||||
| Net cash provided by (used for) operating activities of discontinued operations |
— | (5,860 | ) | 3,875 | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by operating activities |
60,705 | 46,547 | 32,712 | |||||||||
|
|
|
|
|
|
|
|||||||
| Cash Flows from Investing Activities: |
||||||||||||
| Purchases of property and equipment |
(49 | ) | (19 | ) | (1,186 | ) | ||||||
| Proceeds from sale of Protected |
— | 74,544 | — | |||||||||
| Expenditures for internal-use software development costs |
(6,486 | ) | (6,112 | ) | (5,510 | ) | ||||||
| Purchase of business—net of cash acquired |
— | — | (35,941 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used for) investing activities of continuing operations |
(6,535 | ) | 68,413 | (42,637 | ) | |||||||
| Net cash used for investing activities of discontinued operations |
— | (247 | ) | (120 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used for) investing activities |
(6,535 | ) | 68,166 | (42,757 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Cash Flows from Financing Activities: |
||||||||||||
| Proceeds from term loan |
— | — | 35,000 | |||||||||
| Proceeds from line of credit |
— | 20,000 | 32,000 | |||||||||
| Repayment of term loan |
(11,636 | ) | (63,423 | ) | (6,380 | ) | ||||||
| Repayment of line of credit |
— | (34,862 | ) | (32,000 | ) | |||||||
| Payments for deferred financing cost |
(382 | ) | — | — | ||||||||
| Related party loan |
(1,500 | ) | — | — | ||||||||
| Member capital contributions |
227 | 2,255 | 7,257 | |||||||||
| Payments on contingent consideration from purchase of companies |
(6,715 | ) | (5,500 | ) | — | |||||||
| Payments for financing costs |
— | — | (1,075 | ) | ||||||||
| Distributions to members from sale of Protected |
— | (28,765 | ) | — | ||||||||
| Distributions to members |
(14,579 | ) | (17,780 | ) | (8,655 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used for) financing activities |
(34,585 | ) | (128,075 | ) | 26,147 | |||||||
| Effect of exchange rate changes in cash, cash equivalent and restricted cash |
41 | (450 | ) | (148 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net Increase (decrease) in cash |
19,626 | (13,812 | ) | 15,954 | ||||||||
| Cash and cash equivalents and restricted cash, beginning of year |
29,013 | 42,825 | 26,871 | |||||||||
|
|
|
|
|
|
|
|||||||
| Cash and cash equivalents and restricted cash, end of year |
$ | 48,639 | $ | 29,013 | $ | 42,825 | ||||||
|
|
|
|
|
|
|
|||||||
| Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets: |
||||||||||||
| Cash and cash equivalents |
$ | 47,896 | $ | 29,013 | $ | 39,136 | ||||||
| Restricted cash |
$ | 743 | $ | — | $ | 3,689 | ||||||
|
|
|
|
|
|
|
|||||||
| Total cash, cash equivalents and restricted cash |
$ | 48,639 | $ | 29,013 | $ | 42,825 | ||||||
|
|
|
|
|
|
|
|||||||
| Supplemental cash flow information: |
||||||||||||
| Cash paid for interest |
$ | 14,740 | $ | 22,227 | $ | 21,442 | ||||||
| Cash paid for taxes |
$ | 2,750 | $ | 4,397 | $ | 55 | ||||||
See notes to consolidated financial statements.
F-31
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
S1 Holdco, LLC and subsidiaries (“S1 Holdco,” “System1,” or the “Company”) is an omnichannel customer acquisition platform, delivering high-intent customers to advertisers. The Company provides these services through its proprietary responsive acquisition marketing platform, or RAMP. Operating seamlessly across major advertising networks and advertising category verticals to acquire users on its behalf, RAMP allows the Company to monetize these acquired users through its relationships with third party advertisers and advertising networks, which the Company refers to as its “Advertising Partners”. RAMP also allows third party advertising platforms and publishers, which the Company refers to as its “Network Partners”, to send user traffic to and monetize user traffic on the Company’s websites. RAMP is integrated across the Company’s network of owned and operated websites and related products, allowing the Company to monetize user traffic that the Company sources from acquisition marketing channels, including Google, Facebook and Taboola.
Through RAMP, the Company processes approximately almost 15 million daily advertising campaign optimizations and ingests 6 billion rows of data daily across 50 advertising verticals. The Company is able to efficiently monetize user intent by linking data on consumer engagement, such as first party search data, with data on monetization and advertising spend. This context-enriched data, combined with the Company’s proprietary and data science driven algorithms, creates a closed-loop system that is not reliant on personally identifiable information or information obtained through third-party cookies, but which allows RAMP to efficiently match consumer demand with the appropriate advertiser or advertising experience across advertising verticals.
The Company was founded in 2013 with a focus on monetizing user traffic acquired by its network. Since launching, the Company has expanded to support additional advertising formats across numerous advertising platforms, and has acquired several leading websites, enabling the Company to control user acquisition and experience, and monetize user traffic on its own behalf. Today the Company owns and operates over 40 websites, including search engines like info.com and Startpage.com, and publishing digital media sites and utilities such as HowStuffWorks, Mapquest and ActiveBeat.
S1 Holdco, LLC was formed as a limited liability company (LLC) under the laws of the State of Delaware on July 25, 2017. On August 22, 2017, OpenMail LLC (“OpenMail”) entered into a transaction (the “Transaction”) with Court Square Capital Partners and its related entities (“Court Square”), whereby Court Square obtained a 51% interest in S1 Holdco through its own contributions and a recapitalization and distribution to the members of OpenMail. The Company is governed by an LLC agreement between Court Square and OpenMail. All the management powers over the business and affairs of the Company are retained by the board of directors, including the approval of debt transactions, issuance or transfer of membership units (the “Units”), approval to buy and sell Company assets or any other significant transaction, and declaring and making distributions.
As of December 31, 2021, the board of directors is composed of three individuals designated by Court Square, and two individuals designated by OpenMail. However, in addition to a majority vote, board of directors’ actions must be approved by at least one Court Square director and one OpenMail director. Consequently, the Company has determined that its members share power and, thus, there was no change in control as of the date of the Transaction.
The Company’s primary operations are in the United States; however, the Company also has operations in Canada, the United Kingdom, Germany, Israel, Hungary and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems and various political and economic environments. Among the risks are changes in existing tax laws, possible limitations on foreign investment and income repatriation, government price or foreign exchange controls, and exposure to currency exchange fluctuations. The Company does not engage in hedging activities to mitigate its exposure to fluctuations in foreign currency exchange rates. Revenue attributable to the United States represents 95%, 98% and 97% of total revenue for the years ended December 31, 2021, 2020 and 2019, respectively, and long-lived assets attributable to the United States represent 86% and 87% of total long-lived assets as of December 31, 2021 and 2020, respectively.
F-32
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
On October 16, 2018, System1 SS Protect Holdings, Inc., a subsidiary of System1, acquired a 50.1% interest in SS Protect Limited (“Protected”) for a total consideration of $55,000. System1 consolidated Protected under the voting model of ASC 810, Consolidation, since the Company controlled three of five board seats or 60% of the voting rights of Protected.
On November 13, 2020 the Company disposed of its interest in Protected in a sale to a group led by Protected and System1 management. Accordingly, the results of Protected have been accounted for as discontinued operations for the periods ended December 31, 2020 and prior.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The accompanying consolidated financial statements include the accounts of S1 Holdco, LLC and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Capital Resources and Liquidity
To date, the Company’s available liquidity and operations have been financed through member contributions and loans, loan facilities, and cash flows from operations. The Company is subject to certain business risks, including dependence on key employees, dependence on key contracts, competition from alternative technologies, market acceptance, and dependence on growth to achieve its business plan. The Company’s revenue is dependent on three key Advertising Partners, which are Google, Yahoo!, and Microsoft, which comprised 84%, 2%, and 5%, respectively, of the Company’s revenue for the year ended December 31, 2021, 82%, 5% and 4% of the Company’s revenue for the year ended December 31, 2020, and 75%, 7%, and 7% of the Company’s revenue for the year ended December 31, 2019. The Company has (i) two paid search advertising partnership contracts with Google, (ii) one paid search advertising partnership contract with Yahoo!, and (iii) one paid search advertising partnership contract with Microsoft. One of the Google contracts was renewed with an effective date of March 1, 2021, and has a two-year term through February 28, 2023. The other Google contract was renewed with a one-year term through April 30, 2021, and in July of 2021 was extended to July 1, 2022. The Yahoo! contract (which consolidated three separate and pre-existing contracts into a single contract) was entered into effective as of December 1, 2020, and has an initial two year term ending November 30, 2022. All arrangements under the Microsoft contract expired on November 30, 2021 and the parties agreed to a three-month extension through February 28, 2022, and then the contract auto-renewed on a month to month basis as the parties finalize a renewal or long-term extension of this arrangement. All four agreements may be terminated by the respective Advertising Partner immediately or with minimal notice under certain circumstances.
F-33
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Impact of COVID-19
The worldwide spread of COVID-19 has resulted, and is expected to continue to result, in a global slowdown of economic activity which is likely to decrease demand for a broad variety of goods and services, including those provided by the Company’s clients, while also disrupting sales channels and advertising and marketing activities for an unknown period of time until the virus is contained or economic activity normalizes. The Company’s revenue in 2021 increased by 45% compared to 2020 despite the headwinds created by the COVID-19 pandemic. The extent to which ongoing and future developments related to the global impact of the COVID-19 pandemic and related vaccination measures designed to curb its spread continue to impact its business, financial condition and results of operations, all of which cannot be predicted with certainty. Many of these ongoing and future developments are beyond its control, including the speed of contagion, the development, distribution and implementation of effective preventative or treatment measures, including vaccines (and vaccination rates), the scope of governmental and other restrictions on travel, discretionary services and other activity, and the public reactions and receptiveness to these developments.
A summary of the significant accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements is set forth below.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period.
Significant estimates and assumptions reflected in these consolidated financial statements include, but are not limited to, valuation of goodwill and long-lived assets for impairment and inputs into the valuation of the Company’s share-based compensation awards. Significant estimates affecting the consolidated financial statements have been prepared on the basis of the most current and best available information, including historical experience, known trends and other market-specific or other relevant factors that the Company believes to be reasonable. On an ongoing basis, management evaluates its estimates, as there are changes in circumstances, facts and experience. Changes in estimates are recorded in periods which they become known. However, actual results from the resolution of such estimates and assumptions may vary from those used in the preparation of the consolidated financial statements. The full extent to which the COVID-19 pandemic will directly or indirectly impact the Company’s business, results of operations and financial condition will depend on future developments that are highly uncertain. The Company’s business, results of operations and financial condition may be impacted by new information that may emerge concerning COVID-19 and the actions taken to contain or treat it, and the economic impact on its customers and markets. The Company has made estimates of the impact of COVID-19 within its financial statements and there may be changes to those estimates in future periods. Actual results may differ from these estimates.
Cash and cash equivalents
Cash and cash equivalent consist of cash in banks and bank deposits. The Company’s cash balance consists of amounts held as bank deposits.
Accounts receivable
Accounts receivable represent amounts due from the Advertising Partners and are stated at the amount the Company expects to collect from outstanding balances and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: past transaction history with the customer, and current economic industry trends. These receivables have historically been paid timely. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection and no allowance for doubtful accounts is required as of December 31, 2021 and 2020, respectively. The payment terms for the Company’s accounts receivable are typically 30 days.
F-34
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Concentration of credit risk
Financial instruments that potentially subject the Company to credit risk consist principally of cash and accounts receivable. Cash is deposited with high-credit-quality financial institutions and, at times, such balances with any one financial institution may exceed the insurance limits of the prevailing regulatory body. Historically, the Company has not experienced any losses related to these balances and believes that there is minimal risk of expected future losses. However, there can be no assurance that there will not be losses on these deposits.
Accounts receivable are primarily derived from advertisers located inside the United States. As of December 31, 2021, the Company’s two largest Advertising Partners; Google and Yahoo! represented 72% and 10%, respectively, of the Company’s accounts receivables balance. As of December 31, 2020, the Company’s two largest Advertising Partners; Google and Yahoo! represented 67% and 13%, respectively, of the Company’s accounts receivables balance.
Foreign Currency
The Company’s reporting currency is the US dollar. The balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. The statement of operations amounts have been translated using the average exchange rate for the month in which the activity related. Accumulated net translation adjustments and foreign currency transaction gains/losses resulting from exchange rate fluctuations on transactions denominated in a currency other than the functional currency were not material.
Fair Value of Financial Instruments
The Company applies the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, which provides a single authoritative definition of fair value, sets out a framework for measuring fair value, and expands on required disclosures about fair value measurement.
The provisions of ASC 820 relate to financial and nonfinancial assets and liabilities, as well as other assets and liabilities carried at fair value on a recurring basis.
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for that asset or liability in an orderly transaction between market participants on the measurement date.
The Company measures fair value based on a three-level hierarchy of inputs, maximizing the use of observable inputs, where available, and minimizing the use of unobservable inputs when measuring fair value. A financial instrument’s level within the three-level hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The three-level hierarchy of inputs is as follows:
Level 1: Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
F-35
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs are based on the Company’s own assumptions about current market conditions and require significant management judgment or estimation.
Financial instruments consist of cash equivalents, restricted cash, accounts receivable, other assets accounted for at fair value, accounts payable and accrued liabilities. Cash equivalents and restricted cash, are stated at fair value on a recurring basis. Accounts receivable, accounts payable, and accrued liabilities are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment date. The carrying amount of the Company’s outstanding debt approximates the fair value. The Company classify the fair value of debt within Level 2 in the fair value hierarchy.
The Company does not have any assets that are required to be carried at fair value on a recurring basis at December 31, 2021 and 2020, respectively. The Company’s liabilities measured at fair value relate to the Former CEO equity interest and Contingent Consideration.
The fair value of the former CEO equity interest was determined with an option pricing model and utilizing significant unobservable inputs for a discount for lack of marketability and projected financial information. The fair value Contingent Consideration was determined with an option pricing model and contains significant unobservable inputs for projected financial information.
Changes in estimated fair value of Level 3 financial liabilities for the years ended December 31, 2021 and December 31, 2020, respectively, are as follows:
| Contingent consideration |
Former CEO equity interest* |
|||||||
| Fair value of liabilities at January 1, 2019 |
$ | (8,900 | ) | $ | — | |||
| Additions |
(2,200 | ) | — | |||||
| Change in fair value |
73 | (1,000 | ) | |||||
|
|
|
|
|
|||||
| Fair value of liabilities at December 31, 2019 |
$ | (11,027 | ) | $ | (1,000 | ) | ||
| Settlements |
5,500 | — | ||||||
| Change in fair value |
(2,713 | ) | (3,236 | ) | ||||
|
|
|
|
|
|||||
| Fair value of liabilities at December 31, 2020 |
$ | (8,240 | ) | $ | (4,236 | ) | ||
| Settlements |
6,716 | — | ||||||
| Change in fair value |
(158 | ) | (6,896 | ) | ||||
|
|
|
|
|
|||||
| Fair value at December 31, 2021 |
$ | (1,682 | ) | $ | (11,132 | ) | ||
|
|
|
|
|
|||||
| * | Former CEO equity interest as further described in executive compensation Note 11. |
The total impact of changes in fair values related to Contingent Consideration and Former CEO equity interest are included in selling, general and administrative expenses, and salaries, commissions and benefits expenses, respectively in the consolidated statements of operations.
Certain assets, including intangible assets, are also subject to measurement at fair value on a nonrecurring basis if they are deemed to be impaired as a result of an impairment review. The fair value of these assets is determined using unobservable inputs to fair value the assets.
F-36
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Restricted cash
The Company had restricted cash of $743 as of December 31, 2021, which was held at the Company’s financial institution to secure the Company’s letter of credit for its Marina del Rey, California facility lease. There was no restricted cash as of December 31, 2020.
Property and equipment, net
Property and equipment, net are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Estimated useful lives are three (3) years for computer equipment and software, seven (7) years for furniture and equipment, and the shorter of the remaining lease term or estimated useful life for leasehold improvements. Repairs and maintenance are charged to expense as incurred, while improvements are capitalized. Upon the sale or retirement of property and equipment, the accounts are relieved of the cost and the related accumulated depreciation, and any resulting gain or loss is included in the consolidated statement of operations.
Internal-use software development costs, net
The Company capitalizes certain internal-use software development costs associated with creating and enhancing internally developed software related to the Company’s technology infrastructure. These costs include personnel and related employee benefits’ expenses for employees who are directly associated with and who devote time to software projects and external direct costs of materials and services consumed in developing or obtaining the software. Software development costs that do not meet the qualification for capitalization are expensed as incurred and recorded in salaries, commissions, and benefits expense in the consolidated statement of operations.
Software development activities generally consist of three stages: (i) the planning stage, (ii) the application and infrastructure development stage, and (iii) the post-implementation stage. Costs incurred in the planning and post implementation stages of software development, including costs associated with the post configuration training and repairs and maintenance of the developed technologies, are expensed as incurred. The Company capitalizes costs associated with software developed for internal use when the preliminary project stage is completed, management has authorized further funding for the completion of the project, and it is probable that the project will be completed and performed as intended. Costs incurred in the application and infrastructure development stages, including significant enhancements and upgrades, are capitalized. Capitalization ends once a project is substantially complete, and the software and technologies are ready for their intended purpose. Internal-use software development costs are amortized using a straight-line method over an estimated useful life of three (3) years, commencing when the software is ready for its intended use. The straight-line recognition method approximates the manner in which the expected benefit will be derived. The Company does not transfer ownership of its software, or lease its software, to third parties.
F-37
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Intangible assets
Intangible assets primarily consist of acquired developed technology and trade names/trademarks. The Company determines the appropriate useful life based on its estimate of economic useful life. Intangible assets are amortized over their estimated useful lives using a straight-line method, which approximates the pattern in which the economic benefits are consumed. The estimated useful lives of the Company’s intangible assets are as follows:
| Useful Life | ||||||||
| (Years) | ||||||||
| Developed technology |
4 | |||||||
| Customer relationships |
5 | — | 10 | |||||
| Trademarks and trade names |
10 | — | 12 | |||||
| Noncompete |
2 | |||||||
| Professional service agreement |
3 | |||||||
| Other intangibles |
3 | |||||||
The weighted average amortization period for all intangibles is 9 years.
Impairment of Long-Lived Assets
The Company assesses the recoverability of its long-lived assets when events or changes in circumstances indicate that their carrying value may not be recoverable. Such events or changes in circumstances may include a significant adverse change in the extent or manner in which a long-lived asset is being used; significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of a long-lived asset; current or future operating or cash flow losses that demonstrate continuing losses associated with the use of a long-lived asset; or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The Company performs impairment testing at the asset group level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The Company assesses recoverability of a long-lived asset by determining whether the carrying value of the asset group can be recovered through projected undiscounted cash flows over their remaining lives. If the carrying value of the asset group exceeds the forecasted undiscounted cash flows, an impairment loss is recognized and measured as the amount by which the carrying amount exceeds the estimated fair value. An impairment loss is charged to operations in the period in which management determines such impairment. Management has determined there to be no impairment of long-lived assets during the years ended December 31, 2021, 2020 and 2019.
Business Combinations
The results of a business acquired in a business combination are included in the Company’s consolidated financial statements from the date of acquisition. The Company allocates the purchase price, which is the sum of the consideration provided which may consist of cash, equity, or a combination of the two, in a business combination to the identifiable assets and liabilities of the acquired business at their acquisition-date fair values. Any excess amount paid over the identifiable net assets is recorded as goodwill. The goodwill is non-deductible for tax purposes. The process for estimating the fair values of the acquired business involves the use of significant estimates and assumptions, including estimating average industry purchase price multiples and estimating future cash flows. The Company estimates the fair value based on assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, the Company may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. At the conclusion of the measurement period, any subsequent adjustments are reflected in the Company’s consolidated statements of operations.
F-38
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Transaction costs associated with business combinations are expensed as incurred and are included in selling, general and administrative expenses in the Company’s consolidated statements of operations. When purchase consideration includes contingent consideration, the Company records the fair value of the contingent consideration as of the date of acquisition and subsequently remeasures the contingent consideration at fair value each reporting period through earnings.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired and identifiable intangibles in a business combination. The Company accounts for goodwill in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles—Goodwill and Other, which requires the Company to test goodwill at the reporting unit level for impairment at least annually.
The Company has the option to assess goodwill for possible impairment by performing a qualitative analysis to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount or to perform the quantitative impairment test. The quantitative test involves comparing the estimated fair value of a reporting unit with its respective book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, an impairment loss is recognized in an amount equal to the excess.
The determination of fair values requires us to make significant estimates and assumptions. These estimates include, but are not limited to future expected cash flows from a market participant perspective, discount rates, industry data and management’s prior experience. Unanticipated events or circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results.
The Company tests for goodwill impairment annually at December 31st. During the years ended December 31, 2021, 2020, and 2019, there were no impairment charges recorded on goodwill. In 2021 and 2019, the Company performed qualitative goodwill assessments at December 31, 2021 and December 31, 2019 and concluded it was not more likely than not that the fair values of its reporting units are less than its carrying amount. In 2020, the Company performed a quantitative goodwill assessment at December 31, 2020, where the fair value exceeded the carrying value for all the reporting units and, accordingly, the Company concluded that there was no impairment of goodwill at December 31, 2020.
Operating Leases
The Company records rent expense for operating leases on a straight-line basis over the lease term. The Company begins recognition of rent expense on the date of initial possession, which is generally when the Company enters the leased premises and begins to make improvements in preparation for its intended use. The Company accounts for the difference between the straight-line expense and rent paid as a deferred rent liability.
Noncontrolling Interests
Interests held by third parties in consolidated majority-owned subsidiaries are presented as noncontrolling interests, which represents the noncontrolling stockholders’ interests in the underlying net assets of the Company’s consolidated majority-owned subsidiaries. Noncontrolling interests that are reported in the equity section of the Consolidated Balance Sheets.
F-39
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Revenue Recognition
The Company recognizes revenue when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration it expects to be entitled to in exchange for those goods or services. The Company determines revenue recognition through the following steps:
| • | Identification of a contract with a customer, |
| • | Identification of the performance obligations in the contract, |
| • | Determination of the transaction price, |
| • | Allocation of the transaction price to the performance obligations in the contract, and |
| • | Recognition of revenue when or as the performance obligations are satisfied. |
The Company’s revenue is principally derived from the following areas:
Advertising and Other Revenue
Revenue is earned from revenue-sharing arrangements with the Company’s Network Partners for the use of the RAMP platform and related services provided to them to direct advertising by the Advertising Partners on traffic acquired and directed to the Company’s platform by the Network Partners to their advertising space. The Company determined it is the agent in these transactions and reports revenue on a net basis. The Company does not control the underlying advertising space, the Company does not acquire the traffic and does not have risk of loss, and the pricing is in the form of a substantively fixed-percentage revenue-sharing arrangement. The Company reports this revenue on a net basis for the amount retained from its revenue-sharing arrangements representing the difference between amounts received from the Advertising Partners, less amounts remitted to the Network Partners based on underlying contracts.
The Company also earns revenue by directly acquiring traffic to its owned and operated websites and utilizing its own RAMP platform and related services to connect its Advertising Partners to its own websites. For this revenue stream, the Company is the principal in the transaction and reports revenue on a gross basis for the amount received from the Advertising Partners. For this revenue, the Company has determined that it is the principal since it has a risk of loss on the traffic that it is acquiring for monetization by its Advertising Partners, and in the case of its owned and operated websites, the Company maintains the website, provides the content and bears the cost and risk of loss associated with its websites’ advertising space. The Company’s key Advertising Partners are Google, Yahoo!, and Microsoft.
The Company recognizes revenue upon delivering traffic to its Advertising Partners based on a cost-per-click or cost-per-thousand impression basis. The payment term is typically 30 days.
SS Protect Revenue
The Company’s SS Protect business provides real-time antivirus protection, a safe-browsing / VPN feature, adblocking, identity-theft protection, blocking of malicious websites and data breach monitoring. The performance obligations related to subscription, maintenance and support are satisfied over time and revenue associated with these is recognized over the contract term on a ratable basis, which is consistent with transfer of control. As described in Note 1, the Company sold SS Protect in November 2020 and accounted for this disposition as a discontinued operation.
F-40
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Contract balances
The timing of customer billing and payment relative to the start of the service period varies from contract to contract; however, the Company bills many of its customers in advance of the provision of services under its contracts, resulting in contract liabilities consisting of deferred revenue (“contract liabilities”). Deferred revenue represents billings under noncancellable contracts before the related product or service is transferred to the customer. The portion of deferred revenue that is anticipated to be recognized as revenue during the succeeding twelve-month period is recorded within Accrued expenses and other current liabilities and the remaining portion is recorded within Other liabilities.
Cost of revenues
Cost of revenues includes traffic acquisition costs, which consists primarily of costs to place advertisements to attract customers to the Company’s websites, mapping costs, domain name registration costs, and licensing costs to provide mapping services to Mapquest.com. The Company does not pay any up-front payments, incentive payments or bonuses and such costs are expensed as incurred.
Salaries, Commissions, and Benefits
Salaries, commissions and benefits expenses include salaries, bonuses, stock-based compensation, and employee benefits costs.
Share-Based Compensation
The Company accounts for share-based compensation under ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment. Compensation cost related to share-based payment transactions is measured based on the fair value of the Units issued and recognized within “Salaries, commissions, and benefits” in the Company’s consolidated statement of operations. The Company has elected to treat share-based payment awards with graded vesting schedules and time-based service conditions as a single award and recognizes share-based compensation expense on a straight-line basis over the employee service vesting period, which is generally four (4) years.
The assumptions used in the Black-Scholes model to compute the fair value of all equity awards as discussed in Note 9 are based upon the following:
| • | Fair Value of Common Stock: As the Company’s common stock is not publicly traded, the fair value was determined by management and contemporaneous valuation reports prepared by a third-party valuation specialist. |
| • | Expected Term: The expected life of the option is estimated by considering the contractual term of the option, the vesting period of the option, the employees’ expected exercise behavior and the post-vesting employee turnover rate. For non-employees, the expected life equals the contractual term of the option. |
| • | Risk-free Interest Rate: The risk-free interest rate is based on published U.S. Treasury Department interest rates for the expected terms of the underlying options. |
| • | Volatility: The expected stock price volatility of the underlying shares over the expected term of the option is based upon historical share price data of an index of comparable publicly traded companies. |
On August 22, 2017, OpenMail members’ Class B Units were modified to allow the service vesting condition to be met based on continued employment with System1 (see Note 9).
F-41
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
During 2021, 2020 and 2019, Class F Units were issued by OpenMail to S1 Holdco employees. These units are accounted for as a profit-sharing arrangement under ASC 710-10, Compensation—General. Class F Units remain unvested and forfeitable by the grantee until the later of (i) such date as the Company has disposed of its entire (direct or indirect ownership interest) and (ii) the four-year anniversary of the issuance date, except for one 2021 grant which vest at the one-year anniversary of the issuance date. The units will thereafter fully vest and become nonforfeitable subject to the grantee’s continuous employment by the Company. As of December 31, 2021, the above conditions were not met and therefore no liability has been recognized for the Class F Units.
Selling, general, and administrative expenses
Selling, general, and administrative expenses consist of fees for professional services, occupancy costs, travel and entertainment. These costs are expensed as incurred.
Depreciation and Amortization
Depreciation and amortization expenses are primarily attributable to the Company’s capital investment and consist of fixed asset depreciation and amortization of intangibles with finite lives.
Income Taxes
The Company has elected to be taxed as a limited liability company for federal and state tax purposes and, as a result, is not subject to US income taxes; rather the tax effect of the Company’s operations is passed through to each of its members. Various subsidiaries of the Company are subject to income tax in the United States and in other countries.
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. A valuation allowance is established, when necessary, to reduce deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company recognizes a tax benefit for uncertain tax positions when the Company’s position is more likely than not to be sustained upon examination by the relevant taxing authority.
Estimates of future taxable income are based on assumptions that are consistent with the Company’s plans. Assumptions represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. If actual amounts differ from the Company’s estimates, the amount of its tax expense and liabilities could be materially impacted. The Company recognizes the tax effects of an uncertain tax position only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date, and then, only in an amount more likely than not to be sustained upon review by the tax authorities.
Where applicable, the Company classifies associated interest and penalties as income tax expense. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments, and which may not accurately anticipate actual outcomes.
F-42
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
The Financial Accounting Standards Board (“FASB”) issued guidance regarding accounting for uncertainty in income taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a threshold of more-likely-than-not for recognition of tax benefits of uncertain tax positions taken or expected to be taken in a tax return. This guidance also provides related guidance on measurement, derecognition, classification, interest and penalties, and disclosures.
The Company recognizes interest and penalties related to unrecognized tax positions as income tax expense. As of December 31, 2021, 2020 and 2019, the Company had not incurred any related interest and penalties.
Recent Accounting Pronouncements
In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. Under the new guidance, a customer will apply the same criteria for capitalizing implementation costs of a cloud computing arrangement as it would for an on-premises software license. This guidance is effective for annual periods beginning after December 15, 2020, and early adoption is permitted. The Company early adopted this guidance in the first quarter of 2020 with no material impact on its consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which was subsequently amended in January 2021, related to contracts that reference the London Interbank Offered Rate (LIBOR) or other reference rates that are expected to be discontinued due to reference rate reform. The new standard provides for optional expedients and other guidance regarding the accounting related to modifications of contracts and other transactions affected by reference rate reform. The Company has elected to adopt the new standard. The adoption did not have a material accounting impact on the Company’s consolidated financial statements.
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The new guidance also improves consistent application of and simplifies U.S. GAAP for other areas of Topic 740 by clarifying and amending the existing guidance. The ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022 for non-public companies with early adoption permitted. The Company is currently evaluating the effect of the new guidance.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to recognize a lease liability and a right-of-use asset in the Consolidated Balance Sheet and aligns many of the underlying principles of the new lessor model with those in ASC 606, Revenue From Contracts With Customers. ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. Upon adoption, there will be a material increase in total assets and total liabilities in the Consolidated Balance Sheet due to the recognition of right-of-use assets and lease liabilities for the Company’s leases. In June 2020, the FASB issued ASU No. 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842). ASU No. 2020-05 defers the effective date of Leases for private entities (the “all other” category) to fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. On January 1, 2022, the Company adopted this pronouncement and recognized right-of-use assets of approximately $6,700 and lease liabilities of approximately $8,000 in its consolidated balance sheet.
F-43
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
In June 2016, the FASB issued ASU No. 2016-13, including subsequent amendments, Measurement of Credit Losses on Financial Instruments (Topic 326), which modifies the accounting methodology for most financial instruments. The guidance requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. This guidance is effective for annual periods beginning after December 15, 2022, and early adoption is permitted. The Company does not expect the adoption of this update to have a material effect on its consolidated financial statements.
In October 2021, the FASB issued ASU 2021-08, Accounting for Contract Assets and Contact Liabilities from Contracts with Customers (“ASU 2021-08”). ASU 2021-08 requires an acquirer in a business combination to recognize and measure contract assets and contract liabilities from acquired contracts using the revenue recognition guidance under Accounting Standards Codification Topic 606 in order to align the recognition of a contract liability with the definition of performance obligation. This approach is different from the current requirement to measure contract assets and contract liabilities acquired in a business combination at fair value. ASU 2021-08 is effective for financial statements issued for fiscal years beginning after December 15, 2022 and early adoption is permitted. The Company is currently evaluating the requirements of ASU No. 2021-08 and has not yet determined the effect on its consolidated financial statements.
3. ACQUISITIONS
On March 12, 2019, the Company entered into a securities purchase agreement to purchase Concourse Media (“Concourse”), an online publisher of websites focused on the verticals of health, travel, food, entertainment and consumer lifestyle. The Company acquired all assets and assumed all liabilities of Concourse in exchange for $8,000. During the closing of the sale, the Company identified $509 in adjustments that increased the final consideration to $8,509, which include adjustments for closing indebtedness, closing cash, and net working capital.
Additionally, the Company made additional payments of $2,216 to the sellers as contingent consideration since certain operating contribution performance targets were met for the period from April 1, 2019, through and including April 30, 2021. Upon acquisition, the Company recognized a liability for contingent consideration of $2,200. As of December 31, 2019, there were no changes in the recognized amounts or range of outcomes for the contingent consideration recognized as a result of the acquisition of Concourse.
On September 19, 2019, the Company entered into an asset purchase agreement (APA) with MapQuest, Inc. (“MapQuest”), a recognized brand that provides mapping solutions. Pursuant to the APA, on September 19, 2019, the Company acquired all assets and assumed all liabilities of MapQuest in exchange for $27,000. During the closing of the sale, the Company identified $281 in adjustments that lowered the final consideration to $26,719. The Company is leveraging MapQuest’s assets to achieve synergies with its own platform to drive growth in its consumer facing revenue streams.
On December 13, 2019, the Company entered into a securities purchase agreement to purchase Waterfox Limited (“Waterfox”). Waterfox manages and develops the Waterfox Web browser. Pursuant to the agreement, the Company acquired 100% of the outstanding shares of Waterfox in exchange for payment of $1,555. The Company acquired Waterfox for its intellectual property and for the expected synergies with the Waterfox browser as a distribution partner for the Company’s monetization platform. As the transaction related primarily to the purchase of a single asset, it was accounted for as an asset acquisition.
F-44
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
The following table shows the final allocation of the purchase price to the estimated fair values of assets and liabilities acquired in the transaction and goodwill for each of the acquisitions made in 2019.
| Concourse | MapQuest | Waterfox | ||||||||||
| Cash |
$ | 139 | $ | — | $ | 187 | ||||||
| Accounts receivable |
1,365 | 4,349 | 60 | |||||||||
| Other current assets |
196 | — | — | |||||||||
| Property and equipment |
43 | — | — | |||||||||
| Intangible assets |
4,000 | 16,900 | 1,850 | |||||||||
| Goodwill |
5,049 | 7,113 | — | |||||||||
| Accounts payable |
(583 | ) | — | — | ||||||||
| Accrued expenses and other liabilities |
— | (148 | ) | (247 | ) | |||||||
| Deferred revenue |
— | (1,643 | ) | — | ||||||||
| Other noncurrent liabilities |
(1,700 | ) | — | (295 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Consideration transferred |
$ | 8,509 | $ | 26,571 | $ | 1,555 | ||||||
|
|
|
|
|
|
|
|||||||
For the acquisitions, the excess of the purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Goodwill is primarily attributable to the value expected from the synergies of the combination of operations. This goodwill is not deductible for income tax purposes. The useful life of the intangible assets acquired was determined based on their expected economic lives.
The results of operations of Concourse, Mapquest and Waterfox have been included in the Company’s consolidated financial statements from the date of acquisition. The Concourse, Mapquest and Waterfox acquisitions did not have a material impact on the Company’s consolidated financial statements, and therefore historical and pro forma disclosures have not been presented. The following table shows the revenue and net loss for Concourse, MapQuest and Waterfox from their date of acquisition through December 31, 2019.
| Concourse | MapQuest | Waterfox | ||||||||||
| Revenue |
$ | 15,193 | $ | 5,035 | $ | — | ||||||
| Net loss |
$ | 3,705 | $ | 3,549 | $ | — | ||||||
4. PROPERTY AND EQUIPMENT, NET
Property and equipment, net as of December 31, 2021 and 2020, consisted of the following:
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Computer equipment |
$ | 415 | $ | 332 | ||||
| Furniture and equipment |
475 | 1,382 | ||||||
| Leasehold improvements |
976 | 1,173 | ||||||
|
|
|
|
|
|||||
| Property and equipment—gross |
1,866 | 2,887 | ||||||
| Less accumulated depreciation |
(1,036 | ) | (1,830 | ) | ||||
|
|
|
|
|
|||||
| Property and equipment—net |
$ | 830 | $ | 1,057 | ||||
|
|
|
|
|
|||||
Total depreciation expense on property and equipment was $310, $411 and $439 for the years ended December 31, 2021, 2020 and 2019, respectively.
F-45
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
5. GOODWILL, INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET
Goodwill
Goodwill as of December 31, 2021 and 2020, resulted from the acquisitions of Concourse, and Mapquest in 2019 (see Note 3) and the prior acquisition of InfoSpace in 2016 and Qool Media, Inc. in 2017. The changes in goodwill by reportable segments were as follows:
| Owned and Operated |
Partner Network |
Total | ||||||||||
| Goodwill at January 1, 2020 |
$ | 24,403 | $ | 20,417 | $ | 44,820 | ||||||
| Additions |
— | — | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Goodwill at December 31, 2020 |
24,403 | 20,417 | 44,820 | |||||||||
| Additions |
— | — | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Goodwill at December 31, 2021 |
$ | 24,403 | $ | 20,417 | $ | 44,820 | ||||||
|
|
|
|
|
|
|
|||||||
Internal-use software development costs, net and intangible assets, net consist of the following:
| December 31, 2021 | ||||||||||||
| Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
||||||||||
| Total internal-use software development costs |
$ | 21,274 | $ | (10,061 | ) | $ | 11,213 | |||||
|
|
|
|
|
|
|
|||||||
| Intangible assets: |
||||||||||||
| Developed technology |
$ | 8,398 | $ | (7,242 | ) | $ | 1,156 | |||||
| Trademarks and trade names |
69,007 | (21,375 | ) | 47,632 | ||||||||
| Professional service agreement |
3,100 | (2,359 | ) | 741 | ||||||||
| Customer relationships |
1,500 | (661 | ) | 839 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total intangible costs |
$ | 82,005 | $ | (31,637 | ) | $ | 50,368 | |||||
|
|
|
|
|
|
|
|||||||
| December 31, 2020 | ||||||||||||
| Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
||||||||||
| Total internal-use software development costs |
$ | 16,026 | $ | (6,366 | ) | $ | 9,660 | |||||
|
|
|
|
|
|
|
|||||||
| Intangible assets: |
||||||||||||
| Developed technology |
$ | 8,398 | $ | (6,699 | ) | $ | 1,699 | |||||
| Trademarks and trade names |
69,007 | (14,541 | ) | 54,466 | ||||||||
| Professional service agreement |
3,100 | (1,326 | ) | 1,774 | ||||||||
| Customer relationships |
1,500 | (430 | ) | 1,070 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total intangible costs |
$ | 82,005 | $ | (22,996 | ) | $ | 59,009 | |||||
|
|
|
|
|
|
|
|||||||
F-46
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
The internal-use software development costs include internal-use software development costs in progress of $2,540 and $1,423 as of December 31, 2021 and 2020, respectively. The Company recorded amortization expense of $4,934, and $8,641 for internal-use software development costs and intangible assets, respectively, during 2021. The Company recorded amortization expense of $3,471, and $9,891 for internal-use software development costs and intangible assets, respectively, during 2020. The Company recorded amortization expense of $2,590 and $8,133 for internal-use software development costs and intangible assets, respectively, during 2019. No impairment of internal-use software development cost or intangible assets was identified for the years ended December 31, 2021, 2020 and 2019.
As of December 31, 2021, the expected amortization expense associated with the Company’s intangible assets and internal-use software development costs for each of the next five years as of December 31, 2021, is as follows:
| Amortization Expense | ||||
| 2022 |
$ | 13,612 | ||
| 2023 |
11,652 | |||
| 2024 |
8,993 | |||
| 2025 |
6,904 | |||
| 2026 |
6,646 | |||
| Thereafter |
13,774 | |||
|
|
|
|||
| $61,581 | ||||
|
|
|
|||
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Former CEO profit interest |
$ | 11,132 | $ | — | ||||
| Payable to employees |
10,091 | 6,757 | ||||||
| Accrued legal service fees |
6,242 | — | ||||||
| Deferred revenue |
1,971 | 1,889 | ||||||
| Contingent consideration |
1,682 | 6,682 | ||||||
| Other liabilities |
1,543 | 3,454 | ||||||
| Accrued tax liability |
361 | 257 | ||||||
| Deferred rent |
233 | — | ||||||
|
|
|
|
|
|||||
| Accrued expenses and other current liabilities |
$ | 33,255 | $ | 19,039 | ||||
|
|
|
|
|
|||||
7. OTHER LIABILITIES
Other liabilities consisted of the following:
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Deferred tax liability |
$ | 7,789 | $ | 9,409 | ||||
| Former CEO profit interest |
— | 4,237 | ||||||
| Contingent consideration |
— | 1,558 | ||||||
| Deferred rent |
969 | 597 | ||||||
|
|
|
|
|
|||||
| Other liabilities |
$ | 8,758 | $ | 15,801 | ||||
|
|
|
|
|
|||||
F-47
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
8. MEMBERS’ DEFICIT
Outstanding Units
The Company’s authorized, issued, and outstanding membership units (“Units”) held by OpenMail and Court Square were 9,848,698 and 10,638,907, respectively, as of December 31, 2021. There were no changes in OpenMail or Court Square units during 2021, 2020, or 2019.
The Units are subject to certain transfer restrictions and no member has the right to voluntarily withdraw as a member of the Company, except with the consent of the board of directors, which consent can be withheld at the sole discretion of the board of directors.
The Units share in profits and losses or liquidation of the Company based on the terms of the amended and restated LLC agreement. Any negative capital accounts attributable to members are not considered to be debts owned by the members to the Company. The following summarizes the key rights and privileges of the outstanding Units pursuant to the LLC agreement.
Voting Rights of Members
Each director has one vote in any decision of the board of directors. However, in addition to the majority vote, board of directors’ actions must be approved by at least one Court Square member and at least one OpenMail member, except for limited circumstances whereby the counterparty in the matter requiring approval is Court Square (including its related parties) or OpenMail (including its related parties) in such instance the director will recuse him or herself from such discussions.
Distributions
The following distribution rights are provided for in the LLC agreement.
Interim Distributions:
OpenMail Classes B, B-1, B-2, B-3, and B-4 Units—These units were issued to employees and nonemployees of OpenMail and are generally subject to vesting provisions as described in Note 9. The holders of the vested and unvested Class B, Class B-2, and following March 1, 2019, Class B-3 Units are eligible for all distributions and the Class B-1 and Class B-4 Units are eligible for extraordinary, transaction, and liquidating distributions. The Class B Unitholders, regardless of vesting, cease to be eligible for interim distributions upon their termination of service to the Company. Extraordinary distributions may, at the discretion of the OpenMail’s board of managers, exclude or be paid other than pro rata to Class B-1 and Class B-4 Unitholders. Accordingly, it was determined that for accounting purposes, the Classes B, B-1, and B-4 Units did not represent substantive equity instruments, given their ongoing employment requirement and discretion of the OpenMail’s board of managers to pay distributions to these classes of OpenMail Units. The regular, transaction, and extraordinary distributions paid to the Class B, Class B-1, and Class B-4 Unitholders of $1,698, $3,323 and $7,579 were recorded as compensation expense within salaries, commissions, and benefit expenses in the accompanying consolidated statement of operations for the years ended December 31, 2021, 2020 and 2019, respectively. Vested Units are eligible for liquidating distributions.
OpenMail Class F Units—These units were issued as part of the ninth amended and restated operating agreement of OpenMail, LLC dated March 13, 2019, as additional incentive to Company management and are subject to a participation threshold and vesting provisions as described in Note 9. These Units are all unvested as of December 31, 2021; however, the holders of the Class F Units that are employed by System1 are eligible, after a participation threshold and at the discretion of the board of managers of OpenMail, for regular and extraordinary distributions. During 2021 and 2020, no regular and extraordinary distributions were paid to the Class F Unitholders.
F-48
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Value Creation Units (VCUs)—These units were issued to employees and nonemployees of System1 and are subject to vesting provisions as described in Note 9. These Units are all unvested as of December 31, 2021; however, the holders of the VCUs that are employed by System1 are eligible, based on the discretion of the board of directors of System1 and board of managers of OpenMail, for regular and extraordinary distributions. The regular, transaction, and extraordinary distributions paid to the VCU holders of $585, $1,383 and $1,926 were recorded as compensation expense within Salaries, commissions, and benefit expenses in the accompanying consolidated statement of operations for the years ended December 31, 2021, 2020 and 2019, respectively.
Regular Distributions—In its sole discretion, the board of directors of S1 Holdco determined the amount and timing of regular distributions of available cash from S1 Holdco’s operations. These distributions made to OpenMail are made on a pro rata basis to the holders of the OpenMail Units, based on the aggregate number of OpenMail Units so held, provided that any holder of OpenMail Units could waive his, her, or its entitlement to these distributions and the distribution would be distributed pro rata to those holders of OpenMail Units, who had not waived their entitlement. Any waived distributions by OpenMail members may be caught up at the next distribution that such OpenMail member would otherwise receive. For the year ended December 31, 2021, regular distributions to Court Square Capital Partners were $8,257 and OpenMail were $8,614, with $6,322 recorded within equity and $2,292 to holders of OpenMail’s Class B Units and VCUs, who are employees of S1 Holdco, which were expensed. For the year ended December 31, 2020, regular distributions to Court Square Capital Partners were $11,975 and OpenMail were $10,851, with $5,805 recorded within equity and $5,046 to holders of OpenMail’s Class B Units and VCUs, who are employees of S1 Holdco, which were expensed. For the year ended December 31, 2019, regular distributions to Court Square Capital Partners were $1,489 and OpenMail were $9,414, with $7,166 recorded within equity and $2,248 to holders of OpenMail’s Classes B and B 1 Units and VCU, who are employees of S1 Holdco, which were expensed.
Distributions from the Transaction—In accordance with the terms of the Transaction, at the close of the Transaction, $11,200 was distributed to OpenMail and held in an escrow account to be paid to System1 employees, previously employed by OpenMail, as their Units vested and VCUs met the service vesting condition. Amounts are withdrawn from the escrow account by OpenMail and contributed to System1 and then distributed to Unitholders. OpenMail withdrew and distributed $245, $1,698 and $2,878 in 2021, 2020 and 2019, respectively, from the escrow account, all of which was expensed.
Extraordinary Distributions—In its sole discretion, the board of directors determines the timing and recipients of extraordinary distributions. At the time of the Transaction, Court Square took a 51% stake in S1 Holdco, which represented OpenMail’s core business prior to the transaction. However, this did not include the podcast business, which was contributed to Stuff Media and owned 100% by OpenMail.
Liquidating Distributions—Liquidating distributions shall be made upon the occurrence of a liquidating event, as defined, to the members in the following order and priority:
First, until $14,000 in total is distributed, 51.93% to the Court Square members and 48.07% to the OpenMail member.
Second, to the Former CEO with respect to the former CEO’s profit interest, as discussed in the Executive Compensation section of Note 11 below.
F-49
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Third, distributed to Unit and VCU holders who had previously waived their rights to certain regular distributions, according to a distribution record as approved by the board of directors on a quarterly basis.
Lastly, on a pro rata basis to the holders of Units, provided that any holder of Units may waive his, her, or its entitlement to distributions and such holder’s pro rata share of the distribution shall be distributed pro rata to those holders of Units, who have not waived their entitlement.
9. SHARE-BASED COMPENSATION
The Company’s legacy OpenMail employees and nonemployee consultants were previously granted equity awards by OpenMail, which were modified to allow for employment at System1 to satisfy the service condition and are paid by OpenMail through distributions from System1. Accordingly, these awards became nonemployee awards of System1. Stock-based payments to nonemployees are recognized as an expense over the period of performance. On January 1, 2019, the Company early adopted ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share- Based Payment Accounting, using a modified retrospective transition approach. Thus, the Company’s equity classified awards were remeasured on the basis of their adoption-date fair value. The adoption did not result in a material cumulative effect adjustment to equity as of the beginning of the fiscal year. The Company has elected to account for forfeitures as they occur therefore it does not apply estimated forfeiture rates. The share-based compensation cost is recorded as compensation expense within Selling, general, and administrative expenses in the accompanying consolidated statement of operations. System1 has not granted any units to employees.
The fair value of all equity awards was estimated using the Black-Scholes valuation model with the following assumptions:
| B units | OM VCUs | S1 VCUs | ||||||||
| Fair market value of stock |
$ | 6.59 | $ | 5.91 | $5.91 — $10.46 | |||||
| Volatility |
65 | % | 65 | % | 40% — 65% | |||||
| Expected term |
4 | 4.00 | 1.25 — 4.00 | |||||||
| Expected dividend yield |
NA | NA | NA | |||||||
| Risk-free rate |
2.53 | % | 2.53 | % | 0.1% — 2.53% | |||||
OpenMail Classes B, B-1, B-2, B-3, and B-4 Units—The Company’s issued and outstanding Classes B, B-1, B-2, B-3, and B-4 Units as of December 31, 2021, were 2,754,182; 576,198; 125,000; 192,000; and 255,020 respectively, which generally vest at a rate of 25% at the first anniversary of the date of issuance and quarterly thereafter for three years on continuous employment with OpenMail or System1. As of December 31, 2021, the number of shares vested (net of cancellation) are 3,892,834 for all Classes of B Units. Share-based compensation expense amounting to $413, $1,012 and $1,764 were recognized during the years ended December 31, 2021, 2020 and 2019, respectively, within Salaries, commissions, and benefit expenses. The aggregate fair value of the units vested during the year was $387, $1,064 and $1,583 for the years ended December 31, 2021, 2020, and 2019, respectively. The unrecognized compensation expense associated with the unvested Classes B, B-1, and B-4 Units at December 31, 2021, was $31, all of which is expected to be recognized by April 30, 2022.
F-50
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
VCUs—During 2016, OpenMail adopted the 2016 VCU Plan (the “VCU Plan”), and during 2017, System1 adopted the 2017 VCU Plan, which provides certain employees, managers, and consultants of System1 with an opportunity to participate in appreciation of the Company’s value upon the occurrence of a qualifying liquidity event (QLE) (i.e., IPO or a change in control). As of December 31, 2021, there were no units available for issuance under the VCU Plans. Each VCU shall become fully vested upon the satisfaction of both a service condition, which includes service in System1 for the OpenMail VCUs, and a performance condition. The contractual term for these VCUs is six (6) years from the grant date. The VCUs shall vest at a rate of 25% in the first year and 6.25% quarterly thereafter and is subject to continuous employment. In addition, vesting is contingent upon the occurrence of a QLE. If VCUs held do not become fully vested on or prior to the sixth anniversary of the applicable grant date, such VCUs shall expire and be forfeited. Further, each fully vested VCU holder shall be entitled to receive (either in cash or equity securities) based on the discretion of board of managers for OpenMail Units and the board of directors for the System1 Units: (a) the per-unit consideration payable to the units in connection with the QLE, minus (b) the applicable per-unit threshold amount, which is determined by the board of managers of OpenMail or board of directors of System1 for each individual grant.
During the years ended December, 2021, 2020 and 2019, 802,550; 718,249 and 776,896 VCUs (net of cancellation), respectively, were issued to employees and nonemployees. The weighted average grant date fair value of System1 VCU’s granted during the year were $2.95, $2.17 and $2.09 for the years ended December 31, 2021, 2020 and 2019, respectively. As of December 31, 2021 a QLE was not deemed probable; accordingly, no share based compensation costs have been recognized for the VCUs.
The units are issued for a nominal fee to the System1 employees and consultants. No share-based compensation was capitalized as software development expense on the basis the costs were not material.
A summary of Classes B Units and VCU activity for the years ended December 31, 2021, 2020 and 2019, are as follows:
| Number of Units | ||||||||||||||||||||
| Class B Units | Class B-1 Units | Class B-2 Units | Class B-3 Units | Class B-4 Units | ||||||||||||||||
| Outstanding—January 1, 2019 |
2,780,299 | 576,198 | 125,000 | 192,000 | 271,277 | |||||||||||||||
| Canceled |
(22,367 | ) | — | — | — | (9,285 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2019 |
2,757,932 | 576,198 | 125,000 | 192,000 | 261,992 | |||||||||||||||
| Canceled |
(3,750 | ) | — | — | — | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2020 |
2,754,182 | 576,198 | 125,000 | 192,000 | 261,992 | |||||||||||||||
| Canceled |
— | — | — | — | (6,972 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2021 |
2,754,182 | 576,198 | 125,000 | 192,000 | 255,020 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Weighted-Average Exercise Price | ||||||||||||||||||||
| Class B Units | Class B-1 Units | Class B-2 Units | Class B-3 Units | Class B-4 Units | ||||||||||||||||
| Outstanding—January 1, 2019 |
$ | 0.51 | $ | 2.57 | $ | 1.42 | $ | 1.42 | $ | 7.09 | ||||||||||
| Canceled |
1.30 | — | — | 1.42 | 7.09 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2019 |
0.50 | 2.57 | 1.42 | 1.42 | 7.09 | |||||||||||||||
| Canceled |
1.15 | — | — | — | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2020 |
0.50 | 2.57 | 1.42 | 1.42 | 7.09 | |||||||||||||||
| Canceled |
— | 7.09 | — | — | 7.09 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2021 |
$ | 0.50 | $ | 2.57 | $ | 1.42 | $ | 1.42 | $ | 7.09 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
F-51
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
| S1 Holdco VCUs | Weighted- Average Exercise Price |
OpenMail VCUs | Weighted- Average Exercise Price |
|||||||||||||
| Outstanding—January 1, 2019 |
1,157,741 | $ | 10.00 | 469,683 | $ | 1.15 | ||||||||||
| Granted |
921,500 | 10.00 | — | — | ||||||||||||
| Canceled |
(119,226 | ) | 10.00 | (25,378 | ) | 1.15 | ||||||||||
|
|
|
|
|
|||||||||||||
| Outstanding—December 31, 2019 |
1,960,015 | 10.00 | 444,305 | 1.15 | ||||||||||||
| Granted |
926,000 | 10.00 | — | — | ||||||||||||
| Canceled |
(202,907 | ) | 10.00 | (4,844 | ) | 1.15 | ||||||||||
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2020 |
2,683,108 | 10.00 | 439,461 | 1.15 | ||||||||||||
| Granted |
1,178,350 | 10.00 | — | — | ||||||||||||
| Canceled |
(372,870 | ) | 10.00 | (2,930 | ) | 1.15 | ||||||||||
|
|
|
|
|
|
|
|||||||||||
| Outstanding—December 31, 2021 |
3,488,588 | 10.00 | 436,531 | 1.15 | ||||||||||||
|
|
|
|
|
|
|
|||||||||||
A summary of the Company’s unvested Units as of December 31, 2021, 2020 and 2019, are as follows:
| Number of Class B Units |
Number of Class B-1 Units |
Number of Class B-4 Units |
Number of of S1 VCUs |
Number OpenMail VCUs |
||||||||||||||||
| Nonvested—January 1, 2019 |
359,673 | 194,413 | 193,362 | 1,157,741 | 469,683 | |||||||||||||||
| Granted |
— | — | — | 921,500 | — | |||||||||||||||
| Vested |
(201,698 | ) | (66,627 | ) | (62,069 | ) | — | — | ||||||||||||
| Canceled |
(22,367 | ) | — | (9,285 | ) | (119,226 | ) | (25,378 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Nonvested—December 31, 2019 |
135,608 | 127,786 | 122,008 | 1,960,015 | 444,305 | |||||||||||||||
| Granted |
— | — | — | 926,000 | — | |||||||||||||||
| Vested |
(114,329 | ) | (59,906 | ) | (65,678 | ) | — | — | ||||||||||||
| Canceled |
(3,750 | ) | — | — | (202,907 | ) | (4,844 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Nonvested—December 31, 2020 |
17,529 | 67,880 | 56,330 | 2,683,108 | 439,461 | |||||||||||||||
| Granted |
— | — | — | 1,178,350 | — | |||||||||||||||
| Vested |
(17,145 | ) | (51,174 | ) | (49,050 | ) | — | — | ||||||||||||
| Canceled |
— | (7,812 | ) | (6,972 | ) | (372,870 | ) | (2,930 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Nonvested—December 31, 2021 |
384 | 8,894 | 308 | 3,488,588 | 436,531 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
There were no unvested Classes B-2 and B-3 Units at December 31, 2021, 2020 and 2019, respectively.
F-52
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
10. INCOME TAXES
Income from continuing operations before income taxes are as follows:
| Year Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Domestic |
$ | 30,521 | $ | 15,336 | $ | 17,448 | ||||||
| Foreign |
3,440 | 2,935 | 7,503 | |||||||||
|
|
|
|
|
|
|
|||||||
| Income before income taxes |
$ | 33,961 | $ | 18,271 | $ | 24,951 | ||||||
|
|
|
|
|
|
|
|||||||
The components of the income tax provision (benefit) from continuing operations for the years ended December 31, 2021, 2020, and 2019 are as follows:
| 2021 | 2020 | 2019 | ||||||||||
| Current: |
||||||||||||
| Federal |
$ | — | $ | — | $ | — | ||||||
| State |
55 | — | — | |||||||||
| Foreign |
1,882 | 1,875 | 2,845 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total |
$ | 1,937 | $ | 1,875 | $ | 2,845 | ||||||
| Deferred: |
||||||||||||
| Federal |
$ | — | $ | — | $ | — | ||||||
| State |
— | — | — | |||||||||
| Foreign |
(972 | ) | 32 | (2,143 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total |
$ | (972 | ) | $ | 32 | $ | (2,143 | ) | ||||
| Income tax expense |
$ | 965 | $ | 1,907 | $ | 702 | ||||||
|
|
|
|
|
|
|
|||||||
The income tax expense varied from the expense calculated using the federal statutory income tax rate for the years ended December 31, 2021, 2020 and 2019, primarily due to income (loss) from non-taxable pass-through entities, deferred tax impact of foreign rate change, and foreign rate differential.
| Year Ended December 31, | ||||||||||||||||||||||||
| (In thousands, except percentages) | 2021 | % | 2020 | % | 2019 | % | ||||||||||||||||||
| Federal tax expense at U.S. statutory rate |
$ | 7,131 | 21.0 | % | $ | 3,836 | 21.0 | % | $ | 5,239 | 21.0 | % | ||||||||||||
| Federal tax expense effect of flow-through entity |
(6,409 | ) | -18.9 | % | (3,289 | ) | -18.0 | % | (4,045 | ) | -16.2 | % | ||||||||||||
| Deferred tax impact of foreign rate change |
254 | 0.7 | % | 1,158 | 6.3 | % | (1,100 | ) | -4.4 | % | ||||||||||||||
| Foreign rate differential |
88 | 0.3 | % | 137 | 0.8 | % | 291 | 1.2 | % | |||||||||||||||
| Transaction cost |
— | — | — | — | 267 | 1.0 | % | |||||||||||||||||
| Other |
(99 | ) | -0.3 | % | 65 | 0.3 | % | 50 | 0.2 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total income tax expense |
$ | 965 | 2.8 | % | $ | 1,907 | 10.4 | % | $ | 702 | 2.8 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
F-53
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Deferred Income Taxes
| As of December 31, | ||||||||
| (In thousands) | 2021 | 2020 | ||||||
| Deferred tax assets: |
||||||||
| Interest expense carry forwards |
$ | 165 | $ | 165 | ||||
| Other |
5 | 5 | ||||||
| Total deferred tax assets |
170 | 170 | ||||||
|
|
|
|
|
|||||
| Valuation allowance |
(170 | ) | (170 | ) | ||||
| Total net deferred tax assets |
— | — | ||||||
|
|
|
|
|
|||||
| Deferred tax liabilities: |
||||||||
| Intangibles |
7,789 | 9,408 | ||||||
| Total deferred tax liabilities |
7,789 | 9,408 | ||||||
|
|
|
|
|
|||||
| Net deferred tax assets (liabilities) |
$ | (7,789 | ) | $ | (9,408 | ) | ||
|
|
|
|
|
|||||
In assessing the realization of deferred tax assets for the years ended December 31, 2021, and 2020, the management considers whether it is more likely than not some portion or all of the deferred tax assets will be realized, as prescribed by ASC 740. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income. The management considers all available evidence in making this assessment and has determined that a full valuation allowance should be recorded on net deferred tax assets.
The Company has recorded a full valuation allowance against its otherwise recognizable deferred income tax assets as of December 31, 2021, and 2020. Management has determined, after evaluating all positive and negative historical and prospective evidence, that it is more likely than not that these assets will not be realized. The valuation allowance is consistent, and there were no material changes for the years ended December 31, 2021, and 2020.
The Company determined that there are no unrecognized tax benefits for the reporting periods.
The Company regularly determined certain foreign earnings to be indefinitely reinvested outside the United States. The Company will continue to evaluate its reinvestment policy on a quarterly basis and will adjust its estimate of its income tax provision accordingly to the extent there is a change and an adjustment is required. As of December 31, 2021, the amount of undistributed earnings was approximately $24,225. The Company did not provide for U.S. income taxes on the undistributed earnings and other outside temporary differences of foreign subsidiaries as they are considered indefinitely reinvested outside the United States. As of December 31, 2021, the amount of temporary differences related to undistributed earnings and other outside temporary differences upon which U.S. income taxes have not been provided is immaterial to the consolidated financial statements.
The Company files income tax returns in the U.S. federal, states, and various foreign countries. For U.S. federal income tax purposes, as of December 31, 2021, tax year 2018 and later remain open for examination by the tax authorities. For foreign income tax purposes, as of December 31, 2021 tax year 2016 and later remain open for examination by the tax authorities under the Netherland’s five year statute of limitations.
F-54
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
11. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office facilities under noncancelable operating lease agreements. During 2021, the Company had leases for facilities in Marina del Rey and Venice, California; Bellevue, Washington; and Guelph, Canada.
In March 2021, the Company entered into an agreement for a lease of office space in Marina del Rey, California. The initial minimum lease payment is $147 per month. The initial term of the lease is in effect until November of 2025 with no renewal periods.
Rent expense was $2,221, $2,262 and $1,825 for the years ended December 31, 2021, 2020 and 2019 which was included in Selling, general, and administrative expenses. Two of the three Venice leases expired in the second quarter of 2021 and were not renewed when they expired. The remaining Venice lease was not renewed when it expired in October 2021. The Bellevue lease is in effect until May 2025. The Guelph, Canada office space is a month-to-month lease. As of December 31, 2021, the expected future operating lease obligation are as follows:
| Year ending December 31, | Amount | |||
| 2022 |
$ | 1,957 | ||
| 2023 |
$ | 1,950 | ||
| 2024 |
$ | 1,950 | ||
| 2025 |
$ | 1,663 | ||
Litigation
The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company believes the ultimate liability, if any, with respect to these actions will not materially affect the consolidated financial position, results of operations, or cash flows. There can be no assurance, however, that the ultimate resolution of such actions will not materially or adversely affect the Company’s consolidated financial position, results of operations, or cash flows. The Company accrues for losses when the loss is deemed probable and the liability can reasonably be estimated.
System1, LLC (a wholly owned subsidiary of S1 Holdco LLC) was named in a lawsuit alleging breach of partnership agreement, breach of fiduciary duty and breach of contract (among other claims), along with other affiliated defendants, by an individual who alleges that he was a co-founder and equity owner of OpenMail LLC (a significant shareholder of S1 Holdco) related to facts, circumstances and events that principally occurred prior to the formation of S1 Holdco. This matter was fully settled by the parties at no monetary and non-monetary expense or exposure to System1 or S1 Holdco, and included a complete release of claims against all named defendants, including System1 and S1 Holdco. The case was voluntarily dismissed with prejudice in March 2021.
F-55
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
In July 2021, the Company received initial correspondence from counsel for a United Kingdom-based marketing research company and its United States subsidiary (collectively, the “Demanding Group”) alleging trademark infringement based on its use of the “SYSTEM1” trade name and mark in the United States, and alleged use of the “SYSTEM1” trade name and mark in the United Kingdom. The correspondence demanded that we cease and desist from using the “SYSTEM1” name and mark, and made reference to potential legal action if we did not comply with that demand. While the Company was engaged in active discussions and correspondence with the Demanding Group to attempt to resolve the matter, the Demanding Group filed a lawsuit in the United States District Court for the Southern District of New York in September 2021 (the “Infringement Suit”), alleging (i) trademark infringement, (ii) false designation of origin, (iii) unfair competition and (iv) certain violations of New York business laws, seeking, among other things, an injunction, disgorgement of profits, actual damages and attorneys’ fees and costs. The Company believes that the Demanding Group’s infringement and other allegations and claims set forth in the Infringement Suit may be subject to a laches defense, among other defenses, and the Company intends to vigorously defend its rights in the Infringement Suit. The matter is currently pending, and the Company has filed a motion to dismiss the Infringement Suit in November 2021, and the parties are waiting for the court to hear the pending motion. Even though the Company received similar correspondence from the Demanding Group regarding its alleged use of the SYSTEMl trade name and mark in the United Kingdom, no lawsuit has been filed in the United Kingdom. The Company does not believe that its activities infringe any rights of the Demanding Group in the United Kingdom because, among other defenses, the Company does not actively offer services to customers using the SYSTEMl name and mark in the United Kingdom, and the Company’s counsel has informed the Demanding Group’s UK counsel of these circumstances, and the Demanding Group’s UK counsel confirmed receipt of this correspondence.
Service Agreements
On June 18, 2021 the Company entered into an agreement with a service provider whereby the Company is contractually obligated to pay $6,900 and $8,000 in the first and second years of the contract, respectively. The contract commencement date was July 1, 2021. The Company paid $4,226 to this service provider as of December 31, 2021.
Executive Compensation
Ian Weingarten was hired as CEO on April 10, 2019. He is entitled to a cash-settled profit interest of 5% of S1 Holdco, LLC, which is contingent upon a participation threshold of $300 million (which was subject to adjustment as set forth in the S1 Holdco operating agreement) contingent on a four-year vesting term, or if a qualifying change in control transaction occurs. The Company recorded a liability for this arrangement of $11,132 and $4,237 as of December 31, 2021 and 2020, respectively.
In February 2021, The Company’s former Chief Executive Officer, Ian Weingarten, terminated employment with the Company and entered into a separation agreement with the Company. In connection with the separation agreement, the Company agreed to payment of separation pay benefits consistent with the terms of Mr. Weingarten’s employment agreement, including the payment of the liability accrued for the cash-settled profit interest of 5% of S1 Holdco, LLC, which was deemed vested as to a 3.75% Profits Interest and forfeited as to the remaining 1.25% Profits Interest above the applicable adjusted threshold amount (subject to further reduction to a 2.5% Profits Interest in the event that the Business Combination is not consummated). As discussed in Note 18, the Company has settled the liability and agreement with the Company’s former Chief Executive Officer subsequent to December 31, 2021.
In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, investors, directors, officers, employees, and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement claims made by third parties. These indemnifications may survive termination of the underlying agreement and the maximum potential amount of future payments the Company could be required to make under these indemnification provisions may not be subject to claims related to these indemnifications. As a result, the Company believes the estimated fair value of these agreements is immaterial. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2021.
F-56
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
12. DEBT
The Company has secured financing from Cerberus Business Finance, LLC. As of December 31, 2021, the Company had principal of $172,038 outstanding under a term loan. Payments of $1,750 are due quarterly and, upon delivery of the prior year’s audited consolidated financial statements, the Company must make a payment of 50% of excess free cash flow, as defined. In the second quarter of 2021, the Company made a payment of $4,636. The Company also has a revolving line of credit, which was increased to $20,000 during 2019. No amounts are outstanding as of December 31, 2021 under the revolving line of credit.
Interest payments of the financing are due monthly at London InterBank Offered Rate (“LIBOR”), plus 7% with a LIBOR floor of 1%. Maturity for the financing is August 22, 2022. The facility has certain financial and nonfinancial covenants, including a leverage ratio. The Company was in compliance with the financial covenants as of December 31, 2021.
As of December 31, 2021, future minimum principal payments on short-term debt are as follows: 2022—$172,038. Loan fees amounting to $1,443 have been offset against the loan balance. Interest expense were $16,884, $24,669 and $26,033 for the years ended December 31, 2021, 2020 and 2019, respectively.
The Company has settled these debt instruments subsequent to December 31, 2021 as part of its Business Combination with Trebia and Protected.
13. NET INCOME PER UNIT ATTRIBUTABLE TO MEMBERS
Basic net income per unit attributable to members is calculated by dividing the net income attributable to common stockholders by the weighted-average number of membership units. The Company does not have any dilutive securities outstanding for the years ended December 31, 2021, 2020 and 2019. Therefore, diluted net income per share is the same as basic.
| For the Years Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Numerator: |
||||||||||||
| Net income from continuing operations |
$ | 32,996 | $ | 16,364 | $ | 24,249 | ||||||
| Net income (loss) from discontinued operations |
$ | — | $ | 47,397 | $ | (15,454 | ) | |||||
| Denominator: |
||||||||||||
| Weighted-average membership units outstanding: |
||||||||||||
| Weighted-average membership units outstanding—basic and diluted (units in thousands) |
20,488 | 20,488 | 20,488 | |||||||||
| Income (loss) earnings per membership units |
||||||||||||
| Income from continuing operations per membership units – basic and diluted |
$ | 1.61 | $ | 0.80 | $ | 1.18 | ||||||
| Income (loss) from discontinued operations membership units – basic and diluted |
$ | — | $ | 2.31 | $ | (0.75 | ) | |||||
| Income per membership units – basic and diluted |
$ | 1.61 | $ | 3.11 | $ | 0.43 | ||||||
F-57
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
14. SEGMENT REPORTING
ASC Subtopic 280-10, “Segment Reporting,” establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or CODM, in deciding how to allocate resources and assess performance. System1’s Chief Executive Officer, who is considered to be its CODM, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance.
The CODM measures and evaluates reportable segments based on segment operating revenues as well as Adjusted Gross Margin and other measures. The Company defines and calculates Adjusted Gross Margin as revenue less advertising expense to acquire users. The remaining cost of revenues consist of non-advertising expenses such as set-up costs, royalties and fees. The Company excludes the following items from segment Adjusted Gross Margin: depreciation and amortization of property, equipment and leasehold improvements, amortization of intangible assets and, at times, certain other transactions or adjustments, that the CODM does not consider for the purposes of making decisions to allocate resources among segments or to assess segment performance. Although these amounts are excluded from segment Adjusted Gross Margin, they are included in reported consolidated net income from continuing operations before income tax and are included in the reconciliation that follows.
The Company’s computation of segment Adjusted Gross Margin may not be comparable to other similarly-titled measures computed by other companies because all companies do not calculate segment Adjusted Gross Margin in the same fashion.
Operating segments do not sell products and services across segments, and, accordingly, there are no intersegment revenues to be reported. The accounting policies for segment reporting are the same as for System1 as a whole.
The CODM of the Company reviews operating results, assesses performance and makes decisions by operating segment. Management views each of the Company’s business lines as an operating segment. The Company has three business lines and operating segments: Publishing and Lead Generation, Search and Applications, and Partner Network.
The Publishing and Lead Generation and Search & Applications operating segments are aggregated into one reportable segment, referred to as Owned and Operated, based on their similar economic characteristics, technology platform utilized, types of services provided, Advertising Partners, and cost structures. The Company has two reportable segments: Owned and Operated and Partner Network. The following summarizes total assets by reportable segment as of December 31:
| 2021 | 2020 | |||||||
| Owned and Operated |
$ | 214,968 | $ | 184,236 | ||||
| Partner Network |
41,943 | 34,448 | ||||||
|
|
|
|
|
|||||
| $ | 256,911 | $ | 218,684 | |||||
|
|
|
|
|
|||||
F-58
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
The following summarizes revenue by reportable segment for the years ended December 31:
| 2021 | 2020 | 2019 | ||||||||||
| Owned and Operated |
$ | 652,884 | $ | 437,501 | $ | 369,570 | ||||||
| Partner Network |
35,505 | 38,476 | 37,923 | |||||||||
|
|
|
|
|
|
|
|||||||
| Revenue |
$ | 688,389 | $ | 475,977 | $ | 407,493 | ||||||
|
|
|
|
|
|
|
|||||||
The following summarizes Adjusted Gross Margin by reportable segment for the years ended December 31:
| 2021 | 2020 | 2019 | ||||||||||
| Owned and Operated |
$ | 143,284 | $ | 110,012 | $ | 108,635 | ||||||
| Partner Network |
35,505 | 38,476 | 37,923 | |||||||||
|
|
|
|
|
|
|
|||||||
| Adjusted gross margin |
$ | 178,789 | $ | 148,488 | $ | 146,558 | ||||||
|
|
|
|
|
|
|
|||||||
| Other cost of revenues |
11,513 | 13,507 | 14,835 | |||||||||
| Salaries, commissions and benefits |
66,747 | 55,548 | 48,389 | |||||||||
| Selling, general and administrative |
35,813 | 22,979 | 19,960 | |||||||||
| Depreciation and amortization |
13,885 | 13,832 | 11,244 | |||||||||
| Interest expense |
16,870 | 24,351 | 26,033 | |||||||||
| Other expense |
— | — | 1,146 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net income from continuing operations before income tax |
$ | 33,961 | $ | 18,271 | $ | 24,951 | ||||||
|
|
|
|
|
|
|
|||||||
15. RELATED-PARTY TRANSACTIONS
PlayaNext LLC (“Playa”), in which the Company’s former CEO is a principal shareholder, entered into a service agreement with the Company in which Playa shall reimburse the Company for a mutually agreed upon allocation of costs incurred by the Company in connection with employing the personnel necessary to provide Playa’s personnel services. In addition, Playa will pay the Company a quarterly fee for general and administrative support based on estimated calculations set forth in the service agreement. Based on the separation agreement between the Company and the former CEO, Playa paid fifty percent of the amount due in October 2021 with the remaining fifty percent to be paid in April 2022. The balances on these receivables were $223 and $410 as of December 31, 2021 and 2020, respectively. In 2021, the service agreement between Playa and the Company ended. Additionally in January 2022 as part of the Business Combination with Trebia and Protected, the receivables with the Company’s former CEO were repaid in full.
During 2018, the Company’s president did not take a salary for the year. On October 16, 2018, S1 Holdco and its subsidiaries purchased a 50.1% interest in a UK-based company, Protected LTD., for $55,000. At the time of the transaction, an investment vehicle known as Lone Investment Holdings LLC (LIH) was a shareholder and creditor of Protected. LIH owned 7.7% of the equity of Protected, and also was a creditor for $10,500, of shareholder loans for which Protected was the obligor. LIH’s shareholders primarily consist of members of the Company’s management team. As a result of the transaction, LIH’s shareholder loan to Protected was repaid, with interest, and LIH also received $1,158 in proceeds from the sale of its equity. LIH also retains a 3.85% equity ownership stake in Protected through System1 Surfboard Holdings, Inc.
F-59
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
During 2017, in connection with proceeds from the Transaction, the Company extended loans to two senior executives, one of whom terminated their employment with the Company in 2021. The balance of the loans were $969 and $969 as of December 31, 2021 and 2020, respectively. Additionally, during 2021, the Company extended a loan of $1,500 to its former CEO in connection with the separation agreement. In January 2022 as part of the Business Combination with Trebia and Protected, all related-party receivables were repaid in full.
Protected.net utilizes multiple payment processors in order to process credit card payments from its subscription customers, including Paysafe. Paysafe recently completed a merger with Foley Trasimene Acquisition Corp. II, a special purpose acquisition company sponsored by entities affiliated with William Foley, who is also a sponsor of Trebia Acquisition Corp. Protected.net’s payment processing agreement with Paysafe was negotiated before the announcements of both the Company’s business combination among System1, Protected.net and Trebia as well as the business combination between Paysafe and Foley Trasimene.
16. DISCONTINUED OPERATIONS
In the third quarter of 2020, the Company’s Board of Directors approved a plan to dispose of the Company’s 50.4% interest in Protected. The transaction closed on November 13, 2020 and the Company’s interest in Protected was sold for $81,419. The final proceeds from the sale were $38,193, net of the settlement of Protected debt. OpenMail’s share of the proceeds of $17,164 was not distributed but reinvested in Protected. Court Square’s share of the proceeds was $21,028, of which $11,601 were distributed to Court Square directly by the buyers, and $9,427 distributed to the Company (and subsequently distributed to Court Square). As a result of the disposition, the Company recorded a gain on disposal of $55,070, which is comprised of the cash received by the Company and the net reduction in carrying value of the assets and liabilities of Protected.
The Company disposed of Protected as it represents a business (subscription anti-virus), which the Company was no longer pursuing at that time. Furthermore, Protected operates on its own technology platform separate from the Company’s core technology platform, and has a customer base that the Company no longer planned to serve. As such, the disposal of Protected represents a strategic shift. Accordingly, the results of Protected have been accounted for as discontinued operations for all periods prior to 2021. Refer to Note 17 regarding the transaction with Trebia and recombination with Protected.
The financial results of Protected are presented as loss from discontinued operations, net of income taxes in the Consolidated Statements of Operations. The following table presents the financial results of Protected:
| For the year ended December 31, |
||||||||
| 2020 | 2019 | |||||||
| Revenue |
$ | 72,937 | $ | 45,222 | ||||
|
|
|
|
|
|||||
| Cost of revenues (exclusive of depreciation and amortization shown separately below) |
79,958 | 67,272 | ||||||
| Salaries, commissions, and benefits |
1,835 | 1,678 | ||||||
| Selling, general, and administrative |
4,047 | 4,289 | ||||||
| Depreciation and amortization |
2,412 | 2,891 | ||||||
|
|
|
|
|
|||||
| Total operating costs and expenses |
88,252 | 76,130 | ||||||
|
|
|
|
|
|||||
| Operating loss |
(15,315 | ) | (30,908 | ) | ||||
| Gain on disposal of Protected |
55,070 | — | ||||||
| Noncontrolling interest |
7,642 | 15,454 | ||||||
| Income tax |
— | — | ||||||
|
|
|
|
|
|||||
| Income (loss) from discontinued operations, net of income taxes |
$ | 47,397 | $ | (15,454 | ) | |||
|
|
|
|
|
|||||
F-60
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
The following table presents depreciation, amortization, capital expenditures, and significant non-cash items of the discontinued operations related to Protected:
| For the year ended December 31, |
||||||||
| 2020 | 2019 | |||||||
| Depreciation |
$ | 59 | $ | 29 | ||||
| Amortization |
2,353 | 2,862 | ||||||
| Capital expenditures |
29 | 171 | ||||||
| Noncontrolling interest |
7,642 | 15,454 | ||||||
17. MERGER
On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), (the “Business Combination Agreement”) by and among Trebia Acquisition Corporation (“Trebia”) and Protected (together with System1 and Trebia, collectively, the “Companies”). On January 27, 2022 (the “Closing Date”), the Company consummated the merger (the “Merger”) pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company (“Post Closing Company”) is organized in an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected. Additionally, Trebia’s ordinary shares, warrants and units ceased trading on the New York Stock Exchange (“NYSE”), and System1 Inc. Class YSE on January 28, 2022 under the symbols “SST” and “SST.WS,” respectively.
The consideration paid to the existing Securityholders of System1 and Protected in connection with the Merger was a combination of cash and equity.
The aggregate cash consideration payable under the Business Combination Agreement (“Closing Cash Consideration”) was $445,432 of which $195,070 cash proceeds was received or is to be received by System1 Equityholders and Protected Equityholders, and $250,362 cash proceeds was received by Court Square.
The aggregate equity consideration paid under the Business Combination Agreement and/or retained S1 Holdco Class B Units (“Closing Equity Consideration”) was approximately $667,500, consisting of (a) the aggregate equity consideration payable under the Business Combination Agreement, consisting of shares of Class A Common Stock (valued at $10.00 per share), RSUs and Class C Common Stock, and (b) the aggregate S1 Holdco Class B Units retained by System1 Equityholders at the Closing (valued at $10.00 per share).
In connection with the Merger, Trebia and Cannae Holdings, Inc. entered into the Backstop Agreement (the “Backstop Agreement”) whereby Cannae agreed, subject to the other terms and conditions, to subscribe for Trebia Class A Common Stock in order to fund redemptions by shareholders of Trebia. As a result of shareholder redemptions, Trebia shareholders provided $7,031 of funding and Cannae provided $246,484 per the Backstop Agreement.
In connection with the Business Combination Agreement, System1 Midco, LLC entered into a new loan (“Term Loan”) and revolving facility (“Revolving Facility”). See Note 18 for further details.
F-61
S1 Holdco, LLC and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except for per unit amounts and number of units)
Concurrently with the consummation of the Merger, System1 entered into a tax receivable agreement with Trebia (the “Tax Receivable Agreement”), pursuant to which, among other things, the parties to the Tax Receivable Agreement have agreed to the allocation and payment of 85% of the actual savings, if any, in U.S. federal, state and local income tax that Trebia may realize as a result of certain tax benefits related to the transactions contemplated by the Business Combination Agreement and future exchanges of units in the Company for Trebia Class A Common Stock.
18. SUBSEQUENT EVENTS
Concurrently with the Merger with Trebia and Protected.net, System1 Midco, LLC entered into a new loan agreement with Bank of America, N.A. on January 27, 2022 for a 5.5 year term loan with a principal of $400,000 and with the net proceeds of $376,000, of which a portion of the proceeds was used to settle the Company’s outstanding debt of $172,038. For every 6-month interest period, the interest rate is the adjusted Term Secured Overnight Financing Rate (“SOFR”) plus 4.75% with an adjusted Term SOFR floor of 0.50%. The Term Loan will amortize in quarterly installments on each Scheduled Payment Date (commencing with the Scheduled Payment Date occurring on June 30, 2022). The new loan comes with a springing covenant, which goes into effect if the utilization on the Revolving Facility exceeds 35% at each quarter-end starting from the first full quarter after the effective date of the Merger, such that the first lien leverage ratio (as defined in the credit agreement) should not exceed 5.40. For the period covering June 30, 2022 through and including December 31, 2025, $5,000 of the amortization payment will be made quarterly. For March 31, 2026 (scheduled payment date) and thereafter, $7,500 of the amortization payment will be made quarterly. In addition, the Company also obtained a Revolving Facility of $50,000 on January 27, 2022. The Revolving Facility will mature five years after the Closing. The interest rate on the Revolving Facility is the adjusted Term SOFR plus 2.75% with an adjusted Term SOFR floor of 0%. In March 2022, the Company borrowed $49,000 on its Revolving Facility.
In January 2022, as part of the Merger with Trebia and Protected, the liability and agreement with the Company’s former CEO was settled.
On May 28, 2021, the Company executed a letter of intent to acquire assets of RoadWarrior LLC, a subscription-based business. On February 10, 2022, the Company closed the transaction for a total consideration of up to $22,150, consisting of $19,650 in cash up front, and up to $2,500 in a combination of cash and stock in 2023 subject to the achievement of certain financial objectives in 2022. The required information for purchase price allocation in accordance with the FASB ASC Topic 805 is not presented because the initial accounting for the business combination is incomplete as of the date of this filing, due to the short period since acquisition.
Prior to the end of 2021, the Company entered into a non-binding Letter of Intent to acquire NextGen Shopping, Inc.’s CouponFollow, a coupon destination for online shoppers, for up to $115,000, with the total consideration consisting of a combination of cash and stock, inclusive of earnout payments earned and payable over three years upon the achievement of certain financial objectives. On March 4, 2022, the Company closed the transaction for a total consideration of up to $115,000, consisting of 2,000 shares to be granted, $60,000 in cash due between the close and January 2023, and a maximum of cash and stock up to $35,000 payable over three years upon the achievement of certain financial objectives. The required ASB ASC Topic 805 is not presented because the initial accounting for the business combination is incomplete as of the date of this filing, due to the short period since acquisition.
F-62
Exhibit 99.2
SYSTEM1 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless otherwise indicated or the context otherwise requires, references in this section to the “Company,” “System1,” “we,” “us,” “our” and other similar terms refer to S1 Holdco, LLC and its subsidiaries prior to the Business Combination.
The following discussion and analysis of the financial condition and results of operations of System1 should be read together with our audited consolidated financial statements, unaudited condensed consolidated financial statements, and related notes included elsewhere in this prospectus. The discussion and analysis should also be read together with the section entitled “Business” and our pro forma financial information as of and for the year ended December 31, 2021 and for the year ended December 31, 2020. See “Unaudited Pro Forma Condensed Combined Financial Information.” In addition to historical information, the following discussion contains forward-looking statements. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in the sections entitled “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” Certain amounts may not foot due to rounding, and all figures presented are in thousands.
Company Overview
We are an omnichannel customer acquisition platform, delivering high-intent customers to advertisers and to our own subscription products. We provide these services through our proprietary responsive acquisition marketing platform, or RAMP. Operating seamlessly across major advertising networks and advertising category verticals to acquire users on our behalf, RAMP allows us to monetize these acquired users through our relationships with third party advertisers and advertising networks, which we refer to as our “Advertising Partners”. RAMP also allows third party advertising platforms and publishers, which we refer to as our Network Partners, to send user traffic to and monetize user traffic on our websites. RAMP is integrated across our network of owned and operated websites and related products, allowing us to monetize user traffic that we source from acquisition marketing channels, including Google, Facebook and Taboola.
Through RAMP, we process approximately almost 15 million daily advertising campaign optimizations and ingest 6 billion rows of data daily across 50 advertising verticals. We are able to efficiently monetize user intent by linking data on consumer engagement, such as first party search data, with data on monetization and advertising spend. This context-enriched data, combined with our proprietary and data science driven algorithms, creates a closed-loop system that is not reliant on personally identifiable information or information obtained through third-party cookies, but which allows RAMP to efficiently match consumer demand with the appropriate advertiser or advertising experience across advertising verticals.
We were founded in 2013 with a focus on monetizing user traffic acquired by our network. Since launching, we have expanded to support additional advertising formats across numerous advertising platforms, and have acquired several leading websites, enabling us to control user acquisition and experience, and monetize user traffic on our own behalf. Today we own and operate over 40 websites, including leading search engines like info.com and Startpage.com, and publishing digital media sites and utilities such as HowStuffWorks, Mapquest and ActiveBeat.
S1 Holdco, LLC was formed as a limited liability company (“LLC”) under the laws of the State of Delaware on July 25, 2017. On August 22, 2017, OpenMail LLC (“OpenMail”) entered into a transaction (the “Transaction”) with Court Square Capital Partners and its related entities (“Court Square”), whereby Court Square obtained a 51% interest in S1 Holdco through its own contributions and a recapitalization and distribution to the members of OpenMail. The Company is governed by an LLC agreement between Court Square and OpenMail. All the management powers over the business and affairs of the Company are retained by the board of directors, including the approval of debt transactions, issuance or transfer of membership units (the “Units”), approval to buy and sell Company assets or any other significant transaction, and declaring and making distributions.
70
The Company’s primary operations are in the United States; however, the Company also has operations in Canada, the United Kingdom, Germany, Israel, Hungary and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems and various political and economic environments. Among the risks are changes in existing tax laws, possible limitations on foreign investment and income repatriation, government price or foreign exchange controls, and exposure to currency exchange fluctuations. The Company does not engage in hedging activities to mitigate its exposure to fluctuations in foreign currency exchange rates.
On October 16, 2018, System1 SS Protect Holdings, Inc., a subsidiary of System1, acquired a 50.1% interest in Protected.net Group Limited (f/k/a SS Protect Limited) (“Protected”) for a total consideration of $55,000. System1 consolidated Protected under the voting model of ASC 810, Consolidation, since the Company controlled three of five board seats or 60% of the voting rights of Protected.
On November 13, 2020 the Company disposed of its interest in Protected in a sale to a group led by Protected and System1 management. Accordingly, the results of Protected have been accounted for as discontinued operations for the periods ended December 31, 2020 and prior.
The Business Combination
On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), the “Business Combination Agreement”) by and among Trebia Acquisition Corporation (“Trebia”) and Protected (together with System1 and Trebia, collectively, the “Companies”). On January 27, 2022 (the “Closing Date”), the Company consummated the business combination (the “Business Combination”) pursuant to the Business Combination Agreement. Following the consummation of the Business Combination, the combined company (“Post Closing Company”) is organized in an “Up-C” structure, in which substantially all of the assets and business of System1 is held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected.
The consideration paid to the existing Securityholders of System1 and Protected in connection with the Transaction was a combination of cash and equity consideration.
The aggregate cash consideration payable under the Business Combination Agreement (“Closing Cash Consideration”) was approximately $445,432 of which approximately $195,070 cash proceeds was received by System1 Equityholders and Protected Equityholders, and $250,362 cash proceeds was received by Court Square.
The aggregate equity consideration paid under the Business Combination Agreement and/or retained S1 Holdco Class B Units (“Closing Equity Consideration”) was approximately $667,500, consisting of (a) the aggregate equity consideration payable under the Business Combination Agreement, consisting of shares of Class A Common Stock (valued at $10.00 per share), RSUs and Class C Common Stock, and (b) the aggregate S1 Holdco Class B Units retained by System1 Equityholders at the Closing (valued at $10.00 per share).
In connection with the Business Combination, Trebia and Cannae Holdings, Inc. entered into the Backstop Agreement (the “Backstop Agreement”) whereby Cannae agreed, subject to the other terms and conditions, to subscribe for Trebia Class A Common Stock in order to fund redemptions by shareholders of Trebia. As a result of shareholder redemptions, Trebia shareholders provided $7,031 of funding and Cannae provided $246,484 per the Backstop Agreement.
In connection with the Business Combination Agreement, Trebia entered into a Term Loan arranged by Bank of America, whereby System1 Midco, LLC, as a borrower, would receive a term loan of $400,000 (“Term Loan”) , and a $50,000 revolving facility (the “Revolving Facility” and, together with the Term Loan, the “New Facility”). The Term Loan will mature seven years after the Closing and will amortize in equal quarterly installments in an aggregate annual amount equal to 1% of the original principal amount of the Term Loan and with an originating issuer discount of 6%, and $376,000 of Term Loan proceeds in aggregate. The Revolving Facility will mature five years after the Closing. The New Facility, along with the proceeds from the Business Combination noted above, will be used to pay off the Company’s outstanding term loan due 2022, distribute cash to existing shareholders, provide cash for working capital, and pay transaction fees incurred with the Business Combination.
71
Concurrently with the consummation of the Business Combination, System1 entered into a tax receivable agreement with Trebia (the “Tax Receivable Agreement”), pursuant to which, among other things, the parties to the Tax Receivable Agreement have agreed to the allocation and payment of 85% of the actual savings, if any, in U.S. federal, state and local income tax that Trebia may realize as a result of certain tax benefits related to the transactions contemplated by the Business Combination Agreement and future exchanges of units in the Company for Trebia Class A Common Stock.
COVID-19
The worldwide spread of COVID-19 has resulted, and is expected to continue to result, in a global slowdown of economic activity which is likely to decrease demand for a broad variety of goods and services, including those provided by our clients, while also disrupting sales channels and advertising and marketing activities for an unknown period of time until the virus is contained or economic activity normalizes. Our revenue growth and results of operations have been resilient despite the headwinds created by the COVID-19 pandemic. The extent to which ongoing and future developments related to the global impact of the COVID-19 pandemic and related vaccination measures designed to curb its spread continue to impact our business, financial condition and results of operations, all of which cannot be predicted with certainty. Many of these ongoing and future developments are beyond our control, including the speed of contagion, the development, distribution and implementation of effective preventative or treatment measures, including vaccines (and vaccination rates), the scope of governmental and other restrictions on travel, discretionary services and other activity, and the public reactions and receptiveness to these developments. See “Risk Factors” for further discussion of the adverse impacts of the COVID-19 pandemic on our business.
Components of Our Results of Operations
Segment Results:
We operate in two reportable segments.
The following summarizes revenue and adjusted gross profit by reportable segment for the years ended December 31:
| For Years Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Revenue: |
||||||||||||
| Owned and Operated |
$ | 652,884 | $ | 437,501 | $ | 369,570 | ||||||
| Partner Network |
35,505 | 38,476 | 37,923 | |||||||||
|
|
|
|
|
|
|
|||||||
| $ | 688,389 | $ | 475,977 | $ | 407,493 | |||||||
|
|
|
|
|
|
|
|||||||
|
For Years Ended December 31, |
||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Segment Adjusted Gross Profit: |
||||||||||||
| Owned and Operated |
$ | 143,284 | $ | 110,012 | $ | 108,635 | ||||||
| Partner Network |
35,505 | 38,476 | 37,923 | |||||||||
|
|
|
|
|
|
|
|||||||
| $178,789 | $148,488 | $146,558 | ||||||||||
|
|
|
|
|
|
|
|||||||
72
Revenue
Revenue is earned from revenue-sharing arrangements with the Company’s Network Partners for the use of the RAMP platform and related services provided to them to direct advertising by the Advertising Partners on traffic acquired and directed to the Company’s platform by the Network Partners to their advertising space. The Company determined it is the agent in these transactions and reports revenue on a net basis. The Company does not control the underlying advertising space, the Company does not acquire the traffic and does not have risk of loss, and the pricing is in the form of a substantively fixed-percentage revenue-sharing arrangement. The Company reports this revenue on a net basis for the amount retained from its revenue-sharing arrangements representing the difference between amounts received from the Advertising Partners, less amounts remitted to the Network Partners based on underlying contracts.
The Company also earns revenue by directly acquiring traffic to its owned and operated websites and utilizing its own RAMP platform and related services to connect its Advertising Partners to its own websites. For this revenue stream, the Company is the principal in the transaction and reports revenue on a gross basis for the amount received from the Advertising Partners. For this revenue, the Company has determined that it is the principal since it has a risk of loss on the traffic that it is acquiring for monetization by its Advertising Partners and in the case of its owned and operated websites, the Company maintains the website, provides the content and bears the cost and risk of loss associated with its websites’ advertising space. The Company’s key Advertising Partners are Google, Yahoo!, and Microsoft.
The Company recognizes revenue upon delivering traffic to its Advertising Partners based on a cost-per- click or cost-per-thousand impression basis. The payment term is typically 30 days.
The Company sold SS Protect in November 2020 and accounted for this disposition as a discontinued operation. Therefore, revenue from SS Protect has been excluded from our results of operations. Please see Note 17 of the S1 Holdco, LLC and Subsidiaries Consolidated Financial Statements for the year ended December 31, 2021 for more information.
Revenue may fluctuate from period to period due to a number of factors including seasonality and the shift in mix of user acquisition sources from Advertising Partners.
Operating Expenses
We classify our operating expenses into the following four categories:
Cost of Revenues. Cost of revenues includes traffic acquisition costs which consists primarily of costs to place advertisements to attract customers to the Company’s websites, mapping costs, domain name registration costs, and licensing costs to provide mapping services to Mapquest.com. The Company does not pay any up-front payments, incentive payments or bonuses and such costs are expensed as incurred.
We expect platform operations expenses to increase in absolute dollars in future periods as we incur higher traffic acquisition expenses and drive more user traffic through our platform, including to Mapquest.
Salaries, Commissions, and Benefits. Salaries, commissions and benefits expenses include salaries, bonuses, stock-based compensation, costs incurred in the preliminary project and post-implementation stages of internal-use software development, employee benefits costs associated with our executive, finance, legal, human resources, compliance, and other administrative personnel, as well as accounting and legal professional services fees.
Selling, General, and Administrative. Selling, general, and administrative expenses consist of fees for professional services, occupancy costs, travel and entertainment. These costs are expensed as incurred.
73
We expect to continue to invest in corporate infrastructure to support our growth. We expect general and administrative expenses to increase in absolute dollars in future periods.
Depreciation and Amortization. Depreciation and amortization expenses are primarily attributable to our capital investment and consist of fixed asset depreciation and amortization of intangibles considered to have finite lives.
Other Expenses
Other expenses consist of the following:
Interest Expense. Interest expense is primarily related to our debt, which carries a variable interest rate.
Other Income (Expense). Other income (expense) is primarily related to realized losses on the sale of investments in equity securities.
Provision for (Benefit from) Income Taxes
The provision for (benefit from) income taxes consist primarily of U.S. federal, state, and foreign income taxes. The Company has elected to be taxed as an LLC for federal and state tax purposes and, as a result, is not subject to US income taxes; rather the tax effect of the Company’s operations is passed through to each of its members. Various subsidiaries of the Company are subject to income tax in the United States and in other countries.
Deferred tax assets and liabilities are recognized with respect to the tax consequences attributable to differences between the financial statement carrying values and tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. A valuation allowance is established, when necessary, to reduce deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company recognizes a tax benefit for uncertain tax positions when the Company’s position is more likely than not to be sustained upon examination by the relevant taxing authority. The Company recognizes interest and penalties related to unrecognized tax benefits, if any, as a component of income tax expense.
Realization of our deferred tax assets is dependent primarily on the generation of future taxable income. In considering the need for a valuation allowance, we consider our historical, as well as future, projected taxable income along with other objectively verifiable evidence. Objectively verifiable evidence includes our realization of tax attributes, assessment of tax credits and utilization of net operating loss carryforwards during the year.
74
Results of Operations
The following tables set forth our consolidated results of operations and our consolidated results of operations as a percentage of revenue for the periods presented.
| Year Ended December 31, | ||||||||||||
| ($ in thousands) | 2021 | 2020 | 2019 | |||||||||
| Revenue |
$ | 688,389 | $ | 475,977 | $ | 407,493 | ||||||
| Operating expenses: |
||||||||||||
| Cost of revenues |
521,113 | 340,996 | 275,770 | |||||||||
| Salaries, commissions, and benefits |
66,747 | 55,548 | 48,389 | |||||||||
| Selling, general, and administrative |
35,813 | 22,979 | 19,960 | |||||||||
| Depreciation and amortization |
13,885 | 13,832 | 11,244 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total operating expenses |
637,558 | 433,355 | 355,363 | |||||||||
| Operating income |
50,831 | 42,622 | 52,130 | |||||||||
| Interest expense |
16,870 | 24,351 | 26,033 | |||||||||
| Other expense |
— | — | 1,146 | |||||||||
|
|
|
|
|
|
|
|||||||
| Income from continuing operations before income tax |
33,961 | 18,271 | 24,951 | |||||||||
| Income tax expense |
965 | 1,907 | 702 | |||||||||
| Net income from continuing operations |
32,996 | 16,364 | 24,249 | |||||||||
| Income (loss) from discontinued operations, net of taxes |
— | 47,397 | (15,454 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) |
$ | 32,996 | $ | 63,761 | $ | 8,795 | ||||||
|
|
|
|
|
|
|
|||||||
| Year Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| Revenue |
100 | % | 100 | % | 100 | % | ||||||
| Operating expenses: |
||||||||||||
| Cost of revenues |
76 | 72 | 68 | |||||||||
| Salaries, commissions, and benefits |
10 | 12 | 12 | |||||||||
| Selling, general, and administrative |
5 | 5 | 5 | |||||||||
| Depreciation and amortization |
2 | 3 | 3 | |||||||||
| Total operating expenses |
93 | 92 | 87 | |||||||||
| Operating income |
7 | 9 | 13 | |||||||||
| Interest expense |
2 | 5 | 6 | |||||||||
| Other expense (income) |
— | — | — | |||||||||
| Income from continuing operations before income tax |
5 | 4 | 6 | |||||||||
| Income tax expense (benefit) |
— | — | — | |||||||||
| Net income from continuing operations |
5 | 3 | 6 | |||||||||
| Income (loss) from discontinued operations, net of taxes |
— | 10 | (4 | ) | ||||||||
| Net income (loss) |
5 | % | 13 | % | 2 | % | ||||||
| * | Percentages may not sum due to rounding |
The comparability of our operating results for the fiscal year ended December 31, 2020 compared to the fiscal year ended December 31, 2019 was impacted by the acquisitions of Concourse in March of 2019 and Mapquest in September of 2019. In the discussion of our results of operations for these periods we may quantitatively disclose the impact of our acquired businesses to the extent they remain ascertainable. Expense contributions from our recent acquisitions for each of the respective period comparisons generally were not separately identifiable due to the integration of these businesses into our existing operations.
75
Comparison of the Years Ended December 31, 2021, 2020, and 2019
Revenue
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Revenue |
$ | 688,389 | $ | 475,977 | $ | 407,493 | $ | 212,412 | 45 | % | $ | 68,484 | 17 | % | ||||||||||||||
The increase in revenue in 2021 was primarily due to growth in our Owned and Operated segment. Owned and Operated revenue increased $215,383 driven by an increase in revenue per session ("RPS") of $0.04 and an increase of 545 million sessions. Partner Network segment revenue decreased $2,971 as sessions decreased by 317 million with RPS approximately flat.
The increase in revenue in 2020 was primarily due to growth in our Owned and Operated segment. Owned and Operated revenue increased $67,931 driven by an increase in RPS of $0.03 partially offset by a decrease in sessions of 171 thousand. Excluding revenue from our Concourse ($24,424 in 2020 compared to $15,193 in 2019 on a pro-forma basis to include the pre-acquisition period) and Mapquest ($27,317 in 2020 compared to $6,252 in 2019 on a pro-forma basis to include the pre-acquisition period) acquisitions, as well as revenue from our Social Publishing product line ($5,646 in 2020 compared to $39,303 in 2019) which was discontinued in April of 2020, Owned and Operated revenue increased $71,292, driven by an increase in RPS of $0.03 partially offset by a decrease in sessions of 81.5 million. Partner Network segment revenue increased $553 due to an increase of 261 thousand sessions and flat RPS.
Cost of revenue
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Cost of revenue |
$ | 521,113 | $ | 340,996 | $ | 275,770 | $ | 180,117 | 53 | % | $ | 65,226 | 24 | % | ||||||||||||||
| Percent of revenue |
76 | % | 72 | % | 68 | % | ||||||||||||||||||||||
The increase in cost of revenues in 2021 was primarily due to an increase in user acquisition costs of $182,110 related to our Owned and Operated segment. 2021 user acquisition costs were $509,599 and drove 3.4 billion sessions to our Owned and Operated sites at a $0.15 cost per session (“CPS”) , compared to 2020 user acquisition costs of $327,489, which drove 2.8 billion sessions to our Owned and Operated sites at a $0.12 CPS. User acquisition costs accounted for 98% and 96% of total cost of revenue in 2021 and 2020, respectively.
The increase in cost of revenues in 2020 was primarily due to an increase in user acquisition costs of $66,554 related to our Owned and Operated segment. 2020 user acquisition costs were $327,489 and drove 2.8 billion sessions to our Owned and Operated sites at a $0.12 CPS, compared to 2019 user acquisition costs of $260,935, which drove 3.0 billion sessions to our Owned and Operated sites at a $0.09 CPS. User acquisition costs accounted for 96% and 95% of total cost of revenue in 2020 and 2019, respectively. Excluding user acquisition costs associated with our terminated Social Publishing product line, 2020 user acquisition costs were $322,275 compared to 2019 user acquisition costs of $226,639.
Excluding the impact of acquisitions and terminated business lines, user acquisition costs grew by $11,287 more than revenue in 2020 compared to 2019. This was as a result of the impact on COVID-19 on the digital advertising market, where O&O CPS and O&O RPS both increased by $0.03. As COVID-19’s impact on advertiser demand lessened towards the end of the year, O&O RPS has steadily increased, and we have not seen a similar trend YTD in 2021.
76
Segment adjusted gross profit for our Owned and Operated segment increased by $33,272 in 2021 compared to 2020, due to an increase in Owned and Operated revenue of $215,383, as described above, offset by an increase in user acquisition costs of $182,110, as described above.
Segment adjusted gross profit for our Owned and Operated segment increased by $1,377 in 2020 compared to 2019, due to an increase in Owned and Operated revenue of $67,931, as described above, offset by an increase in user acquisition costs of $66,554, as described above.
Salaries, commissions, and benefits
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Salaries, commissions, and benefits |
$ | 66,747 | $ | 55,548 | $ | 48,389 | $ | 11,199 | 20 | % | $ | 7,159 | 15 | % | ||||||||||||||
| Percent of revenue |
10 | % | 12 | % | 12 | % | ||||||||||||||||||||||
The increase in salaries, commissions, and benefits was primarily due to an increase in the fair value of our former CEO’s profits interest of $5,392, an increase in salaries and bonus related expenses of $6,851 due to salary increases in 2021 to align with market rates and an increase in average headcount from 289 employees in 2020 to 320, and an increase in contractor costs of $1,523 to support the Company’s growth. These increases were partially offset by an increase in capitalized payroll costs as a result of higher capitalization of internally developed software costs, and decreases in profit-sharing distributions to Class B Unitholders of $2,760.
The increase in salaries, commissions, and benefits in 2020 was primarily due to an increase in Company headcount, which went from an average of 245 employees throughout 2019 to an average headcount of 289 in 2020, as well as a full year of expense in 2020 as compared to $1,900 in 2019 related to the 33 employees acquired as part of the Concourse and Mapquest acquisitions in 2019.
Selling, general, and administrative
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Selling, general, and administrative |
$ | 35,813 | $ | 22,979 | $ | 19,960 | $ | 12,834 | 56 | $ | 3,019 | 15 | % | |||||||||||||||
| Percent of revenue |
5 | % | 5 | % | 5 | % | ||||||||||||||||||||||
The increase in selling, general, and administrative expense was primarily due to an increase of $10,128 in costs related to the Business Combination, and an increase in network and bandwidth costs of $1,881, and an increase in audit fees of $776 as a result of the Business Combination.
The increase in selling, general, and administrative expense in 2020 was primarily due to increases in the fair value of contingent consideration related to the Concourse acquisition of $2,700 and an increase in one-time non-recurring costs related to the Business Combination of $1,323. These increases were partially offset by decreases in consulting costs of $1,220.
Depreciation and amortization
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Depreciation and amortization |
$ | 13,885 | $ | 13,832 | $ | 11,244 | $ | 53 | — | % | $ | 2,588 | 23 | % | ||||||||||||||
| Percent of revenue |
2 | % | 3 | % | 3 | % | ||||||||||||||||||||||
77
The increase in depreciation and amortization expense was primarily due to an increase in amortization of internal-use software as a result of increase in software development activities to build and enhance the Company’s technology platform, partially offset by a decrease in amortization of intangible assets as they become fully amortized and there have been no acquisitions during 2021.
The increase in depreciation and amortization expense in 2020 was primarily due to increases in amortization of intangible assets of $1,758 as a result of a full year of amortization on our 2019 acquisitions, and an increase in amortization of internal-use software of $881 as a result of increase in software development activities to build and enhance the Company’s technology platform.
Interest expense
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Interest expense |
$ | 16,870 | $ | 24,351 | $ | 26,033 | $ | (7,481 | ) | (31 | )% | $ | (1,682 | ) | (6 | )% | ||||||||||||
The decrease in interest expense was primarily due to a decrease in our outstanding loan balances. Our outstanding loan balance, excluding loan origination fees, was $172,038 and $183,674 at December 31, 2021 and 2020, respectively.
The decrease in interest expense in 2020 was primarily due to a decrease in interest rates owed on outstanding loan balance, as well as the impact of the paydown of our term loan balance in 2020. Outstanding loan balance, excluding loan origination fees, was $183,674 and $254,734 at December 31, 2020 and 2019, respectively.
Other expense
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Other expense |
$ | — | $ | — | $ | 1,146 | $ | — | — | % | $ | (1,146 | ) | (100 | )% | |||||||||||||
The decrease in other expense in 2020 was primarily due to loss on disposal of an equity method investment in 2019.
Provision for (Benefit from) Income Taxes
| Year Ended December 31, | 2021 vs 2020 Change |
2020 vs 2019 Change |
||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | $ | % | $ | % | ||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||
| Provision for income taxes |
$ | 965 | $ | 1,907 | $ | 702 | $ | (942 | ) | (49 | )% | $ | 1,205 | 172 | % | |||||||||||||
| Effective tax rate |
3 | % | 10 | % | 3 | % | ||||||||||||||||||||||
The income tax expense varied from the expense calculated using the federal statutory income tax rate for the years ended December 31, 2021 and 2020, primarily due to income (loss) from non-taxable pass-through entities, deferred tax impact of foreign rate change, and foreign rate differential.
78
Liquidity and Capital Resources
As of December 31, 2021 and 2020, we had cash and cash equivalents of $47,896, and $29,013, respectively, which consists of amounts held as bank deposits.
To date, the Company’s available liquidity and operations have been financed through member contributions and loans, loan facilities, and cash flows from operations. The Company is subject to certain business risks, including dependence on key employees, dependence on key contracts, competition from alternative technologies, market acceptance, and dependence on growth to achieve its business plan. The Company’s revenue is dependent on three key Advertising Partners, which are Google, Yahoo!, and Microsoft, which comprised, 84%, 2% and 5%, respectively, of the Company’s revenue for the nine months ended September 30, 2021, 83%, 4% and 4%, respectively, of the Company’s revenue for 2021, 82%, 5%, and 4%, respectively, of the Company’s revenue for 2020, and 75%, 7% and 8%, respectively of the Company’s revenue for 2019.
The Company has (i) two paid search advertising contracts with Google, (ii) one paid search advertising contract with Verizon Media, and (iii) one paid search advertising contract with Microsoft. One of the Google contracts was renewed with an effective date of March 1, 2021 and has a two-year term through February 28, 2023. The other Google contract was renewed with an effective date of August 1, 2021 and has a two-year term through July 31, 2023. The Yahoo! contract (which consolidated three separate and pre-existing contracts into a single contract) was entered into effective as of December 1, 2020, and has an initial two-year through November 30, 2022. All arrangements under the Microsoft contract expired on November 30, 2021 and the parties have agreed to a three-month extension through February 28, 2022, and then the contract automatically renews on a month to month basis as the parties finalize a renewal or long-term extension of this arrangement. All four agreements may be terminated by the respective Advertising Partner immediately or with minimal notice under certain circumstances.
We evaluate whether any conditions or events have occurred, individually and in the aggregate, that could raise substantial doubt about our ability to continue as a going concern for the twelve month assessment period from the date of this filing. Our ability to continue as a going concern is dependent on our ability to generate sufficient cash flow from operations to meet our financial obligations including scheduled debt payments and maturities. Our term loan matures on August 22, 2022, at which time the balance is estimated to be approximately $148,000. Based on the Business Combination Agreement executed on January 27, 2022, the outstanding balance under the term loan was settled concurrent with the closing of the Business Combination. As a part of the Business Combination the Company entered into a new loan agreement on January 27, 2022 for a 5.5-year term loan with a principal of $400,000, of which a portion of the proceeds was used to settle the Company’s outstanding debt of $172,038. Interest payments are due monthly at LIBOR plus 4.75% with a LIBOR floor of 0.50%. In addition, the Company also obtained a revolving line of credit of $50,000 on January 27, 2022. The new loan comes with a springing covenant, which goes into effect if the utilization on the Revolving Facility exceeds 35% at each quarter end after the effective date of the Business Combination, such that the first lien leverage ratio should not exceed 5.40. The Company has been able to and expect to continue to be able to make payments on the principal and interest on a timely basis.
The coronavirus pandemic has adversely affected the Company’s results of operations and the Company has experienced unpredictable reductions in demand for certain products and services. There is uncertainty around the duration and breadth of the COVID-19 pandemic and, as a result, the ultimate impact on the Company’s business, financial condition, or operating results cannot be reasonably estimated with certainty at this time. To the extent that existing capital resources and sales growth are not sufficient to fund future activities, the Company may need to raise capital resources through additional equity or debt financings. Additional funds may not be available on terms favorable to the Company or at all. Failure to raise additional capital, if and when needed, could have a material adverse effect on the Company’s consolidated financial position, results of operations, and cash flows.
79
Debt
The Company has secured financing from Cerberus Business Finance, LLC. As of December 31, 2021 and December 31, 2020, the Company had principal, excluding loan origination fees, of $172,038 and $183,674 outstanding under a term loan. Payments of $1,750 are due quarterly. In addition, upon delivery of the most recent annual audited consolidated financial statements, the Company must make a payment of 50% of excess free cash flow, as defined. In June 2021, the Company made a payment of $4,600 for 2020. The Company also had a revolving line of credit, which was increased to $20,000 during 2019. No amounts are outstanding as of December 31, 2021 under the revolving line of credit.
Interest payments of the financing are due monthly at London InterBank Offered Rate (“LIBOR”), plus 7% with a LIBOR floor of 1%. Maturity for the financing is August 22, 2022. The facility has certain financial and nonfinancial covenants, including a leverage ratio. The Company was in compliance with the financial covenants as of December 31, 2021 and December 31, 2020.
As of December 31, 2021, future minimum principal payments on debt were $172,038, all of which were due in 2022.
As part of the Business Combination with Trebia and Protected, System1 Midco, LLC, entered into a new loan agreement on January 27, 2022 for a 5.5-year term loan with a principal of $400,000, of which a portion of the proceeds was used to settle the Company’s outstanding debt of $172,038. Interest payments are due monthly at LIBOR plus 4.75% with a LIBOR floor of 0.50%. In addition, the Company also obtained a revolving line of credit of $50,000 on January 27, 2022.
Cash Flows
The following table summarizes our cash flows for the periods presented:
| Year Ended December 31, | ||||||||||||
| 2021 | 2020 | 2019 | ||||||||||
| ($ in thousands) | ||||||||||||
| Net cash provided by operating activities |
60,705 | 46,547 | 32,712 | |||||||||
| Net cash provided by (used in) investing activities |
(6,535 | ) | 68,166 | (42,757 | ) | |||||||
| Net cash provided by (used in) financing activities |
(34,585 | ) | (128,075 | ) | 26,147 | |||||||
Operating Activities
Our cash flows from operating activities are primarily influenced by growth in our operations, increases or decreases in collections from our clients and related payments to our suppliers for advertising inventory and data. We typically pay suppliers in advance of collections from our clients. Our collection and payment cycles can vary from period to period. In addition, seasonality may impact cash flows from operating activities on a sequential quarterly basis during the year.
In 2021, cash provided by operating activities of $60,705 resulted primarily from Owned and Operated advertising revenue, offset by user acquisition costs incurred to drive the growth and salaries, commissions and benefits costs, non-cash expenses of $22,632, and change in operating assets and liabilities of $5,077 primarily due to an increase in accounts payable of $20,756 due to increased user acquisition costs, and an increase in accrued expenses of $12,113 primarily related to the business combination. This was partially offset by a decrease in accounts receivable of $19,064 as a result of increased collections, an increase in prepaid assets of $4,968 due to an increase in vendor services to support the growth of the Company, and a decrease in long term liabilities of $3,842 primarily due to reclassification of the former CEO’s profit interest to short term liabilities.
80
In 2020, cash provided by operating activities of $46,547 resulted primarily from Owned and Operated advertising revenue, offset by user acquisition costs incurred to drive the growth and salaries, commissions and benefits costs, non-cash expenses of $24,527, and change in operating assets and liabilities of $11,516 primarily due to decrease in accounts receivable of $6,833 as a result of increased collections, and increase in accounts payable of $4,234 due to increased user acquisition costs.
Investing Activities
Our primary investing activities consist of acquisitions and divestitures of businesses, such as the acquisition of Mapquest and Concourse in 2019 as well as costs capitalized for internally developed software.
In 2021, cash used in investing activities of $6,535 resulted primarily from capitalized expenditures related to internal-use software development costs.
In 2020, cash provided by investing activities of $68,166 resulted primarily from the sale of the Company’s interest in Protected of $74,544, offset by capitalized expenditures related to internal-use software development costs of $6,112.
Financing Activities
Our financing activities consisted primarily of borrowings and repayments of our debt, distributions to members related to tax obligations, acquisition related contingent consideration and or proceeds from the sale of assets.
In 2021, cash used in financing activities of $34,585 resulted primarily from repayments of debt of $11,636, payment of acquisition related contingent consideration of $5,000 related to the acquisition of Startpage, $1,715 related to the acquisition of Concourse, distributions to members of $14,579, and the issuance of a related party loan of $1,500.
In 2020, we used $128,075 of cash in financing activities, consisting of $78,285 of net debt repayments on our term loan and line of credit, $28,765 of distributions to members related to the sale of the Company’s interest in Protected, $17,780 tax distributions to members, and payment of $5,500 of contingent consideration related to our 2018 acquisition of Startpage.
Off-Balance Sheet Arrangements
We do not have any relationships with entities often referred to as structured finance or special purpose entities that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We did not have any other off-balance sheet arrangements during the periods presented other than the indemnification agreements.
Contractual Obligations and Known Future Cash Requirements
Leases
The Company leases office facilities under noncancelable operating lease agreements. The Company leases such facilities in Venice and Marina del Rey, California; Bellevue, Washington; Guelph, Canada; and Atlanta, Georgia. Rent expense was $2,221, $2,262 and $1,825 for the years ended December 31, 2021, 2020 and 2019, which were included in the selling, general, and administrative expenses. The Venice office facilities were on two-year renewable leases. The Bellevue lease is valid until May 2025. The Guelph, Canada, lease was valid until September 2021.
81
In March 2021, the Company entered into an agreement for a lease of office space in Marina del Rey, California. The initial term of the lease is in effect until November of 2025 with no renewal periods. The Venice office leases expired in October 2021 and were not renewed. The Guelph, Canada office space expired in September 2021 and is on a monthly renewal plan. As of December 31, 2021, the expected future operating lease obligations is as follows:
| Payments Due by Period | ||||||||||||||||||||
| Less than 1 Year |
1 -3 Years | 3 - 5 Years | More than 5 Years |
Total | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Operating lease obligations |
$ | 1,957 | $ | 3,900 | $ | 1,663 | $ | — | $ | 7,520 | ||||||||||
Service Agreements
On June 18, 2021 the Company entered into an agreement with a service provider whereby the Company is contractually obligated to pay $6,900 and $8,000 in the first and second years of the contract, respectively. The contract commencement date was July 1, 2021.
Executive Compensation
Ian Weingarten was hired as CEO on April 10, 2019. He is entitled to a cash-settled profit interest of 5% of S1 Holdco, LLC, which is subject to a participation threshold of $300,000 (which was subject to adjustment as set forth in the S1 Holdco operating agreement) and a four-year vesting term (which is accelerated if a qualifying change in control transaction occurs). The Company recorded a liability for this arrangement of $4,237 as of December 31, 2020.
In January 2021, the Company notified Ian Weingarten, its Chief Executive Officer since April 2019, of its decision to terminate his employment with the Company as of February 2021. In connection with such termination, the Company agreed to payment of separation pay benefits consistent with the terms of Mr. Weingarten’s Employment Agreement, including the payment of the liability accrued for the cash-settled profit interest of 5% of S1 Holdco, LLC, which was deemed vested as to a 3.75% Profits Interest and forfeited as to the remaining 1.25% Profits Interest above the applicable adjusted threshold amount (subject to further reduction to a 2.5% Profits Interest in the event that the Business Combination is not consummated). In January 2022, in connection with the closing of the Business Combination, the vested portion of Mr. Weingarten’s Profits Interest was paid in full, and there are no further amounts due to Mr. Weingarten.
Contingencies
From time to time, System1 is subject to contingencies that arise in the ordinary course of business. System1 records an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. System1 does not currently believe the resolution of any such contingencies will have a material adverse effect upon System1’s consolidated balance sheets, statements of comprehensive loss, or statements of cash flows.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions, impacting our reported results of operations and financial condition.
82
Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of assets and liabilities and the recognition of income and expenses. Management considers these accounting policies to be critical accounting policies. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results are described below. Refer to Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included elsewhere in this prospectus for more detailed information regarding our critical accounting policies.
Business combinations
The results of a business acquired in a business combination are included in the Company’s consolidated financial statements from the date of acquisition. The Company allocates the purchase price, which is the sum of the consideration provided which may consist of cash, equity, or a combination of the two, in a business combination to the identifiable assets and liabilities of the acquired business at their acquisition-date fair values. Any excess amount paid over identifiable assets is recorded as goodwill. The process for estimating the fair values of the acquired business involves the use of significant estimates and assumptions, including estimating average industry purchase price multiples and estimating future cash flows. The Company estimates the fair value based on assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, the Company may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. At the conclusion of the measurement period, any subsequent adjustments are reflected in the Company’s consolidated statements of operations.
Transaction costs associated with business combinations are expensed as incurred and are included in selling, general and administrative expenses in the Company’s consolidated statements of operations. When purchase consideration includes contingent consideration, the Company records the fair value of the contingent consideration as of the date of acquisition and subsequently remeasures the contingent consideration at fair value each reporting period through earnings.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired and identifiable intangibles in a business combination. The Company accounts for goodwill in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles—Goodwill and Other, which requires the Company to test goodwill at the reporting unit level for impairment at least annually.
The Company has the option to assess goodwill for possible impairment by performing a qualitative analysis to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount or to perform the quantitative impairment test. The quantitative test involves comparing the estimated fair value of a reporting unit with its respective book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, an impairment loss is recognized in an amount equal to the excess.
The determination of fair values requires us to make significant estimates and assumptions. These estimates include, but are not limited to future expected cash flows from a market participant perspective, discount rates, industry data and management’s prior experience. Unanticipated events or circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results.
The Company tests for goodwill impairment annually at December 31st. During the years ended December 31, 2021, 2020, and 2019 there were no impairment charges recorded on goodwill. In 2021 and 2019, the Company performed qualitative goodwill impairment assessments and concluded that there were no qualitative impairment indicators. In 2020, the Company performed a quantitative goodwill assessment at December 31, 2020. The fair values exceeded the carrying value for all the reporting units and, accordingly, the Company concluded that there was no impairment of goodwill at December 31, 2020.
83
Share-based compensation
On January 1, 2019, the Company adopted ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment. The adoption of ASU 2018-07 resulted in a change in the accounting for awards to nonemployees. Compensation cost related to share-based payment transactions is measured based on the fair value of the Units issued and recognized within “Salaries, commissions, and benefits” in the Company’s consolidated statement of operations. The Company has elected to treat share-based payment awards with graded vesting schedules and time-based service conditions as a single award and recognizes share- based compensation expense on a straight-line basis over the vesting period, which is generally four years. The assumptions used in the Black-Scholes model referred to above are based upon the following:
| • | Fair Value of Common Stock: As the Company’s common stock is not publicly traded, the fair value was determined by the Company’s management with input from contemporaneous valuation reports prepared by a third-party valuation specialist. |
| • | Expected Term: The expected life of the option is estimated by considering the contractual term of the option, the vesting period of the option, the employees’ expected exercise behavior and the post- vesting employee turnover rate. For non-employees, the expected life equals the contractual term of the option. |
| • | Risk-free Interest Rate: The risk-free interest rate is based on published U.S. Treasury Department interest rates for the expected terms of the underlying options. |
| • | Volatility: The expected stock price volatility of the underlying shares over the expected term of the option is based upon historical share price data of an index of comparable publicly traded companies. |
Recently Issued Accounting Pronouncements
Recently issued and adopted accounting pronouncements are described in Note 2 of the Audited Consolidated Financial Statements.
Quantitative and Qualitative Disclosure about Market Risk
We have operations within the U.S. and internationally, and we are exposed to market risks in the ordinary course of our business. These risks include primarily inflation, interest rate, credit risk, and foreign currency exchange risk.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition, or results of operations. However, if our costs were to become subject to significant inflationary pressures, we may not be able to fully offset higher costs through price increases and our inability or failure to do so could potentially harm our business, financial condition, and results of operations.
Interest Rate Risk
We are exposed to market risk from changes in interest rates on our term loan, which accrues interest at a variable rate. We have not used any derivative financial instruments to manage our interest rate risk exposure. Based upon the outstanding principal amounts, excluding loan origination fees, of $172,038 and $183,674 as of December 31, 2021 and December 31, 2020 a hypothetical one percentage point increase or decrease in the interest rate would result in a corresponding increase or decrease in interest expense of approximately $1,700 annually.
84
Credit Risk
Financial instruments that potentially subject System1 to a concentration of credit risk consist primarily of cash and cash equivalents, restricted cash, and accounts receivable. System1 deposits cash and cash equivalents with high-quality financial institutions. Accounts receivable are typically unsecured and are derived from advertisers located within the United States. Credit risk is concentrated in two customers, who accounted for 82% and 80% of the accounts receivable balance as of December 31, 2021 and December 31, 2020. System1 has historically experienced insignificant credit losses. System1 maintains allowances for estimated credit losses based on management’s assessment of the likelihood of collection.
Foreign Currency Exchange Rate Risk
The functional currency of the company’s foreign subsidiaries is generally the local currency. Assets and liabilities are translated into U.S. dollars at the exchange rate in effect at the consolidated balance sheet date. Operating accounts are translated at an average rate of exchange for the respective accounting periods. Translation adjustments resulting from the process of translating foreign currency financial statements into U.S. dollars are reported as a component of accumulated other comprehensive income (loss). Transaction gains and losses reflected in the functional currencies are charged to income or expense at the time of the transaction.
85
Exhibit 99.3
Board of Directors
Protected.Net Group Limited
Fareham, United Kingdom
Opinion
We have audited the consolidated financial statements of Protected.Net Group Limited and its subsidiaries (the “Company”), which comprise the consolidated balance sheets as of December 31, 2021 and 2020, and the related consolidated statements of operations and comprehensive income (loss), changes in shareholders’ deficit, and cash flows for the years then ended, and the related notes to the consolidated financial statements.
In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
Basis for Opinion
We conducted our audits in accordance with auditing standards generally accepted in the United States of America (GAAS). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are required to be independent of the Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audits. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Responsibilities of Management for the Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the consolidated financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued or available to be issued.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement when it exists. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Misstatements are considered material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the consolidated financial statements.
F-63
In performing an audit in accordance with GAAS, we:
| • | Exercise professional judgment and maintain professional skepticism throughout the audit. |
| • | Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, and design and perform audit procedures responsive to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. |
| • | Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, no such opinion is expressed. |
| • | Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the consolidated financial statements. |
| • | Conclude whether, in our judgment, there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern for a reasonable period of time. |
We are required to communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit, significant audit findings, and certain internal control-related matters that we identified during the audit.
/s/ BDO LLP
BDO LLP
Southampton, United Kingdom
March 31, 2022
F-64
| At December 31, | ||||||||
| 2021 | 2020 | |||||||
| Assets |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 35,067,389 | $ | 6,252,719 | ||||
| Restricted cash |
1,333,456 | 5,603,764 | ||||||
| Prepaid expenses and other current assets [Note 3] |
546,352 | 359,329 | ||||||
| Deposits |
15,365 | 3,000,000 | ||||||
|
|
|
|
|
|||||
| Total current assets |
36,962,562 | 15,215,812 | ||||||
| Due from related parties [Note 16] |
33,081,720 | 10,229,719 | ||||||
| Property, plant, and equipment [Note 4] |
616,092 | 270,495 | ||||||
| Intangible assets [Note 5] |
369,179 | 53,230 | ||||||
| Deferred Tax Assets [Note 13] |
17,236,520 | — | ||||||
| Goodwill [Note 5] |
283,809 | — | ||||||
|
|
|
|
|
|||||
| Total assets |
$ | 88,549,882 | $ | 25,769,256 | ||||
|
|
|
|
|
|||||
| Liabilities and Shareholders’ Deficit |
||||||||
| Accounts payable |
$ | 216,035 | $ | 3,004,879 | ||||
| Accrued expenses and other liabilities [Note 6] |
10,162,350 | 6,704,093 | ||||||
| VAT tax liability [Note 17] |
11,403,760 | 6,366,454 | ||||||
| Deferred revenue [Note 10] |
57,405,368 | 47,430,897 | ||||||
| Related party deferred revenue [Note 16] |
165,594 | 167,712 | ||||||
| Current portion of note payable [Note 7] |
2,812,500 | 1,500,000 | ||||||
| Due to related party [Note 16] |
22,509 | 4,389 | ||||||
| Refund liability [Note 10] |
536,753 | 511,779 | ||||||
|
|
|
|
|
|||||
| Total current liabilities |
82,724,869 | 65,690,203 | ||||||
| Note payable, net of current portion and deferred financing costs [Note 7] |
10,546,448 | 8,351,806 | ||||||
|
|
|
|
|
|||||
| Total liabilities |
93,271,317 | 74,042,009 | ||||||
|
|
|
|
|
|||||
| Commitments and Contingencies [Note 8] |
||||||||
| Shareholders’ Deficit [Note 9]: |
||||||||
| Class A Preferred shares, par value £0.001 per share, 7,992,009 shares authorized, issued, and outstanding on December 31, 2021 and December 31, 2020, respectively |
10,515 | 10,515 | ||||||
| Class B Common shares, par value £0.001 per share, 7,960,105 shares authorized, issued, and outstanding on December 31, 2021 and December 31, 2020, respectively |
10,558 | 10,558 | ||||||
| Additional paid-in capital |
40,953,320 | 40,953,320 | ||||||
| Accumulated deficit |
(45,695,828 | ) | (89,247,146 | ) | ||||
|
|
|
|
|
|||||
| Total Shareholders’ Deficit |
(4,721,435 | ) | (48,272,753 | ) | ||||
|
|
|
|
|
|||||
| Total Liabilities and Shareholders’ Deficit |
$ | 88,549,882 | $ | 25,769,256 | ||||
|
|
|
|
|
|||||
The accompanying notes are an integral part of these consolidated financial statements.
F-65
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
| Year Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Continuing operations |
||||||||
| Revenue [Note 10] |
$ | 144,541,221 | $ | 90,908,297 | ||||
| Cost of revenue |
98,946,484 | 97,980,269 | ||||||
|
|
|
|
|
|||||
| Gross profit (loss) |
45,594,737 | (7,071,972 | ) | |||||
| Operating Expenses |
||||||||
| General and administrative expenses [Note 14] |
15,912,393 | 6,711,066 | ||||||
| Related party rent expense [Note 16] |
664,697 | 536,200 | ||||||
|
|
|
|
|
|||||
| Total operating expenses |
16,577,090 | 7,247,266 | ||||||
| Other Operating (Expense) Income |
||||||||
| Gain on sale of intangible assets [Note 11] |
— | 1,580,000 | ||||||
| Foreign currency transaction loss |
(1,340,513 | ) | (134,514 | ) | ||||
| Other operating income |
343,268 | 48,054 | ||||||
|
|
|
|
|
|||||
| Total other operating (expense) income, net |
(997,245 | ) | 1,493,540 | |||||
|
|
|
|
|
|||||
| Operating income (loss) |
28,020,402 | (12,825,698 | ) | |||||
|
|
|
|
|
|||||
| Non-Operating Income (Expense) |
||||||||
| Related party interest expense [Note 16] |
— | (405,767 | ) | |||||
| Interest expense [Note 7] |
(583,428 | ) | (29,085 | ) | ||||
| Related party interest income [Note 16] |
941,416 | 2,285 | ||||||
|
|
|
|
|
|||||
| Total non-operating income (expense) |
357,988 | (432,567 | ) | |||||
|
|
|
|
|
|||||
| Income (Loss) before income taxes |
28,378,390 | (13,258,265 | ) | |||||
| Income tax benefit [Note 13] |
15,172,928 | — | ||||||
|
|
|
|
|
|||||
| Net Income (Loss) and Comprehensive Income (Loss) |
$ | 43,551,318 | $ | (13,258,265 | ) | |||
|
|
|
|
|
|||||
The accompanying notes are an integral part of these consolidated financial statements.
F-66
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ DEFICIT
| Preferred shares | Common shares | Additional Paid-in Capital |
Accumulated Deficit |
Shareholders’ Total Deficit |
||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||||||
| Balance on January 1, 2020 |
7,992,009 | $ | 10,515 | 7,960,105 | $ | 10,558 | $ | 40,953,320 | $ | (75,988,881 | ) | $ | (35,014,488 | ) | ||||||||||||||
| Net loss and comprehensive loss |
— | — | — | — | — | (13,258,265 | ) | (13,258,265 | ) | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Balance on December 31, 2020 |
7,992,009 | $ | 10,515 | 7,960,105 | $ | 10,558 | $ | 40,953,320 | $ | (89,247,146 | ) | $ | (48,272,753 | ) | ||||||||||||||
| Net income and comprehensive income |
— | — | — | — | — | 43,551,318 | 43,551,318 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Balance on December 31, 2021 |
7,992,009 | $ | 10,515 | 7,960,105 | $ | 10,558 | $ | 40,953,320 | $ | (45,695,828 | ) | $ | (4,721,435 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-67
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income (loss) |
$ | 43,551,318 | $ | (13,258,265 | ) | |||
| Adjustments to reconcile net income (loss) to net cash used in operating activities: |
||||||||
| Depreciation |
151,347 | 74,652 | ||||||
| Amortization |
93,953 | 66,646 | ||||||
| Amortization of deferred financing costs |
82,142 | 1,806 | ||||||
| Financing fee income on loan with System1 SS Protect Holdings, Inc. |
(77,121 | ) | (2,285 | ) | ||||
| Gain on sale of Network Protect intangible assets |
— | (1,580,000 | ) | |||||
| Change in operating assets and liabilities: |
||||||||
| Deposits |
2,984,635 | (3,000,000 | ) | |||||
| Prepaid expenses and other current assets |
(275,168 | ) | (176,637 | ) | ||||
| Accounts payable |
(3,117,740 | ) | (55,698 | ) | ||||
| Accrued expenses |
3,543,626 | 2,072,446 | ||||||
| VAT tax liability |
5,037,306 | (1,801,173 | ) | |||||
| Refund liability |
24,974 | 95,239 | ||||||
| Deferred revenue |
9,974,471 | 17,727,066 | ||||||
| Deferred tax assets |
(17,236,520 | ) | — | |||||
| Related party deferred revenue |
(2,118 | ) | 167,712 | |||||
| Due from related party |
(866,240 | ) | (165,215 | ) | ||||
| Due to related party |
18,120 | (250,348 | ) | |||||
|
|
|
|
|
|||||
| Net cash provided by (used in) operating activities |
43,886,985 | (84,054 | ) | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Cash received in acquisition of Host Plus Limited, net |
13,393 | — | ||||||
| Loan advanced to Just Develop It Limited |
(29,634,886 | ) | — | |||||
| Repayment of loan by Just Develop It Limited |
29,634,886 | — | ||||||
| Loan advanced to Company director |
(2,216,341 | ) | — | |||||
| Repayment of loan by Company director |
2,216,341 | — | ||||||
| Loan advance to System1 SS Protect Holdings, Inc. |
(21,908,640 | ) | (10,059,719 | ) | ||||
| Proceeds from sale of intangibles |
100,000 | 1,500,000 | ||||||
| Purchases of intangibles, property, plant, and equipment |
(523,846 | ) | (212,966 | ) | ||||
|
|
|
|
|
|||||
| Net cash used in investing activities |
(22,319,093 | ) | (8,772,685 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Proceeds from loan |
5,000,000 | 10,000,000 | ||||||
| Repayment of principal on bank loan |
(1,500,000 | ) | — | |||||
| Payment of financing costs |
(75,000 | ) | (150,000 | ) | ||||
| Proceeds from related party loans |
— | 10,999,947 | ||||||
| Repayment of related party loan |
(448,530 | ) | (10,999,947 | ) | ||||
|
|
|
|
|
|||||
| Net cash provided by financing activities |
2,976,470 | 9,850,000 | ||||||
| Effect of exchange rate changes on cash |
||||||||
| Net change in cash |
24,544,362 | 993,261 | ||||||
| Cash and restricted cash, beginning of year |
11,856,483 | 10,863,222 | ||||||
|
|
|
|
|
|||||
| Cash and restricted cash, end of year |
$ | 36,400,845 | $ | 11,856,483 | ||||
|
|
|
|
|
|||||
| Supplemental disclosure of cash and non-cash investing and financing activities |
||||||||
| Cash paid for interest |
$ | (501,610 | ) | $ | (474,663 | ) | ||
|
|
|
|
|
|||||
| Receivable from the sale of Network Protect Limited intangible assets |
— | 100,000 | ||||||
|
|
|
|
|
|||||
The accompanying notes are an integral part of these consolidated financial statements.
F-68
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| 1. | BUSINESS AND LIQUIDITY |
Business
Protected.net Group Limited (“Protected.net” or the “Company”) was formed on May 1, 2016 as a private company limited by shares incorporated in England and Wales. The Company established a wholly owned subsidiary, Network Protect Limited., in England and Wales, for the purpose of selling VPN software packages to end user customers. This Company was divested during 2020.
Protected.Net provides Antivirus Software solutions to its customers, offering its customers a single packaged solution that provides protection and reporting to the end user.
The Company operates through one entity in one industry, delivering Antivirus software directly to end-user customers across the world. With global reach, the Company transacts across five different currencies, GBP, EUR, CAD, AUD, and USD.
The Company services all customers and operations from a single location from within the UK, with support functions being operated at several overseas locations, dependent on the level of support required and the physical location of the customer.
The product offering comprises a core security package with varying levels of extra protection of a more specific nature should the customer require these.
Liquidity and Going Concern
The accompanying consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has financed its activities principally from the issuance of ordinary and preferred equity securities.
In March 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic (the “Pandemic”). The Pandemic has created and may continue to create significant uncertainty in macroeconomic conditions, and the extent of its impact on our operational and financial performance will depend upon certain developments, including the duration and spread of the outbreak and the impact on our customers and our sales cycles. During the years ended December 31, 2021 and 2020, our estimates and assumptions required increased judgment and carried a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods. As of the date of issuance of these consolidated financial statements, we are not aware of any specific event or circumstance that would require us to update our estimates, judgments or adjust the carrying value of our assets or liabilities. These estimates may change, as new events occur and additional information is obtained, and will be recognized in the consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to our consolidated financial statements.
The Company has incurred substantial and negative cash flows from operations in every fiscal period from inception through 2020. For the year ended December 31, 2021, the Company reported net income of $43,551,318 and generated $43,886,985 in cash from operations. In addition, the Company had an accumulated deficit of $45,695,828 as of December 31, 2021. The Company’s cash and restricted cash as of December 31, 2021 is $36,400,845. The Company has achieved positive financial performance in 2021, which is forecasted to continue through the next twelve months following the issuance of these financial statements. In addition, the Company has extended one of its major business relationships with the provider of its Antivirus licenses through 2025. In early 2022, upon completion of the business combination, the Company repaid its loan with SVB and entered into an intercompany loan agreement worth up to $50,000,00. Neither of these subsequent events impact going concern.
F-69
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Management prepares an annual budget which is then re-forecasted monthly using latest assumptions to help ascertain the going concern basis. In addition, a weekly cash forecast is also prepared to ensure that financial viability can continue. In 2021, the COVID-19 pandemic provided an element of uncertainty regarding macroeconomic conditions that may impact potential future earnings of the company. However, the Company was able to capitalize on growth opportunities afforded by the COVID-19 pandemic due to more people working from home and utilizing their devices, which provided a larger customer base and market. As a result of this, the Company was able to grow its customer base throughout the year. The Company anticipates these trends to continue in 2022.
On January 27, 2022, the Company executed and closed a business combination agreement (the “Business Combination”) with Trebia Acquisition Corp which, through a series of business combination transactions, resulted in the new company being listed on the New York Stock Exchange. As part of this transaction, the intercompany loan to System1 SS Protect Holdings, Inc. was repaid in full as well as the outstanding loan with Silicon Valley Bank. Refer to the Subsequent Events footnote at Note 19 for additional discussion on the merger.
Management uses internal transactional data to measure key business metrics, such as cost to acquire, average order value, and attrition rates to help assess the going concern basis. The Company is also constantly assessing its software offering to the public to ensure that it not only matches the customers’ needs and is priced reasonably, but also to explore potential add-ons or new products.
Given the Company’s net income, operating margin, its cash balance, and items discussed above, this will be sufficient to fund its operations for the next 12 months from the date of issuance of these financial statements.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: |
Directors Responsibilities
The Directors are responsible for preparing these consolidated financial statements for the Company as of December 31, 2021 and 2020 and for the two years then ended, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company, and for identifying and ensuring that the Company complies with the law and regulations applicable to their activities. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Directors confirm that suitable accounting policies have been used and applied consistently for the years presented. They also confirm that reasonable and prudent judgments and estimates have been made in preparing the consolidated financial statements and that applicable accounting standards have been followed.
Basis for Preparation
These consolidated financial statements do not constitute the Company’s statutory accounts for 2021 and 2020. Statutory accounts prepared in accordance with FRS 102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland” for the year ended December 31, 2020, which were presented in US dollars, have been reported on by the Independent Auditors’ in the United Kingdom. The Independent Auditors’ Reports on the Annual Report and Financial Statements for the year ended December 31, 2020 was unqualified and did not contain a statement under s498(2) or s498(3) of the United Kingdom Companies Act 2006.
The Directors have prepared these non-statutory financial statements for the years ended December 31, 2021 and 2020 for inclusion in a prospectus on Form S-1 to be submitted by System1, Inc. to the United States Securities and Exchange Commission (“SEC”).
F-70
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Basis of Consolidation
The consolidated financial statements include the accounts of Protected.net Group Limited and its wholly-owned subsidiaries. The Company does not have any nonconsolidated subsidiaries. All intercompany balances and transactions have been eliminated on consolidation, including unrealized gains and losses on transactions between the companies.
Management’s Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company’s financial statements relate to the estimate of variable consideration for revenue recognition, including the refund liability, impairment of long-lived assets, goodwill, and the valuation allowance of deferred tax assets. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the financial statements, actual results may materially vary from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of 90 days or less at acquisition to be cash equivalents. Of the total cash balance held by the Company, $33,529,408 and $4,391,673 are held with banks as of December 31, 2021 and 2020, respectively. The remaining cash balances are held with merchants.
Restricted Cash
The Company’s restricted cash consists of merchant reserve balances with our credit card processors held due to arrangements under which our credit card processors withhold credit card funds to cover charge backs in the event we are unable to honor our commitments. These cash balances are shown as a separate financial statement line item within current assets on our consolidated balance sheet.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown on the consolidated statements of cash flows.
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cash held at banks |
$ | 33,482,467 | $ | 4,391,673 | ||||
| Cash held with merchants |
1,584,922 | 1,861,046 | ||||||
|
|
|
|
|
|||||
| Subtotal Cash and Cash Equivalents |
$ | 35,067,389 | $ | 6,252,719 | ||||
| Restricted Cash |
1,333,456 | 5,603,764 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 36,400,845 | $ | 11,856,483 | ||||
|
|
|
|
|
|||||
F-71
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Accounts Receivable
Accounts receivable is stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. These receivables have historically been paid timely. In addition, customers pay in advance for software and other services which are then earned over the life of the contract. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection and no allowance for doubtful accounts is required as of December 31, 2021 and 2020, respectively.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and accounts receivable. Periodically, the Company maintains cash deposits in financial institutions in excess of government insured limits. Management believes that the Company is not exposed to significant credit risk as the Company’s cash deposits are held at financial institutions that management believes to be of high credit quality and the Company has not experienced any losses in these deposits.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, less accumulated depreciation. Maintenance and repairs are expensed when incurred. Additions and improvements that extend the economic useful life of the asset are capitalized and depreciated over the remaining useful lives of the assets. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts, and any resulting gain or loss is reflected in current earnings. Depreciation and amortization are provided using the straight line method to amortize the cost of the assets to operations over their estimated useful lives. The below table outlines the estimated useful life for property, plant and equipment used for depreciation:
| Asset Type |
Depreciation Method |
Estimated Useful Life | ||
| Computers |
Straight-line | 3 years | ||
| Furniture and Fixtures |
Straight-line | 4 years | ||
| Motor Vehicles |
Straight-line | 4 years | ||
| Office Equipment |
Straight-line | 3 years |
Impairment of Long-Lived Assets (excluding goodwill)
Management evaluates whether events or changes in circumstances might indicate that the remaining estimated useful life of long-lived assets may warrant revision, or that the carrying value may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, the Company uses an estimate of the related undiscounted cash flows compared to the carrying value of the asset to determine if an impairment is probable. If impairment is probable the carrying amount of the asset is reduced to the asset’s fair value Measurement of the amount of impairment would be based on generally accepted valuation methodologies, as deemed appropriate. An impairment loss is recognized immediately as an operating expense in the consolidated statement of operations and comprehensive income (loss). Reversal of previously recorded impairment losses are prohibited. As of December 31, 2021 and 2020, the Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required.
F-72
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Business Combinations
The Company accounts for its business combinations under the provisions of ASC Topic 805, Business Combinations (“ASC 805”), which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values. ASC 805 also specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combinations and are expensed as incurred. If the business combination provides for contingent consideration, the Company records the contingent consideration at fair value at the acquisition date and any changes in fair value after the acquisition date are accounted for as a measurement-period adjustment. Changes in fair value of contingent consideration resulting from events after the acquisition date, such as earn-outs, are recognized as follows: 1) if the contingent consideration is classified as equity, the contingent consideration is not re-measured and its subsequent settlement is accounted for within equity, or 2) if the contingent consideration is classified as a liability, the changes in fair value are recognized in earnings. For transactions that are business combinations, the Company evaluates the existence of goodwill or a gain from a bargain purchase.
The estimated fair value of net assets acquired, including the allocation of the fair value to identifiable assets and liabilities, is determined using established valuation techniques. The estimated fair value of the net assets acquired determined using the income approach to valuation is based on the discounted cash flow method. Under this method, expected future cash flows of the business on a stand-alone basis are discounted back to a present value. The estimated fair value of identifiable intangible assets, such as trade names, may be determined using the cost to recreate method or a relief from royalty method depending on the asset acquired. During the measurement period, which can be up to one year from the acquisition date, the Company may record adjustments to the fair value of the assets acquired and liabilities assumed.
The most significant assumptions under the cost to recreate method is to value acquired intangible assets including the cost and time to build the acquired technology as well as the developers’ profit and rate of return. Management develops these assumptions based on historical knowledge of the business and projected financial information of the Company. These assumptions may vary based on future events, perceptions of different market participants and other factors outside the control of Management, and such variations may be significant to estimated values.
Goodwill Impairment
The Company records as goodwill the excess of the purchase price over the fair value of the identifiable net assets and other intangible assets acquired. Goodwill is tested for impairment annually as well as when a triggering event occurs that indicates that the fair value of the Company may be below its carrying amount. When a triggering event occurs, the Company has the option to first assess the qualitative factors to determine whether the quantitative impairment test is necessary. If that qualitative assessment indicates that it is more likely than not that the fair value of the entity is less than its carrying amount, the entity must perform the quantitative test to compare the entity’s fair value with its carrying amount, including goodwill. If the qualitative assessment indicates that it is not more likely than not that goodwill is impaired, further testing is unnecessary. Based on the results of the qualitative assessment, there were no indications of impairment at December 31, 2021.
F-73
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Instruments
ASC 820, Fair Value Measurements, provides guidance on the development and disclosure of fair value measurements. Under this accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability.
The accounting guidance classifies fair value measurements in one of the following three categories for disclosure purposes:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace.
Level 3: Unobservable inputs which are supported by little, or no market activity and values determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
Fair value measurements discussed herein are based upon certain market assumptions and pertinent information available to management as of and during the years ended December 31, 2021 and 2020. The carrying value of the Company’s cash, restricted cash, deposits, prepaid expenses, accounts payable, and accrued expenses approximate fair value because of the short-term maturity of these financial instruments.
Leases
In February 2016, the FASB established Topic 842, Leases, by issuing ASU No. 2016-02 (“ASU 2016-02”), which requires lessees to recognize leases on the consolidated balance sheets and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (“ROU”) that requires a lessee to recognize a ROU asset and lease liability on the consolidated balance sheets for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.
The Company adopted ASU 2016-02 effective January 1, 2019 using the modified retrospective transition method. In addition, the Company elected the transition package of three practical expedients permitted within the standard, among other practical expedients which allowed the Company to carry forward prior conclusions about lease identification and classification.
Adoption of the new standard did not result in any recognition of ROU assets or lease liabilities given that the Company did not identify any leases as part of its evaluation. Refer to the related party footnote at Note 16 for discussion on the rental contract with a related party, Just Develop It Limited.
Revenue
On January 1, 2019, the Company adopted ASC 606, Revenue from Contracts with Customers (“ASC 606”), using the modified retrospective method with respect to all non-completed contracts. ASC 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes nearly all existing revenue recognition guidance, including industry-specific guidance.
The guidance is based on the principle that an entity should recognize revenue to depict the transfer of products or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those products or services. The guidance also requires added disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgment and changes in judgments and assets recognized from costs incurred to fulfill a contract. The adoption of ASC 606 did not have a material effect on the Company’s financial position, results of operations, or internal controls over financial reporting.
F-74
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Revenue is primarily derived from the (i) delivery of the Antivirus software and (ii) delivery of the additional add-on service(s), which all are provided on a fixed-price basis. The Company recognizes revenue following the five-step model prescribed under ASC 606: (i) identify contract(s) with a customer; (ii) identify the performance obligation(s) in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligation(s) in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration it is entitled to in exchange for the services it transfers to the customer. These contracts are all substantially the same and only differ depending on which, if any, additional add-on services are purchased.
Performance obligations are satisfied over time, being the length of the service contract (which is either monthly or annually). The Company’s services rendered to customers are generally paid for in advance with cash receipts recorded as deferred revenue with revenue recognized over time based on the satisfaction of the performance obligations to date.
The Company recognizes revenues from sales transactions containing sales refund provisions at the time of the sale. The potential for customer refunds are considered a component of variable consideration under ASC 606 and are considered when estimating the transaction price for a sale. The Company uses the expected value method to determine the amount of refunds expected using historical refund data. The amount of expected returns is recognized as a refund liability, representing the obligation to return consideration to the customer.
The Company has elected the practical expedient for treatment of contract costs and expensed them as incurred.
Functional Currency and Operations
The Company and its subsidiaries functional and reporting currency is United States dollars (“USD”). Financial instruments and non-monetary assets denominated in currencies other than the functional currency are remeasured at year end with any income or loss recorded in the Statement of Operations. For the years ended December 31, 2021 and 2020, the Company and its subsidiaries recognized a loss of $1,340,513 and $134,514, respectively, due to this remeasurement.
Income Taxes
Income taxes are recorded in accordance with ASC 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach. The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are provided, if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company accounts for uncertain tax positions in accordance with the provisions of ASC 740. When uncertain tax positions exist, the Company recognizes the tax benefit of tax positions to the extent that the benefit would more likely than not be realized assuming examination by the taxing authority. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances. The Company recognizes any interest and penalties accrued related to unrecognized tax benefits as income tax expense.
F-75
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Advertising Expense
Advertising costs are expensed as incurred. Advertising costs were $26,616,136 and $26,769,881 for the years ended December 31, 2021 and 2020, respectively, and are included in cost of revenue on the consolidated statement of operations and comprehensive income (loss).
Other Operating Income
Other operating income is recognized when earned. Other operating income is made up of recharged income in which subscriptions are paid to a third party by the Company in full which Protected recovers such costs from the other related party companies. In addition, this balance includes a $220,000 commission payment that was received from a Company merchant during the year ended December 31, 2021. This was received due to an issue with the merchants system which impacted payment success rates, which has since been resolved. This balance also includes Coronavirus Job Retention Scheme grants which totalled $0 and $30,325 for the years ended December 31, 2021 and 2020, respectively.
License Costs
License costs are expensed as incurred. The costs relate to license arrangements with other antivirus providers who charge the Company per user for utilizing the core antivirus engine behind the Company’s product. The Company is typically invoiced on a quarterly basis on a forward-looking basis. Such costs are capitalized to prepaid expenses when they are paid and amortized through cost of revenue in the period that the services are provided.
Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) which is intended to simplify the accounting for income taxes by eliminating certain exceptions and simplifying certain requirements under Topic 740. Updates are related to intraperiod tax allocation, deferred tax liabilities for equity method investments interim period tax calculations, tax laws or rate changes in interim periods, and income taxes related to employee share ownership plans. The guidance for ASU No. 2019-12 is required for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2020, for business entities that are public, and after December 15, 2021, including interim periods within those annual periods, for all other entities, with early adoption permitted.” The Company adopted this guidance effective on January 1, 2021. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In October 2020, the FASB issued ASU 2020-10, Codification Improvements. This ASU codifies the disclosure guidance of all codifications which provide entities with an option to either present information on the face or disclose it in the notes to the financial statements. ASU 2020-10 also clarifies application of various provisions in the codifications where the guidance may have been unclear. The ASU is effective for fiscal years beginning after December 15, 2020. The Company adopted this guidance effective on January 1, 2021. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, Accounting for Credit Losses (Topic 326), which requires the use of an “expected loss” model on certain types of financial instruments. The standard also amends the impairment model for available-for-sale debt securities and requires estimated credit losses to be recorded as allowances instead of reductions to amortized cost of the securities. Update No. 2016-13 is effective for annual periods beginning after December 15, 2022, including interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact the standard will have on its consolidated financial statements.
F-76
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which aims to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the new guidance, goodwill impairment will be measured as the amount by which the carrying value exceeds the fair value. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The standard is effective for annual and interim reporting periods beginning after December 15, 2022. Early adoption is permitted. The Company had evaluated that this standard will have no effect on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The standard is effective for annual reporting periods beginning after December 15, 2020 and interim periods within annual periods beginning after December 15, 2021. Early adoption is permitted. The Company is currently evaluating the impact the standard will have on its consolidated financial statements.
In August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which simplifies the accounting for convertible instruments by removing certain separation models in Subtopic 470-20, Debt—Debt with Conversion and Other Options, for convertible instruments and also increases information transparency by making disclosure amendments. The standard is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.
| 3. | PREPAID EXPENSES AND OTHER CURRENT ASSETS |
Prepaid expenses and other current assets consist of the following:
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Prepaid Advertising |
$ | 97,800 | $ | 39,689 | ||||
| Prepaid Subscriptions |
235,825 | 168,289 | ||||||
| Prepaid Technical Support |
131,760 | — | ||||||
| Other Prepaid Expenses |
80,967 | 151,351 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 546,352 | $ | 359,329 | ||||
|
|
|
|
|
|||||
F-77
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| 4. | PROPERTY, PLANT, AND EQUIPMENT |
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Computers |
$ | 265,511 | $ | 113,684 | ||||
| Furniture & Fixtures |
316,209 | 217,008 | ||||||
| Motor Vehicles |
179,585 | — | ||||||
| Office Equipment |
114,127 | 47,796 | ||||||
|
|
|
|
|
|||||
| $ | 875,432 | $ | 378,488 | |||||
| Less: Accumulated Depreciation |
(259,340 | ) | (107,993 | ) | ||||
|
|
|
|
|
|||||
| $ | 616,092 | $ | 270,495 | |||||
|
|
|
|
|
|||||
Property, plant, and equipment consist of the following:
| December 31, 2021 | ||||||||||||||||||||||||
| Estimated Useful Life |
Beginning Balance |
Additions | Disposals | Accumulated Depreciation |
Net Book Value |
|||||||||||||||||||
| Computers |
3 years | $ | 113,684 | $ | 149,389 | — | $ | (94,220 | ) | $ | 168,853 | |||||||||||||
| Furniture and fixtures |
4 years | 217,008 | 99,202 | — | (125,270 | ) | 190,940 | |||||||||||||||||
| Motor Vehicles |
4 years | — | 179,585 | — | (3,741 | ) | 175,844 | |||||||||||||||||
| Office equipment |
3 years | 47,796 | 68,768 | — | (36,109 | ) | 80,455 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total |
$ | 378,488 | $ | 496,944 | $ | — | $ | (259,340 | ) | $ | 616,092 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||
| Estimated Useful Life |
Beginning Balance |
Additions | Disposals | Accumulated Depreciation |
Net Book Value |
|||||||||||||||||||
| Computers |
3 years | $ | 56,151 | $ | 57,533 | — | $ | (41,069 | ) | $ | 72,615 | |||||||||||||
| Furniture and fixtures |
4 years | 90,818 | 126,190 | — | (52,396 | ) | 164,612 | |||||||||||||||||
| Office equipment |
3 years | 26,314 | 21,482 | — | (14,528 | ) | 33,268 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total |
$ | 173,283 | $ | 205,205 | $ | — | $ | (107,993 | ) | $ | 270,495 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Depreciation expense was $151,347 and $74,652 for the years ended December 31, 2021 and 2020, respectively.
| 5. | GOODWILL AND INTANGIBLE ASSETS |
Intangible assets consist of the following:
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Software |
$ | 275,668 | $ | 255,668 | ||||
| Technology |
312,000 | — | ||||||
| Domain Name |
100,089 | 22,187 | ||||||
|
|
|
|
|
|||||
| $ | 687,757 | $ | 277,855 | |||||
| Less: Accumulated amortization |
(318,578 | ) | (224,625 | ) | ||||
|
|
|
|
|
|||||
| $ | 369,179 | $ | 53,230 | |||||
|
|
|
|
|
|||||
F-78
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| December 31, 2021 | ||||||||||||||||||||||||
| Estimated Useful Life |
Beginning Balance |
Additions | Sales | Accumulated Amortization |
Net Book Value |
|||||||||||||||||||
| Software |
3 years | $ | 255,668 | $ | 20,000 | $ | — | $ | (249,496 | ) | $ | 26,172 | ||||||||||||
| Technology |
5 years | — | 312,000 | — | (46,800 | ) | 265,200 | |||||||||||||||||
| Domain Names |
5 years | 22,187 | 77,902 | — | (22,282 | ) | 77,807 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| $ | 277,855 | $ | 409,902 | $ | — | $ | (318,578 | ) | $ | 369,179 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||
| Estimated Useful Life |
Beginning Balance |
Additions | Sales | Accumulated Amortization |
Net Book Value |
|||||||||||||||||||
| Software |
3 years | $ | 243,168 | $ | 12,500 | $ | — | $ | (210,445 | ) | $ | 45,223 | ||||||||||||
| Domain Names |
5 years | 47,187 | — | (25,000 | ) | (14,180 | ) | 8,007 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| $ | 290,355 | $ | 12,500 | $ | (25,000 | ) | $ | (224,625 | ) | $ | 53,230 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Amortization expense was $93,953 and $66,646 for the years ended December 31, 2021 and 2020, respectively.
The following table displays the changes in goodwill as of December 31, 2021 and 2020, respectively:
| Goodwill | ||||
| Balance at January 1, 2021 |
$ | — | ||
| Additions |
283,809 | |||
|
|
|
|||
| Balance at December 31, 2021 |
$ | 283,809 | ||
|
|
|
|||
6. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses consist of the following:
| As of December 31, | ||||||||
| 2021 | 2020 | |||||||
| Marketing |
$ | 5,344,603 | $ | 4,361,567 | ||||
| Income taxes payable |
2,063,592 | — | ||||||
| Payroll |
661,187 | 632,880 | ||||||
| Network Protected Limited post-deal activity |
3,285 | 433,063 | ||||||
| Accounting and professional fees |
959,599 | 570,069 | ||||||
| License and royalties |
809,584 | 387,017 | ||||||
| Software |
78,000 | 74,500 | ||||||
| Administrative |
243,500 | 223,400 | ||||||
| Other |
214,872 | 134,610 | ||||||
|
|
|
|
|
|||||
| Total accrued expenses and other liabilities |
$ | 10,162,350 | $ | 6,704,093 | ||||
|
|
|
|
|
|||||
7. NOTE PAYABLE
On December 17, 2020, the Company entered into a new Facilities Agreement (the “Agreement”) with Silicon Valley Bank that provides for a facility of up to $10,000,000 (“Facility A”), and an additional facility (“Facility B”) up to $5,000,000, not to be used until Facility A is fully used. The Company was charged an arrangement fee of $150,000 in respect to Facility A. The arrangement fee was paid on December 17, 2020 relating to Facility A.
F-79
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Agreement contains financial covenants, requiring a leverage ratio of between 2.50-3.00:1, and minimum liquidity amounts between $3,000,000 and $5,000,000 during the period ending on the termination date of December 17, 2023. The Company was in compliance with all covenants as of December 31, 2021. Facility A and Facility B both carry a variable interest rate of 3.5% - 7.5%, payable on a quarterly basis. The note requires principal payments of $375,000 for the first 8 quarters and $1,750,000 for the final four quarters. On January 27, 2022, the Company repaid its outstanding principal and interest owed to Silicon Valley Bank as part of the Facilities Agreement. Refer to the Subsequent Events footnote at Note 19 for additional discussion on the loan payoff.
On March 31, 2021, the Company borrowed an additional $5,000,000 from its original new Facilities Agreement with Silicon Valley Bank that provided up to $5,000,000 to be borrowed from Facility B. The Company was charged an arrangement fee of $75,000 in respect to Facility B. The Facilities Agreement contains financial covenants, requiring a leverage ratio of between 2.50-3.00:1, and minimum liquidity amounts between $3,000,000 and $5,000,000 during the period ending on the termination date of December 17, 2023. Facility B carries an interest rate of 3.75% for the first two years and 17.5% during the final year. The additional draw requires principal payments of $187,500 for the first 8 quarters and $875,000 for the final four quarters. The principal amount due in the next twelve months totals $2,812,500.
As of December 31, 2021 and 2020, the total loan balance was $13,500,000 and $10,000,000, respectively, and financing costs totalled $141,052 and $148,194, respectively. The deferred financing costs are amortized over a straight-line basis, which approximates the amortization under the effective interest rate method. Amortization of deferred financing costs during the years ended December 31, 2021 and 2020 was $82,142 and $1,806, respectively. Additionally, the Company incurred $583,428 and $29,085 of interest associated with the Note payable during the years ended December 31, 2021 and 2020, respectively.
8. COMMITMENTS AND CONTINGENCIES
Legal proceedings
In the normal course of business, the Company may become involved in legal disputes regarding various litigation matters. In the opinion of management, any potential liabilities resulting from such claims would not have a material effect on the financial statements.
9. SHAREHOLDERS’ DEFICIT
The Company had one class of preferred and common shares, as outlined below, during the years ended December 31, 2021 and 2020. The common share classes are displayed in aggregate on the Consolidated Balance Sheets and Consolidated Statements of Shareholders’ Equity (Deficit). On December 31, 2021, the Company has the authority to issue up to 0 shares of £0.0001 par value Class A Preferred Shares and 0 shares of £0.0001 par value Class B Ordinary Shares.
Preferred Shares
The Preferred Shares have a par value of £0.001 per share. Each share of the Company’s Preferred Shares entitled the holder to one vote on all matters to be voted upon by the Shareholders. Preferred Shares shall be first in priority to receive distributions based on the original value of the shares plus any accrued and unpaid dividends. As of December 31, 2021 and 2020, the Company had 7,992,009 preferred shares authorized and issued. The Preferred Shares carry a fixed cumulative preferred dividend at a rate of 7% per annum on the original value of these shares plus any accrued but unpaid dividend amounts, compounded annually.
F-80
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Common Shares
The Company had one class of common shares, as outlined below, during the years ended December 31, 2021 and 2020. These share classes are displayed in aggregate on the Consolidated Balance Sheets and Consolidated Statements of Shareholders’ Deficit.
The Ordinary Shares have a par value of £0.001 per share. Each share of the Company’s Ordinary Shares entitles the holder to one vote on all matters voted upon by the Shareholders. On liquidation or any distributions made to holders of Ordinary Shares, holders of Ordinary Shares shall be second in priority to receive distributions after payments are made to Preferred Shareholders. As of December 31, 2021 and 2020, the Company had 7,960,105 common shares authorized and issued.
10. REVENUE WITH CUSTOMERS
Under ASC 606, revenue is recognized throughout the life of the executed agreement. The Company measures revenue based on consideration specified in a contract with a customer. Furthermore, the Company recognizes revenue when a performance obligation is satisfied by transferring control over the service to the customer which could occur over time.
A performance obligation is a promise in a contract to transfer a distinct service to the customer. The transaction price of a contract is allocated to each distinct performance obligation and recognized as revenue when or as the customer receives the benefit of the performance obligation. Customers typically receive the benefit of the Company’s services as (or when) they are performed. Substantially all customer contracts provide that compensation is received for services performed to date. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer, are recorded as a reduction of revenue with a corresponding liability recognized.
Nature of goods and services
The following is a description of the Company’s services from which the Company generates revenue, as well as the nature, timing of satisfaction of performance obligations, and significant payment terms for each:
| i. | Delivery of Antivirus Software |
Antivirus Subscription Services – The Company is a leading distributor of computer protection software. Their primary software, TotalAV Antivirus Pro, provides antivirus and anti-malware protection, spyware removal, adware cleaning, and more. The program can be installed and downloaded on 3 separate devices.
| ii. | Delivery of additional add-on service(s) |
In addition to TotalAV Antivirus Pro, the customers can sign up for additional services. These additional services include password vault, smartphone protection, identity protection, Ad Block Pro, protection on additional devices, Safe Browsing (VPN), and Advanced Cloud Scanning, among others.
The Company recognizes the sale of software over the length of the subscription (annually or monthly). The Company has two performance obligations (i.e., the Delivery of Antivirus Software and the Delivery of Additional Add-On Service(s)). Allocation of the transaction price was not necessary as the transaction prices for each separate performance obligation are separately stated in the contract.
F-81
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company recognizes revenues from sales transactions containing sales refund provisions at the time of the sale. The potential for customer refunds are considered a component of variable consideration under ASC 606 and are considered when estimating the transaction price for a sale. The Company uses the expected value method to determine the amount of refunds expected using historical refund data. The amount of expected returns is recognized as a refund liability, representing the obligation to return consideration to the customer. The total refund liability totaled $536,753 and $511,779 as of December 31, 2021 and 2020, respectively.
During the year ended December 31, 2021 and 2020, the Company recognized $114.9 million and $66.7 million, respectively, of revenue from the satisfaction of delivery of antivirus software. During the year ended December 31, 2021 and 2020, the Company recognized $29.6 million and $24.2 million of revenue from the satisfaction of delivery of additional add-on services, respectively.
The following table presents our revenues disaggregated by revenue stream.
| For the Year Ended | ||||||||
| December 31, | ||||||||
| 2021 | 2020 | |||||||
| Major products/service lines |
||||||||
| Antivirus software revenue |
$ | 114,892,069 | $ | 66,729,758 | ||||
| Additional add-on service revenue |
29,649,152 | 24,178,539 | ||||||
|
|
|
|
|
|||||
| Total revenue |
$ | 144,541,221 | $ | 90,908,297 | ||||
|
|
|
|
|
|||||
The following table presents our revenues disaggregated by geographic region.
| For the Year Ended | ||||||||
| December 31, | ||||||||
| 2021 | 2020 | |||||||
| Geographic Region |
||||||||
| Germany |
$ | 14,862,815 | $ | 10,938,787 | ||||
| United Kingdom |
22,162,283 | 13,222,636 | ||||||
| Rest of Europe |
23,860,130 | 17,638,111 | ||||||
| United States |
62,170,066 | 35,983,970 | ||||||
| Rest of North America |
7,862,060 | 4,917,152 | ||||||
| Other |
13,623,867 | 8,207,641 | ||||||
|
|
|
|
|
|||||
| Total revenue |
$ | 144,541,221 | $ | 90,908,297 | ||||
|
|
|
|
|
|||||
F-82
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Deferred Revenues
We record deferred revenues when cash payments are received in advance of our performance, primarily for subscription revenues. The increase in deferred revenues for the year ended December 31, 2021 is primarily driven by sales increases and periodic invoices due in advance of satisfying our performance obligations. Deferred revenue is released over the customers agreed term (monthly or annually) at a daily level. All brought forward deferred balances were released in the year to December 2021.
| For the Year Ended December 31, |
||||||||
| 2021 | 2020 | |||||||
| Deferred revenue at beginning of period |
$ | 47,430,897 | $ | 29,703,831 | ||||
| Deferred revenue recognized during period |
(145,733,685 | ) | (58,088,574 | ) | ||||
| Additions to deferred revenue during period |
155,708,156 | 75,815,640 | ||||||
|
|
|
|
|
|||||
| Deferred revenue at end of period |
$ | 57,405,368 | $ | 47,430,897 | ||||
|
|
|
|
|
|||||
Practical Expedients and Exemptions
The Company has elected the practical expedient for treatment of contract costs as part of the adoption of ASC 606 and expensed them as incurred.
11. SALE OF NETWORK PROTECT LIMITED
On August 13, 2020, Network Protect Limited (“Seller”), a wholly owned subsidiary of the Company, entered into an Asset Purchase Agreement to sell its virtual private network subscription service business to Intersections Inc. (“Buyer”) for a total price of $1,600,000. Of the total purchase price, $1,500,000 was payable in cash at the time of closing with the remaining $100,000 to be payable on August 13, 2021. The remaining amount was paid from the Buyers to Seller on August 13, 2021. The assets sold included its customer lists as well as the rights to the Seller’s domain names. This sale excludes certain assets of the Seller such as cash, accounting records not related to the customer lists and domain names, advance receipts and debts, and the intellectual property rights to the software, websites, and apps.
The intangible assets which had a carrying value of $20,000 were disposed of and the difference between the sale price and carrying value, or $1,580,000, was recognized as a gain on sale of intangible assets within the other operating income section of the statement of operations and comprehensive income (loss).
The disposal did not meet the definition of discontinued operations given that it did not represent a strategic shift given Network Protect Limited’s total assets, revenue, and net income in comparison to the consolidated entity’s totals.
12. ACQUISITION OF HOST PLUS LIMITED
On March 31, 2021, the Company entered into a Share Purchase Agreement (the “Host Plus Agreement”) with Boxer Investment Group LLC, Christopher Philips, and Nicholas Baker (collectively, the “Sellers”) to purchase Host Plus Limited (“Host Plus”). Host Plus has developed a web hosting product for release to the public market, which has not yet been released as of the acquisition date (the “Host Plus Transaction”). The purpose of the acquisition for Protected.net is to enter a new business line in which it can leverage its marketing expertise and cross-sell the web hosting services to its antivirus solutions customer base. Pursuant to the Host Plus Agreement, the total purchase price was $448,668, which consisted of a payment of $138 in cash (the “Closing Payment”) to the Sellers as well as the assumption of Host Plus outstanding debt totalling $448,530. The outstanding debt assumed by the Buyer was due to Just Develop It Limited (“JDI”), who is the parent company of the Buyer and a related party. The Closing Payment was paid to the Sellers on March 31, 2021 (the “Closing Date”).
F-83
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The fair value of the identifiable net assets acquired was less than the aggregate purchase consideration paid, and accordingly the Company recorded goodwill of $283,809, which will be evaluated for impairment annually. The Company evaluated whether the goodwill balance shall be impaired as of December 31, 2021. Given that no impairment indicators were found in Host Plus Limited, which is not a separate reporting unit, there was no impairment required for goodwill as of December 31, 2021.
| Cash |
$ | 138 | ||
| Host Plus debt assumed at closing |
448,530 | |||
|
|
|
|||
| Total consideration |
$ | 448,668 | ||
|
|
|
The following table summarizes the preliminary purchase price allocations relating to the Host Plus acquisition:
| Consolidated Fair Value |
||||
| Cash Consideration |
$ | 138 | ||
| Host Plus Debt Assumed at Acquisition |
448,530 | |||
|
|
|
|||
| Total Purchase Price |
448,668 | |||
| Current Assets Acquired |
||||
| Net Working Capital (Including Cash) |
$ | (218,141 | ) | |
|
|
|
|||
| Total Current Identifiable Assets |
(218,141 | ) | ||
| Non-Current Assets Acquired |
||||
| Technology |
312,000 | |||
| Domain Name |
71,000 | |||
|
|
|
|||
| Total Non-Current Identifiable Assets |
383,000 | |||
| Goodwill |
$ | 283,809 | ||
13. INCOME TAXES
A reconciliation of the statutory income tax rate to the Company’s effective tax rate consists of the following:
| For the Years Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Statutory United Kingdom income tax rate |
19.0 | % | 19.0 | % | ||||
| Permanent items |
0.9 | % | -0.1 | % | ||||
| Change in UK tax law to deferred taxes |
-8.5 | % | — | |||||
| Prior year adjustments |
-5.5 | % | — | |||||
| Change in valuation allowance |
-59.4 | % | -18.9 | % | ||||
|
|
|
|
|
|||||
| Effective tax rate |
-53.5 | % | — | % | ||||
|
|
|
|
|
|||||
F-84
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The components of income tax provision/(benefit) are as follows:
| December 31, | ||||||||
| 2021 | 2020 | |||||||
| United Kingdom: |
||||||||
| Current |
$ | 2,170,803 | $ | — | ||||
| Deferred |
(17,343,731 | ) | — | |||||
|
|
|
|
|
|||||
| Total |
$ | (15,172,928 | ) | $ | — | |||
|
|
|
|
|
|||||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. The temporary differences that give rise to deferred tax assets and liabilities are as follows:
| December 31, | ||||||||
| 2021 | 2020 | |||||||
| Deferred tax assets/(liabilities): |
||||||||
| Net operating loss carryforwards |
$ | 17,346,628 | $ | 16,869,434 | ||||
| Deferred financing costs |
(26,800 | ) | (28,157 | ) | ||||
| Property, plant and equipment |
(20,105 | ) | (335 | ) | ||||
| Intangible assets |
(63,203 | ) | — | |||||
|
|
|
|
|
|||||
| 17,236,520 | 16,840,942 | |||||||
| Valuation allowance |
— | (16,840,942 | ) | |||||
|
|
|
|
|
|||||
| Deferred tax assets, net of allowance |
$ | 17,236,520 | $ | — | ||||
|
|
|
|
|
|||||
The Company recorded a full valuation allowance against its deferred tax assets as of December 31, 2020. The Company provides a valuation allowance for deferred tax assets when it is more likely than not that some portion, or all of its deferred tax assets, will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. The Company considers all available positive and negative evidence and makes certain assumptions in evaluating the realizability of its deferred tax assets. Many factors are considered which impact the Company’s projections of future sustained profitability.
For the year ended December 31, 2021, after considering all positive and negative evidence, including past earnings, historical trends and projected future taxable income from operating activities, the Company concluded that all of its deferred tax assets were more likely than not to be realized. Accordingly, the Company reversed the valuation allowance, which resulted in a $16,840,942 tax benefit to the income tax provision.
As of December 31, 2021 and 2020, the Company had net operating loss carry forwards of $78,538,911 and $88,786,492, respectively. The net operating loss carry forwards generated in the tax years from 2016 to 2021 and have an unlimited carry forward period.
The Company has no uncertain tax positions, or penalties and interest accrued, that if recognized would reduce net operating loss carry forwards or effect tax expense.
The Company files tax returns as prescribed by the tax laws in the United Kingdom in which they operate. In the normal course of business, the Company is subject to examination by the federal jurisdiction based on the statute of limitations. As of December 31, 2021, open years related to the United Kingdom are 2021 and 2020.
F-85
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company has no open tax audits with any taxing authority as of December 31, 2021.
14. GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses are comprised of the following items:
| For the Years Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Depreciation and amortization |
$ | 245,299 | $ | 141,298 | ||||
| Value-added tax provision (Note 17) |
4,602,494 | 2,934,307 | ||||||
| SPAC transaction costs |
1,163,786 | — | ||||||
| Software |
1,050,479 | 1,051,157 | ||||||
| Salaries and benefits |
5,332,195 | 793,779 | ||||||
| Legal fees |
813,468 | 515,318 | ||||||
| Other general and administrative expenses |
2,704,672 | 1,275,207 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 15,912,393 | $ | 6,711,066 | ||||
|
|
|
|
|
|||||
15. DEFINED CONTRIBUTION PENSION
The Company operates a defined contribution pension scheme. The assets of the scheme are held separately from those of the Company in an independently administered fund. The pension cost charge represents contributions payable by the Company to the fund. Contributions for the years ended December 31, 2021 and 2020 were $208,001 and $131,109, respectively. As of December 31, 2021 and 2020, $27,286 and $12,446 was owed to the pension scheme, respectively.
16. RELATED PARTY TRANSACTIONS
The Company has an agreement with JDI Property Holdings Limited (“JDI”) which allows for the Company to occupy desks at JDI’s property in such a place as JDI specifies from time to time in exchange for £25,000 per month. The agreement expires on June 21, 2022. The Company was also charged management fees and other staff costs by Just Develop It Limited and its subsidiaries (JDI and Skylark Golf & Country Club Limited), a group with common directors. The total of these expenses was $1,142,912 and $646,060 for the years ended December 31, 2021 and 2020 respectively. Of these amounts, $664,697 and $536,200 related to rent expense, respectively.
As of December 31, 2019, the Company had an outstanding payable due to a former shareholder of the Company totaling $237,671. The payable related to taxes withheld to be remitted to the United Kingdom that were later determined to be over-collected. This payable was paid back to the directors by the Company in full in 2020.
On February 3, 2020, the Company entered into a short-term intercompany loan with a director of the Company. Under this agreement, the director agreed to provide the Company with a $3,000,000 loan that carried an interest rate of 10%. The loan was drawn by the Company on February 3, 2020 in full. The loan had a maturity date of March 17, 2020, which the Company paid back in full on this date. The Company incurred $35,000 of interest on this loan during the year ended December 31, 2020.
On March 13, 2020, the Company entered into an intercompany loan payable with System1 SS Protect Holdings, Inc. Under this agreement, SS Protect Holdings agreed to provide the Company with a $6,000,000 loan that carried an interest rate of 10%. The loan was drawn by the Company on March 13, 2020 in full. The loan had a maturity date of March 13, 2021. The Company paid the loan back in full on November 13, 2020. The Company incurred $356,384 of interest expense on this loan during the year ended December 31, 2020.
F-86
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
On November 13, 2020, the Company entered into an intercompany loan payable with Protected Security Holdings LLC, the parent company of System1 SS Protect Holdings, Inc. Under this agreement, Protected Security Holdings agreed to provide the Company with a $1,999,947 loan that carried an interest rate of 7.5%. The loan was drawn on November 13, 2020 in full. The loan had a maturity date of November 13, 2023. The Company paid the loan back in full on December 18, 2020. The Company incurred $14,383 of interest expense on this loan during the year ended December 31, 2020.
On December 17, 2020, the Company entered into an intercompany loan receivable with System1 SS Protect Holdings, Inc. Under this agreement, the Company agreed to provide System1 SS Protect Holdings, Inc. with a line of credit with a maximum amount of $30,000,000. The line of credit has an interest rate of 0% from December 17, 2020 to December 31, 2020, 5% from January 1, 2021 to March 31, 2021, and 3.5% from April 1, 2021 until the agreement is terminated. The loan has a maturity date of January 1, 2023. On December 17, 2020, System1 S1 SS Protect Holdings, Inc. drew a total of $10,059,719 from the line of credit. As part of this loan, the Company charged S1 SS Protect Holdings a set-up fee of $170,000. The set-up fee is being recognized through income over the term of the loan.
During the year ended December 31, 2021, S1 SS Protect Holdings drew an additional $21,908,640 from the line of credit provided by the Company as part of the loan agreement. The loan draw will accrue interest at an interest rate of 3.5% from the time of the loan draw until funds are paid back to the Company. The loan has a maturity date of January 1, 2023. As part of this loan, the Company charged S1 SS Protect Holdings a set-up fee of $75,000. The set-up fee shall be recognized through income over the term of the loan.
As of December 31, 2021 and 2020, the total outstanding balance of the loan with System1 S1 SS Protect Holdings, Inc. was $32,832,653 and $10,059,719, respectively. As of December 31, 2021 and 2020, the total amount included in deferred revenue relating to financing fees not yet recognized was $165,594 and $167,712, respectively. Total financing fees recognized during the years ended December 31, 2021 and 2020 were $77,121 and $2,285, respectively. The Company recognized $941,416 and $0 of interest income related to this loan during the years ended December 31, 2021 and 2020, respectively.
On March 31, 2021, the Company entered into a Share Purchase Agreement to purchase Host Plus Limited (as described in Note 12). Each Seller of Host Plus Limited is a minority shareholder of the Company. In addition, the Company assumed the debt of Host Plus Limited as part of the acquisition, which was payable to JDI. As noted above, JDI is the parent company of Protected. On April 1, 2021, the Company provided an intercompany loan to Host Plus Limited who then repaid the outstanding loan in full on the same day in the amount of $448,530. The loan between Host Plus Limited and JDI did not have a stated maturity date and carried an interest rate of 0%.
During the year ended December 31, 2021, the Company entered into a short term loan agreement with Just Develop It Limited, which carried an interest rate of 0%. These loans allowed multiple drawdowns which totaled $29,634,886 and were fully repaid by the end of the period. In addition to this, as a part of the Host Plus Share Purchase Agreement, the Company assumed a debt payable to Just Develop It Limited which was repaid in full on April 1, 2021.
On May 19, 2021, the Company entered into a loan receivable with a director of the Company. Under this agreement, the Company agreed to provide the director with a loan facility of up to $2,000,000 which carried an interest rate of 0%. The loan did not specify a stated maturity date. The director of the Company drew multiple amounts in accordance with the facility during the year ended December 31, 2021. The loan was repaid in full to the Company on December 24, 2021.
F-87
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
17. VAT TAX LIABILITY
The Company has recorded a liability for worldwide VAT and US sales tax of $11,403,760 and $6,366,454 as of December 31, 2021 and 2020, respectively. The liability represents the Company’s best estimate of amounts due for sales tax and VAT due for sales that have occurred over the applicable periods subject to such indirect taxes. The Company has not been registered for sales tax in states where the group had created a Nexus, or VAT in certain countries. The Company has started the remediation process by appointing third party tax advisors to evaluate amounts due and disclosures to each tax jurisdiction. At the date of the issuance of these financial statements the business has registered in (and began to settle) its historic VAT obligations in: Australia, New Zealand, Norway and Switzerland.
18. SEGMENT REPORTING
Segment Reporting Disclosures
ASC Subtopic 280-10, “Segment Reporting,” establishes standards for reporting information about operating segments. The Company has voluntarily chosen to disclose certain operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or CODM, in deciding how to allocate resources and assess performance. The Company has one business line and operating segment. The information for revenue category service line, geography and timing of revenue recognition is summarized in Note 10, “Revenue with Customers”. Each of the long-lived assets are held in the United Kingdom.
The Company, including its CODM, uses Adjusted Operating Income (Loss), a non-GAAP financial metric, to evaluate Protected’s core operating performance and trends and to make strategic decisions regarding the allocation of capital and new investments. Additionally, the Company uses Adjusted Operating Income (Loss) as basis for setting variable compensation for its employees, the Company’s lenders use Adjusted Operating Income (Loss) to measure its compliance with credit facility covenants and the Company believes Adjusted Operating Income (Loss) is another approximation to measure its operating cash flow. Adjusted Operating Income (Loss) is defined as operating income/(loss) before depreciation and amortization, VAT accrual for previously uncollected VAT, directors’ salary payments which will cease upon completion of the Business Combination, non-recurring and restructuring expense and adjusted to remove earnings from terminated product lines and the change in deferred revenue during the period. Change in deferred revenue includes the movement in deferred revenue as well as the movement in the refund liability. Nonrecurring expenses include foreign exchange adjustments, costs incurred to date in regards to the business combination with System1 and costs incurred in regards to the Silicon Valley Bank financing agreement, which will cease upon completion of the Business Combination.
Adjusted Operating Income (Loss) for the years ended December 31, 2021 and 2020 are as follows:
| For the Years Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Operating Income (Loss) |
$ | 28,020,402 | $ | (12,825,698 | ) | |||
| Depreciation and amortization |
245,300 | 141,298 | ||||||
| Terminated product lines |
(80,775 | ) | (1,777,261 | ) | ||||
| VAT accrual for previously uncollected VAT |
4,674,727 | 2,934,307 | ||||||
| Director Salary Payments |
2,806,497 | — | ||||||
| Non-cash foreign exchange adjustments |
1,340,513 | 110,090 | ||||||
| Non-recurring expense, primarily related to acquisitions, financing and SPAC transaction costs |
1,690,426 | 489,955 | ||||||
| Changes in deferred revenue |
9,974,471 | 18,083,645 | ||||||
|
|
|
|
|
|||||
| Adjusted operating income |
$ | 48,671,561 | $ | 7,156,336 | ||||
|
|
|
|
|
|||||
F-88
PROTECTED.NET GROUP LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19. SUBSEQUENT EVENTS
The Company has evaluated subsequent events through the date of issuance of March 31, 2022 and determined that there have been no events that have occurred that would require adjustments to our disclosures in the consolidated financial statements except for the below items.
On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), (the “Business Combination Agreement”) by and among Trebia Acquisition Corporation (“Trebia”) and Protected (together with System1 and Trebia, collectively, the “Companies”). On January 27, 2022 (the “Closing Date”), the Company consummated the merger (the “Merger”) pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company (“Post Closing Company”) is organized in an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected. Additionally, Trebia’s ordinary shares, warrants and units ceased trading on the New York Stock Exchange (“NYSE”), and System1 Inc.’s Class A Common Stock began trading on the NYSE on January 28, 2022 under the symbols “SST” and “SST.WS,” respectively.
The consideration paid to the existing Securityholders of System1 and Protected in connection with the Merger was a combination of cash and equity.
On January 27, 2022, the Company repaid its outstanding principal and interest owed to Silicon Valley Bank as part of the Facilities Agreement (as described in Note 7). The total amount paid back to Silicon Valley Bank was $13,167,694, which included a principal amount of $12,937,500 accrued interest of $36,132, and a prepayment charge of $194,063.
On January 27, 2022, the Company entered into a loan agreement with System1 LLC, a related party. This loan enables System1 LLC to draw up to $50,000,000 at an interest rate of 0.44% per annum on the drawn balance. The drawn balance to date is $23,153,067.
F-89
Exhibit 99.4
PROTECTED MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless otherwise indicated or the context otherwise requires, references in this section to “Protected,” “we,” “us,” “our” and other similar terms refer to Protected.net Group Limited and its subsidiaries prior to the Business Combination.
The following discussion and analysis of the financial condition and results of operations of Protected should be read together with our audited consolidated financial statements, unaudited consolidated condensed financial statements, and related notes included elsewhere in this prospectus. The discussion and analysis should also be read together with the section entitled “Business” and our pro forma financial information for the year ended December 31, 2021. See “Unaudited Pro Forma Condensed Combined Financial Information.” In addition to historical information, the following discussion contains forward-looking statements. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in the sections entitled “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” Certain amounts may not foot due to rounding.
Company Overview
Protected provides a comprehensive antivirus product solution to its customers that provides robust and resilient protection against online threats. The product consists of a core Antivirus software, with the ability to add additional products and services, to build up a security package based on a customer’s needs. These products include unlimited devices, VPN, Adblock, ID Protect and are managed to ensure they provide a value added service to the customer base. This software is sold in either a monthly or annual subscription predominantly through the flagship brand TotalAV.
Protected.net Group Limited was formed as a limited liability company in England and Wales on 4th May 2016, under the company number 10161957.
Protected sells its software all over the world, with the vast majority of these sales being made in the United States, the United Kingdom, Germany, France, Australia, Canada, Italy and Spain. Operations outside of the United Kingdom are subject to inherent risks due to operating in different legal systems and economic environments. Among the risks are; changes and differences in tax laws, income repatriation and exposure to currency fluctuations. Protected does not currently engage in hedging activities to mitigate its exposure to fluctuations in foreign currency exchange rates, however this is something that it may consider in the future as the business grows.
COVID-19
The worldwide spread of COVID-19 has resulted, and is expected to continue to result, in a global slowdown of economic activity which is likely to decrease demand for a broad variety of goods and services. However, Protected is fortunate to have suffered minimal adverse effects as a result of the COVID-19 pandemic. Throughout 2020, Protected was able to increase its customer base, which is partly attributable to more people working from home and using their devices. While its offices were required to close, Protected was able to provide its staff with the required tools to work effectively from home. In 2021, the business was able to see the renewal revenue for this cohort of customers start to come through, with these sales sharing similar renewal patterns to the remaining customer base. The extent to which ongoing and future developments related to the global impact of the COVID-19 pandemic and related vaccination measures designed to curb its spread continue to impact the Protected business, financial condition and results of operations, cannot be predicted with certainty. Many of these ongoing and future developments are beyond the control of Protected, including the speed of contagion, the development, distribution and implementation of effective preventative or treatment measures, including vaccines (and vaccination rates), the scope of governmental and other restrictions on travel, discretionary services and other activity, and the public reactions and receptiveness to these developments.
86
Components of Our Results of Operations
Revenue
The following is a description of Protected’s products and services from which it generates revenue, as well as the nature, timing of satisfaction of performance obligations, and significant payment terms for each:
Delivery of Antivirus Software
Protected is a leading distributor of computer protection software. Its primary software, TotalAV Antivirus Pro, provides antivirus and anti-malware protection, spyware removal, adware cleaning, and more. The program can be installed and downloaded on up to three separate devices.
Delivery of additional add-on service(s)
In addition to TotalAV Antivirus Pro, customers can sign up for additional services. These additional services include password vault, smartphone protection, identity protection, Ad Block Pro, protection on additional devices, Safe Browsing (VPN), and Advanced Cloud Scanning, among others.
Protected recognizes the sale of software over the length of the subscription (annually or monthly). It has two performance obligations (i.e., the delivery of antivirus software and the delivery of additional add-on service(s)). Each product has its own pricing, which is then acknowledged and deferred out over the period of that subscription. Accordingly, we recognize deferred revenue that changes significantly from period to period.
For a description of our revenue recognition policies see “Note 2—Summary of Significant Accounting Policies—Revenue” of Protected’s consolidated financial statements for the years ended December 31, 2021 and 2020 included elsewhere in this prospectus.
Cost of Revenues
Cost of revenues includes marketing costs, data centre, royalties, support, risk prevention and merchant fees as well as salary costs for our customer facing workforce. The most significant cost within cost of revenue is marketing expense, which is intrinsically linked to sales. Such costs are expensed as incurred. Marketing costs relate to the costs paid to third party affiliates and advertisers to promote its brands and products. These costs are the largest category of expenses that Protected incurs.
Protected expects its cost of revenue to increase in absolute dollars in future periods as its customer base continues to grow. Growth in our customer base means that Protected will incur greater marketing costs, merchant processing costs and increased support costs in addition to increased headcount and staff costs, Protected does anticipate that these costs will fluctuate materially as a percentage of revenue.
Other Operating Income
Protected classifies its other operating income into the following categories:
Gain on sale of intangible assets are exclusively made up from the proceeds of selling the customer base of Network Protect Limited (a 100% owned subsidiary) in 2020.
Foreign currency, gains and losses which are Accounted for at period end, or when an invoice is paid or received.
87
Other operating income is made up of income generated from recharging expenses incurred by Protected to the relevant parties, compensation received from one of our merchant processors and fund received from the UK government in relation to the Coronavirus Job Retention Scheme.
Operating Expenses
Protected classifies its operating expenses into the following categories:
General, and administrative costs primarily include:
Salaries and benefits relating to its non-customer facing workforce. This breakdown also includes the national insurance and employee benefit costs for these staff.
Other related costs which include, software costs incurred to service its customers, travel and entertaining costs as well as professional and legal fees, costs related to the merger and the VAT provisions currently held.
Related party rent expense includes rent paid in regards to the license to occupy held at our company offices.
Non-Operating Income (Expense)
Non-operating income (expense) primarily includes the following:
Related party interest expense is mainly related to a loan received from System1 in 2020, which carried a 10% interest rate. This loan was repaid in full in 2020. Interest expense is accrued on the loan agreement with Silicon Valley Bank for a combined $15 million facility, which accrues interest between 3.5% and 7.5% dependent on financial performance.
Related party interest income relates to income received through a loan agreement held with System1 SS Protect Holdings Inc. which carried an interest rate at 3.5% from March 31, 2021, prior to this the rate was 5%.
Income Tax Benefit
The provision for (benefit from) income taxes consist primarily of UK corporation tax.
Protected recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are provided, if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Protected accounts for uncertain tax positions in accordance with the provisions of ASC 740. When uncertain tax positions exist, Protected recognizes the tax benefit of tax positions to the extent that the benefit would more likely than not be realized assuming examination by the taxing authority. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances. Protected recognizes any interest and penalties accrued related to unrecognized tax benefits as income tax expense.
88
Results of Operations
The following tables set forth Protected’s consolidated results of operations and our consolidated results of operations as a percentage of revenue for the periods presented.
| Year ended December 31, |
||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Revenue |
$ | 144,541 | $ | 90,908 | ||||
| Cost of revenues |
98,946 | 97,980 | ||||||
|
|
|
|
|
|||||
| Gross income/(loss) |
45,595 | (7,072 | ) | |||||
| Other Operating Income: |
||||||||
| Gain on sale of intangible assets |
— | 1,580 | ||||||
| Other operating income/(expense) |
(997 | ) | (86 | ) | ||||
|
|
|
|
|
|||||
| Total other operating income/(expense) |
(997 | ) | 1,493 | |||||
| Operating Expenses: |
||||||||
| General and administrative expense |
15,912 | 6,711 | ||||||
| Related party rent expense |
665 | 536 | ||||||
|
|
|
|
|
|||||
| Total Operating Expenses |
16,577 | 7,247 | ||||||
| Operating income/(loss) |
28,020 | (12,826 | ) | |||||
| Non-operating income (expense) |
||||||||
| Related party interest expense |
— | (406 | ) | |||||
| Related party interest income |
941 | 2 | ||||||
| Interest expense |
(583 | ) | (29 | ) | ||||
|
|
|
|
|
|||||
| Total non-operating income (expense) |
358 | (433 | ) | |||||
|
|
|
|
|
|||||
| Income/(loss) from continuing operations before income taxes |
28,378 | (13,258 | ) | |||||
| Income tax benefit |
15,173 | — | ||||||
|
|
|
|
|
|||||
| Net income/(loss) |
$ | 43,551 | $ | (13,258 | ) | |||
|
|
|
|
|
|||||
89
| Year ended December 31, |
||||||||
| (as a percentage of revenue) | 2021 | 2020 | ||||||
| Revenue |
100 | % | 100 | % | ||||
| Cost of revenues |
68 | 108 | ||||||
| Gross income/(loss) |
32 | (8 | ) | |||||
| Other Operating Income: |
||||||||
| Gain on sale of intangible assets |
— | 2 | ||||||
|
|
|
|
|
|||||
| Other operating income/(expense) |
(1 | ) | — | |||||
| Total other operating income/(expense) |
(1 | ) | 2 | |||||
| Operating Expenses: |
||||||||
| General & administrative expenses |
11 | 7 | ||||||
| Related party rent expenses |
— | 1 | ||||||
|
|
|
|
|
|||||
| Total Operating Expenses |
11 | 8 | ||||||
| Operating loss |
19 | (14 | ) | |||||
| Non-operating income (expense) |
||||||||
| Related party interest expense |
— | — | ||||||
| Related party interest income |
1 | |||||||
| Interest expense |
— | — | ||||||
| Other income (expense) |
1 | — | ||||||
|
|
|
|
|
|||||
| Total non-operating income/(expense) |
— | — | ||||||
| Income/(loss) from continuing operations before income taxes |
20 | (15 | ) | |||||
| Income tax benefit |
10 | — | ||||||
|
|
|
|
|
|||||
| Net income (loss) |
30 | (15 | ) | |||||
|
|
|
|
|
|||||
Comparison of the Years Ended December 31, 2021 and 2020
Revenue
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Revenue |
$ | 144,541 | $ | 90,908 | $ | 53,633 | 59 | % | ||||||||
The increase in revenues in 2021 over 2020 largely relate to the compounding effect of subscription renewals on our ever-increasing customer base. Subscription renewal revenue contributed 91.99% of the revenue increase in the period with the remaining 8.01% attributable to new revenue, chargeback disputes & refunds in the period. In 2021, Protected onboarded 1,402 new paying customers and ended the period with 2,208 paying customers, compared to 1,338 and 1,905, respectively, over prior year. The larger customer base results in higher renewals for the business which in turn leads to increased revenue. From a dollar increase, subscription renewals before chargbacks and refunds increased by $53,978 up to $132,959.
Cost of Revenues
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Cost of Revenues |
$ | 98,946 | $ | 97,980 | $ | 966 | 1 | % | ||||||||
| Percent of revenue |
68 | % | 108 | % | ||||||||||||
90
The change in the cost of revenues is attributed to an increase in merchant fee costs of $2,566 and support costs of $546. Protected has increased activity with its two primary merchant processors in 2021, this resulted in higher overall fees but the increase is due to a greater number of transaction volumes. These merchants offer better returns and success rates of payment processing. In line with the continuous growth of our customer base, support headcount and outsourced costs have also increased to ensure that customers continue to receive the same high level of service and to ensure internal SLA’s are met. Advertising spend has remained relatively consistent with 2020 (a small decrease of $821). Protected advertising spend, excluding advertising spend for subscribers for terminated product lines, for 2021 was $76,449 to acquire 1,397 new subscribers, and in 2020, Protected advertising spend, excluding advertising spend for subscribers for terminated product lines, was $76,664 to acquire 1,338 new subscribers. Cost of revenues as a percentage of revenue decreased compared to the prior year because of a mix shift in revenue towards renewal revenue versus new customer revenue, as described above, and cost of revenue is primarily driven by advertising spend to acquire new customers. Excluding advertising spend on non- terminated product lines, cost of revenues as a percent of revenue was 16% in 2021 as compared to 23% in 2020. Cost of revenues excluding advertising spend as a percentage of revenue decreased due to a mix shift in revenue towards renewal revenue versus new customer revenue, as described above, as renewing subscribers typically pay a higher price for the product.
Gain on Sale of Intangible Assets
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Gain on Sale of Intangible Assets |
$ | — | $ | 1,580 | $ | (1,580 | ) | 100 | % | |||||||
| Percent of revenue |
0 | % | 2 | % | ||||||||||||
The decrease in gain on sale of intangible assets was due to the sale of the Network Protect customer base in August 2020 for $1,600.
General and Administrative Expenses
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| General and administrative expenses |
$ | 15,912 | $ | 6,711 | $ | 9,201 | 137 | % | ||||||||
| Percent of revenue |
11 | % | 7 | % | ||||||||||||
The increase in general and administrative expenses is primarily due to the increase of $4,538 in indirect salary costs as a result of increased headcount as well as two directors commencing salary withdrawals from the business and the relevant National Insurance contributions from these. There was also an increase in the VAT provision held in the period of $1,492. This also includes merger related expenses incurred by the business ($1,163). Consultancy costs increased by $532 which included the costs of preparing our financials to US GAAP. In addition to this, accountancy costs increased by $97 in the period.
Related Party Rent Expenses
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Related party Rent expenses |
$ | 665 | $ | 536 | $ | 129 | 24 | % | ||||||||
| Percent of revenue |
0 | % | 1 | % | ||||||||||||
91
Related party rent expense increased by $129 due to an increase in the license to occupy held with the related party.
Other Operating (Expense)/Income
| Year ended December 2021 |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Other operating income/(expenses) |
$ | (997 | ) | $ | (86 | ) | $ | (911 | ) | (1060 | )% | |||||
| Percent of revenue |
(1 | )% | — | % | ||||||||||||
The increase in other operating expense was primarily due to increased foreign exchange costs of $1,341 in 2021 compared with $135 in 2020. As the business collects revenue from its customers in AUD, CAD, EUR, GBP and USD, the company holds cash balances in a variety of accounts that are subject to changes in foreign exchange rates. The business is considering the use of financial instruments as a way of minimising this risk. The remaining difference is a result of the business receiving compensation from one of its merchant processors due to an issue in their reporting ($220).
Non-Operating Income/(Expense)
| Year ended December 31, |
2021 vs 2020 Change |
|||||||||||||||
| ($ in thousands, except percentages) | 2021 | 2020 | $ | % | ||||||||||||
| Non-Operating Income/(Expense) |
$ | 358 | ($ | 433 | ) | $ | 790 | 182 | % | |||||||
The business had increased interest costs in 2021 of $583 as a result of the Silicon Valley Bank loan taken out in 2020 and 2021. The business utilised this to loan funds to its parent company System1 SS Protect Holdings Inc. The loan attracted interest income of $941 in 2021.
Liquidity and Capital Resources
As of December 31, 2021, Protected had cash and cash equivalents of $35.1 million, which consists of amounts held with current banks and cash held in our merchant accounts.
Historically, Protected’s available liquidity and operations have been financed through the issuance of ordinary and preferred equity securities. Protected has incurred substantial and negative cash flows from operations in every fiscal period up to December 2020. In 2021, with the effect of its renewing customer base became cash generative. In 2021, we achieved net income of $43.6 million and generated $43.9 million in cash from operations and had an accumulated deficit of $45.7 million as of December 31, 2021. In addition, Protected has extended one of its major business relationships with the provider of its antivirus licenses through 2025. Protected was also able to secure a loan facility in December 2020, described below under “Debt”.
Protected believes that its operating results and cash balance will be sufficient to fund its operations for the next 12 months from the date of issuance of these financial statements. Future capital requirements will depend on many factors, including Protected’s rate of revenue growth and the level of expenditures of Protected. During the years ended December 31, 2021 and 2020, our estimates and assumptions required increased judgment and carried a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods. As of the date of issuance of the consolidated financial statements, Protected is not aware of any specific event or circumstance that would require an update to its estimates, judgments or adjust the carrying value of its assets or liabilities. These estimates used in the preparation of Protected’s financial statements may change, as new events occur and additional information is obtained, and will be recognized in the consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to Protected’s consolidated financial statements.
92
Debt
On December 17, 2020, Protected entered into a new Facilities Agreement with Silicon Valley Bank that provides for a facility of up to $10.0 million (“Facility A”), and an additional facility (“Facility B”) up to $5.0 million, not to be used until Facility A is fully used. Protected was charged an arrangement fee of $150 thousand in respect to Facility A and $75 thousand in respect to Facility B. The arrangement fee was paid on December 17, 2020 relating to Facility A. The Facilities Agreement contains financial covenants, requiring a leverage ratio of between 2.50-3.00:1, and minimum liquidity amounts between $3.0 million and $5.0 million during the period ending on the termination date of December 17, 2023. Facility A and Facility B both carry an interest rate of between 3.5% and 7.5% dependent on Protected’s financial performance. Repayments are at 3.75% of principal for the first two years and 17.5% during the final year.
The total loan balance was $13.5 million and $10 million as of December 31, 2021 and December 31, 2020, respectively. Deferred financing fees related to this loan totaled $141,052 and $148,194 as of December 31, 2021 and December 31, 2020, respectively. The deferred financing costs are amortized over a straight-line basis, which approximates the amortization under the effective interest rate method. Amortization of deferred financing costs during the year ended December 31, 2021 was $82,143.
Cash Flows
The following table summarizes Protected’s cash flows for the periods presented:
| Year ended December 31, |
||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Net cash provided by/(used in) operating activities |
$ | 43,887 | $ | (84 | ) | |||
| Net cash provided used in investing activities |
(22,319 | ) | (8,773 | ) | ||||
| Net cash provided by financing activities |
2,976 | 9,850 | ||||||
Operating Activities
Protected’s operating cash flows are predominantly impacted by three primary factors; new customer revenue, subscription renewal revenue and marketing costs.
As part of Protected’s model, marketing costs and customer acquisition cost (“CAC”) exceed new customer revenue and average order value (“AOV”), which, on average, results in a loss to acquire each new customer. Importantly, Protected incurs no direct marketing costs for subscription renewals, and due to the renewal being charged at full price, the AOV is higher than that of the initial subscription. The effect of no marketing expenditures on subscription renewals, greater AOV, and strong retention rates results in Year on Year (YoY) growth in operating cash flows from the primary drivers and positive Return on Investment (ROI) on the customer base.
Subscription renewals also lead to increases in deferred revenue year on year, which is referred to in Protected’s non-GAAP measures. The change in cash position during 2021 is reflected in the increase in deferred revenue each year, as revenue is recognised over the term of the customer’s subscription period, whereas marketing costs are recognised at the time of sale.
93
Aside from the three primary underlying drivers mentioned above, staff costs (salaries, bonuses and benefits) are the only other item that impacts operating cash flows in any material way. However, they do not grow linearly with revenue resulting in further increased operating cash flows over time.
In 2021, cash provided by operating activities of $43,887 resulted primarily from customer billings of $154,541 offset by advertising costs ($52,261) and payroll expenses ($7,350), and an increase in deferred revenue of $9,999 driven by a mix shift in revenue to renewing subscribers who typically pay a higher price for the product, as described above. For further information on the increases in billings, advertising and payroll expense, please refer to the Results of Operations section above. During this period, the business has utilized its cash generated to help reduce its account payables by $3,118. The business also carries an increased VAT liability of $5,037 which is linked to the increase in revenue in the period.
In 2020, cash used in operating activities of $84 resulted primarily from customer billings of $107,871 offset by advertising costs ($80,113) and payroll expenses ($3,411), and an increase in deferred revenue of $18,084 driven by a mix shift in revenue to renewing subscribers who typically pay a higher price for the product, as described above. For further information on the increases in billings, advertising and payroll expense, please refer to the Results of Operations section above. In 2020, the Company also settled its VAT obligations to EU member countries which was outstanding at the end of 2019, leading to a $1,801 decrease in the VAT tax liability accrual for the period.
Investing Activities
Protected’s primary investing activities consist of the disposal of the customer base of Network Protect in August 2020, funds advanced to System1 SS Protect Holdings, Inc., and the purchase of fixed assets.
In 2021, cash used by investing activities of $22.3 million was primarily due to the funds advanced to System1 SS Protect Holdings.
In 2020, cash used by investing activities of $8.8 million was primarily due to the funds advanced to System1 SS Protect Holdings.
Financing Activities
Protected’s financing activities consisted primarily of borrowings and repayments of our debt, as well as the payment of deferred financing costs.
In 2021, cash provided by financing activities of $3.0 million was due to the drawdown of funds from Silicon Valley Bank less any repayments in addition to the financing costs paid in relation to this loan. In 2020, cash provided by financing activities of $9.9 million was primarily due to the drawdown of funds from Silicon Valley Bank.
Contractual Obligations and Known Future Cash Requirements
Contingencies
From time to time, Protected is subject to contingencies that arise in the ordinary course of business. Protected does not currently believe the resolution of any such contingencies will have a material adverse effect upon Protected’s consolidated balance sheets, statements of comprehensive loss, or statements of cash flows.
94
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.
We believe that the most significant estimates in our consolidated financial statements relate to business combinations, goodwill, the estimate of variable consideration for revenue recognition, including the refund liability, impairment of long-lived assets, deferred taxes and the VAT liability as these have the greatest potential impact on the consolidated financial statements. These are described below.
Business Combinations
We account for our business combinations under the provisions of ASC Topic 805, Business Combinations (“ASC 805”), which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values. The estimated fair value of net assets acquired, including the allocation of the fair value to identifiable assets and liabilities, is determined using established valuation techniques. The estimated fair value of the net assets acquired determined using the income approach to valuation is based on the discounted cash flow method. Under this method, expected future cash flows of the business on a stand-alone basis are discounted back to a present value. The estimated fair value of identifiable intangible assets, such as trade names, is determined using the cost to recreate method or a relief from royalty method depending on the asset acquired.
The most significant assumptions under the cost to recreate method is to value acquired intangible assets including the cost and time to build the acquired technology as well as the developers’ profit and rate of return. Management develops these assumptions based on historical knowledge of the business and projected financial information of the Company. These assumptions may vary based on future events, perceptions of different market participants and other factors outside the control of Management, and such variations may be significant to estimated values.
If the business combination provides for contingent consideration, we record the contingent consideration at fair value at the acquisition date and any changes in fair value after the acquisition date are accounted for as a measurement-period adjustment. Changes in fair value of contingent consideration resulting from events after the acquisition date, such as earn-outs, are recognized as follows: 1) if the contingent consideration is classified as equity, the contingent consideration is not re-measured and its subsequent settlement is accounted for within equity, or 2) if the contingent consideration is classified as a liability, the changes in fair value are recognized in earnings.
Goodwill
Our methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques. Goodwill represents a residual value as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any non-controlling interest in the acquired company over the fair value of net assets acquired, including contingent consideration. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests if a triggering event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.
95
Management makes judgments about the recoverability of purchased intangible assets with finite lives whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of purchased intangible assets with finite lives is measured by comparing the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Assumptions and estimates about future values and remaining useful lives of our purchased intangible assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts.
The goodwill recorded in the consolidated balance sheet as of December 31, 2021 was $283,809. In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill or other intangible assets.
There was no impairment of goodwill or purchased intangible assets in the year ended December 31, 2021.
Revenue Recognition
We recognize revenues from sales transactions which contain sales refund provisions at the time of the sale. The potential for customer refunds are considered a component of variable consideration under Accounting Standards Codification (“ASC”) 606, Revenue from contracts with customers, and are considered when estimating the transaction price for a sale. We use the expected value method to determine the amount of refunds using historical refund data. The amount of expected returns is recognized as a refund liability, representing the obligation to return consideration to the customer. The total refund liability totalled $536,753 and $511,779 as of December 31, 2021 and December 31, 2020, respectively.
Impairment of long-lived assets
We periodically evaluate long-lived assets held for use, which include property, plant and equipment, and intangible assets whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. Assets are grouped and evaluated for impairment at the lowest level of which there are identifiable cash flows. Such assets are reviewed for impairment using factors including, but not limited to, our future operating plans and projected cash flows.
The determination of whether impairment has occurred is based on an estimate of undiscounted future cash flows directly related to that asset or group of assets, compared to the carrying value of the assets. We recognize impairment if the sum of the undiscounted future cash flows does not exceed the carrying value of the assets. For impaired assets, we recognize a loss equal to the difference between the net book value of the asset and its estimated fair value. Fair value is based on discounted future cash flows of the asset using a discount rate commensurate with the risk. In addition, at the time a decision is made to sell or discontinue use of an asset or group of assets, we record an impairment charge, if appropriate, or accelerate depreciation over the revised useful life of the asset. As of December 31, 2021, June 30, 2021, December 31, 2020 and 2019, management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required.
Deferred Tax
Management exercises significant judgement in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, management considers all available positive and negative evidence bearing upon its ability to realize the deferred tax assets, including past operating results, estimates of future taxable income, reversal patterns of taxable and deductible temporary differences and the feasibility of tax planning strategies. In the event we change our determination as to the amount of its deferred tax assets that can be realized, the valuation allowance is adjusted with a corresponding impact to the provision for income taxes in the period in which such determination is made.
96
Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by tax effects of non- deductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations.
VAT Liability
We operate in a number of international tax jurisdictions. Judgement is required in respect of the interpretation of state, federal and international tax law and practices as e-commerce and tax continues to evolve. We file our tax returns and duty calculations and estimate our tax and indirect tax provisions based on current tax rules and practices, together with advice received from professional advisors and management believe that accruals for tax liabilities are adequate. We have recorded a provision for Worldwide VAT and US sales tax of $9,140,811 and $6,366,454 as of December 31, 2021 and December 31, 2020, respectively. The liability represents management’s best estimate of amounts due for sales tax and VAT due for sales that have occurred over the applicable periods subject to such indirect taxes. We have not been registered for sales tax in states where the Group had created a Nexus, or VAT in certain countries. We have started the remediation process by appointing third party tax advisors to evaluate amounts due and disclosures to each tax jurisdiction. At the date of this statement the business has registered in (and began to settle) its historic VAT obligations in: Australia, New Zealand, Norway and Switzerland.
Recently Issued Accounting Pronouncements
Recently issued and adopted accounting pronouncements are described in Note 2 to Protected’s consolidated financial statements included elsewhere in this prospectus.
Quantitative and Qualitative Disclosure about Market Risk
We have operations within the U.S. and internationally, and are exposed to market risks in the ordinary course of our business. These risks include primarily foreign currency exchange risk, inflation, interest rate risk and credit risk.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition, or results of operations. However, if our costs were to become subject to significant inflationary pressures, we may not be able to fully offset higher costs through price increases and our inability or failure to do so could potentially harm our business, financial condition, and results of operations.
Interest Rate Risk
We are exposed to market risk from changes in interest rates on our term loan, which accrues interest at a variable interest rate of 3.5%-7.5%, payable on a quarterly basis. We have not used any derivative financial instruments to manage our interest rate risk exposure. As of December 31, 2021 and December 31, 2020, the total loan balance was $13,500,000 and $10,000,000. A hypothetical one percentage point increase or decrease in the interest rate would result in a corresponding increase or decrease in the interest expense of approximately $135,000 annually.
Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk consist primarily of cash and cash equivalents, restricted cash, and accounts receivable. Periodically, we maintain cash deposits in financial institutions in excess of government insured limits. Management believes that we are not exposed to significant credit risk as the Company’s cash deposits are held at financial institutions that management believes to be of high credit quality and Protected has not experienced any losses in these deposits.
97
Foreign Currency Exchange Rate Risk
Our and our subsidiary’s functional and reporting currency is the United States dollars (“USD”). Financial instruments and non-monetary assets denominated in currencies other than USD are remeasured at year end with operating income or loss recorded in the condensed consolidated statement of operations and comprehensive income (loss).
98
Exhibit 99.5
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
System1, Inc. (the “Company”, f/k/a/ Trebia Acquisition Corp. (“Trebia” or “System1”), is providing the following unaudited pro forma condensed combined financial information that presents the combination of the financial information of S1 Holdco, LLC (“S1 Holdco”) and its subsidiaries and Protected.net Group Limited (“Protected UK”) and Trebia, adjusted to give effect to the consummation of the transactions pursuant to the Merger Agreement and the Transaction and Combination Agreement (the “Business Combination”) on January 28, 2022 (“Closing”). The following unaudited pro forma condensed combined financial information has been prepared in accordance with Article 11 of Regulation S-X as amended by the final rule, Release 33-10786 “Amendments to Financial Disclosures about Acquired and Disposed Businesses”. The unaudited pro forma condensed combined financial information presents the pro forma effects of the following transactions:
| • | The acquisition of S1 Holdco and Protected UK by Trebia, resulting reorganization into an umbrella partnership C-corporation structure, and other agreements entered into as part of the Business Combination Agreement as of June 28, 2021 and amended on November 30, 2021, by and among Trebia, S1 Holdco, and Protected UK (collectively, the “Companies”), the Blockers, the Blocker Merger Subs and the Company Merger Sub (the “Business Combination”); |
| • | Repayment of the existing S1 Holdco debt and entering into a financing agreement. |
The organizational structure following the completion of the Business Combination, is commonly referred to as an umbrella partnership C corporation (or “Up-C”) structure. This organizational structure will allow the Flow-Through Sellers to retain equity ownership in S1 Holdco, an entity that is classified as a partnership for U.S. federal income tax purposes, in the form of S1 Holdco Common Units. The Flow-Through Sellers may exchange S1 Holdco Common Units (together with the cancellation of an equal number of shares of voting, System1 Class C Common Stock) into System1 Class A Common Stock. In addition, upon the completion of the Business Combination, Trebia, S1 Holdco, and the Flow-Through Sellers will be a party to a Tax Receivable Agreement. The Trebia Public Shareholders will continue to hold Trebia Class A Ordinary Shares, which, upon consummation of the Business Combination, was renamed to System1, Inc., a Delaware corporation that is a domestic corporation for U.S. federal income tax purposes. The parties agreed to structure the Business Combination in this manner for tax and other business purposes, and we do not believe that our “Up-C” organizational structure will give rise to any significant business or strategic benefit or detriment.
On January 10, 2022, Trebia entered into the Amended and Restated Backstop Facility Agreement (the “Cannae Backstop Agreement”), for an aggregate backstop commitment $250,000,000 by purchasing shares of Trebia Class A Common Stock for $10 a share.
Pursuant to the Business Combination Agreement, certain members of management of S1 Holdco and Protected UK have agreed to reduce cash consideration and increase equity consideration in an amount equal to 50% of the Trebia Shareholder Redemption Value in excess of $417,500,000 (the “Seller Backstop”), the Seller Backstop amount could not be less than $0 or greater than $50,000,000.
On January 10, 2022, Trebia entered into the Amended and Restated Sponsor Agreement (the “Sponsor Agreement”) by and among BGPT Trebia LP (the “BGPT Sponsor”), Trasimene Trebia, LP (the “Trasimene Sponsor” and, together with the BGPT Sponsor, the “Sponsors”), in order to provide that the Sponsors will forfeit up to (a) 1,275,510 Founder Shares to Trebia, and Trebia will issue to Cannae an equal number of shares of Trebia Class A Common Stock in connection with, and based upon the extent of, Cannae’s existing backstop obligations under the Original Backstop Agreement, (b) 1,000,000 Founder Shares to Trebia, and Trebia will issue to members of management of S1 Holdco and Protected UK an equal number of shares of Trebia Class A Common Stock in connection with, and based upon the extent of, their backstop obligations under the Business Combination Agreement, and (c) an additional 1,352,941 Founder Shares to Trebia, and Trebia will issue to Cannae an equal number of shares of Trebia Class A Common Stock in connection with, and based upon the extent of, Cannae’s obligation with respect to Cannae’s obligation, to the extent that the total Trebia Shareholder Redemption Value is in excess of $417,500,000, to backstop up to 50% of the Trebia Shareholder Redemption Value in excess of $417,500,000.
50
On January 27, 2022 Trebia entered into a Credit and Guaranty Agreement (the “Credit Agreement”) with Bank of America, N.A. (“Bank of America”) pursuant to which Trebia, as the borrower, a $400 million first lien term loan facility for net proceeds of $376 million (the “New Term Loan”) and a $50 million revolving facility (the “Revolving Facility” and, together with the Term Facility, the “New Facility”). The Term Loan will mature five and one-half years after Closing and will amortize in equal quarterly installments in an aggregate annual amount equal to 5% of the original principal amount of the Term Loan. The Revolving Facility will mature five years after the Closing. This new financing, along with the proceeds from the Business Combination noted above, was utilized to pay off S1 Holdco’s existing credit facility, fund redemptions of Trebia Class A Ordinary Shares, provide cash for working capital and pay transaction fees incurred with the Business Combination.
The pro forma financial statements are not necessarily indicative of what the combined company’s balance sheet or statement of operations actually would have been had the Business Combination been completed as of the dates indicated, nor do they purport to project the future financial position or operating results of the combined company. The actual financial position and results of operations may differ significantly from the pro forma amounts reflected herein due to a variety of factors. The pro forma financial information is presented for illustrative purposes only and does not reflect the costs of any integration activities or cost savings or synergies that may be achieved as a result of the Business Combination.
The following unaudited pro forma condensed combined balance sheet as of December 31, 2021 assumes that the Business Combination occurred on December 31, 2021. The unaudited pro forma condensed combined statements of operations for the year ended December 31, 2021 present the pro forma effect of the Business Combination as if it has been completed on January 1, 2021.
The unaudited pro forma combined consolidated financial information was derived from and should be read in conjunction with the following historical financial statements and the accompanying notes:
| • | The historical audited financial statements of Trebia for the year ended December 31, 2021; |
| • | The historical audited consolidated financial statements of S1 Holdco for the year ended December 31, 2021; and |
| • | The historical audited consolidated financial statements of Protected UK for the year ended December 31, 2021. |
Immediately following the consummation of the Business Combinations, the S1 Holdco and Protected UK sellers own approximately 68% of the voting Common Stock of the Company. The following table summarizes the pro forma capitalization by shares outstanding at the Closing of the Business Combinations (whether Class C Common Stock or Class A Common Stock). At Closing, S1 Holdco sellers, hold non-economic Class A Common Stock, which possess voting rights and can be redeemed in the future for shares of Class A Common Stock. The percentages below represent pro forma voting percentages held by each class of equity holder:
| Equity Capitalization Summary | Shares | % | ||||||
| Trebia Shareholders (1) |
703,108 | 1 | % | |||||
| Founder Shares(2) |
6,574,486 | 6 | % | |||||
| Seller Equity Consideration(3) |
72,328,135 | 68 | % | |||||
| Cannae Backstops (4) |
27,181,771 | 25 | % | |||||
|
|
|
|
|
|||||
| Total Outstanding Common Stock(5) |
106,787,500 | 100 | % | |||||
|
|
|
|
|
|||||
| (1) | 51,046,892 shares of the 51,750,000 outstanding shares of Trebia Class A Common Stock were redeemed in connection with the Business Combination. |
| (2) | The Sponsors have agreed to forfeit up to 3,463,014 (in the aggregate) shares of Trebia Class B Common Stock in connection with the equity backstop commitments by Cannae and S1 Holdco and Protected UK Management and Sponsor Agreement. BGPT Sponsor and Trasimene Sponsor have each also agreed to forfeit 1,450,000 shares of Trebia Class B Common Stock (the “Class B Forfeiture”) (2,900,000 in the aggregate). |
51
| (3) | The S1 Holdco and Protected UK sellers will receive 72,328,135 shares of Trebia Class A and Class C Ordinary Shares. This includes the impact of vesting of restricted stock units of 3,079,274. Additionally, this includes the Flow-Through Sellers’ noncontrolling economic interest in Common Units of S1 Holdco, LLC and issuance of voting, non-economic Class C Common Stock in Trebia of 22,077,423 which will be exchangeable (together with the cancellation of an equal number of shares of Class C common stock) into Class A common stock on a 1-for-1 basis. |
| (4) | 24,648,446 shares of Class A Ordinary Common Stock are issued to Cannae at $10.00 per share, pursuant to the Cannae Backstop and Cannae Incremental Backstop Agreements. Additionally, Cannae received an additional 2,533,325 of the Founders’ Forfeiture shares, respectively. |
| (5) | Excluded from outstanding common stock is the dilutive impact of 17,250,000 Public Warrants and 8,233,334 Private Placement Warrants exercisable at $11.50 per share, as well as, 725,000 shares of System1 Class D Common Stock to the Sponsors, and 725,000 RSUs subject to a market vesting condition, which have not been met. |
The unaudited pro forma condensed combined financial statements were prepared in accordance with Article 11 of Regulation S-X and the acquisition method of accounting under the provisions of Accounting Standards Codification (“ASC”) Topic 805, (“ASC 805”) on the basis of System1 as the accounting acquirer and S1 Holdco and Protected UK as the accounting acquirees. For accounting purposes, the acquirer is the entity that has obtained control of another entity and, thus, consummated a business combination. The determination of whether control has been obtained begins with the evaluation of whether control should be evaluated based on the variable interest or voting interest model pursuant to ASC Topic 810, Consolidation (“ASC 810”). If the acquiree is a variable interest entity (“VIE”), the primary beneficiary would be the accounting acquirer. S1 Holdco meets the definition of a VIE and System1 has been determined to be the primary beneficiary:
| • | System1, Inc. will be the sole managing member of S1 Holdco, and the managing member has full and complete charge of all affairs of S1 Holdco and the existing non-managing members of S1 Holdco do not have substantive kick-out or substantive participating rights. |
| • | System1, Inc. acquires all of the outstanding stock of Protected UK in exchange for cash and equity consideration. |
| • | No single party will have the ability to nominate a majority of the members of the Board of Directors of System1, Inc. |
| • | No individual legal entity or shareholder controlled S1 Holdco and Protected UK before the Business Combination. |
| • | No individual legal entity or shareholder will control System1, Inc. following the Business Combination. |
The factors discussed above support the conclusion that System1, Inc. will acquire a controlling interest in S1 Holdco and Protected UK. System1, Inc. will be the primary beneficiary of S1 Holdco which is a variable interest entity. Therefore, the Business Combination will be accounted for using the acquisition method of accounting. Under the acquisition method of accounting, the purchase price will be allocated to the tangible and identifiable intangible assets acquired and liabilities assumed, based on their estimated acquisition-date fair values.
52
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
| As of December 31, 2021 | ||||||||||||||||||||||||
| Trebia | S1 Holdco | Protected UK as Adjusted (Note 1) |
Pro Forma Adjustments |
Notes | Pro Forma Combined |
|||||||||||||||||||
| Assets |
||||||||||||||||||||||||
| Current assets: |
||||||||||||||||||||||||
| Cash and cash equivalents |
$ | 53 | $ | 47,896 | $ | 35,067 | $ | (36,854 | ) | 3 | (a) | $ | 46,162 | |||||||||||
| Restricted cash |
— | 743 | 1, 333 | 5,895 | 3 | (a) | 7,971 | |||||||||||||||||
| Cash held in Trust |
517,500 | — | — | (517,500 | ) | 3 | (b) | — | ||||||||||||||||
| Accounts receivable, net of allowance for doubtful accounts |
— | 90,203 | — | — | 90,203 | |||||||||||||||||||
| Prepaid expenses and other current assets |
67 | 7,689 | 562 | (131 | ) | 8,187 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total current assets |
517,620 | 146,531 | 36,962 | (548,590 | ) | 152,523 | ||||||||||||||||||
| Property and equipment - net |
— | 830 | 616 | — | 1,446 | |||||||||||||||||||
| Internal-use software development cost - net |
— | 11,213 | — | — | 11,213 | |||||||||||||||||||
| Intangible assets - net |
— | 50,368 | 369 | 454,163 | 3 | (c) | 504,900 | |||||||||||||||||
| Deferred tax assets |
— | — | 17,237 | (17,237 | ) | 3 | (k) | — | ||||||||||||||||
| Goodwill |
— | 44,819 | 284 | 697,974 | 3 | (c) | 743,077 | |||||||||||||||||
| Due from related parties |
— | 2,469 | 33,082 | (33,082 | ) | 3 | (l) | 2,469 | ||||||||||||||||
| Other assets |
— | 298 | — | — | 298 | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total assets |
$ | 517,620 | $ | 256,528 | $ | 88,550 | $ | 553,228 | $ | 1,415,926 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Liabilities and stockholders’ equity |
||||||||||||||||||||||||
| Current liabilities: |
||||||||||||||||||||||||
| Accounts payable |
— | 72,846 | 216 | — | 73,062 | |||||||||||||||||||
| Accrued expenses and other current liabilities |
12,557 | 31,051 | 22,103 | (9,788 | ) | 3 | (d) | 55,923 | ||||||||||||||||
| Due to related party |
— | — | 22 | (22 | ) | 3 | (l) | — | ||||||||||||||||
| Deferred revenue |
— | 1,971 | 57,571 | (37,456 | ) | 3 | (e) | 22,086 | ||||||||||||||||
| Notes payable, current |
450 | 170,071 | 2,813 | (152,884 | ) | 3 | (f) | 20,450 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total current liabilities |
13,007 | 275,939 | 82,725 | (200,150 | ) | 171,521 | ||||||||||||||||||
| Tax receivable agreement liability |
— | — | — | — | 3 | (g) | — | |||||||||||||||||
| Deferred tax liability |
— | 7,789 | — | 69,052 | 3 | (k) | 76,841 | |||||||||||||||||
| Notes payable, noncurrent |
— | — | 10,546 | 345,454 | 3 | (f) | 356,000 | |||||||||||||||||
| Tax agreement receivable agreement liability |
— | — | — | — | 3 | (g) | — | |||||||||||||||||
| Other liabilities |
— | 1,201 | — | (1,201 | ) | 3 | (h) | |||||||||||||||||
| Warrant liability |
29,306 | — | — | — | 29,306 | |||||||||||||||||||
| Deferred underwriting fee payable |
18,113 | — | — | (18,113 | ) | 3 | (a) | — | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total liabilities |
60,426 | 284,929 | 93,271 | 195,042 | 633,668 | |||||||||||||||||||
| Class A Ordinary Shares subject to possible redemption, 51,750,000 shares at redemption value at December 31, 2021 |
517,500 | — | — | (517,500 | ) | 3 | (i) | — | ||||||||||||||||
| Stockholders’ equity |
||||||||||||||||||||||||
| Preferred shares, $0.0001 par value; 1,000,000 shares authorized; none issued and outstanding |
— | — | 11 | (11 | ) | 3 | (i) | — | ||||||||||||||||
| Class A Common Stock |
— | — | — | 9 | 3 | (i) | 9 | |||||||||||||||||
| Class B Common Stock |
1 | — | 11 | (12 | ) | 3 | (i) | — | ||||||||||||||||
| Class C Common Stock |
— | — | — | 2 | 3 | (i) | 2 | |||||||||||||||||
| Additional paid-in capital |
— | — | 40,953 | 621,205 | 3 | (i) | 662,158 | |||||||||||||||||
| Accumulated deficit |
(60,307 | ) | — | (45,696 | ) | 38,434 | 3 | (i) | (67,569 | ) | ||||||||||||||
| Member’s deficit |
— | (28,829 | ) | — | 28,829 | 3 | (i) | — | ||||||||||||||||
| Accumulated other comprehensive income |
— | 428 | — | (428 | ) | 3 | (i) | — | ||||||||||||||||
| Noncontrolling interest |
— | — | — | 187,658 | 3 | (j) | 187,658 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total shareholders’ equity |
457,194 | (28,401 | ) | (4,721 | ) | 358,186 | 782,258 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Total liabilities and shareholders’ equity |
$ | 517,620 | $ | 256,528 | $ | 88,550 | 553,228 | $ | 1,415,926 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
53
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
| For the Year Ended December 31, 2021 | ||||||||||||||||||||||||
| Trebia | S1 Holdco |
Protected UK as Adjusted (Note 1) |
Pro Forma Adjustments |
Notes | Pro Forma Combined |
|||||||||||||||||||
| Revenue |
$ | — | $ | 688,389 | $ | 144,541 | $ | (37,456 | ) | 4 | (a) | $ | 795,474 | |||||||||||
| Operating costs and expenses: |
||||||||||||||||||||||||
| Cost of revenues |
— | 521,113 | 96,364 | 617,477 | ||||||||||||||||||||
| Formation and operating costs |
13,327 | — | — | — | 13,327 | |||||||||||||||||||
| Salaries, commissions, and benefits |
— | 66,747 | 7,938 | 13,926 | 4 | (b) | 88,611 | |||||||||||||||||
| Selling, general and administrative |
— | 35,812 | 11,974 | 13,380 | 4 | (c) | 61,166 | |||||||||||||||||
| Depreciation and amortization |
— | 13,885 | 245 | 62,232 | 4 | (d) | 76,362 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total operating costs and expenses |
13,327 | 637,557 | 116,520 | 856,942 | ||||||||||||||||||||
| Operating Income (loss) |
(13,327 | ) | 50,832 | 28,021 | (61,468 | ) | ||||||||||||||||||
| Interest expense |
— | 16,870 | 583 | 8,653 | 4 | (e) | 26,106 | |||||||||||||||||
| Related party interest income |
(941 | ) | 941 | 4 | (f) | — | ||||||||||||||||||
| (Gain) on termination of FPA |
(3,160 | ) | — | — | — | (3,160 | ) | |||||||||||||||||
| (Gain) on change in fair value of warrant liability |
(23,700 | ) | — | — | — | (23,700 | ) | |||||||||||||||||
| (Gain) on change in fair value of FPA liability |
(7,494 | ) | — | — | — | (7,494 | ) | |||||||||||||||||
| Other expense (income) |
— | — | — | — | — | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Income (loss) before income tax |
21,027 | 33,962 | 28,379 | (53,220 | ) | |||||||||||||||||||
| Income tax expense (benefit) |
— | 965 | (15,173 | ) | (12,128 | ) | 4 | (g) | (26,336 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Net income (loss) |
21,027 | 32,997 | 43,552 | (26,885 | ) | |||||||||||||||||||
| Net income (loss) attributable to noncontrolling interest |
— | — | — | (8,377 | ) | 4 | (h) | (8,377 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
| Net income (loss) attributable to controlling interest |
$ | 21,027 | $ | 32,997 | $ | 43,552 | $ | (18,508 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Earnings per share (basic) |
$ | (0.23 | ) | |||||||||||||||||||||
| Earnings per share (diluted) |
$ | (0.23 | ) | |||||||||||||||||||||
| Weighted average shares outstanding (basic) |
82,233 | |||||||||||||||||||||||
| Weighted average shares outstanding (diluted) |
82,233 | |||||||||||||||||||||||
| 1. | Basis of pro forma presentation |
The unaudited pro forma condensed combined financial statements have been prepared in accordance with Article 11 of Regulation S-X and assuming the Business Combination is accounted for using the acquisition method of accounting with System1 as the accounting acquirer. Under the acquisition method of accounting, the assets and liabilities of S1 Holdco and Protected UK will be recorded at their fair values measured as of the acquisition date. The excess of the purchase price over the estimated fair values of the net assets acquired, if applicable, will be recorded as goodwill. The acquisition method of accounting is based on ASC 805 and uses the fair value concepts defined in ASC Topic 820, Fair Value Measurements (“ASC 820”). In general, ASC 805 requires, among other things, that assets acquired, and liabilities assumed be recognized at their fair values as of the acquisition date by System1, who was determined to be the accounting acquirer.
54
ASC 820 defines fair value, establishes a framework for measuring fair value, and sets forth a fair value hierarchy that prioritizes and ranks the level of observability of inputs used to develop the fair value measurements. Fair value is defined in ASC 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This is an exit price concept for the valuation of the asset or liability. In addition, market participants are assumed to be buyers and sellers in the principal (or the most advantageous) market for the asset or liability. Fair value measurements for a non-financial asset assume the highest and best use by these market participants. Many of these fair value measurements can be highly subjective, and it is possible that other professionals applying reasonable judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts.
The unaudited condensed pro forma adjustments, which are described in the accompanying notes, may be revised as additional information becomes available and is evaluated. Therefore, it is likely that the actual adjustments will differ from the pro forma adjustments and it is possible the difference may be material. System1 believes that its assumptions and methodologies provide a reasonable basis for presenting all of the significant effects of the Business Combination based on information available to management at this time and that the pro forma adjustments give appropriate effect to those assumptions and are properly applied in the unaudited pro forma condensed combined financial information.
Accounting Policy Alignment
The unaudited pro forma condensed combined financial information has been prepared using S1 Holdco’s significant accounting policies as set forth in its audited consolidated financial statements for the fiscal year ended December 31, 2021. Based on the procedures performed to date, the accounting policies of Trebia and Protected UK are materially consistent with S1 Holdco’s accounting policies.
Reclassifications
Certain historical consolidated balance sheet line items of Protected UK were reclassified in order to conform to S1 Holdco’s historical financial statement presentation as follows (in thousands):
55
PROTECTED UK’S CONSOLIDATED STATEMENT OF FINANCIAL POSITION RECLASSIFICATIONS
| As of December 31, 2021 | ||||||||||||||||||
| S1 Holdco Presentation | Protected UK Presentation | Protected Historical |
Reclassification Adjustment |
Notes | Protected as Adjusted |
|||||||||||||
| Assets |
Assets | |||||||||||||||||
| Cash and cash equivalents |
Cash | $ | 35,067 | $ | 35,067 | |||||||||||||
| Restricted cash |
1,333 | 1,333 | ||||||||||||||||
| Accounts receivable, net of allowance for doubtful accounts |
||||||||||||||||||
| Prepaid expenses and other current assets |
Prepaid expenses and other current assets | 546 | 16 | (i) | 562 | |||||||||||||
| Deposits | 16 | (16 | ) | (i) | — | |||||||||||||
| Total current assets |
Total current assets | 36,962 | 36,962 | |||||||||||||||
| Property and equipment, net |
Property, plant equipment | 616 | 616 | |||||||||||||||
| Internal-use software |
||||||||||||||||||
| Development cost, net |
||||||||||||||||||
| Intangible assets, net |
Intangible Assets | 369 | 369 | |||||||||||||||
| Deferred tax assets |
Deferred tax assets | 17,237 | 17,237 | |||||||||||||||
| Goodwill |
goodwill | 284 | 284 | |||||||||||||||
| Due from Related Party |
Due from related parties | 33,082 | 33,082 | |||||||||||||||
|
|
|
|
|
|||||||||||||||
| Total assets |
total assets | $ | 88,550 | $ | 88,550 | |||||||||||||
|
|
|
|
|
|||||||||||||||
| Liabilities and members’ deficit |
Liabilities and Shareholders’ | |||||||||||||||||
| Deficit | ||||||||||||||||||
| Current liabilities: |
||||||||||||||||||
| Accounts payable |
Accounts payable | 216 | 216 | |||||||||||||||
| Accrued expenses and other |
||||||||||||||||||
| Current liabilities |
Accrued expenses | 10,162 | 11,941 | (ii)(iii) | 22,103 | |||||||||||||
| VAT tax liability | 11,404 | (11,404 | ) | (ii) | — | |||||||||||||
| Deferred revenue | 57,405 | 166 | (iv) | 57,571 | ||||||||||||||
| Related party deferred revenue | 166 | (166 | ) | (iv) | — | |||||||||||||
| Notes payable, current |
Current portion of note payable | 2,813 | 2,813 | |||||||||||||||
| Due to related party | 23 | 23 | ||||||||||||||||
| Refund liability | 537 | (537 | ) | (iii) | — | |||||||||||||
|
|
|
|
|
|||||||||||||||
| Total current liabilities |
Total current liabilities | 82,726 | 82,726 | |||||||||||||||
| Notes payable, non-current |
Note payable, net of current | |||||||||||||||||
| Portion and deferred financing | ||||||||||||||||||
| Costs | 10,546 | 10,546 | ||||||||||||||||
|
|
|
|
|
|||||||||||||||
| Other liabilities |
||||||||||||||||||
| Deferred tax liability |
Corporate Tax Liability | |||||||||||||||||
| Total liabilities |
Total liabilities | 93,272 | 93,272 | |||||||||||||||
| Members’ deficit: |
||||||||||||||||||
| Class A Preferred shares | 11 | 11 | ||||||||||||||||
| Class B Preferred shares | 11 | 11 | ||||||||||||||||
| Additional paid-in capital | 40,953 | 40,953 | ||||||||||||||||
| Accumulated deficit | (45,697 | ) | (45,697 | ) | ||||||||||||||
| Members’ deficit in S1 Holdco |
||||||||||||||||||
| Noncontrolling interest |
||||||||||||||||||
| Accumulated other comprehensive income (loss) |
||||||||||||||||||
| Total members’ deficit |
Total Shareholders’ deficit | (4,722 | ) | (4,722 | ) | |||||||||||||
|
|
|
|
|
|||||||||||||||
| Total Liabilities and Members’ Deficit |
Total Liabilities and Shareholders’ Deficit | $ | 88,550 | $ | 88,550 | |||||||||||||
|
|
|
|
|
|||||||||||||||
| (i) | “Deposits” of $16 was reclassified to “Prepaid expenses and other current assets” |
| (ii) | “VAT tax liability” of $11,404 was reclassified to “Accrued expenses and other current liabilities” |
| (iii) | “Refund liability” of $537 was reclassified to “Accrued expenses and other current liabilities” |
| (iv) | “Related party deferred revenue” of $166 was reclassified to “Deferred Revenue” |
56
PROTECTED UK’S CONSOLIDATED STATEMENT OF OPERATIONS RECLASSIFICATIONS
| For the Year Ended December 31, 2021 | ||||||||||||||||
| S1 Holdco Presentation |
Protected UK Presentation | Protected Historical |
Reclassification Adjustment |
Notes | Protected as Adjusted |
|||||||||||
| Revenue |
Revenue | $ | 144,541 | $ | 144,541 | |||||||||||
| Operating costs and expenses: |
||||||||||||||||
| Cost of revenues |
Cost of revenue | 98,946 | $ | (2,582 | ) | (i) | $ | 96,364 | ||||||||
| Gross profit |
Gross profit | 45,595 | 48,177 | |||||||||||||
| Operating expenses |
||||||||||||||||
| Salaries, commissions, and benefits |
7,938 | (i)(ii) | 7,938 | |||||||||||||
| Selling, general, and administrative expenses |
General and administrative expense | 15,912 | (3,938 | ) | (ii)(iii) (iv)(v)(vi) | 11,974 | ||||||||||
| Depreciation and amortization |
245 | (iii) | 245 | |||||||||||||
| Related party rent expense | 665 | (665 | ) | (iv) | — | |||||||||||
|
|
|
|
|
|||||||||||||
| Total operating costs and expenses |
Total operating expenses Other Operating (Income) Expense | 16,577 | 20,157 | |||||||||||||
| Total other Operating (Income) Expense | ||||||||||||||||
| Foreign currency transaction (gain)/loss | 1,341 | (1,341 | ) | (v) | — | |||||||||||
| Other operating income |
(343 | ) | 343 | (vi) | — | |||||||||||
|
|
|
|
|
|||||||||||||
| Total other operating expense, net | 998 | — | ||||||||||||||
| Operating income (loss) |
Operating income | 28,021 | 28,021 | |||||||||||||
| Interest expense |
Interest expense | 583 | 583 | |||||||||||||
| Related-party interest income | (941 | ) | (941 | ) | ||||||||||||
|
|
|
|
|
|||||||||||||
| Total non-operating income | (358 | ) | (358 | ) | ||||||||||||
|
|
|
|
|
|||||||||||||
| Income from continuing operations before income tax |
Income before income taxes |
28,379 | 28,379 | |||||||||||||
| Income tax expense |
Income tax expense | (15,173 | ) | (15,173 | ) | |||||||||||
|
|
|
|
|
|||||||||||||
| Net income |
Net income | $ | 43,552 | $ | 43,552 | |||||||||||
|
|
|
|
|
|||||||||||||
| (i) | Salaries, commissions, and benefits of $2,582 was reclassified from “Cost of revenues” to “Salaries, commissions, and benefits” |
| (ii) | Salaries, commissions, and benefits of $5,356 was reclassified from “General and administrative expenses” to “Salaries, commissions, and benefits” |
| (iii) | Depreciation and amortization expense of $245 was reclassified from “General, and administrative” to “Depreciation and amortization” |
| (iv) | Related party rent expense of $665 was reclassified to “Selling, general, and administrative” |
| (v) | “Foreign currency and transaction loss (gain) of $1,341 was reclassified to “Selling, general, and administrative” |
| (vi) | “Other operating income” of $343 was reclassified to “Selling, general, and administrative” |
57
| 2. | Description of the Business Combination |
Preliminary Purchase Price Accounting
The pro forma adjustments to the Unaudited Pro Forma Condensed Combined Balance Sheet as of December 31, 2021 are preliminary. The adjustment amounts are estimates of the fair value and useful lives of the assets acquired and liabilities assumed as of December 31, 2021. These adjustments have been prepared to illustrate the estimated effect of the Transaction. The allocation is dependent upon certain valuation and other studies that have not yet been completed. Accordingly, the preliminary purchase price allocation and related adjustments reflected are subject to further adjustment as additional information becomes available and as additional analyses and final valuations are completed.
The following table summarizes the preliminary allocation of the purchase consideration to the identifiable assets acquired and liabilities assumed of S1 Holdco and Protected UK:
| Purchase Price Allocation (in thousands) |
||||
| Fair value of equity consideration |
$ | 400,957 | ||
| Cash consideration |
439,686 | |||
| Cash paid to extinguish S1 Holdco outstanding credit facility |
175,538 | |||
| Fair value of replacement awards attributable to pre-combination service |
7,695 | |||
| Acquisition costs paid on behalf of S1 Holdco |
19,875 | |||
|
|
|
|||
| Total consideration |
$ | 1,043,752 | ||
|
|
|
|||
| Cash and cash equivalents |
82,965 | |||
| Restricted cash |
2,076 | |||
| Accounts receivable |
90,203 | |||
| Prepaid expenses and other current assets |
8,120 | |||
| Property and equipment |
1,446 | |||
| Internal-use software |
11,213 | |||
| Intangible assets |
504,900 | |||
| Goodwill |
743,076 | |||
| Other assets |
2,767 | |||
| Accounts payable |
(73,062 | ) | ||
| Accrued expenses and other current liabilities |
(43,367 | ) | ||
| Deferred revenue |
(22,086 | ) | ||
| Deferred tax liability |
(76,841 | ) | ||
| Fair value of noncontrolling interest |
(187,658 | ) | ||
|
|
|
|||
| $ | 1,043,752 | |||
|
|
|
Intangible Assets: The following describes identified intangible assets that met either the separability criterion or the contractual-legal criterion described in ASC 805, and the anticipated valuation approach. The trademark and trade name intangible assets represent the trade names that S1 Holdco and Protected UK originated or acquired that were estimated utilizing the relief-from-royalty method. The customer relationships intangible asset represents the existing customer relationships of S1 Holdco and Protected UK which were estimated by applying an excess earnings method. The developed technology intangible asset represents technology acquired by S1 Holdco and Protected UK for the purpose of generating income for S1 Holdco and Protected UK, which was valued using a multi-period excess earnings method considering technology migration.
| Trademark |
15.0 | $ | 235,400 | |||||
| Customer relationships |
8.4 | 88,500 | ||||||
| Technology |
7.0 | 181,000 | ||||||
|
|
|
|||||||
| Total |
$ | 504,900 | ||||||
|
|
|
58
Goodwill: Approximately $743 million has been allocated to goodwill. Goodwill represents the excess of the gross consideration transferred over the estimated fair value of the underlying net tangible and identifiable intangible assets acquired. Qualitative factors that contribute to the recognition of goodwill include certain intangible assets that are not recognized as separate identifiable intangible assets. Goodwill represents future economic benefits arising from acquiring S1 Holdco and Protected UK primarily due to its strong market position and its assembled workforce that are not individually identified and separately recognized as intangible assets. Goodwill will not generate amortization deductions for income tax purposes.
In accordance with ASC Topic 350, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead will be tested for impairment at least annually or more frequently if certain indicators are present. In the event management of the combined company determines that the value of goodwill has become impaired, an accounting charge for impairment during the quarter in which the determination is made may be recognized.
| 3. | Adjustments to Pro Forma Condensed Combined Balance Sheet |
Explanations of the adjustments to the pro forma balance sheet are as follows:
| (a) | Below is a table to describe the cash sources and use of funds as it relates to the Business Combination: |
Estimated Cash Sources and Uses (in thousands):
| Sources |
||||
| Cash held in Trust(1) |
$ | 517,500 | ||
| New Term Loan(2) |
376,000 | |||
| Cannae Backstop Commitment(3) |
246,484 | |||
| Uses |
||||
| Cash paid for redemptions(1) |
510,469 | |||
| Cash consideration to Court Square Capital(4) |
250,362 | |||
| Cash consideration to S1 Holdco and Protected UK(5) |
189,325 | |||
| Cash held in escrow for replacement awards granted(6) |
5,895 | |||
| Cash to payoff existing S1 Holdco debt(7) |
175,538 | |||
| Transaction costs(8) |
45,249 | |||
|
|
|
|||
| Pro forma adjustment to cash and cash equivalents |
$ | (36,854 | ) | |
|
|
|
| (1) | $517.5 million of cash held in trust by Trebia. 51,046,892 Public Shares were redeemed in connection with the Business Combination for $510.5 million. |
| (2) | $376 million in net proceeds received from the $400 million New Term Loan obtained by Trebia under the Credit Agreement. |
| (3) | Represents the cash proceeds of $246.5 million received under the Cannae Backstop and Incremental Backstop Agreements. |
| (4) | Represents the cash proceeds of $250 million paid to blocker-seller Court Square Capital. |
| (5) | Represents the cash proceeds paid to S1 Holdco and Protected UK sellers. |
| (6) | Represents unvested cash compensation held in trust account until employee service condition is completed. |
| (7) | Represents the amount of existing S1 Holdco debt paid off at Closing. |
59
| (8) | Estimated transaction costs incurred by Trebia, S1 Holdco in connection with the Business Combination. The table below details the nature of the transaction costs incurred: |
| Transaction costs (in thousands) | ||||
| Deferred Underwriter fees paid by Trebia |
$ | 11,773 | ||
| Acquisition costs incurred by S1 Holdco and Protected UK |
20,097 | |||
| Acquisition costs incurred by Trebia |
13,380 | |||
|
|
|
|||
| Total transaction costs |
$ | 45,249 | ||
|
|
|
|||
| (b) | Reflects the reclassification of $517.5 million of cash and cash equivalents held in the Trust Account that become available for transaction expenses, underwriting commission, redemption of Trebia Public Shares and the operating activities of Trebia following the business combination. |
| (c) | Represents the adjustment to the estimated preliminary purchase price allocation for the S1 Holdco business resulting from the Business Combination. The preliminary calculation of total consideration and allocation of the purchase price to the fair value of S1 Holdco’s assets acquired and liabilities assumed is presented below as if the Business Combination was consummated on December 31, 2021. The Company has not completed the detailed valuations necessary to estimate the fair value of the assets acquired and the liabilities assumed and, accordingly, the adjustments to record the assets acquired and liabilities assumed at fair value reflect the best estimates of the Company based on the information currently available and are subject to change once additional analyses are completed. Potential differences may include, but are not limited to, changes in allocation to intangible assets and change in fair value of property, plant, and equipment. |
| Intangibles (in thousands) | As of December 31, 2021 | |||
| Remove carrying value of historical balance |
$ | (50,737 | ) | |
| Record fair value of acquired intangibles |
504,900 | |||
|
|
|
|||
| Pro forma adjustment |
$ | 454,163 | ||
|
|
|
|||
| As of December 31, 2021 | ||||
| Goodwill (in thousands) |
||||
| Remove carrying value of historical balance |
$ | (45,103 | ) | |
| Goodwill recorded at acquisition |
743,077 | |||
|
|
|
|||
| Pro forma adjustment |
$ | 697,974 | ||
|
|
|
|||
| (d) | To record assumed liability for cash settled replacement awards attributable to pre-combination service. The liability was determined as the fair value of the replaced awards multiplied by the ratio of the pre-combination employee’s service period to the total service period. Additionally, to remove profit interest liability payable to the former CEO of S1 Holdco, which was settled in connection to the Business Combination. |
| As of December 31, 2021 | ||||
| Assumed liability for replacement awards cash settled and attributable to precombination service |
$ | 1,473 | ||
| To remove historical CEO profit interest liability payable to the former CEO of S1 Holdco settled in connection to the Business Combination |
(11,129 | ) | ||
| Other current liabilities |
(132 | ) | ||
|
|
|
|||
| Pro forma adjustment |
$ | (9,788 | ) | |
|
|
|
|||
| (e) | Reflects a reduction in deferred revenues related to the estimated fair value of the acquired deferred revenue related to the Business Combination. The adjustment is based on fair value estimates for deferred revenue, which was estimated utilizing an income approach based on the estimated costs to fulfill the liabilities assumed, plus normal profit margin. The difference between the fair value of deferred revenue and historical carrying value results in a revenue reduction on a pro forma basis. |
60
| To remove carrying value of deferred revenue |
$ | (59,542 | ) | |
| To record fair value of deferred revenue liability assumed |
22,086 | |||
|
|
|
|||
| Pro forma adjustment |
$ | (37,456 | ) | |
|
|
|
| (f) | Represents adjustments to short-term and long-term debt due to the following inflows and outflows as a result of the Business Combination. In connection with the Business Combination the outstanding debt of S1 Holdco and Protected UK will be paid off. The cash paid to settle the outstanding Protected UK debt will be a reduction of the cash consideration. The following pro forma adjustments are to give effect to the settlement of the outstanding S1 Holdco and Protected UK debt and issuance of the new Term Loan under the Commitment Letter: |
| As of December 31, 2021 | ||||||||||||
| Notes payable, current |
Notes payable, noncurrent |
Total | ||||||||||
| Record New Credit Facility |
$ | 20,000 | $ | 356,000 | $ | 376,000 | ||||||
| Repayment of S1 Holdco and Protected UK outstanding debt |
(172,844 | ) | (10,546 | ) | (183,430 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Pro forma adjustment |
$ | (152,884 | ) | $ | 345,454 | $ | 192,570 | |||||
|
|
|
|
|
|
|
|||||||
| (g) | The estimate of the fair value of the Tax Receivable Agreement contingent consideration is subject to additional analyses. The adjustments to the Tax Receivable Agreement will be recorded as an adjustment to goodwill. Trebia anticipates that it will account for the income tax effects resulting from future taxable exchanges of Common Units by the Flow-Through Sellers for shares of Class A common stock thereof by recognizing an increase in deferred tax assets, based on enacted tax rates at the date of each exchange. Based on actual redemption levels, the Company estimates the value of the tax receivable agreement to be approximately $0 as of Closing. |
| Further, Trebia intends to evaluate the likelihood that it will realize the benefit represented by the deferred tax asset, and, to the extent that it estimates that it is more likely than not that Trebia will not realize the benefit, Trebia will reduce the carrying amount of the deferred tax asset with a valuation allowance. For the same reasons, the Company will not record a liability related to the tax savings it would realize from the utilization of such deferred tax assets after concluding it will not be probable that such TRA liability would be paid based on its estimates of future taxable income. |
| (h) | To adjust Other liabilities to remove deferred rent leased facilities of S1 Holdco. |
| (i) | The following table summarizes the pro forma adjustments impacting equity (amounts in thousands) as of December 31, 2021: |
| Adjustments to Historical Equity (1) |
New Equity Structure (2) |
Other Items (3) |
Total Pro Forma Adjustments |
|||||||||||||
| Trebia Class A Common Stock |
$ | — | $ | (517,500 | ) | $ | (517,500 | ) | ||||||||
| Protected UK Class A Preferred shares |
(11 | ) | (11 | ) | ||||||||||||
| System1, Inc Class A Common Stock |
9 | 9 | ||||||||||||||
| Protected UK and Trebia Class B Stock |
(12 | ) | (12 | ) | ||||||||||||
| System1, Inc Class C Common Shares |
2 | 2 | ||||||||||||||
| Additional paid in capital |
(40,953 | ) | 662,158 | 621,205 | ||||||||||||
| Accumulated Deficit |
45,696 | (7,262 | ) | 38,434 | ||||||||||||
| S1 Holdco Member Deficit |
28,829 | 28,829 | ||||||||||||||
| S1 Holdco Accumulated other comprehensive loss |
(428 | ) | (428 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| $ | 33,121 | 144,669 | (7,262 | ) | 170,528 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| (1) | To remove historical equity balances and retained earnings of S1 Holdco and Protected UK, as well as, the conversion of Founder Shares, net of forfeiture, from Trebia Class B Common Stock to System1 Class A Common Stock. |
61
| (2) | Includes equity consideration payable under the Business Combination Agreement with a fair value of $401 million, $246 million issued under the Cannae Backstop Agreement, Conversion Trebia Class Common Stock of $7 million, less $11 million allocated to par value of common stock, and plus $7.7 million related to Fair value of replacement awards attributable to pre-combination service. |
| (3) | Represents a reduction to retained earnings for estimated acquisition costs incurred by Trebia of $14 million, less the reduction of Trebia deferred underwriter costs of $7 million. |
| (j) | Represents the pro forma adjustment to record the Flow-Through Sellers’ noncontrolling interest in S1 Holdco Common Units of $188 million or approximately 22%. |
| (k) | Represents adjustments to reflect applicable deferred taxes. Refer to Note 2 for the purchase price allocation. The deferred taxes are primarily related to the difference between the financial statement and tax basis in the System1 partnership interests, acquired tax attributes of the Blockers, and Protected. This basis difference primarily results from the Business Combination where System1, Inc. recorded a fair market value basis on all assets for financial accounting purposes and a fair value step-up on a portion of the assets for income tax purposes. The $76.8 million adjustment related to the deferred tax liability is assuming: (1) the U.S. GAAP balance sheet as of December 31, 2021 adjusted for the pro forma entries described herein, (2) estimated tax basis as of December 31, 2021 adjusted for the pro forma entries described herein, (3) a federal income tax rate of 21.0% and a blended state tax rate of 2.35%, and the applicable statutory tax rates in the jurisdictions in which the Company operates (4) no material changes in tax law. |
| (l) | Represents amounts due from(to) related party loans that were settled as a result of the Business Combination. |
| 4. | Adjustments to Pro Forma Condensed Combined Statements of Operations |
| Explanations | of the adjustments to the pro forma statement of operations are as follows: |
(a) Reflects a reduction in revenues related to the estimated fair value of the acquired deferred revenue related to the Business Combination. The performance obligations associated with the assumed liability is expected to be satisfied within twelve months of the acquisition.
| Revenues (in thousands) | December 31, 2021 |
|||
| Revenues pro forma adjustment |
$ | (37,456 | ) | |
(b) To record expense related to the fair value of replacement awards attributable to post combination service, partially offset by the elimination of S1 Holdco and Protected UK historical stock-based compensation expense.
| Salaries, commissions, and benefits (in thousands) | For the year ended December 31, 2021 |
|||
| Stock-based compensation related to the fair value replacement awards attributable to post combination service |
$ | 14,339 | ||
| Pro forma Adjustment |
(413 | ) | ||
|
|
|
|||
| To remove historical stock-based compensation |
$ | 13,926 | ||
|
|
|
|||
(c) To record $13.4 million of transaction costs for the twelve months ending December 31, 2021.
62
(d) Represents adjustments to depreciation and amortization for intangible assets recorded in connection with the Business Combination. This pro forma adjustment has been proposed assuming the Business Combination occurred on January 1, 2021. The following table is a summary of information related to certain intangible assets acquired, including information used to calculate the pro forma change in amortization expenses that is adjusted to administrative expenses:
| Weighted Average Useful Life (Years) |
Fair Value | For the year ended December 31, 2021 |
||||||||||
| Trademarks |
15 | $ | 235,400 | $ | 15,693 | |||||||
| Customer relationships |
8.4 | 88,500 | 32,473 | |||||||||
| Technology |
7 | 181,000 | 27,641 | |||||||||
|
|
|
|
|
|||||||||
| Total pro forma amortization expense |
504,900 | 75,807 | ||||||||||
| To remove historical amortization expense of intangibles |
(13,575 | ) | ||||||||||
|
|
|
|||||||||||
| Pro forma adjustment |
$ | 62,232 | ||||||||||
Amortization expense for trademarks intangible assets is computed on a straight-line basis, amortization for customer relationship intangible assets is computed considering historical and estimated customer attrition, and amortization of developed technology intangible assets, is computed considering the estimate of platform migration to the developed technology. Below is the pro forma amortization expense for intangible assets for each of the next five fiscal years:
| As of December 31, 2021 | ||||
| 2022 |
$ | 72,963 | ||
| 2023 |
60,573 | |||
| 2024 |
50,962 | |||
| 2025 |
45,308 | |||
| 2026 |
37,790 | |||
| Thereafter |
161,498 | |||
|
|
|
|||
| Total |
$ | 429,094 | ||
|
|
|
|||
(e) Represents estimated differences in interest expense resulting from the New Term Loan and extinguishing historical S1 Holdco debt. The estimated annual effective interest rate of the New Term Loan is 7.05%.
| (in thousands) | For the year ended December 31, 2021 |
|||
| Record interest on the New Term Loan |
$ | 26,107 | ||
| Eliminate historical interest expense |
(17,454 | ) | ||
|
|
|
|||
| Pro forma adjustment |
$ | 8,653 | ||
|
|
|
|||
(f) To remove interest income from Protected UK related party loan that will be settled as a result of the Business Combination.
(g) Represents the income tax effect of the pro forma adjustments calculated using the enacted applicable statutory income tax rates in the respective countries in which the company operates applied to the income or loss before income taxes applicable to the controlling interest. The effective tax rate of the combined company could be significantly different as the legal entity structure and activities of the combined company are integrated.
(h) Represents the pro forma adjustment to record earnings attributable to noncontrolling interest in S1 Holdco.
63
| 5. | Pro Forma Earnings Per Share Information |
Basic earnings per share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method.
| For the year ended December 31, 2021 |
||||
| Net income (loss) attributable to controlling interest |
$ | (18,508 | ) | |
| Weighted average shares outstanding, controlling (basic, shares in thousands) |
82,233 | |||
| Weighted average shares outstanding, controlling (diluted, shares in thousands) |
82,233 | |||
| Income (loss) per share (basic) |
$ | (0.23 | ) | |
| Income (loss) per share (diluted) |
$ | (0.23 | ) | |
Earnings per share excludes from outstanding common stock the impacts of (i) 17,250,000 Trebia Public Warrants and 8,233,334 Trebia Private Placement Warrants, which are out of the money (ii) 725,000 shares of System1 Class D Common Stock to the Sponsors, and 725,000 RSUs subject to a market vesting condition, which has not been met.
64