Earnings Call Transcript - SST Q1 2025

Operator, Operator

Thank you for standing by and welcome to the First Quarter 2025 Earnings Conference Call for System1. Joining me today to discuss System1's business and financial results are our Co-Founder and Chief Executive Officer, Michael Blend; and our Chief Financial Officer, Tridivesh Kidambi. A recording of this conference call will be available on our Investor Relations website shortly after this call has ended. I'd like to take this opportunity to remind you that during the call, we will make certain forward-looking statements. This includes statements relating to the operating performance of our business, future financial results and guidance, strategy, long-term growth and overall future prospects. We may also make statements regarding regulatory or compliance matters. These statements are subject to known, unknown risks and uncertainties that could cause our actual results to differ materially from those projected or implied during this call. In particular, those described in our risk factors included in our annual report on Form 10-K for the fiscal year 2024 filed on March 10th, as well as the current uncertainty and unpredictability in our business, the markets and the global economy generally. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on management's assumptions and beliefs as of the date hereof, and System1 disclaims any obligation to update any forward-looking statements, except as required by law. Our discussion today will include non-GAAP financial measures, including adjusted EBITDA and adjusted gross profit. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. Historical performance and future estimates provided during this call exclude results from total security. Information regarding our non-GAAP financial measures, including a reconciliation of our non-GAAP financial measures to our most comparable historical GAAP financial measures may be found on our Investor Relations website. I would now like to turn the conference call over to System1's Co-Founder and Chief Executive Officer, Michael Blend.

Michael Blend, CEO

Thanks Kyle. Good afternoon, everyone and thank you for joining System1 on our Q1 earnings call. I'm happy to share that our team executed really well in Q1 and delivered another solid quarter. Revenue, as well as our key operating metrics, gross profit and EBITDA were all above the high end of our guidance range. First quarter revenue was approximately $75 million and adjusted gross profit was $41.5 million, which is a 33% year-over-year increase. Adjusted EBITDA came in at $12.1 million, up from just $400,000 in the prior year quarter. These year-over-year comps are good indicators of the progress we have made over the last year, driven by strong execution and a lot of very hard work by our team. Our owned and operated products continue to perform well with revenue increasing 51% year-over-year. As a reminder, our primary O&O products include CouponFollow in the discount shopping vertical, Startpage in private search and MapQuest in mapping. Each of these is among the leaders in their respective category and we have good momentum across our entire portfolio. Our marketing-driven businesses continue to be impacted by the Google-related product changes we mentioned last quarter. Although so far, we have done a very good job navigating the ongoing volatility. While overall marketing-driven revenue is down on an annual basis, margins are up significantly and our network business in particular continues to do well. On the technology front at System1, we continue to lean in heavily on AI-powered automation driven by Agentic coding. We are incorporating Agentic coding across the entire company and are using it to increase scale, accelerate product development and streamline many of our business operations. Overall, it's a really exciting time to be in technology if you're pushing heavily into Agentic coding as System1 is. If you had asked me 18 months ago what our biggest obstacle to growth was I would have said the difficulty of finding enough engineering and product resources to develop our technology. Now with Agentic coding, productivity is through the roof and the biggest challenge is picking the right ideas to pursue. Let's go into more detail on our owned and operated segment, which includes both our marketing-driven businesses and our owned and operated products. Total owned and operated revenue came in at $58 million, reflecting a 16% year-over-year decline and a 10% decrease sequentially. This decline was driven by a 34% annual revenue decrease in our marketing businesses which was primarily due to a decline in a non-core, low-gross-margin business segment. The marketing decline was partially offset by a 51% increase in our owned and operated products line. Adjusted gross profit was $28 million, up 24% year-over-year and down 13% sequentially from Q4. The sequential decline primarily was driven by seasonality, coming off a seasonally strong fourth quarter for shopping. Sessions across our O&O properties totaled 1.3 billion, down 32% from Q4 but up 6% year-over-year. Our year-over-year growth reflects increased scale of marketing campaigns running through our RAMP platform, as well as growth in our owned and operated properties. International markets remain a key focus for us, with international revenue representing 30% of total owned and operated revenue, up slightly from 29% in Q1 of 2024. A bright spot in our marketing-driven business is the increased scale of our marketing campaigns. In Q1, we launched over 41,000 marketing campaigns, up five times year-over-year and up from 22,000 in Q4. We continue to make large strides on advertising campaign automation, and we're focused on leveraging AI to dramatically increase the scale we operate on in the marketing side. Moving on to our O&O products, the group continues to perform well and is heavily focused on expanding the reach of our couponing, mapping, and private search services. Let's move on to some highlights in those products. I'll start with CouponFollow, which continues to be a top couponing and promo code service in Google's organic rankings. In the first quarter, CouponFollow's user sessions were up over 160% year-over-year, driven by our best-in-class experience for both consumers and merchants. We have a great flywheel going on with CouponFollow. As traffic ramps on CouponFollow, we're able to capture more data on consumer demand. We then leverage that data into better merchant deals that, in turn, improve the overall consumer experience the next time our customers come back. Now let's turn to Startpage, which, as a reminder, is our privacy-centric search engine that competes with DuckDuckGo. In Q1, Startpage user sessions grew 11% year-over-year and 7% sequentially as we ride increased consumer demand for greater privacy. The private browser apps we launched in late 2024 continue to gain traction as we integrate search widgets like mapping that improve the overall search experience. And lastly, let's talk about MapQuest, which is having a brand and business resurgence. MapQuest has had some really fun viral moments recently, with mentions on CNN and the Stephen Colbert show, driven by our Gulf of Mexico naming generator. MapQuest continues to grow user sessions, with Q1 sessions up over 30% year-over-year. The MapQuest team has been focused on enhancing our mobile apps, adding new mapping functionality, and introducing new products. Now let's switch gears to our Partner Network. Partner Network revenue was $70 million, up 4% year-over-year and 1% sequentially after adjusting for the out-of-period revenue adjustments made last quarter. Adjusted gross profit was $15 million, up 37% year-over-year and 4% sequentially. Partner Network results were positively impacted by the in-period recognition of some previously withheld partner revenue related to invalid traffic that our partners sent to us. In Q1, total active partners decreased 14% from Q4 to around 265 partners. The total number of partners was partially offset by a 7% quarter-over-quarter increase in average revenue per partner. In Q4, we had 54 scale partners, a 17% decrease from the fourth quarter. We consider a platform customer to be a scale partner when they are generating at least $550,000 of revenue per quarter on RAMP. The sequential decrease in active partners was impacted by our push to move partners to Google's new RSOC product for monetization. And on this front, the team did a great job in Q1, significantly increasing the number of partners monetizing with RSOC. Looking ahead to the rest of 2025, we remain cautiously optimistic. Our owned and operated products continue to show strong fundamentals. We've been making large strides on the AI technology front, and we're putting ourselves in a position to capitalize on the marketing side, as we begin to see a little more stability. Our biggest challenge over the next couple of quarters continues to be related to volatility with Google, which, as you know is our biggest revenue partner. Last quarter we announced that Google informed us of their plan to automatically opt out advertisers from AdSense for domains monetization, which is known as AFD. While this has created some uncertainty for us, we have not yet seen a material impact to our performance or revenue from that policy change. That being said, we do anticipate Google's continued shift away from AFD to their newer RSOC product is going to continue to cause volatility that we'll have to manage and navigate over the next few quarters. As a result of this uncertainty, as well as broader volatility in online advertising demand and the potential impact of evolving tariff policies, we do not plan to provide financial guidance for the second quarter of 2025. But most importantly, we remain well positioned regardless of how these shifts evolve. We're continuing to benefit from our long-standing AFD partnership while also leaning into the momentum behind RSOC. As RSOC continues to gain traction, we're seeing new opportunities to diversify and grow alongside Google with their evolving monetization strategy. Overall, I would say our System1 team is executing very well across the board. We have quickly made the transition to become an AI-first product and engineering organization and we can see this paying off in faster execution that is also beginning to show up in our financials. As Tridi will detail below, we aren't yet prepared to give full-year guidance as we plan to wait to see how the Google product transition shakes out. That being said, once we get through the Google volatility over the next couple of quarters, I believe we're really well positioned for the medium and long term here at System1. To close, I want to reiterate as I always do, System1's leadership team remains fully aligned with our shareholders. And as a group we remain one of the company's largest shareholder bases. As one example I, through my family foundation, recently purchased 4.5 million shares of SST and I believe strongly in the company's future. As System1 continues our transition back to growth mode, we appreciate your continued support and we look forward to delivering long-term value to our shareholders. With that, I'll hand things over to Tridi to go over our financials.

Tridivesh Kidambi, CFO

Thanks Michael. We are pleased with our first quarter financial results as we were above the high range of guidance on revenue, adjusted gross profit, and adjusted EBITDA. The $12.1 million of adjusted EBITDA in the first quarter represents significant year-over-year growth and highlights the high level of execution by our team across all of our businesses, which has resulted in both year-over-year gross profit growth and ongoing G&A efficiencies, resulting in reductions to operating expenses. Let's get into the details. Q1 revenue was $74.5 million, representing a 12% year-over-year decrease and a sequential decline of 1%. Owned and operated advertising revenue was $57.9 million, down 16% year-over-year and 10% sequentially. The year-over-year decrease is driven by a 35% decrease in advertising spend, which is a result of a mix shift change between our marketing-driven business lines and our owned and operated product lines. Owned and operated product revenue was $22.3 million, representing 38% of total owned and operated advertising revenue compared to 21% of total revenue in Q1 of 2024. The sequential decline is largely attributable to an expected decrease in operated product revenue as Q4 is a seasonally strong quarter for our owned and operated product businesses. Network revenue was $16.6 million and was buttressed by the benefit of a contra-revenue charge related to the reversal of certain prior period network partner rev share payments that was related to invalid traffic sent by some of our network partners in Q2 of 2024. Revenue was up 1% sequentially excluding the gross to net accounting revenue adjustment made in Q4. Adjusted gross profit was $41.5 million, up 33% year-over-year and down 7% sequentially, primarily due to typical Q4 to Q1 seasonality. Revenue less ad spend for our owned and operated advertising segment was $27.8 million, representing a 24% year-over-year increase and a 13% decline sequentially. Revenue less ad spend for our owned and operated products was $21 million, up 53% year-over-year and down 18% sequentially with the quarter-over-quarter decline driven by seasonality. Network revenue less agency fees was $15 million, up 37% year-over-year and up 4% sequentially. First quarter owned and operated advertising sessions were 1.3 billion, up 6% year-over-year and down 32% sequentially. RPS was $0.045, an increase of 32% from the fourth quarter and CPS was $0.023, up 36% sequentially with the sequential increase resulting largely from a combination of mix shift changes in our percentage of international traffic and the networks we advertise on. The spread between RPS and CPS was 92% compared to 98% in Q4 and 48% in Q1 of 2024. Network partner sessions were 1.7 billion, up 11% year-over-year and down 8% sequentially. Partner Network RPS decreased 6% year-over-year and increased 10% sequentially after adjusting for the out-of-period revenue adjustment in Q4. Total sessions processed by RAMP in the most recent quarter was 3 billion, up 9% year-over-year and down 20% sequentially. On to operating expenses and adjusted EBITDA. In Q1, OpEx net of add-backs were $29.4 million down 5% year-over-year and up 10% sequentially. The quarter-over-quarter increase was expected and was impacted by non-wage-related employee costs. Q1 of 2025 marks the seventh straight quarter of year-over-year declines in OpEx, and we will continue to focus on reducing costs in order to create greater operating leverage. Adjusted EBITDA was $12.1 million in Q1 versus just $400,000 in the same quarter last year. Q1 represented the fourth consecutive quarter of year-over-year increases in adjusted EBITDA. With respect to liquidity, we ended the quarter with $43.9 million of unrestricted cash on our balance sheet. Our $20 million use of cash in the quarter was primarily driven by a $13 million cash payment related to the CouponFollow acquisition earn-out, as well as a $4.4 million outflow related to the payment of our 2024 annual bonuses, which were approved and paid in Q1 of this year. As of March 31, we had an outstanding balance of $275 million of term loan debt under our credit agreement and our net consolidated leverage at quarter end was approximately 4.6 times. We also have $50 million of availability under our revolver, as of the end of Q1. As Michael mentioned, due to evolving dynamics and announced changes in Google's absence for Domain's marketplace, along with the broader market uncertainty tied to advertising demand and other potential macro headwinds, we are currently not in a position to provide financial guidance for Q2 of 2025 or the balance of the year. We believe it is prudent at this time to wait for greater clarity on these items, before offering financial projections. But in the interim, we remain focused on executing efficiently in this dynamic environment. We remain confident in the fundamentals of our overall business. Owned and operated products are performing well and provide a strong financial foundation. Our focus on cost reduction is evident in the numbers, and we remain focused on driving OpEx savings. The volatility in our marketing-driven businesses has hindered our ability in the near term to sustainably grow those businesses. However, we are confident in the power of our RAMP platform and our ability to leverage new technologies such as AI and Agentic coding to create a long-term competitive advantage. Thanks for joining us today.

Operator, Operator

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

Tom Forte, Analyst

Okay. Now, I'm unmuted. Okay. So Michael, Tridi, congrats on the quarter. I have two questions. So, first off, can you hear me?

Michael Blend, CEO

We can hear you fine.

Tridivesh Kidambi, CFO

We can hear you.

Tom Forte, Analyst

Alright. So I recognize you're not providing guidance on the second quarter, given the current uncertainty. But as longtime participants in the digital ad market, I'd appreciate your thoughts on the following. So, it seems like digital advertising is holding up including your own performance, and having a lot more resiliency in the current challenging macro, when you compare with prior periods of weakness where digital advertising seemed to weaken first. So, to what do you attribute the change?

Michael Blend, CEO

Well, I would say, first of all, you're right. We're not seeing any issues yet in our numbers, which is nice. What I would say is that typically in a downturn, I think a leading indicator is going to be more on the branded advertising side than performance marketing. We're much more performance marketers. So, if there is going to end up being any kind of macro downturn and really affecting digital marketing, I think we will be the last to see it. And as you know, Tom from the past, sometimes when we do see some issues in performance marketing, it can benefit us as well, because it drives down our buy-side pricing. But I would say, that it's probably a little early in any cycle for us to see any issues.

Tom Forte, Analyst

Excellent. Alright. So the second and final question, can you discuss and compare what you're seeing in advertiser verticals that are likely less directly impacted by tariffs such as health and finance and then how that compares with those that are much more impacted like autos?

Michael Blend, CEO

Sure. As I mentioned, we're not observing significant effects yet in any verticals typically expected to be influenced by tariffs. Some areas, like certain segments that rely heavily on imports from China, aren't major parts of our business. Overall, across our various verticals, there hasn't been any substantial movement so far. This doesn't imply that changes won't occur in the future, which is why we're choosing not to provide guidance for the quarter. We're waiting to understand how the economy develops, along with shifts in consumer demand and advertising behavior. But at this point, we're not noticing much change. Tridi, would you like to add anything on that?

Tridivesh Kidambi, CFO

Yes, I think that’s correct. That was definitely the lesson. The last significant disruption occurred in 2022 and 2000 around COVID, particularly affecting ad formats that show a very high measurable return on ad spend. Specifically, when we partner with Google, that's usually the last advertising channel marketers will eliminate because they can clearly track the ROI on that spending.

Tom Forte, Analyst

Good. Thanks, Michael. Thanks, Tridi.

Tridivesh Kidambi, CFO

Thanks, Tom. Thanks for joining.

Operator, Operator

The next question is from Daniel Kurnos with Benchmark. Dan?

Daniel Kurnos, Analyst

Yes. Sorry, can you hear me? Also like Tom, we'll start off with the Tom question. Michael, look, obviously, I'm going to ask you about Google. So we've got remedies, plans, potential breakup of GAM. You guys are super leveraged through the Google network. It's probably going to give you guys a good opportunity because it's going to cause some disruption, but just love to hear your thoughts on if it starts playing out, what it means for kind of you and the ecosystem.

Michael Blend, CEO

There are a lot of regulatory issues happening with Google right now. As you know, several trials are in progress and they are entering the damages phase. Most people listening are likely aware that any significant negative outcomes for Google will probably take years to materialize as appeals are processed. What I can say is that if Google does end up being split up in some capacity, we believe that each of those segments might become more competitive, which is likely to be beneficial for us. If Google were to lose market share, for example, their search partner network, where we play a significant role, would likely seek more revenue. Google itself will be looking for revenue from search. Our relationship with Google involves us creating demand for their services. When users visit Google and search for something, that's their organic traffic. We create similar demand by engaging with other networks, prompting consumers to click on ads, which ultimately leads to them clicking on Google Ads. If regulatory scrutiny increases on this side of the business, we would expect Google to become more reliant and eager for revenue from its partners, which would be advantageous for us. The same could happen on the display side, though it's difficult to predict the outcomes regarding pricing on both the buying and selling ends, especially concerning Google Display inventory. It's challenging to assess if those circumstances would be beneficial or detrimental to us. If conditions improve on the buying side, it may negatively impact the selling side, and vice versa. We don't foresee any adverse effects from the regulatory situations, and it's important to note that we have an independent search engine, Startpage, that competes with major players like Bing and Google. Any developments that allow independent search engines to capture more market share should positively affect Startpage. Overall, we view this as likely net positive for us, though we don't welcome any regulatory challenges concerning Google at this time.

Daniel Kurnos, Analyst

Given the broader pressures we're witnessing in the market and possibly from a top-down perspective, we've seen some players exit the market. You mentioned this earlier, and it has created a vacuum, particularly in the social space, which has been filled effectively. We haven't faced significant challenges in PLA, and eCPMs seem to be stable in the programmatic sector. I'm curious if this disruption is presenting opportunities for you to capture additional market share domestically. On an international scale, TikTok's exit from the US has opened up considerable opportunities for growth abroad. This is something we've discussed, and it seems like a promising platform. Your international presence has been expanding, so I'm interested in your thoughts on the distinct opportunities you have domestically versus internationally amid these disruptions.

Michael Blend, CEO

We definitely welcome lower prices on the buy-side. With major Chinese app advertisers exiting the market, especially in the social space, those two companies alone contributed more than 10% of our advertising revenue. As more advertisers leave internationally, it should benefit us domestically. We're seeing some positive signs on social media right now, which is encouraging. In many ways, fewer advertisers on the social side would be beneficial for us. The same applies internationally. TikTok, as you mentioned, also offers a strong audience network that has been a significant source of traffic for us, and we continue to invest heavily in that. We are seeing positive results internationally. It's worth noting that Tridi mentioned TikTok remains a substantial and growing part of our business. We don't foresee any issues or negatives related to either area discussed. Furthermore, we're not heavily reliant on TikTok in the United States. We're neutral on whether TikTok continues to operate in the US. Currently, it seems likely that TikTok will remain available for use in the US. If that holds true, we will invest more in it, but if it doesn’t, it won't affect us significantly.

Daniel Kurnos, Analyst

And look, I mean the question was definitely framed in a benefit to you not as a disruptor to you Michael just given what's going in the marketplace. Can you just a little bit? Can you elaborate on the productivity improvements from transitioning to Agentic? We could have an extensive discussion about this, but for the sake of everyone on the call, could you simplify it? Please explain what this means, such as whether it allows for more opportunities at a lower production cost or greater efficiency in creating content. Any additional details would help clarify the impact on the platform.

Michael Blend, CEO

Certainly. It's become quite common to hear discussions about AI and the use of Agentic coding to enhance business efficiency. We're fortunate to have a sizable company and strong engineering and product teams, allowing us to take significant steps to integrate Agentic coding throughout our organization on both the business and product sides. Starting with the business side, the impact is substantial. I don't want to exaggerate, but it's impressive to see the positive effects not only on our company but also across the industry as others adopt Agentic coding. We're witnessing transformations in processes such as signing contracts with partners and creating mockups of new product ideas. In the past, creating something like an automated contract sign-up would require input from engineers and product designers. Now, our business team members are able to develop these solutions independently using tools like Claude to streamline their workflows. If you look around our company today, you'll find business leaders actively creating their products, which is quite remarkable. Moreover, we are also beginning to explore the finance and legal sectors. On the product and engineering front, we made a strategic decision to stop some engineers from working on our core platform to help them quickly adapt to using the new coding tools, which have improved significantly. We're observing productivity increases of three to five times in product development. This acceleration is enabling us to bring products to market more swiftly and generate more ideas for new offerings. The productivity gains are significant; companies that do not embrace this new development approach risk falling behind rapidly. At System1, we were early adopters of this innovative product development methodology. For instance, our headquarters in Los Angeles hosts the Southern California AI meet-up, bringing together top developers and product teams leading the way in Agentic coding. I'm amazed by how fast our company is evolving, and I believe this pace will only increase as more employees utilize these tools and as the tools themselves continue to improve. Tridi, do you have anything to add?

Tridivesh Kidambi, CFO

Yeah. I mean I think just specifically our ability to test new ideas and new initiatives, it's so much faster and not having to make an investment decision early. Do we need to allocate three, four, five heads or design resources, engineering resources to test something? It just allows us to innovate much quicker too, which is where I've definitely seen it just in the last 1.5 quarters to two quarters here.

Operator, Operator

That ends our questions. Now we're going to turn it over to Michael Blend for closing remarks.

Michael Blend, CEO

Alright. Well, thanks everyone for joining us on our Q1 earnings call. It's nice to have a little bit of momentum here. We're glad we put up a nice Q4 followed up by a good Q1. Look forward to everybody joining next quarter, where I hope we can continue the momentum. Thank you everybody. Take care.