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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| | | | | |
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2022
OR
| | | | | |
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For transition period from __________ to __________
Commission file number 001-39331
System1, Inc.
(Exact name of registrant as specified in its charter)
| | | | | | | | |
Delaware | | 98-1531250 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
4235 Redwood Avenue Marina Del Rey, CA | | 90066 |
(Address of Principal Executive Offices) | | (Zip Code) |
(310) 924-6037
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | | | | | | | |
| Title of each class | | Trading Symbol(s) | | Name of each exchange on which registered |
| Class A common stock, par value $0.0001 per share | | SST | | The New York Stock Exchange |
| Redeemable warrants, each whole warrant exercisable for one Class A common stock at an exercise price of $11.50 per share | | SST.WS | | The New York Stock Exchange |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days: Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| | | | | | | | | | | | | | |
| Large accelerated filer | ☐ | | Accelerated filer | ☐ |
Non-accelerated filer | ☒ | | Smaller reporting company | ☒ |
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.☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of November 4, 2022, there were 91,455,846 Class A common stock, $0.0001 par value per share, outstanding.
PART I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
System1, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except for par values)
| | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| September 30, 2022 | | | December 31, 2021 |
| ASSETS | | | | |
| Current assets: | | | | |
| Cash and cash equivalents | $ | 31,933 | | | | $ | 47,896 | |
| Restricted cash, current | 7,338 | | | | — | |
| Accounts receivable | 78,846 | | | | 90,203 | |
| Prepaid expenses and other current assets | 8,756 | | | | 7,689 | |
| Total current assets | 126,873 | | | | 145,788 | |
| Restricted cash, non-current | 2,772 | | | | 743 | |
| Property and equipment, net | 4,349 | | | | 830 | |
| Internal-use software development costs, net | 12,599 | | | | 11,213 | |
| Intangible assets, net | 506,018 | | | | 50,368 | |
| Goodwill | 904,240 | | | | 44,820 | |
| Operating lease assets | 6,893 | | | | — | |
| Other non-current assets | 708 | | | | 3,149 | |
| Total assets | $ | 1,564,452 | | | | $ | 256,911 | |
| LIABILITIES AND EQUITY | | | | |
| Current liabilities: | | | | |
| Accounts payable | $ | 12,242 | | | | $ | 72,846 | |
| Accrued expenses and other current liabilities | 90,265 | | | | 31,284 | |
| Protected.net incentive plan liability, current | 19,266 | | | | — | |
| Deferred revenue | 68,289 | | | | 1,971 | |
| Operating lease liabilities, current | 2,102 | | | | — | |
| Debt, net | 14,954 | | | | 170,453 | |
| Total current liabilities | 207,118 | | | | 276,554 | |
| Operating lease liabilities, non-current | 6,406 | | | | — | |
| Long-term debt, net | 402,273 | | | | — | |
| Warrant liability | 18,158 | | | | — | |
| Deferred tax liability | 120,724 | | | | 7,789 | |
| Protected.net incentive plan liability, non-current | 11,517 | | | | — | |
| Other liabilities | 2,909 | | | | 969 | |
| Total liabilities | 769,105 | | | | 285,312 | |
| Commitments and contingencies (Note 11) | | | | |
| EQUITY / MEMBERS' DEFICIT | | | | |
Class A common stock - $0.0001 par value; 250,000 shares authorized, 91,490 Class A shares issued and outstanding as of September 30, 2022 | 9 | | | | — | |
Class C common stock - $0.0001 par value; 25,000 shares authorized, 21,747 Class C shares issued and outstanding as of September 30, 2022 | 2 | | | | — | |
| Additional paid-in capital | 767,169 | | | | — | |
| Accumulated deficit | (150,016) | | | | — | |
| Members' deficit | — | | | | (28,829) | |
| Accumulated other comprehensive income | 13 | | | | 428 | |
| Total equity/members' deficit attributable to System1, Inc. | 617,177 | | | | (28,401) | |
| Non-controlling interest | 178,170 | | | | — | |
| Total equity/members' deficit | 795,347 | | | | (28,401) | |
| Total liabilities and equity/members' deficit | $ | 1,564,452 | | | | $ | 256,911 | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except for per share and per unit data)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor | | Successor | | | Predecessor |
| Three Months Ended September 30, 2022 | | | Three Months Ended September 30, 2021 | | Period from January 27, 2022 through September 30, 2022 | | | Period from January 1, 2022 through January 26, 2022 | | Nine Months Ended September 30, 2021 |
| Revenue | $ | 201,176 | | | | $ | 171,446 | | | $ | 587,081 | | | | $ | 52,712 | | | $ | 488,586 | |
| Operating costs and expenses: | | | | | | | | | | | |
| Cost of revenues (excluding depreciation and amortization) | 137,681 | | | | 128,885 | | | 410,370 | | | | 41,760 | | | 365,837 | |
| Salaries, commissions, and benefits | 55,862 | | | | 15,139 | | | 144,876 | | | | 35,175 | | | 48,032 | |
| Selling, general, and administrative | 16,520 | | | | 7,936 | | | 47,668 | | | | 14,817 | | | 21,163 | |
| Depreciation and amortization | 33,420 | | | | 3,459 | | | 90,128 | | | | 1,000 | | | 10,260 | |
| Total operating costs and expenses | 243,483 | | | | 155,419 | | | 693,042 | | | | 92,752 | | | 445,292 | |
| Operating income (loss) | (42,307) | | | | 16,027 | | | (105,961) | | | | (40,040) | | | 43,294 | |
| Other expense: | | | | | | | | | | | |
| Interest expense, net | 10,011 | | | | 4,184 | | | 22,111 | | | | 1,049 | | | 12,708 | |
| Change in fair value of warrant liabilities | 4,489 | | | | — | | | 14,111 | | | | — | | | — | |
| Total other expense | 14,500 | | | | 4,184 | | | 36,222 | | | | 1,049 | | | 12,708 | |
| Income (loss) before income tax | (56,807) | | | | 11,843 | | | (142,183) | | | | (41,089) | | | 30,586 | |
| Income tax (benefit) provision | (19,228) | | | | 475 | | | (32,480) | | | | (629) | | | 703 | |
| Net income (loss) | $ | (37,579) | | | | $ | 11,368 | | | $ | (109,703) | | | | $ | (40,460) | | | $ | 29,883 | |
| Net loss attributable to non-controlling interest | (5,936) | | | | — | | | (18,871) | | | | — | | | — | |
| Net income (loss) attributable to System1, Inc. | $ | (31,643) | | | | $ | 11,368 | | | $ | (90,832) | | | | $ | (40,460) | | | $ | 29,883 | |
| | | | | | | | | | | |
| Basic and diluted net loss per share | $ | (0.35) | | | | n/a | | $ | (1.02) | | | | n/a | | n/a |
| Weighted average number of shares outstanding - basic and diluted | 91,002 | | | | n/a | | 88,716 | | | | n/a | | n/a |
| Basic and diluted net income (loss) per unit | n/a | | | $ | 0.55 | | | n/a | | | $ | (1.97) | | | $ | 1.46 | |
| Weighted average units outstanding - basic and diluted | n/a | | | 20,488 | | | n/a | | | 20,488 | | | 20,488 | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(In thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor | | Successor | | | Predecessor |
| Three Months Ended September 30, 2022 | | | Three Months Ended September 30, 2021 | | Period from January 27, 2022 through September 30, 2022 | | | Period from January 1, 2022 through January 26, 2022 | | Nine Months Ended September 30, 2021 |
| Net income (loss) | $ | (37,579) | | | | $ | 11,368 | | | $ | (109,703) | | | | $ | (40,460) | | | $ | 29,883 | |
| Other comprehensive income (loss) | | | | | | | | | | | |
| Foreign currency translation income (loss) | (354) | | | | 101 | | | (126) | | | | 87 | | | 566 | |
| Comprehensive income (loss) | (37,933) | | | | 11,469 | | | (109,829) | | | | (40,373) | | | 30,449 | |
| Comprehensive loss attributable to non-controlling interest | (6,124) | | | | — | | | (19,010) | | | | — | | | — | |
| Comprehensive income (loss) attributable to System1, Inc. | $ | (31,809) | | | | $ | 11,469 | | | $ | (90,819) | | | | $ | (40,373) | | | $ | 30,449 | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
(In thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Class A Common Stock | | Class C Common Stock | | Class D Common Stock | | | | | | | | | |
| Shares | Amount | | Shares | Amount | | Shares | Amount | | Additional Paid-In-Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income | | Non-Controlling Interest | | Total Stockholders’
Equity |
| Successor: | | | | | | | | | | | | | | | | | | |
| For the period from January 27, 2022 to September 30, 2022 | | | | | | | | | | | | | | | | | | |
| BALANCE—January 26, 2022 | 52,680 | | $ | 5 | | | — | | $ | — | | | — | | $ | — | | | $ | 525,579 | | | $ | (59,184) | | | $ | — | | | $ | — | | | $ | 466,400 | |
| Effect of Merger transaction | 29,017 | | 3 | | | 22,077 | | 2 | | | 2,900 | | — | | | 157,046 | | | — | | | — | | | 198,691 | | | 355,742 | |
| BALANCE—January 27, 2022 | 81,697 | | 8 | | | 22,077 | | 2 | | | 2,900 | | — | | — | | 682,625 | | — | | (59,184) | | — | | — | | | 198,691 | | | 822,142 | |
| Net loss | — | | — | | | — | | — | | | — | | — | | | — | | | (29,991) | | | — | | | (8,068) | | | (38,059) | |
| Issuance of common stock in connection with the acquisition of business | 2,000 | | — | | | — | | — | | | — | | — | | | 25,500 | | | — | | | — | | | — | | | 25,500 | |
| Conversion of Class D shares to Class A shares | 2,900 | | 1 | | | — | | — | | | (2,900) | | — | | | — | | | — | | | — | | | — | | | 1 | |
| Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC | — | | — | | | — | | — | | | — | | — | | | (6,752) | | | — | | | — | | | — | | | (6,752) | |
| Other comprehensive income | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | (28) | | | (6) | | | (34) | |
| Share-based compensation | — | | — | | | — | | — | | | — | | — | | | 27,167 | | | — | | | — | | | — | | | 27,167 | |
| Distribution to members | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | — | | | (247) | | | (247) | |
| BALANCE—March 31, 2022 | 86,597 | | $ | 9 | | | 22,077 | | $ | 2 | | | — | | $ | — | | | $ | 728,540 | | | $ | (89,175) | | | $ | (28) | | | $ | 190,370 | | | $ | 829,718 | |
| Net loss | — | | — | | | — | | — | | | — | | — | | | — | | | (29,198) | | | — | | | (4,867) | | | (34,065) | |
| Exercise of warrants | 3,969 | | — | | | — | | — | | | — | | — | | | 27,989 | | | — | | | — | | | — | | | 27,989 | |
| Issuance of restricted stock, net of forfeitures and shares withheld for taxes | 21 | | — | | | — | | — | | | — | | — | | | — | | | — | | | — | | | — | | | — | |
| Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC | — | | — | | | — | | — | | | — | | — | | | 585 | | | — | | | — | | | — | | | 585 | |
| Other comprehensive income | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | 207 | | | 55 | | | 262 | |
| Share-based compensation | — | | — | | | — | | — | | | — | | — | | | 3,888 | | | — | | | — | | | — | | | 3,888 | |
| Distribution to members | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | — | | | (1,254) | | | (1,254) | |
| BALANCE—June 30, 2022 | 90,587 | | $ | 9 | | | 22,077 | | $ | 2 | | | — | | $ | — | | | $ | 761,002 | | | $ | (118,373) | | | $ | 179 | | | $ | 184,304 | | | $ | 827,123 | |
| Net loss | — | | — | | | — | | — | | | — | | — | | | — | | | (31,643) | | | — | | | (5,936) | | | (37,579) | |
| Issuance of restricted stock, net of forfeitures and shares withheld for taxes | 573 | | — | | | — | | — | | | — | | — | | | (2,035) | | | — | | | — | | | — | | | (2,035) | |
| Conversion of Class C shares to Class A shares | 330 | | — | | | (330) | | — | | | — | | — | | | — | | | — | | | — | | | — | | | — | |
| Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC | — | | — | | | — | | — | | | — | | — | | | 14 | | | — | | | — | | | — | | | 14 | |
| Other comprehensive income | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | (166) | | | (188) | | | (354) | |
| Share-based compensation | — | | — | | | — | | — | | | — | | — | | | 8,188 | | | — | | | — | | | — | | | 8,188 | |
| Distribution to members | — | | — | | | — | | — | | | — | | — | | | — | | | — | | | — | | | (10) | | | (10) | |
| BALANCE—September 30, 2022 | 91,490 | | $ | 9 | | | 21,747 | | $ | 2 | | | — | | $ | — | | | $ | 767,169 | | | $ | (150,016) | | | $ | 13 | | | $ | 178,170 | | | $ | 795,347 | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Member's Deficit (Unaudited)
(In thousands)
| | | | | | | | | | | | | | | | | |
| Members’ Capital | | Accumulated Other Comprehensive Income (Loss) | | Total Members’ Deficit |
| Predecessor: | | | | | |
| For the period January 1, 2022 to January 26, 2022 | | | | | |
| BALANCE—January 1, 2022 | $ | (28,829) | | | $ | 428 | | | $ | (28,401) | |
| Net loss | (40,460) | | | — | | | (40,460) | |
| Accumulated other comprehensive income | — | | | 87 | | | 87 | |
| Share-based compensation expense | 27,698 | | | — | | | 27,698 | |
| BALANCE—January 26, 2022 | $ | (41,591) | | | $ | 515 | | | $ | (41,076) | |
| | | | | |
| Members’ Capital | | Accumulated Other Comprehensive Income (Loss) | | Total Members’ Deficit |
| Predecessor: | | | | | |
| For the period January 1, 2021 to September 30, 2021 | | | | | |
| BALANCE—January 1, 2021 | $ | (47,886) | | | $ | (343) | | | $ | (48,229) | |
| Net income | 6,743 | | | — | | | 6,743 | |
| Accumulated other comprehensive income | — | | | 441 | | | 441 | |
| Share-based compensation expense | 146 | | | — | | | 146 | |
| Contribution from OpenMail | 147 | | | — | | | 147 | |
| BALANCE—March 31, 2021 | $ | (40,850) | | | $ | 98 | | | $ | (40,752) | |
| Net income | 11,772 | | | — | | | 11,772 | |
| Accumulated other comprehensive income | — | | | 24 | | | 24 | |
| Share-based compensation expense | 120 | | | — | | | 120 | |
| Distribution to Court Square Capital Partners | (1,814) | | | — | | | (1,814) | |
| Contribution from OpenMail | 3 | | | — | | | 3 | |
| Distribution to OpenMail | (877) | | | — | | | (877) | |
| BALANCE—June 30, 2021 | $ | (31,646) | | | $ | 122 | | | $ | (31,524) | |
| Net income | 11,368 | | | — | | | 11,368 | |
| Accumulated other comprehensive income | — | | | 101 | | | 101 | |
| Share-based compensation expense | 89 | | | — | | | 89 | |
| Distribution to Court Square Capital Partners | (4,088) | | | — | | | (4,088) | |
| Contribution from OpenMail | 109 | | | — | | | 109 | |
| Distribution to OpenMail | (3,014) | | | — | | | (3,014) | |
| BALANCE—September 30, 2021 | $ | (27,182) | | | $ | 223 | | | $ | (26,959) | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
| | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Period from January 27, 2022 through September 30, 2022 | | | Period from January 1, 2022 through January 26, 2022 | | Nine Months Ended September 30, 2021 |
| Cash flows from Operating Activities: | | | | | | |
| Net income (loss) | $ | (109,703) | | | | $ | (40,460) | | | $ | 29,883 | |
| Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: | | | | | | |
| Depreciation and amortization | 90,128 | | | | 1,000 | | | 10,260 | |
| Share-based compensation | 79,802 | | | | 27,698 | | | 334 | |
| Amortization of debt issuance costs | 3,540 | | | | — | | | 1,696 | |
| Noncash lease expense | (203) | | | | 115 | | | — | |
| Change in fair value of contingent consideration and CEO equity profit interest | — | | | | (9) | | | 4,363 | |
| Change in fair value of warrants | 14,111 | | | | — | | | — | |
| Deferred tax benefits | (37,827) | | | | (816) | | | (731) | |
| Changes in operating assets and liabilities | | | | | | |
| Accounts receivable | 6,670 | | | | 11,118 | | | (14,449) | |
| Prepaids and other assets | 455 | | | | 905 | | | (4,798) | |
| Accounts payable | 1,981 | | | | (67,600) | | | 12,535 | |
| Accrued expenses and other liabilities | (19,017) | | | | 57,170 | | | 65 | |
| Protected.net incentive plan liability | (10,000) | | | | — | | | — | |
| Deferred revenue | 7,133 | | | | 311 | | | 211 | |
| Other long-term liabilities | (26,549) | | | | 78 | | | — | |
| Net cash provided by (used for) operating activities | 521 | | | | (10,490) | | | 39,369 | |
| Cash flows from Investing Activities: | | | | | | |
| Purchases of property and equipment | (3,224) | | | | — | | | — | |
| Capitalized software development costs | (4,796) | | | | (441) | | | (4,901) | |
| Acquisition of businesses, net of cash acquired | (445,405) | | | | — | | | — | |
| Net cash used for investing activities | (453,425) | | | | (441) | | | (4,901) | |
| Cash flows from Financing Activities: | | | | | | |
| Proceeds from term loan and line of credit | 449,000 | | | | — | | | — | |
| Repayment of term loan | (182,488) | | | | — | | | (9,886) | |
| Member capital contributions | — | | | | — | | | 259 | |
| Payments for financing costs | (24,845) | | | | — | | | — | |
| Payments for earnouts | (1,715) | | | | — | | | — | |
| Taxes paid related to net settlement of restricted stock awards | (2,035) | | | | — | | | — | |
| Redemptions of class A common stock | (510,469) | | | | — | | | — | |
| Proceeds from warrant exercises | 5,027 | | | | — | | | — | |
| Cash received from the Backstop | 246,484 | | | | — | | | — | |
| Payments on contingent consideration from purchase of companies | — | | | | — | | | (6,715) | |
| Related party loan | — | | | | — | | | (1,500) | |
| Distributions to members | (1,511) | | | | — | | | (9,793) | |
| Net cash used for financing activities | (22,552) | | | | — | | | (27,635) | |
| Effect of exchange rate changes in cash, cash equivalent and restricted cash | (54) | | | | (132) | | | 363 | |
| Net increase (decrease) in cash, cash equivalents and restricted cash | (475,510) | | | | (11,063) | | | 7,196 | |
| Cash and cash equivalents and restricted cash, beginning of the period | 517,553 | | | | 48,639 | | | 29,013 | |
| Cash and cash equivalents and restricted cash, end of the period | $ | 42,043 | | | | $ | 37,576 | | | $ | 36,209 | |
| Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets: | | | | | | |
| Cash and cash equivalents | $ | 31,933 | | | | $ | 36,833 | | | $ | 36,209 | |
| Restricted cash | 10,110 | | | | 743 | | | — | |
| Total cash, cash equivalents and restricted cash | $ | 42,043 | | | | $ | 37,576 | | | $ | 36,209 | |
| | | | | | |
| Supplemental cash flow information: | | | | | | |
| Cash paid for operating lease liabilities | $ | 1,580 | | | | $ | 175 | | | $ | — | |
| Operating lease assets obtained in exchange for operating lease liabilities | $ | 2,064 | | | | $ | 7,987 | | | $ | — | |
| Capitalized assets financed by accounts payable | $ | 309 | | | | $ | — | | | $ | — | |
| Tenant improvements paid by lessor | $ | 139 | | | | $ | — | | | $ | — | |
| Stock-based compensation included in capitalized software development costs | $ | 340 | | | | $ | — | | | $ | — | |
See notes to unaudited condensed consolidated financial statements.
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
1.ORGANIZATION AND DESCRIPTION OF BUSINESS
System1, Inc. and subsidiaries (“System1” or the “Company”) operates an omnichannel customer acquisition platform, delivering high-intent customers to advertisers and sells antivirus software packages to end user customers.
The Company provides its omnichannel customer acquisition platform services through its proprietary responsive acquisition marketing platform (“RAMP”). Operating seamlessly across major advertising networks and advertising category verticals to acquire users on its behalf, RAMP allows the Company to monetize such users through its relationships with third party advertisers and advertising networks (“Advertising Partners”). RAMP also allows third party advertising platforms and publishers (“Network Partners”), to send user traffic to, and monetize user traffic on, the Company’s owned and operated websites. RAMP operates across the Company’s network of owned and operated websites and related products, allowing it to monetize user traffic that it sources from various acquisition marketing channels, including Google, Facebook, Taboola, Snapchat and TikTok.
The Company, through its wholly owned subsidiary Protected.net Group Limited, a private limited company incorporated in England and Wales (“Protected.net”), also provides antivirus software solutions, offering its customers a single packaged solution that provides protection and reporting to the end user. The Company delivers its antivirus software solutions directly to end-user customers across the world. The antivirus software solutions product offering comprises a core security package with varying levels of extra protection based on a customer's specific needs.
The Company’s primary operations are in the United States; and the Company also has operations in Canada, the United Kingdom, 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 these risks are changes in existing tax laws, possible limitations on foreign investment and income repatriation, government 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.
For the purposes of the condensed consolidated financial statements, periods on or before January 26, 2022 reflect the financial position, results of operations and cash flows of S1 Holdco, LLC, a Delaware limited liability company ("S1 Holdco") and its consolidated subsidiaries prior to the Merger (as defined in Note 3—MERGER), referred to herein as the “Predecessor,” and periods beginning on or after January 27, 2022 reflect the financial position, results of operations and cash flows of the Company and its consolidated subsidiaries as a result of the Merger, referred to herein as the “Successor”.
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation, Principles of Consolidation and Summary of Significant Accounting Policies
The Company was a special purpose acquisition company originally incorporated as a Cayman Islands exempted company on February 11, 2020 under the name Trebia Acquisition Corp. (“Trebia”). The Company was formed for the purpose of effecting a merger, share exchange, asset acquisition, share purchase, reorganization or similar business combination with one or more businesses (the “Merger”). On January 27, 2022, the Company consummated its Merger, which resulted in the acquisition of S1 Holdco and System1 SS Protect Holdings, Inc. (“Protected”). As a result of the Merger, the results of operations, financial position and cash flows of the Predecessor and Successor are not directly comparable.
The Company was deemed the accounting acquirer in the Merger based on an analysis of the criteria outlined in Accounting Standards Codification (“ASC”) 805, Business Combinations. S1 Holdco was deemed to be the predecessor entity based on an analysis. Accordingly, the historical financial statements of S1 Holdco became the historical financial statements of the Company, upon the consummation of the Merger. As a result, the financial statements included in this report reflect (i) the historical operating results of S1 Holdco prior to the Merger and (ii) the combined results of the Company, including S1 Holdco and Protected following the closing of the Merger. The accompanying financial statements include a Predecessor period, which includes the period through January 26,
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
2022 concurrent with the Merger, and a Successor period from January 27, 2022 through September 30, 2022. A black-line between the Successor and Predecessor periods has been placed in the condensed consolidated financial statements and in the tables to the notes to the condensed consolidated financial statements to highlight the lack of comparability between these two periods as the Merger resulted in a new basis of accounting for S1 Holdco.
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The accompanying condensed consolidated financial statements include the accounts of System1, Inc. and its subsidiaries for the Successor period, and S1 Holdco for the Predecessor periods. All intercompany accounts and transactions have been eliminated in the consolidation of the financial statements. The condensed consolidated financial statements have been prepared by the Company and are unaudited, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations. The interim condensed consolidated financial statements included herein reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented. The year-end condensed consolidated balance sheet data was derived from audited financial statements of S1 Holdco and related notes included in the Company’s final prospectus filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on April 19, 2022 (the “Prospectus”), but does not include all disclosures required by U.S. GAAP. The condensed consolidated statements of operations for the period from January 1, 2022 through January 26, 2022 (Predecessor) and for the period from January 27, 2022 through September 30, 2022 (Successor) are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2022 or thereafter.
Certain prior period amounts in the condensed consolidated financial statements have been reclassified to conform with the current period presentation. These reclassifications had no effect on the results of operations or financial position for any period presented.
ASC 842 Adoption
On January 1, 2022, the Company adopted ASC 842, Leases, under the modified transition approach. This lease accounting standard provides several optional practical expedients in transition. The Company elected the “package of practical expedients,” which permits the Company to not reassess its prior conclusions about lease identification, lease classification and initial direct costs. The new standard also provides practical expedients for an entity’s ongoing accounting. The Company elected the short-term lease recognition exemption. Accordingly, for those leases that qualify, the Company did not recognize an operating lease asset or operating lease liability for existing short-term leases of those assets in transition. The Company also elected the practical expedient to not separate lease and non-lease components for its leases. The adoption of the lease standard did not have any effect on its previously reported condensed consolidated statements of operations and did not result in a cumulative catch-up adjustment to opening equity. The Company recorded $6,786 of operating lease assets, $7,987 of lease liabilities and reclassified $1,201 of deferred rent liabilities as a reduction to the beginning operating lease assets upon implementation of ASC 842. See Note 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Leases and Note 7—LEASES for additional details.
Capital Resources, Liquidity, and Concentrations
To date, the Company’s available liquidity and operations have been financed through the initial public offering of Trebia, the Merger (as defined in Note 3—MERGER), credit facilities, and cash flows from operations. The Company is subject to certain business and operational risks, including competition from alternative technologies, as well as dependence on key Advertising Partners, key employees, key contracts, and growth to achieve its business and operational objectives.
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following table illustrates the level of concentration as a percentage of total revenues for its key Advertising Partners:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor | | Successor | | | Predecessor |
| Three Months Ended September 30, 2022 | | | Three Months Ended September 30, 2021 | | Period from January 27, 2022 through September 30, 2022 | | | Period from January 1, 2022 through January 26, 2022 | | Nine Months Ended September 30, 2021 |
| Google | 67 | % | | | 84 | % | | 70 | % | | | 88 | % | | 84 | % |
| Microsoft | 3 | % | | | 5 | % | | 3 | % | | | 4 | % | | 5 | % |
As of September 30, 2022, the Company has (i) two paid search advertising partnership contracts with Google, and (ii) 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 an effective date of August 1, 2021, and has a two-year term through July 31, 2023. The Company renewed its advertising contract with Microsoft with an effective date of July 1, 2022, and has a three-year term through June 30, 2025. All three agreements may be terminated by the respective Advertising Partner immediately or with minimal notice under certain circumstances.
Accounts receivable are primarily derived from Advertising Partners located within the United States. As of September 30, 2022 (Successor), two of the Company’s largest Advertising Partners, Google and Yahoo, represented 64% and 12%, respectively, of the Company’s accounts receivables balance. As of December 31, 2021 (Predecessor), these two Advertising Partners represented 72% and 10%, respectively, of the Company’s accounts receivable balances.
Use of Estimates
The preparation of these condensed 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, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period.
Significant estimates and assumptions reflected in these condensed consolidated financial statements include, but are not limited to: (1) valuation of goodwill, acquired intangible assets and long-lived assets, (2) valuation and recognition of the Company's share-based compensation awards, (3) income taxes, (4) contingent consideration and (5) determination of the fair value of the warrant liabilities. Significant estimates affecting the condensed 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. 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 condensed consolidated financial statements.
Cash and Cash Equivalents
Cash and cash equivalents consist of amounts held as bank deposits.
Accounts Receivable
Accounts receivable primarily represent amounts due from Advertising Partners, and these accounts receivable are stated at the amount the Company expects to collect from outstanding balances and do not bear interest. The Company does not require collateral for its accounts receivable. 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 accounts receivables have historically been paid on a timely basis. Due to the
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection and therefore no allowance for doubtful accounts was required as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor). The payment terms for the Company's accounts receivable are typically 30 days.
Concentration of Credit Risk
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 cash 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.
Foreign Currency
The Company’s reporting currency is the U.S. Dollar. The balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. The statements 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.
Warrant Liability
The Company accounts for the Public Warrants and Private Placement Warrants (collectively, the “Warrants”; which are discussed in further detail in Note 13—WARRANTS and Note 14—FAIR VALUE MEASUREMENT) in accordance with ASC 815-40 under which the Warrants do not meet the criteria for equity classification, and therefore must be recorded as liabilities. The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. The fair value of the Private Placement Warrants has been estimated using the fair value of the Public Warrants.
Fair Value of Financial Instruments
The provisions of ASC 820, Fair Value Measurements and Disclosures ("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. ASC 820 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. 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.
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.
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.
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Financial instruments consist of cash, cash equivalents, restricted cash, accounts receivable, other assets accounted for at fair value, accounts payable, accrued liabilities, and warrant 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. As of September 30, 2022, the Company's outstanding debt included a Term Loan, of which its fair value was estimated using an observable market quotation (Level 2). The carrying value and estimated fair value of the Term Loan were $368,228 and $374,400, respectively, as of September 30, 2022. Refer to Note 12—DEBT, NET for additional information.
The Company does not have any assets, with the exception of cash, cash equivalents and restricted cash, that are required to be carried at fair value on a recurring basis at September 30, 2022 (Successor) and December 31, 2021 (Predecessor). The Company’s liabilities measured at fair value relate to the Public Warrant liabilities (Level 1), Private Placement Warrant liabilities (Level 2), the former CEO of S1 Holdco's equity profits interest liability (Level 3), and contingent consideration (Level 3).
Certain assets, including goodwill, intangible assets and long-lived 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 Company determines the fair value by applying observable inputs to calculate the present value of these assets. To date, no material impairments have been recorded on those assets.
Restricted Cash
The Company had restricted cash of $10,110 and $743 as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor), respectively. The Company’s restricted cash as of September 30, 2022 (Successor) primarily consists of (i) cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office in Marina del Rey, California, (ii) merchant reserve balances with its credit card processors held due to arrangements under which the Company's credit card processors withhold certain credit card funds to cover potential charge backs initiated by the Company’s customers, (iii) the escrow account balance related to the portion of unvested equity awards as of the closing of the Merger that will be cash settled and will be released to the Company's employees as the service requirement is completed, (iv) the escrow account balance related to the indemnification obligations related to its RoadWarrior acquisition and (v) the escrow account balance related to the postcombination compensation arrangement related to the CouponFollow acquisition. The amount of restricted cash as of December 31, 2021 (Predecessor) relates to cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office in Marina del Rey, California.
Property and Equipment, net
Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. 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 condensed consolidated statement of operations.
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The estimated useful lives of the Company’s property and equipment for purposes of computing depreciation are as follows:
| | | | | | | | | | | |
| Useful Life |
| (Years) |
| Computer equipment | 3 |
| Office equipment | 3 |
| Software | 4 |
| Furniture, fixtures and equipment | 3 | - | 7 |
| Motor vehicles | 4 |
| Leasehold improvements | Shorter of the remaining lease term or estimated useful life for leasehold improvements. |
Internal-use Software Development Costs, net
Internal-use software development costs are stated at cost, less accumulated amortization. The Company capitalizes certain internal-use software development costs associated with creating and enhancing internally developed software related to the Company’s technology infrastructure, including continuing to develop and deploy its RAMP platform. These costs are comprised of personnel costs, which include salaries, bonuses, stock-based compensation and employee benefits’ expenses for employees who are directly associated with, and who devote significant time to, software projects, as well as external direct costs of materials and services consumed in developing or obtaining the software. Internal-use software development costs that do not meet the qualification for capitalization are expensed as incurred, and correspondingly recorded in Salaries, commissions, and benefits expense in the condensed consolidated statement of operations.
Internal-use 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 the software will perform as intended. Costs incurred in the application and infrastructure development stage, including significant enhancements and upgrades, are capitalized. Capitalization ends once a project is substantially complete, and the software and technologies are ready for deployment for their intended purpose(s). 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.
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Intangible Assets
Intangible assets primarily consist of acquired technology, customer relationships and trade names/trademarks. The Company determines the appropriate useful life based on management’s estimate of the applicable intangible asset’s remaining economic useful life at the time of acquisition. Intangible assets are amortized over their estimated economic useful lives using a straight-line method, which approximates the pattern in which the economic benefits are consumed. Certain customer relationship intangibles are amortized on an accelerated basis based upon the expected timing of economic benefits which are, derived from an analysis of customer attrition rates over the expected life. The fair value of the intangible assets acquired are determined using either the income, market or replacement cost methodologies.
The estimated useful lives of the Company’s intangible assets are as follows:
| | | | | | | | | | | |
| Useful Life |
| (Years) |
| Developed technology | 4 |
| Customer relationships | 3 | - | 5 |
| Trademarks and trade names | 10 |
| Other intangibles | 4 |
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 changes 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 its long-lived assets by determining whether the carrying value of the asset group can be recovered through projected undiscounted cash flows over their remaining useful 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 has occurred. For the periods presented in this quarterly report, the Company has not recorded any impairments of long-lived assets.
Business Combinations
The results of a business acquired in a business combination are included in the Company’s condensed 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, paid in a business combination for 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 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, customer and service attrition rates and estimating future cash flows. The Company estimates the fair value based on assumptions which the Company's management believes 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
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
conclusion of the measurement period, any subsequent adjustments are reflected in the Company’s condensed 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 condensed 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 as of each reporting date through the Company’s condensed consolidated statements of operations.