System1 Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 9, 2023

There are 2 speakers on the call.

Operator

Thanks for joining us on our Q2 earnings call. Shruti and I are glad to be able to speak with you about the business as our last opportunity was last November for our Q3 2022 earnings. We thankfully are now pass through restatement issues we've been dealing with. We look forward to being able to provide updates to our public stakeholders on a regular basis. Now the most common question we get asked by shareholders is whether we are seeing a rebound in digital marketing.

Operator

So I thought I would start there. The good news is that we are no longer seeing the rapid declines that we experienced in the back half of twenty twenty two and the Q1 of this year. The not so good news is that we continue to see volatility in the areas we focus on, specifically performance marketing. So at this point, we're not yet ready to call a rebound in the market, although we are cautiously optimistic. Now against that backdrop, let's talk about our Q2.

Operator

System 1 delivered $147,000,000 revenue and $53,000,000 of gross profit, which was up 12% sequentially. Our adjusted EBITDA was 14 point $1,000,000 which unfortunately did not deliver on our EBITDA guidance. The specific reason is that we were informed in late July that one of our network Partners was terminated by one of our primary advertising partners. Triti will go into more details on this, but as a result, We took an unexpected $3,300,000 charge to adjusted EBITDA. On the subscription side, we had another Strong quarter with the business acquiring more than 550,000 new paying subscribers.

Operator

Net of churn, we increased our subscriber count from 2,600,000 last quarter almost $2,800,000 at the end of this quarter. Our advertising spend was slightly down quarter over quarter and we increased billings sequentially by 2%, representing a 17% year over year increase. On the advertising side of System 1, we continue to face headwinds in our owned and operated business specifically. Advertising spend was $49,700,000 down 35% sequentially. We generated over 800,000,000 sessions with a spread of $0.03 per session.

Operator

These results are disappointing, and I would like to go into more detail to help shareholders understand the struggles we have had here. The specific reason for the O and O decline is our SEM related business. This is where we place advertisements on search engines like Google and Bing, and then we send the resulting traffic to offers on our platform. It traditionally has been our highest revenue and lowest gross margin business. This business has been in steady decline since last summer when we started experiencing traffic quality issues from traffic we purchased.

Operator

The resulting decline as we pulled back spin represents over 200% of the overall sequential decline in our owned and operated gross profit and the majority of the year over year decline. SCM is no longer a major driver of our gross profit, and the rest of our owned and operated business is up sequentially despite the economic headwinds. On a positive note, our network advertising business continues to shine with revenue and gross profit of $19,600,000 This was up 30% sequentially, and this growth is inclusive of the termination of the network partner I mentioned earlier. Our network advertising business has been the biggest beneficiary of the upgrade to the ramp platform we deployed at the end of last year. We are rapidly winning new customers and expanding revenues from our existing base.

Operator

We expect this part of our advertising business continue to deliver significant year over year growth for the rest of the year. We had several business highlights in the quarter. We announced the official launch of our ramp partner console. This is our new portal designed to provide a comprehensive suite of self serve tools reporting capabilities to our network partners. As I mentioned, this has been very well received in the industry.

Operator

It's been a big help as we launch new partners. On Startpage, our private search engine, We launched a new mobile offering in collaboration with Microsoft Bing, which includes enhanced features such as product listing ads and shopping. The Startpage team has been doing a great job in quickly adding features to what we refer to as the world's most private search engine. We We encourage everybody to use Startpage. In addition to working with Microsoft on Startpage, we were selected as the Global Supply Partner of the Year by Microsoft Advertising.

Operator

We're really proud of our relationship with Microsoft and the whole team there, and we look forward to further growing our business with them in the future. And I can't let the call go by without mentioning how quickly we have integrated large language models into our ramp platform. When you think about how our advertising business works, you can break it down into 3 primary areas. First, the advertisements we place, then the content we show consumers and then ultimately, the monetization of these consumers. LLMs and specifically generative AI have very quickly permeated through the first two steps of our process.

Operator

First, on the ad creation. We manage thousands of advertising campaigns at any given time. Each of these campaigns requires original creative elements, including images, ad headlines and calls to action. And then after someone clicks on an ad, The next step in our flow is presenting content that educates a consumer on an offer. With generative AI, we can optimize much of this creative process, including image creation, headline creatives, content and then categorizing and expanding our advertising verticals.

Operator

And when we find something that works particularly well, algorithms can then create new versions of our winners at almost no cost. I'm really proud of our team for integrating ALLMs into our overall platform so quickly, and we are still in the early stages. I'm anticipating we will see continued efficiencies and upside as we continue to refine our AI related systems. Going forward, we are laser focused on our cost structure and generating operating cash flow in the short term. Overall, over the last year, we have reduced headcount by approximately 15% throughout the business.

Operator

We also are reducing several of non payroll related operating expenses. We will continue to take opportunities to reduce costs where we can without sacrificing investment in future growth opportunities. Now Triti will get into specific guidance for the second half of twenty twenty three, but I remain bullish on our ability to operate through an uncertain macro outlook. As I like to remind our shareholders every quarter, Management is very highly aligned with you as we own over 50% of System 1. We have navigated business cycles in the past and this one will be no different.

Operator

Our team is doing much more with fewer people, and we are set up well as the cycle turns. And while the past year has not been the public debut that we envisioned. We are in this for the long haul and hope you are with us for the ride back up. I'll now hand things off to Triti to discuss the quarterly results in more detail as well as updated guidance. Take it away, Triti.

Operator

Thanks, Michael. Thank you

Speaker 1

everyone for joining us today. Overall, our financial results were varied, with the subscription and network advertising businesses delivering year over year growth. But that growth was more than offset by year over year declines in our owned and operated advertising businesses. That being said, we continue to be bullish on the future payback of the investments we have been making on our ramp platform throughout the past quarters and believe we are poised to be at the forefront of a rebound in advertising marketplaces. Revenue was $147,000,000 as compared to $220,000,000 last year, a 33% decrease year over year.

Speaker 1

The year over year decrease is primarily driven by the owned and operated advertising business, which is down 51%, while network advertising revenue was up 3% and subscription revenue was up 18%. Adjusted gross profit was $53,000,000 down 21% year over year. Revenue less advertising spend for the owned and operated advertising segment declined 25 percent to $28,000,000 while subscription revenue less acquisition spend was down 22 year over year to $17,800,000 versus $22,900,000 last year. This was impacted mainly by increased marketing spend of $12,500,000 year over year. Network revenue less agency fees was up 6% to $14,800,000 versus $13,900,000 last year.

Speaker 1

Continuing a trend we have been seeing throughout the year, both CPS and RPS cost per session and revenue per session were down sequentially. In Q2, RPS was down $0.01 sequentially to $0.09 per session, while CPS was also down $0.01 to $0.06 versus $0.07 versus the last quarter. As a result, we maintained our spread between revenue per session and cost per session at $0.03 On the network advertising business, RPS remained flat at $0.03 per for Sesh. Our subscription business performed well with billings up 17% year over year to 54,200,000. Subscriber ARPU was $20 in the period, roughly flat year over year.

Speaker 1

Total subscribers at June were just under 2,800,000, reflecting a 7% quarter over quarter increase and a 21% increase year over year. We deployed $32,400,000 towards new acquisition, up 63% year over year. We acquired 557,000 new users at a CTA of $58 down year over year from $62. At the start of Q3, we started to see some headwinds in the business with our total customer acquisition marketing spend increasing significantly. I will discuss the implications of this trend later in my remarks when discussing guidance.

Speaker 1

Operating expenses net of add backs were $38,700,000 up 17% year over year, which is reflective of increased accounting and consulting costs associated with the extended audit and financial statement reclassifications. We expect our operating expenses to revert back to the same quarterly levels we saw in the second half of last year, starting with Q3. Adjusted EBITDA was $14,600,000 versus $34,000,000 last year, down 57% year over year and representing a 27% margin on gross profit. In late July, we had a network partner terminated by an advertising partner. And as a result, we're charged in ad credit for the platform revenue generated by the partner during the look back period.

Speaker 1

The net impact on adjusted EBITDA was negative $3,300,000 which represents the amount paid to us by our advertising partner, less any rev share payments to partners that we recovered. Outside of this adjustment, we would have delivered EBITDA within our guidance range. With respect to liquidity, We ended the quarter with $26,200,000 of cash on the balance sheet, of which $8,600,000 was unrestricted. Gross debt was $430,000,000 which includes the full revolver drawdown of $50,000,000 and $5,000,000 of our new $20,000,000 revolver from April drawn. At quarter end, our LTM billings based EBITDA as defined by our credit facility was $99,600,000 resulting in a net leverage ratio of 4.2 times.

Speaker 1

As Michael discussed, we are laser focused on cost structure and also liquidity. While we have already taken several steps throughout the year to improve our cost structure, we're continuing to develop plans for future cost reduction measures to address our forecasted production in future cash flows and reduce the company's leverage ratio. Now on to guidance. Given we are still early in Q3 and do not yet see the expected ramp we would normally see in advertising markets this time of the year. We are not guiding to Q3 specifically, but instead we'll be providing guidance for the back half of twenty twenty three in total.

Speaker 1

Our guidance assumes current levels of advertiser demand continue throughout the year, including the current headwinds we are seeing in our ability to scale advertising spend. On advertising, we expect to see a continuation of the RPS and CPS trends we have seen all year, with RPS and CPS either flat or declining in tandem and ramp maintaining our spread in the $0.03 to $0.04 range on a per session basis. This will also translate to advertising spend being in line with Q2 for the back half of the year, and we expect to deploy approximately $100,000,000 in Q3 and Q4 versus $200,000,000 in the second half of last year. We expect our network advertising business to continue to deliver significant growth with over 60% growth year over year in the second half on network revenue. On the subscription business, as a result of the increased customer acquisition costs I described earlier to start Q3, we expect to spend over $70,000,000 in customer acquisition in the second half of the year versus $48,000,000 last year.

Speaker 1

We are estimating second half revenue to come in between $289,000,000 $297,000,000 representing a 24% year over year decline at the midpoint. We are estimating gross profit to come in between $100,000,000 $105,000,000 representing a 16% decline year over year at the midpoint. We are estimating adjusted EBITDA to come in between $35,000,000 $40,000,000 Our EBITDA guidance for the back half of the year represents a 50% increase over EBITDA for the first half of the year, reflecting our forecast of the stabilization of owned and operated advertising, growth in the network advertising and realization of the benefits of our cost cutting measures. While our recent financial performance has been negatively impacted by market conditions, We have a proven business model with a track record of performing through volatility. In the short term, we will continue to streamline our cost structure, while investing in and deploying our resources against our most compelling opportunities.

Speaker 1

We have been prudent stewards of capital historically, and we expect to be able to continue delivering adjusted EBITDA, operating cash flow and margin expansion in the short term, while managing liquidity needs and without compromising our future success.

Operator

Well, thanks everybody for joining us. We're glad that we're getting back into a regular cadence of communicating with you and look forward to having you join us for our Q3 earnings call. Thank you.

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Earnings Conference Call
System1 Q2 2023
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