Introduction

System1, Inc. (NYSE: SST) is an omnichannel customer acquisition marketing platform that has emerged as a versatile and resilient player in the digital advertising landscape. With a strong focus on technology, data science, and privacy-centric solutions, System1 has carved out a unique niche for itself, weathering industry challenges and positioning itself for long-term growth.

Company Origins and Evolution

The company's origins can be traced back to its founding in 2011, when it set out to revolutionize the way businesses acquire and engage with customers. Over the years, System1 has evolved from a specialized online marketing firm into a comprehensive platform that combines cutting-edge technology, proprietary data, and strategic partnerships to deliver effective and efficient customer acquisition solutions.

Core Technology: RAMP

At the heart of System1's success is its Responsive Acquisition Marketing Platform (RAMP), a sophisticated technology that leverages artificial intelligence and machine learning to optimize the customer acquisition process. RAMP operates across multiple advertising channels and verticals, enabling the company to efficiently match consumer demand with the appropriate advertiser or advertising experience.

Business Model and Segments

One of System1's key strengths is its diversified business model, which includes two reportable segments: Owned and Operated Advertising (OOA) and Partner Network. The OOA segment focuses on the company's owned and operated websites, such as the private search engine Startpage, the mapping solution MapQuest, and the promo code website CouponFollow. These organic, high-intent user platforms have proven to be resilient, accounting for a significant portion of System1's overall revenue and gross profit.

In the third quarter of 2024, the Owned and Operated Advertising segment generated $70.80 million in revenue, up 7% year-over-year. The segment's adjusted gross profit, which excludes depreciation and amortization, was $26.41 million, up 11% compared to the prior year period. This increase was driven by a remarkable 118% year-over-year increase in Owned and Operated Advertising sessions to 2.00 billion, partially offset by a decline in Owned and Operated Advertising revenue-per-session (RPS) from $0.07 to $0.03. The surge in sessions was attributed to the integration of new traffic acquisition sources into RAMP, while the decline in RPS was related to a mix shift to lower RPS traffic and softening of domestic advertiser demand.

The Partner Network segment generated $18.03 million in revenue for the same quarter, down 17% year-over-year. The segment's adjusted gross profit was $13.05 million, down 15% compared to the prior year period. These decreases were primarily due to a decline in Partner Network revenue-per-session (RPS) from $0.02 to $0.01, despite a 156% increase in Partner Network sessions to 2.30 billion. The year-over-year decline in RPS was due to a softening of domestic advertiser demand and instability in the Advertising Partner ecosystem.

Strategic Acquisitions: MapQuest

In 2019, System1 made a significant move by acquiring MapQuest from Verizon. At the time of acquisition, MapQuest was a declining brand with little investment from its previous owner. However, System1 successfully revitalized the brand by migrating it to their own technology stack, introducing new features and points of interest, and enhancing the mobile apps. This effort has paid off, with MapQuest recently experiencing its highest traffic days since the acquisition.

Partner Network Segment

The Partner Network segment is focused on monetizing end-user traffic that System1 acquires through various advertising channels and partners. This diversification has allowed the company to weather fluctuations in the advertising market, as the performance of its owned and operated products has often offset the volatility experienced in the partner-driven segment.

Financials

System1's financial performance has been a mixed bag in recent years, with the company navigating a challenging macroeconomic environment and industry-specific headwinds. In fiscal year 2023, the company reported revenue of $402.0 million, a gross profit of $153.3 million, and an adjusted EBITDA of $29.2 million. While these numbers reflect a year-over-year decline, they also highlight the resilience of System1's business model and its ability to adapt to changing market conditions.

For the most recent quarter (Q3 2024), System1 reported revenue of $88.83 million, up 1% year-over-year, and a net loss of $30.64 million, which represents an 18% increase in net loss compared to the same period last year. The company's operating cash flow for the quarter was negative $5,000, while free cash flow improved to $3.18 million.

It's worth noting that System1 exceeded its guidance for Q3 2024 across key financial metrics. The company reported adjusted EBITDA of $10.3 million, which was above the high end of their guidance range. Revenue of $88.8 million was $800,000 above the high end of their Q3 revenue guidance range, and adjusted gross profit of $37.7 million was above the midpoint of their Q3 guidance by $700,000.

Challenges and Adaptations

One of the key factors impacting System1's performance has been the volatility in the Google Search Partner Network (SPN), a significant revenue source for the company. As Google has implemented various policy and product changes to improve the quality of its advertising network, System1 has had to navigate the resulting fluctuations in pricing and traffic quality. However, the company's investment in its RAMP platform, including the integration of advanced AI and machine learning capabilities, has enabled it to better respond to these challenges and maintain its competitive edge.

Future Strategies and Growth Initiatives

Looking ahead, System1 remains focused on strengthening its technology, expanding its product portfolio, and diversifying its revenue streams. The company's recent acquisition of MapQuest, a well-known mapping solution, and the launch of its private search engine and mapping app initiatives, are examples of its efforts to bolster its owned and operated offerings and enhance its value proposition to both consumers and advertisers.

System1 is also expanding its international presence. In Q3 2024, approximately 35% of owned and operated revenue came from international markets, up from 24% in Q3 2023, with significant operations in Canada and the Netherlands.

Liquidity

System1's financial position remains stable, with $69.09 million in cash and a $50 million available credit line on its 2022 Revolving Facility. The company's current ratio and quick ratio both stand at 1.36, indicating its ability to meet short-term obligations. However, the debt-to-equity ratio of 2.92 suggests a relatively high level of leverage, which the company is working to address.

Moreover, System1's strategic decision to divest its Total Security business in 2023 has provided the company with a substantial cash infusion of $240 million, which it intends to leverage to fuel its core advertising business, improve liquidity, and reduce its debt burden. This move aligns with the company's focus on its strengths and its commitment to driving long-term growth and profitability.

Outlook

Due to ongoing volatility and uncertainty in the market, System1 has decided not to provide financial guidance for Q4 2024 at this time. The management team stated that if they see improvements in stability, they may revisit the possibility of offering guidance later in the quarter. This cautious approach reflects the company's prudent management in the face of market uncertainties.

Conclusion

Despite the challenges faced by the digital advertising industry, System1 has demonstrated its ability to adapt and innovate. The company's diversified business model, investment in technology, and strategic decision-making have positioned it as a resilient player in the market. As the industry continues to evolve, System1's focus on privacy-centric solutions, data-driven insights, and organic growth opportunities may well serve as the foundation for its future success. The company's ability to exceed its own guidance in Q3 2024 is a positive sign, although the decision to withhold Q4 guidance underscores the ongoing challenges in the digital advertising landscape. System1's continued investment in its RAMP platform and its efforts to expand internationally and diversify its revenue streams suggest a forward-looking strategy aimed at long-term growth and stability.