System1, Inc. (SST) Earnings Call Transcript & Summary

All right. I think we're going to go ahead and get started. I'm Stephen Ju from the Crédit Suisse Internet equity research team. Joining me on stage is Michael Blend, the CEO of System1; and Tridi Kidambi, who is the CFO, as well. So I think -- before we get to the Q&A, I think we're going to run through some slides here. I think, Michael, so yes, why don't you kick it off, and it's in your hands.

All right. First of all, thanks for having us. It's been an enjoyable conference so far. And thanks to everybody tuning in. I'd like to introduce you a little bit to System1, run through what we do as a company. So System1 operates one of the largest digital marketing platforms on the planet, a platform that we call RAMP. We use RAMP to power two primary business lines. One of them is a suite of consumer subscription products, where we've got over 2 million paying subscribers. The second one is an advertising-focused business where we work with large pay-per-click networks like Google and Microsoft and Yahoo! to extend the reach of their advertising networks by acquiring customers for them. A quick look at some of our financial KPIs. Tridi, you can go into more detail later, if you want, but we've got over $800 million of revenue this year, close to $260 million of adjusted gross profit as we're forecasting rolls into about $130 million of adjusted EBITDA. And then on the subscription side, we've got over 2 million subscribers paying us, as I described earlier. A little bit about RAMP, our marketing platform. So what RAMP does is it's similar to advertising platform like Trade Desk, where it plugs into any of the possible advertising networks like Pinterest, Google, Facebook, Snapchat, really anywhere that you can acquire customers at scale. We've got APIs directly into those networks. And we advertise across hundreds of different advertising verticals. So on the left side of the slide, you can see where -- our revenue is pretty much split, basically tracks the economy. Health care, finance being our -- couple of our biggest verticals, but we're advertising hundreds of different advertising verticals. And then on the buy side, where we're buying advertising, again, we buy wherever you can really effectively buy advertising that could be search engines, places like Pinterest, social networks like Facebook, really wherever there's going to be volume of consumers. A little bit of [indiscernible] slide on RAMP. We operate at huge scale, as I mentioned. We've got over $0.5 billion of advertising spend that we're managing through our RAMP platform. And we've got close to 200 million monthly visitors into our network. So we're one of kind of the largest Internet companies that you may not have heard of. We're not a household brand name. But when you kind of lift the covers, we've got enormous scale. And then really quickly, how our actual platform works, and this is a very simplified version of it. But if you look at kind of the first one, which is Unlock, what we're doing is we're putting advertisements in front of consumers. It can be for a variety of different verticals. It might be an advertisement for a home security system or do you want to buy a 2023 SUV, could really be for health care products, whatever. As I said, hundreds of verticals. When people click on an advertisement, what we do is something a little bit counterintuitive. Typically, what advertising-focused companies would do is there's a click on an ad and the user goes directly to the advertiser. We don't do that. We put a filter in place. And what that filter does -- this is the Refine, #2, if someone clicks on an advertisement, they come into one of our websites, and we further refine their intent. And what that means is you may see an ad for a home security system and that triggers a potential desire for -- to purchase a home security system. Instead of sending you directly to someone like an ADT, you've come to one of our websites and read an article on home security systems, maybe read reviews of the various security systems out there. And after you read an article and then you do another call to action, which might be like I'm interested, the consumers flagging an interest, at that point, we're either sending the consumer to our own products, so the subscription products I mentioned, or what we're doing is we're calling in advertisements from Google and Bing and Yahoo!, and the consumer has been clicking on those advertisements. And the reason why that interim step is important because if you think about how people go to Google is because they've already come up with the desire to purchase something. They go to Google, enter in a search and they see an advertisement related to that search. What we're doing with our entire process is we're triggering your intent. So you may not be in market for a 2023 SUV, but then you'll see an ad for that, come to our website, read an article, reviewing all the 2023 SUVs. At that point, when you've done a couple of different actions, you look a lot like someone that's gone directly to Google and search for 2023 SUV. And that's why the big networks rely on us to drive more customers through their ad network. A couple -- go through quick growth strategies on our advertising and subscription side. On the advertising side, pretty straightforward. We've got a brand-new, upgraded RAMP platform that we can talk about later in the Q&A, but it's showing really good margin improvement so far. We've just rolled it out over the last couple of months. And so we're pretty excited next year that we're going to have increasing, better margins. There are certain areas where we're not really hugely -- we consider ourselves under-indexed. These are areas like Amazon shopping. We don't play in that -- in the Amazon ad ecosystem. Other areas like international, where we believe there's a lot of room to scale, but we're not yet at scale. And then on the subscription side of the business, it's actually pretty straightforward. What we do is we look at large subscription -- consumer subscription categories. And typically, our playbook is we will create a product in that category, something that's kind of already a big category. We'll create a product that's as good as the incumbents and then use our marketing platform and a CRM platform that we have to scale the business. And an example of how that works is we have almost 2 million subscribers in our antivirus suite, software suite, that competes with like a Norton. That business for us did not exist 5 years ago. So there are already a lot of incumbent players in the antivirus software market. By using our network, by using our platform, we've been able to scale that to a couple of million subscribers. And what we're doing in subscription is we're continuing to -- we're continually rolling out new subscription products. And as one starts getting a little bit mature, so TotalAV, which is our antivirus product, has kind of reached maturity. The next products are coming on and scaling behind them. So you can kind of see the RAMP that we have here. And then lastly, I would like to talk briefly about M&A. We've done over 10 acquisitions in our lifetime. We have very specific kinds of things we like to acquire. We love founder-owned businesses with kind of uncomplicated cap tables. We like to reach out to founders and convince them of the strategic benefits of selling to us. And we like technology things that we can plug and play into our platform. We've been highly successful with M&A, and we've done three acquisitions this year since we went public. And we're kind of waiting for the M&A market, too. As the markets have slowed down a little bit overall, we're waiting for pricing to come down and our targets, and we think we'll be picking up M&A again next year. And I'll just leave you with some investment highlights, and then we can move on to the Q&A.

Awesome. So yes, let's just kick off the questions here. So who exactly are your competitors then? And maybe the other angle is what is the #1 macro trend that is influencing your business investments today?

Yes. So on the competition side, on the subscription business, in particular, I'd mentioned Norton, NortonLifeLock, which is -- we really hold them out. They're pretty scaled business. We're growing a bit faster than they are and taking market share. But we view them in the privacy and security space as a competitor of ours. On the advertising side, the way we think about it is we've got an at-scale marketing platform. And so we look at the other platforms where people buy a lot of advertising through as the places that we compete with. We threw that in like Trade Desk, which is really good in the open web. They've got an at-scale marketing platform. Then we look at companies like an AppLovin where they're at scale in the mobile app marketplace and got good technology that we think is comparable to us.

Got it. Let's go back to the RAMP slide. That was pretty good. I think that was Slide 6.

You had mentioned what we're excited about. Let me find that for you. We've been leaning into privacy. And so about 5 -- 4 or 5 years ago, we started making investments in the AV market. We bought a private search engine called Startpage, which is the second largest private search engine in the world behind DuckDuckGo. And what's great about our RAMP platform is we're not dependent on third-party cookies. Let's call it a first-party data platform. And part of our secret sauce, as I mentioned, is when people click on our ads, they come to our website. And the point when people -- someone hits our website, we're gathering first-party data on that. And so we're all-in on privacy, and the quicker that -- we were happy to see Apple roll out its changes, privacy-related change. We actually wish Google would accelerate theirs as well. They've kind of put off some of the changes they've been making to eliminate third-party cookies to 2024. That will be a nice growth driver for us as well.

Got it. Now for the RAMP business, I mean, obviously, it's at the center of your product suite. So are there other markets where this could be applicable in terms of adjacencies?

Yes. Absolutely. I mean, as I mentioned, one adjacency, which is kind of in our sweet spot, is continuing to roll out subscription products, right? So we just plug subscription product into RAMP, and it tends to scale pretty nicely. The other areas where RAMP will work really well that we're not big in right now, I mentioned AppLovin. We do very, very little in the app world. So we don't do much in terms of helping people generate app downloads. I mentioned Amazon as well. The exact same platform we have will morph into the Amazon network. We're not in there. CTV is another area where -- a lot of talk about CTV. We don't currently play in CTV. Our experience has been when new markets come -- new app markets come out like CTV, typically, the branded advertisers come in. They lead the way. There's really not a very good tracking in terms of performance for new ad markets, but it always does happen. So as CTV is growing and getting a little more mature and as you can start tracking performance from your advertising spend, we'll be charging hard in the CTV.

Okay. Got it. Now can you break down the current makeup of your revenue between advertising and subscription? I suppose as you go forward, the subscription theoretically will become a greater part of deal overall, but how would this trend over the next 5 years or so? And I guess what are the key initiatives in both lines to help you achieve that goal?

Yes. Sure. I mean Tridi can talk about it. But on a macro sense, subscription is growing pretty fast for us right now. Tridi, talk about -- we tend to look at things more on a contribution basis instead of revenue, but go ahead, Tridi.

Yes. So right now, the subscription business is roughly 40% of our operating contribution and growing fast per Michael's point. We expect in 4 to 5 years for it to be the majority of our operating contribution.

Okay. Got it. Now between the two businesses, though, like what do you view as your competitive moats against not only competitors but also new entrants that are coming into your markets?

Yes. Sure. So if you talk about on the advertising side specifically, so our RAMP platform, I can't stress this enough, we've got over $0.5 billion in marketing spend flowing through that right now. But we've also got it in hundreds of different advertiser verticals. So millions of different customer sessions coming in every day, and we're constantly, in a very automated way, adjusting pricing and adjusting what our advertisements look like and popping between different verticals. Quite hard to do what we're doing at a scale, very hard to get into as a new entrant. So we don't really think about like new entrants coming behind us because you've got 10 years of learning to get into that. So we're not too worried. So that's a pretty big competitive moat for us. On the subscription side of the business, again, we've got our RAMP platform that's very hard to replicate, but we also have a little bit of a secret sauce, which is our CRM platform. And what the CRM platform means in the context of subscription, this is the way that we communicate with customers to do things like handle their renewals, to handle their upselling to other products that we have. And as we're getting bigger and bigger and a bigger customer base, we're able to upsell better and more efficiently. So both of our businesses quite hard to compete with us because we've already got scale on both those sides. Anything you want to add, Tridi?

Yes. I think that's right. And certainly, just we're also very much a technology company, and that moat around the technology on both sides is just really hard to replicate.

Yes. And speaking of, I guess, like 10 years of learnings, right, just going back to the RAMP slide here, which is Slide 6, I guess, on the refine part of it, I guess you're more highly qualifying the traffic that you're getting so that you serve your advertisers, right, and these other platforms with more highly qualified leads. So I guess that's -- it sounds like something that kind of improves over time. So -- and I guess that's going to be very difficult even if people were to throw the R&D budgets at it.

It's -- well, it's a great point. So one thing I didn't mention -- so if you look at our relationship with Google, on the buy and sell side combined, we're generating over $1 billion of revenue for Google a year. We're one of their largest partners. I think we're the second largest behind Apple in terms of revenue generation for Google. But when you think about the relationship with us, they're relying on us to send customers through their advertiser network. And so there's a lot of trust that they place in us to make sure that the customers are very qualified before they get to the ultimate advertiser that's paying the money to Google, and Google shares the money with us. And so I personally, through various companies, have been working with Google in this capacity for almost 2 decades. But System1, our current company, we're about a decade into that relationship with Google and being in Yahoo!. And so our technology is 100% designed to make sure that the consumer is qualified by the time they actually get to Google or get to Bing and Yahoo!. And so when you think about what that takes, you have to have really, really sophisticated targeting on the buy side. So the ads have to look great. They've got to be targeting the right cohort. But then you also have to have this network of websites that we own and operate. So we're not -- we don't consider ourselves to be a publisher per se, but we're not dependent on people using our websites organically. But what our websites do is they operate as a filter to make sure that intent is going to be there before, ultimately, the consumer gets to Google. So you've got to have RAMP platform. You've got to have a decade of knowledge in all the verticals, but you'll not know how to qualify the intent.

Yes. I think you brought up international earlier, and it's almost an untapped opportunity for a lot of advertising companies, advertising platforms. I mean it's like 50-50, if not greater, contribution from international. So talk about the opportunity there. Like what do you -- it can't be just so simple as copy and paste. Otherwise, you would have done it already. So what do you need to get there? And what are the challenges that you need to overcome to unlock the international opportunity?

Yes. So we're roughly about 20% international on a revenue basis right now. We think that should be north of 40%. Our short-term goal is north of 30%, but ultimately, as you said, you can make the case for us to be 50-50, domestic, international. What's great about our platform is so it's not a copy and paste. But our platform itself is easily transferable into international markets. And so what we do is we don't have people in the countries, but what we're doing is we're taking our advertisements, we're translating them into typically a foreign language. Some of our international countries are also English as well, but typically a foreign language. We're translating our content. And so it matches the advertisement. And then because we work with the large networks like Google and Bing, they already have liquidity on the advertiser side. So we're able to call in their international advertisers. And we have been actually -- our 20% is up from roughly 0 a few years ago. So we pretty methodically are going into new international markets. We first started tackling the international markets that were English-speaking, easier for us, frankly, places like large parts of India, Australia, the U.K. We're now in process of going into more of the Asian countries and also the EU is a big target of ours. But the nice thing is that we can go into those countries without a lot of CapEx to get into there.

Sorry, if I could just add two points. The other thing that because we're not a publisher, our content scales really nicely as well. So we don't need to translate an entire website into the country. We can translate specific articles and drive literally millions of dollars of marketing to one article, which helps us scale that quicker as well.

Yes, just -- and the ad copy as well. So is there -- I guess, looking at the advertising side of things and the subscription side of things, is the mix different between domestic and international?

The subscription business is a little bit more heavily weighted towards international. The team is actually based in England. So they've been -- there is a fair amount of U.S. subscribers, but I think they're more kind of 35%, 40% international right now. And on a blended basis, the company is roughly 23% internationally.

Got it. I can't let you guys leave without asking the macro question because that's on everybody's minds, right? So we've had a pretty, I guess -- I don't know if I'm trying to be diplomatic about it, but it's a dynamic environment, starting with the pandemic. And now we're staring at the recession or potential recession in the face. So what do you see as the current state of the market right now? And what have you learned as you kind of like start to move through the cycle?

Yes. So first, I'd like to go back and talk about the COVID years or like the pretty 6 months -- dramatic 6 months when everybody went into lockdown and then things kind of came back out. So what we saw during that time was a couple of things, interesting dynamics on our advertising and subscription businesses. We saw the advertising business took a very quick downturn in April first, basically, 2020. Our system -- the way our system works is if advertising markets go down, typically, our pricing on the buy side is going to follow that down. And while we don't see margin compression, in some cases we see margins increase, what we'll see is lower consumer demand, lower volume. So the advertising business will go down or flatten out, maintains profitability while at the same time during COVID, when that happened, we saw our subscription business went through a huge boom. The most customers we've ever seen come in during -- on the subscription side. What we see now, I think, dynamic environment is one way of putting the ad markets. But what we definitely saw happen kind of rolling into the end of summer and September and onward was a little bit unexpected behavior in the ad markets. I think a lot of people are reporting this. Typically, what you'll see rolling towards the end of summer through the end of the year is a pretty sustained uplift. So people come back from their summer vacations, go to school, and you literally see the ad markets kind of go like this. We didn't see that in the last couple of quarters. What we saw was things kind of stay about the same, which was unexpected for us. Hot off the press is real time, thankfully. As Black Friday hit, and we're starting to see shopping, we have seen the boost that we would have expected. So people are still buying things, which is nice, definitely coming off of a lower base. So what we've seen in the last couple of quarters is actually matches pretty closely with what we saw during COVID, where the -- our advertising business hasn't -- it basically started to flatten out. We've adjusted to reduce consumer demand, we lowered pricing, our margins are ticking up on advertising, but we're not really seeing the volume we would have expected, while at the same time we're seeing our subscription business start to post some of the biggest numbers we've seen since the heyday of COVID.

Why is that?

So for us, particularly, it's a little bit different reason from during COVID. In COVID, people were home on their desktop computers. They all wanted to buy security products. So that was a big boost. What we're seeing now is as ad markets kind of -- are a little bit wonky overall, pricing is kind of maybe going up but going down in some markets. Our subscription business because we know what we make when we acquire a new subscriber, we've maintained our pricing on the subscription side. And so we're actually, call it, a more effective advertiser. If this is our pricing on subscription, other people come down, we're a better advertiser at that point, which is -- it's like the heyday for us on subscription. What we expect to see kind of going in -- we'll wrap up Q4, which is going to, I think, be fine for the next few weeks, we hope to see stability in pricing on the advertising side. Stability is really good for us because we can then figure out exactly where to scale up spin. And that's what we would hope to see kind of entering 2023.

Got it. Now just to put a finer point on it, so the margin percent might be the same or increase. But since the overall, the pool of dollars are coming down, so you end up with less profit dollars, I guess.

And you'll also see a shift on the consumer side into some of the lower-paying verticals. So we may, like -- for instance, right now, finance and health are down a little bit for us. Those are particularly higher-paying categories. They may be lower margin for us but higher gross profit. So as consumers shift into different verticals, there will probably be higher margin for us but a little bit lower total gross profit.

Got it. Now I think you touched on M&A earlier, so I think System1 has historically been pretty acquisitive, right? So what do you look for in an acquisition candidate? And how does this overall gel with the capital allocation strategy?

Yes. So we typically, on acquisitions, look for two different areas. We look for bolt-on acquisitions that can improve our technology platform. The other areas we're looking for, areas that we're not currently in, where we can acquire some expertise to get into there quickly. Very often, we're approaching founder-owned businesses, I think as I mentioned. We don't love being in auctions. More power to all the investment bankers out there, but when you're the highest bidder in an auction, that's not always the best sign. So we like to reach out directly to founders in categories that are specific, that are strategic for us to go after. A couple of good examples. I think I've mentioned Startpage, which is a private search engine. That was founder-owned, very uncomplicated cap table. We were the only bidder for the company. And it took us 2 or 3 years to actually get that company under wraps from the time that we acquired it. We will buy under-managed assets that are owned by public companies. We bought MapQuest from Verizon. At the time we bought it, like I mentioned, quite under-managed. We replaced management a bit. We changed the technology stack, [ steadied up, sort of layering on ] marketing. And both those are examples where areas -- where we wanted to get into private search. We bought a company that was already in there and then we wanted to get into more localized advertising, so we bought MapQuest to get in there. And then obviously, our biggest acquisition to date was Protected, which was a subscription business we bought. We took a majority investment in them in 2018, but we thought it was really important. We had this great advertising platform that was making a lot of money for advertisers and for Google and all of our partners. We wanted to basically be our own advertiser and start marketing our own products. And the best way to do that was via acquisition.

Okay. Got it. Now in the few minutes that we have left, so let's jump in a time machine, and we're sitting up here again a year from now. It's December, and we're looking backwards at what we've been able to accomplish in 2023. So what do you think we'll be talking about in terms of what you've done or accomplished?

Yes. So a couple of different areas I mentioned. So we spent the latter half and, basically, the first 9 or 10 months of 2022 essentially working on a major upgrade to our RAMP, to our marketing platform. And we begin rolling that out over the last couple of months. And we're -- it's pretty much completely rolled out across our network right now. I think we're going to look back on 2023 and be like, wow, that was an amazing transition that we had. Our platform is allowing us to pretty quickly get to better scale, and we would expect to see margins tick up. We think our push into international is going to continue really like clockwork. And then I think we're going to have another couple of big subscription products out there. So we -- right now, we publicly announced this, we've got already one subscription product, our TotalAV, antivirus suite over 1 million subscribers. We've got an ad-blocker product, which is almost on the exact same path as TotalAV. I would expect that will be over 1 million subscribers at the end of 2023. But we'd also like to have a couple more subscription products on that path. And we publicly announced 3 or 4 years from now, we want to have 10 products, subscription products with over 1 million subscribers each. We'd like to feel at the end of 2023, we're on the path to get there.

Got you. All right. So I guess, last one to kind of just tack on. I think it seems like most of the technology is built and the work to expand it to the international markets is translation for the most part. So that -- the optimist in me wants to believe that that potentially could be a higher-margin business versus domestic, right, as a lot of the costs are probably deprecated already. So am I thinking about that correctly? Or are there other factors that we should be thinking about?

So in general, we expect -- well, in general costs, we expect to kind of maintain the current level that we're at. So we don't expect we're going to have a lot of OpEx increase. Obviously, as gross profit rolls in and increases, that's going to positively affect our numbers. But as far as international goes, you are correct, international is a little bit, I would say, less liquid, a little bit messier advertising markets than domestically. We do see, as we go international, the opportunity to see increased margins, better margins in there. One thing with a caveat, when we enter new advertising markets, we typically are entering at lower margins because we're doing what we call exploration. So the way that works is, let's say, we're going into the French -- in France, it takes us a month or two to figure out the French market. So as we're going in there, we're doing -- we're spending money to figure it out. Once we figure out a market, margins expand. But I think you're right, the -- I'm an optimist, too. But we -- the actual facts show that international could be a higher-margin business for us.

Got you. So with that, I think we're out of time, and we're going to wrap up. Thanks, gentlemen, for joining us and best of luck for the coming year.

Thank you so much for having us. Appreciate it.

Awesome.