System1, Inc.: Form 10-Q for the period ended Mar 31, 2024

SYSTEM1 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless otherwise indicated or the context otherwise requires, references in this section to “the Company,” “System1,” “we,” “us,” “our” and other similar terms refer to System1, Inc and its subsidiaries.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ending December 31, 2023. In addition to historical information, the following discussion and analysis contains forward-looking statements. Our actual results may differ significantly from those projected in such forward-looking statements. Factors that might cause future results to differ materially from those projected in such forward-looking statements include, but are not limited to, those discussed in the sections entitled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”

References to “Notes” are notes included in our unaudited condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q. The condensed consolidated financial statements as of and for the quarter ended March 31, 2023 have been revised to correct prior period errors as discussed in Note 2, Summary of Significant Accounting Policies. Accordingly, this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations reflects the impact of those revisions.

Company Overview

We operate an omnichannel customer acquisition platform, delivering high-intent customers to brands, advertisers and publishers.

We provide our omnichannel customer acquisition platform services through our proprietary responsive acquisition marketing platform (“RAMP”). Operating seamlessly across major advertising networks and advertising category verticals to acquire high-intent end-users, RAMP allows us to monetize these acquired end users through our relationships with third party advertisers and advertising networks (“Advertising Partners”). RAMP operates across our network of owned and operated websites, allowing us to monetize end-user traffic that we source from various acquisition marketing channels, including Google, Facebook, Zemanta, Taboola, and TikTok. RAMP also allows third party advertising platforms and publishers (“Network Partners”) to send end-user traffic to, and monetize end user traffic on, our owned and operated websites or through our monetization agreements.

Through RAMP, we process approximately 244 million daily advertising campaign optimizations and ingest over 10 billion rows of data daily across approximately 40 advertising vertical categories as of March 31, 2024. We are able to efficiently monetize user intent by linking data on consumer engagement, such as first party search data like traffic sources, device type and search queries, with data on monetization rates and advertising spend. This context-enriched data, combined with our proprietary and data science driven algorithms, creates a closed-loop system that is not reliant on personally identifiable information or information obtained through third-party cookies, but which allows RAMP to efficiently match consumer demand with the appropriate advertiser or advertising experience across advertising category verticals.

We focus on monetizing user traffic acquired by our Network Partners. Since launching, it has expanded to support additional advertising formats across multiple advertising platforms, and has acquired several leading websites, enabling it to control the entire flow of the user acquisition experience, by monetizing user traffic through our network of owned and operated websites. As of March 31, 2024, we own and operates approximately 40 websites, including leading search engines like info.com and Startpage.com, and digital media publishing websites and internet utilities, such as HowStuffWorks, MapQuest, CouponFollow and ActiveBeat.

On June 28, 2021, we entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), (“Business Combination Agreement”) by and among us, S1 Holdco,

LLC ("S1 Holdco") and Total Security Limited, formerly known as Protected.net Group Limited (“Protected”). On January 26, 2022 (“Closing Date”), we consummated the business combination (“Merger”) pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company was organized via an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco, and our combined business continues to operate through the domestic and foreign subsidiaries of S1 Holdco.

Our primary operations are in the United States; and we also have operations in Canada and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems as well as various political and economic environments. Among the risks are changes in existing tax laws, changes in the regulatory framework in foreign jurisdictions, data privacy laws, possible limitations on foreign investment and income repatriation, government foreign exchange controls, exposure to currency exchange fluctuations and employment laws impacting foreign employees. We do not engage in hedging activities to mitigate our exposure to fluctuations in foreign currency exchange rates.

As a result of the current uncertainty in economic activity, including geopolitical developments and other macroeconomic factors such as rising interest rates, inflation and the impact of earlier supply chain disruptions, we are unable to predict the size and duration of the impact on our revenue and our results of operations.

Sale of Protected

We completed the sale of Protected on November 30, 2023. The results of operations of our Protected business prior to its sale are presented as net loss from discontinued operations in our condensed consolidated statements of operations for all periods presented. Unless otherwise noted, the information contained in this Management Discussion and Analysis relates solely to our continuing operations and does not include the operations of our Protected business (see Note 12, Discontinued Operations).

Components of Our Results of Operations

Revenue

We earn revenue by deploying components of our Responsive Acquisition Marketing Platform (RAMP) to our owned and operated websites to acquire and monetize end-users via advertising offerings from our Advertising Partners. For this revenue stream, we are the principal in the transaction and report revenue on a gross basis for the amounts received from our Advertising Partners. Additionally, revenue is earned from revenue-sharing arrangements with our Network Partners, whereby our Network Partners acquire end-users and use RAMP to monetize those end-users via our relationships with Advertising Partners. We have determined that we are the agent in these transactions and therefore report revenue on a net basis, based on the difference between amounts received by us from our Advertising Partners, less amounts remitted to our Network Partners based on the underlying revenue-sharing agreements.

We recognize revenue upon delivering user-traffic to our Advertising Partners based on a cost-per-click or cost-per-thousand impression basis. The payment terms with our Advertising Partners is typically 30 days.

Revenue may fluctuate from period to period due to a number of factors including seasonality and the shift in mix of user acquisition sources from Advertising Partners.

We have two reportable segments:

• Owned and Operated Advertising ("O&O"); and
• Partner Network.

Operating Expenses

We classify our operating expenses into the following categories:

Cost of revenue (excluding depreciation and amortization). Cost of revenue (excluding depreciation and amortization) primarily consists of traffic acquisition costs, which are the costs to place advertisements to acquire customers to our websites and services, as well as domain name registration costs and licensing costs to provide mapping services to Mapquest.com. We do not pre-pay any traffic acquisition costs, and therefore, such costs are expensed as incurred.

Salaries and benefits. Salaries and benefits expenses include salaries, bonuses, stock-based compensation, and employee benefits costs.

Selling, general, and administrative. Selling, general, and administrative expenses consist of fees for professional services, occupancy costs and travel and entertainment. These costs are expensed as incurred.

Depreciation and amortization. Depreciation and amortization expenses are primarily attributable to our capital investment(s) and consist of property and equipment depreciation and amortization of intangible assets with finite lives.

Other Expenses

Other expenses consist of the following:

Interest expense, net. Interest expense consists of interest on our debt and the amortization of deferred financing costs and debt discount.

Gain from debt extinguishment Gain from the repurchase of a portion of our Term Loan indebtedness at a discount.

Change in fair value of warrant liabilities. The mark to market of our liability-classified Public Warrants.

Income tax benefit

We are the sole managing member of S1 Holdco and, as a result, consolidate the financial results of S1 Holdco. S1 Holdco is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, S1 Holdco is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by S1 Holdco is passed through to and included in the taxable income or loss of its members, including us, on a pro rata basis. We are subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income or loss of S1 Holdco, as well as any stand-alone income or loss generated by us.

Results of Operations

Comparisons of the Three Months Ended March 31, 2024 and 2023

The following table summarizes key components of our results of operations for the periods indicated (in thousands):

The following table sets forth our condensed consolidated statements of operations data expressed as a percentage of total revenue for the periods indicated:

Revenue and Cost Metrics

We use total advertising spend, number of Owned & Operated Advertising sessions (“O&O sessions”), number of Partner Network sessions (“Network sessions”), Owned & Operated Advertising cost-per-session (“O&O CPS”), Owned & Operated Advertising revenue-per-session (“O&O RPS”) and Partner Network revenue-per-session (“Network RPS”) to track our operations. We define total advertising spend as the amount of advertising that is spent by us to acquire traffic to our owned and operated websites. We define O&O sessions as the total number of monetizable user visits to our Owned & Operated Advertising websites. We define Network sessions as the number of monetizable user visits delivered by our Network Partners to RAMP. Monetizable visits exclude those visits identified by our Advertising Partners as spam, bot, or other invalid traffic. We define O&O CPS as advertising spend divided by O&O sessions. We define O&O RPS as O&O Revenue divided by O&O sessions. We define Network RPS as Network Partner revenue divided by Network sessions.

Revenue

The following table presents our revenue by reportable segment (in thousands).

Owned and Operated Advertising

Owned and Operated Advertising revenue decreased for the three months ended March 31, 2024 as compared to the prior year comparative period, primarily due to softening domestic advertiser spend. For the quarter ended March 31, 2024 compared to the prior quarter comparative period, sessions increased 183 million to 1,209 million from 1,026 million. RPS for O&O decreased by $0.04 to $0.06 from $0.10.

Partner Network

Partner Network revenue increased for the three months ended March 31, 2024 as compared to the prior year comparative period, due to our continued investment in this business and growth from newer partners that continue to generate more traffic to our platform. This was partially offset by softening advertiser spend, leading to a reduction in RPS. For the quarter ended March 31, 2024, compared to prior quarter comparative period, sessions increased 600 million to 1,048 million from 448 million, and Network RPS decreased by approximately $0.01 to $0.02 from $0.03.

Cost of revenue (excluding depreciation and amortization)

Cost of revenue (excluding depreciation and amortization) decreased in line with a decrease in O&O's revenue. For the three months ended March 31, 2024, compared to prior year comparative period, our CPS decreased $0.03 to $0.04 from $0.07.

Our chief operating decision maker measures and evaluates reportable segments based on segment operating revenue as well as adjusted gross profit and other measures. We define and calculate adjusted gross profit as revenue less advertising expense incurred to acquire users. The remaining cost of revenue consists of non-advertising expenses such as set-up costs, royalties and fees. We exclude the following items from segment adjusted gross profit: depreciation and amortization of property, equipment and leasehold improvements, amortization of intangible assets and, at times, certain other transactions or adjustments.

The following table presents our adjusted gross profit by reportable segment (in thousands).

Refer to the Revenue and Cost of revenue (excluding depreciation and amortization) discussions above.

Salaries and benefits

Salaries and benefits decreased for the three months ended March 31, 2024 as compared to the prior year comparative period, primarily due to a $1.9 million decrease in stock-based compensation and a $1.8 million reduction in salary expense due to lower headcount.

Selling, general, and administrative

Selling, general, and administrative expense decreased for the three months ended March 31, 2024 as compared to the prior year comparative period, primarily due to a $1.7 million decrease in advisory, consulting, and legal fees, and to a lesser extent insurance costs.

Depreciation and amortization

Depreciation and amortization expense increased for the three months ended March 31, 2024 as compared to the prior year comparative period, primarily increased amortization related to our continued investment in internally developed software.

Gain from debt extinguishment

Gain from debt extinguishment increased for the three months ended March 31, 2024 as compared to the prior year comparative period, due to the gain recognized as a result of our repurchase of debt through the Dutch auction that occurred in January of 2024.

Interest expense, net

Interest expense, net decreased for the three months ended March 31, 2024 as compared to the prior year comparative period, primarily due to a lower debt outstanding balance in the current year.

Change in fair value of warrant liabilities

The increase in fair value of our warrant liability for the three months ended March 31, 2024, as compared to the prior year comparative period was due to the remeasurement of warrant liability to its fair value at March 31, 2023 where the fluctuations are driven by the market value of our Class A common stock.

Income tax benefit

The difference between the effective tax rates for the periods presented and the federal statutory tax rate of 21% was primarily due to the exclusion of non-controlling income (loss), non-deductible expenses, valuation allowance and outside basis adjustments.

Net loss from discontinued operations, net of tax

Net loss from discontinued operations, net of tax is comprised of the net loss from discontinued operations, net of tax only includes direct operating expenses incurred that (1) are clearly identifiable as costs being disposed of upon completion of the sale and (2) will not be continued by us on an ongoing basis.

Indirect expenses which supported our subscription business, and which remained as part of the continuing operations following the sale are not reflected in loss from discontinued operations, net of tax.

Liquidity and Capital Resources

We expect existing cash and cash equivalents, cash flows from operations and financing activities to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for at least the next 12 months. Our main sources of liquidity have historically been, and are expected to be from cash on hand, cash flows from operations and financing activities. Our ability to fund future operating expenses and capital expenditures, and our ability to meet our future debt service obligations, will depend on our ability to execute on our operational strategy and may be affected by our profitability, as well as general economic, financial and other factors which are beyond our control.

We continue to develop and implement plans to improve our liquidity. Our main focus is executing on our operational strategy, which includes continued focus on expanding the number of advertising partners that are utilizing or integrated with RAMP by continuing to attract and monetize users with commercial intent on our owned and operated web properties and on behalf of our network partners as well as optimizing bids and driving higher returns on advertising spend. Additionally, we are focused on our current cost structure by reducing our cash operating expenses and debt service obligations. Adverse macroeconomic conditions have affected, and may in the future affect, the demand for advertising, resulting in fluctuations in the amounts our advertisers spend on advertising, which could have a negative impact on our financial condition and operating results.

As of March 31, 2024, we had unrestricted cash and cash equivalents of $69.9 million and $50.0 million available to borrow on our 2022 Revolving Facility. For the three months ended March 31, 2024, the Company had cash outflows from operations of $16.0 million. The principal drivers of our cash outflow from operations for the three months ended March 31, 2024, were cash bonus-related payments of $7.2 million primarily related to 2023 annual employee performance bonuses, $1.8 million of audit fees, $2.4 million of consulting fees, and interest paid on our Term Loan of $8.2 million.

Our revenue is dependent on two key Advertising Partners, which are Google and Microsoft. Refer to our concentration with customers discussion at Note 2, Summary of Significant Accounting Policies for additional information.

Credit Facilities

Term Loan

We entered into a new loan (“Term Loan”) and revolving facility (“2022 Revolving Facility” and, together with the Term Loan "Credit Agreement") with Bank of America, N.A. as administrative agent, on January 27, 2022, providing for a 5.5 year Term Loan with an initial principal balance of $400.0 million and with the net proceeds of $376.0 million. The 2022 Revolving Facility provided borrowing availability of up to $50.0 million. As of March 31, 2024, there was no balance outstanding on the 2022 Revolving Facility and principal of $296.3 million was outstanding on the Term Loan. Through December 31, 2025, $5.0 million of the Term Loan is payable quarterly. From March 31, 2026, $7.5 million of the Term Loan is payable quarterly. The Term Loan matures in 2027.

For every interest period, the interest rate on the Term Loan is the adjusted Secured Overnight Financing Rate (“SOFR”) plus 4.75%. The Term Loan is amortized in quarterly installments on each scheduled payment date. The Term Loan comes with a leverage ratio covenant, which goes into effect only if the utilization on the 2022 Revolving Facility exceeds 35% of the total availability under the 2022 Revolving Facility at each quarter-end starting the second quarter 2022, such that the first lien leverage ratio (as defined in the credit agreement) should not exceed 5.40. The Credit Agreement has certain financial and nonfinancial covenants, including the "springing" leverage ratio covenant described above. The Credit Agreement also requires that we deliver our audited consolidated financial statements to our lenders within 120 days of our fiscal year end, December 31. Should we fail to distribute the financial statements to our lender within 120 days, we have an additional 30 days to cure such default.

The 2022 Revolving Facility matures in January 2027, and accordingly, when there is a balance outstanding it is classified within long-term debt, net on the condensed consolidated balance sheet. The interest rate on the 2022 Revolving Facility is the adjusted SOFR plus 2.5% with an adjusted SOFR floor of 0%. As of March 31, 2024, there was no outstanding balance.

On January 17, 2024, we completed the repurchase of $63.7 million in principal amount of our Term Loan indebtedness or an aggregate purchase price of $40.9 million (at discount of 64.2% of its par value) pursuant to a Dutch auction tender offer. Following the repurchase, the outstanding principal amount of the Term Loan was $301.3 million. We used available cash on hand to fund the repurchase (see Note 5, Debt, Net).

We have been able to and expect to be able to continue to make the required payments of principal and interest on the Credit Agreement (as and when due) on a timely basis.

Cash Flows

The following table summarizes our cash flows for the periods presented (in thousands):

Operating Activities

Our cash flows from operating activities are primarily impacted by growth in our operations, timing of collections from our partner and related payments to our suppliers for advertising inventory and data. We typically pay suppliers in advance of collections from our clients and our collection and payment cycles can vary from period to period. In addition, seasonality may impact cash flows from operating activities on a sequential quarterly basis during the year.

In the three months ended March 31, 2024, cash used in operating activities of $16.0 million. The principal drivers of our cash outflow from operations three months ended March 31, 2024, were cash bonus payments of $7.2 million primarily related to 2023 annual employee performance bonuses, $1.8 million of audit fees, $2.4 million of consulting fees, and interest paid on our Term Loan of $8.2 million.

In the three months ended March 31, 2023, cash used in operating activities of $5.8 million resulted primarily from a net loss of $42.9 million, noncash deferred tax benefit of $7.9 million, an adjustment for the change in fair value of warrants of $1.4 million, a payment of long-term earnout liabilities of $10.0 million and a decrease in accrued expenses and other current liabilities of $5.1 million. This was partially offset by noncash items including depreciation and amortization expense of $29.4 million, stock-based compensation of $14.1 million, an increase in deferred revenue of $6.2 million, a decrease in accounts receivable of $11.3 million, and an increase in other long-term liabilities of $0.3 million.

Investing Activities

Our primary investing activities consisted of costs capitalized for internally developed software.

In the three months ended March 31, 2024, cash used in investing activities of $1.6 million resulted primarily from costs capitalized for internally developed software.

In the three months ended March 31, 2023, cash used in investing activities of $2.4 million resulted primarily from costs capitalized for internally developed software and purchases of property and equipment.

Financing Activities

Our financing activities consisted primarily of repayments of our indebtedness under our credit facilities.

In the three months ended March 31, 2024, cash used in financing activities of $48.2 million resulted primarily from repayment of the 2022 Term Note of $46.1 million.

In the three months ended March 31, 2023, cash used in financing activities of $9.1 million resulted primarily from repayment of existing term loan of $5.0 million, taxes paid related to net settlement of stock awards of $2.8 million, and payment of acquisition holdback of $1.3 million.

Off-Balance Sheet Arrangements

We do not have any relationships with entities often referred to as structured finance or special purpose entities that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We did not have any other off-balance sheet arrangements during the periods presented other than the indemnification agreements.

Contractual Obligations and Known Future Cash Requirements

Service Agreements

In June 2021, we entered into a multi-year agreement with a service provider whereby we are contractually obligated to spend $5.0 million annually between July 2023 and June 2026. As of March 31, 2024, we remain contractually obligated to spend a remaining $10.0 million towards this commitment.

Contingencies

From time to time, we are subject to contingencies that arise in the ordinary course of business. We record an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We do not currently believe the resolution of any such contingencies will have a material adverse effect upon our condensed consolidated financial statements.

Critical Accounting Policies and Estimates

We prepare our financial statements in accordance with GAAP. Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

The critical accounting estimates, assumptions, and judgments that we believe to have the most significant impact on our condensed consolidated financial statements are stock-based compensation, business combinations and valuation of goodwill and income taxes.

There have been no material changes to our critical accounting policies and estimates as described in our Annual Report.

Recently Issued Accounting Pronouncements

For information regarding recent accounting pronouncements, refer to Note 2, Summary of Significant Accounting Policies.

As a “smaller reporting company”, as defined by Rule 10(f)(1) of Regulation S-K, we are not required to provide this information.

Evaluation of Disclosure Controls and Procedures

Pursuant to Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO concluded that, as of March 31, 2024, due to the material weaknesses in our internal control over financial reporting described below, our disclosure controls and procedures were not effective to ensure that the information required to be disclosed in the reports required to be filed or submitted under the Securities Exchange Act is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Material weaknesses in internal control over financial reporting

We have identified material weaknesses in our internal control over financial reporting as of March 31, 2024. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

The material weaknesses identified were as follows:

• We did not design and maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient number of professionals with an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately. Additionally, the limited personnel resulted in an inability to consistently establish appropriate authorities and responsibilities in pursuit of financial reporting objectives, as demonstrated by, among other things, insufficient segregation of duties in our finance and accounting functions.
• We did not design and maintain effective controls in response to the risks of material misstatement. Specifically, changes to existing controls or the implementation of new controls have not been sufficient to respond to changes to the risks of material misstatement to financial reporting.

These material weaknesses contributed to the following additional material weaknesses:

• We did not design and maintain effective controls to timely analyze and record the financial statement effects from complex, non-routine transactions, including acquisitions, dispositions, and post-combination compensation arrangements. Specifically, we did not design and maintain effective controls over the application of US GAAP to such transactions, and, as it relates to acquisitions, did not design and maintain effective controls over (i) the review of the inputs and assumptions used in the measurement of assets acquired and liabilities assumed, including discounted cash flow analysis to value acquired intangible assets at an appropriate level of precision, (ii) the tax impacts of acquisitions to the financial statements, and (iii) conforming of US GAAP and accounting policies of acquired entities to that of the Company. In addition, we did not design and maintain effective controls relating to the oversight and ongoing recording of the financial statement results of the acquired businesses.
• We did not design and maintain formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures, including controls over (i) the preparation and review of business performance reviews, account reconciliations, journal entries, and identification of asset groups and (ii) maintaining appropriate segregation of duties. Additionally, we did not design and maintain controls over the classification and presentation of accounts and disclosures in the consolidated financial statements, including the statement of cash flows.
• We did not design and maintain effective controls over accounting for accrued liabilities, stock-based compensation and equity transactions, including accounting for non-controlling interest.
• We did not design and maintain effective controls over the accuracy and valuation of goodwill, including the allocation of goodwill to reporting units and the identification and measurement of goodwill impairment.

These material weaknesses resulted in the restatement of the Company's condensed consolidated financial statements: as of March 31, 2022 and for the predecessor period from January 1, 2022 to January 26, 2022 and for the successor period from January 27, 2022 to March 31, 2022; as of June 30, 2022 and the predecessor period from January 1, 2022 to January 26, 2022 and the successor periods for the three months ended June 30, 2022 and from January 27, 2022 to June 30, 2022; and as of September 30, 2022 and for the predecessor period from January 1, 2022 to January 26, 2022 and the successor periods for the three months ended September 30, 2022 and from January 27, 2022 to September 30, 2022. These material weaknesses also resulted in immaterial misstatements to substantially all of the S1 Holdco, LLC accounts, which were recorded prior to the issuance of the consolidated financial statements as of December 31, 2021, 2020, 2019 and 2018 and for the years then ended; as of March 31, 2021 and 2020 and for the three-month periods then ended; as of June 30, 2021 and 2020 and for the six-month periods then ended; and as of September 30, 2021 and 2020 and for the nine-month periods then ended. These material weaknesses also resulted in the revision to the consolidated financial statements for the period from January 27, 2022 to December 31, 2022 and each of the three quarterly periods in the years ended December 31, 2022 and 2023.

These material weaknesses also resulted in an immaterial misstatement within cash flows from operating activities of System1, Inc. as of and for the three months ended March 31, 2024. These material weaknesses also resulted in immaterial misstatements within stockholders' equity of the consolidated financial statements of System1, Inc. as of September 30, 2022, December 31 2022, December 31, 2023 and all quarterly periods during 2023.

• We did not design and maintain effective controls over the accounting for complex financial instruments, including the impact of these instruments on earnings per share.

This material weakness also resulted in a material misstatement of the Trebia warrant liabilities, change in the fair value of the Trebia warrant liabilities, forward purchase agreement liabilities, change in the fair value of the forward purchase agreement liabilities, classification of redeemable shares of Class A common stock issued in connection with Trebia’s initial public offering, additional paid-in-capital, accumulated deficit, Earnings Per Share, and related financial disclosures of Trebia Acquisition Corp. as of December 31, 2020 and for the period from February 11, 2020 (inception) through December 31, 2020, as of September 30, 2020 and for three month period ended September 30, 2020 and for the period from February 11, 2020 (inception) through September 30, 2020, as of June 30, 2020 and for three month period ended June 30, 2020 and for the period from February 11, 2020 (inception) through June 30, 2020, as of March 31, 2021 and for three month period ended March 31, 2021. This material weakness also resulted in material adjustments relating to the Trebia forward purchase agreement liabilities and repurchases of common stock impacting the accumulated deficit and additional paid-in capital in the opening balance sheet as of January 27, 2022 and the earnings per share computations for the quarter ended June 30, 2022 of the Company.

Additionally, these material weaknesses could result in a misstatement of substantially all of our accounts or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.

• We did not design and maintain effective controls over information technology (“IT”) general controls for information systems that are relevant to the preparation of our financial statements. Specifically, we did not design and maintain:

i. program change management controls to ensure that IT program and data changes affecting financial IT applications and underlying accounting records are identified, tested, authorized, and implemented appropriately;

ii. user access controls to ensure appropriate segregation of duties and that adequately restrict user and privileged access to financial applications, programs, and data to appropriate Company personnel;

iii.computer operations controls to ensure that critical batch jobs are monitored and data backups are authorized and monitored; and

iv. testing and approval controls for program development to ensure that new software development is aligned with business and IT requirements.

These IT deficiencies did not result in a material misstatement to the financial statements; however, the deficiencies, when aggregated, could impact the effectiveness of IT-dependent controls (such as automated controls that address the risk of material misstatement to one or more assertions, along with the IT controls and underlying data that support the effectiveness of system-generated data and reports) that could result in misstatements potentially impacting all financial statement accounts and disclosures that would not be prevented or detected. Accordingly, we have determined these IT deficiencies in the aggregate constitute a material weakness.

Remediation plan for the material weaknesses

We are in the process of, and we are focused on, designing and implementing effective measures to improve our internal control over financial reporting and remediate the material weaknesses. Our remediation efforts to address the identified material weaknesses are ongoing. Our efforts include a number of actions:

• Assessing the need of additional senior level accounting personnel with applicable technical accounting knowledge, training, and experience in accounting matters, and hiring the appropriately skilled resources, supplemented by third-party resources;
• Designing and implementing controls to formalize roles and review responsibilities to align with our team’s skills and experience and designing and implementing controls ensuring segregation of duties;
• Engaged an accounting advisory firm to assist with the documentation, evaluation, remediation and testing of our internal control over financial reporting based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission;
• Engaged third-party specialists to assist with the preparation of technical accounting analyses and valuations associated with business combinations, and ensuring adequate review by accounting personnel with applicable technical accounting knowledge, training, and experience in accounting for business combinations or dispositions;
• Designing and implementing controls to address the financial reporting risks over the accounting for dispositions, acquisitions and other complex, non-routine transactions, including controls over the preparation and review of accounting memoranda addressing these matters, valuations and key assumptions utilized in the valuations, tax impacts, and ongoing recording of the financial statement results of the acquired businesses;
• Designing and implementing formal accounting policies with periodic reviews, procedures and controls supporting our period-end financial reporting process, including controls over the preparation and review of account reconciliations and journal entries, business performance reviews, foreign exchange gains/losses for intercompany transactions, appropriate determination of asset groups for impairment consideration and classification and presentation of accounts and disclosures, including the statement of cash flows;
• Designing and implementing controls to address the financial reporting risks over accrued liabilities, stock-based compensation and equity transactions, including accounting for non-controlling interest;
• Designing and implementing controls to address the financial reporting risks over the accounting for complex financial instruments, including the earnings per share impacts;
• Designing and implementing controls to address the financial reporting risks over the accuracy and valuation of goodwill, including the allocation of goodwill to reporting units and the identification and measurement of goodwill impairment;
• Designing and implementing IT general controls, including controls over change management, the review and update of user access rights and privileges, controls over batch jobs and data backups, and program development approvals and testing.

We believe the measures described above will facilitate the remediation of the material weaknesses we have identified and will strengthen our internal control over financial reporting. We are committed to continuing to improve our internal control over financial reporting and will continue to review, optimize and enhance our processes, procedures and controls. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies, or we may modify, or in appropriate circumstances not complete, certain of the remediation measures described above. These material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. Therefore, these material weaknesses have not been remediated as of March 31, 2024.

Changes in Internal Control over Financial Reporting

There have been changes to our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the three months ended March 31, 2024 which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors previously disclosed in response to "Part I—Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2023.