System1 Inc

3. Goodwill, Internal-Use Software Development Costs, Net, and Intangible Assets, Net

Goodwill

Goodwill was $82.4 million as of June 30, 2024 and December 31, 2023, all of which is attributable to the Partner Network reporting unit. No impairment of goodwill was recognized in any of the periods presented.

Internal-use Software Development Costs, Net and Intangible Assets, Net

Internal-use software development costs and intangible assets consisted of the following (in thousands):

The internal-use software development costs include construction in progress (which amounts are not subject to amortization until placed in service) of $4.2 million and $3.5 million as of June 30, 2024 and December 31, 2023, respectively.

Amortization expense for internal-use software development costs and intangible assets were as follows (in thousands):

No impairment of internal-use software development cost or intangible assets was recognized for any of the periods presented.

As of June 30, 2024, the weighted average amortization period for all intangible assets was 7 years.

4. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following items as of the periods presented (in thousands):

CouponFollow Incentive Plan

As of June 30, 2024, the Company determined it is probable that the CouponFollow business would achieve certain performance conditions during the Performance Periods, and accordingly, recognized a short-term liability within accrued expenses and other current liabilities of $4.7 million and a non-current liability of $5.6 million within other non-current liabilities in our condensed consolidated balance sheets for the Tier 1 and Tier 2 amounts set forth in the CouponFollow Incentive Plan. The carrying amount of the share-based liabilities approximates its fair value.

For the six months ended June 30, 2024, we issued 1.0 million shares of Class A common stock with an aggregate fair value of $1.7 million, net of shares withheld for taxes, on the date of the settlement to settle the second installment of the Fixed Amount in the amount of $3.3 million. We recognized a gain of$0.5 million for the difference between the fair value of the Class A common stock issued and the carrying value of the liability. For the six months ended June 30, 2024, we recognized $0.8 million for the third installment of the Fixed Amount within salaries and benefits expenses on the condensed consolidated statements of operations.

5. Debt, Net

We entered into a term loan ("Term Loan") and revolving facility ("2022 Revolving Facility") with Bank of America, N.A., on January 27, 2022, providing for a 5.5-year term loan with a principal balance of$400.0 million and with the net proceeds of$376.0 million. The 2022 Revolving Facility provided for borrowing availability of up to$50.0 million. As of June 30, 2024, there wasno balance outstanding on the 2022 Revolving Facility, and principal of $290.1 million was outstanding on the Term Loan. Through December 31, 2025, the outstanding Term Loan is subject to quarterly amortization payments of $5.0 million. From March 31, 2026, the Term Loan is subject to quarterly amortization payments of $7.5 million. 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 covenant, which goes into effect only if the utilization on the 2022 Revolving Facility exceeds 35% of the $50.0 million 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 facility has certain financial and nonfinancial covenants, including a leverage ratio. The facility also requires that we deliver our audited consolidated financial statements toour lender within 120 days of our fiscal year end, December 31. Should we fail to distribute the financial statements toour lender within 120 days, we are allowed an additional 30 days to cure. We were in compliance with our financial covenants as of June 30, 2024.

The interest rate on the 2022 Revolving Facility is the adjusted SOFR plus 2.5% with an adjusted SOFR floor of 0%. As of June 30, 2024, we had $50.0 million available on the 2022 Revolving Facility.

On January 17, 2024, we completed the repurchase of $63.7 million in principal amount of our Term Loan for 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. Our gain on the repurchase was $19.7 million before fees and expenses incurred to negotiate, document and consummate the repurchase.

On April 30, 2024, we completed the repurchase of an additional $1.2 million in principal amount of our Term Loan for an aggregate purchase price of $0.7 million (at discount of 60.0% of its par value) pursuant to a privately negotiated repurchase transaction. Following the repurchase, the outstanding principal amount of the Term Loan was $295.0 million. We used available cash on hand to fund the repurchase. Our gain on the repurchase was $0.4 million before fees and expenses incurred to negotiate, document and consummate the additional repurchase.

On August 1, 2024, the Company undertook a corporate reorganization, the result of which was that all of the assets and business operations of System1 are now held by System1 Holdings, LLC ("System1 Holdings"), a newly formed intermediate holding company of which the Company maintains the controlling interest and where the non-controlling interest is held by the Company's Class C common stockholders. Following the corporate reorganization, (a) System1 Holdings now owns 100% of S1 Holdco, LLC ("S1 Holdco"), the previous intermediate holding company, and 100% of S1 Media, LLC ("S1 Media"), another new subsidiary formed in connection with the corporate reorganization, (b) S1 Media holds the assets and business operations associated with the Company’s owned & operated products businesses, which includes CouponFollow, Startpage and Mapquest, and (c) S1 Holdco holds the Company’s remaining assets and business operations associated with the Company's digital advertising businesses, including its proprietary RAMP platform. S1 Holdco and its subsidiaries remain obligors and guarantors under the Company's Term Loan and 2022 Revolving Facility, and System1 Holdings and S1 Media are not parties thereto.

The carrying values of our debt, net of discounts, deferred financing and debt issuance costs were as follows (in thousands):

6. Income Taxes

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.

We recorded a benefit for income taxes of $0.2 million and $0.2 million for thethree and six months ended June 30, 2024 and a benefit from income taxes of $6.7 million and $10.5 million for thethree and six months ended June 30, 2023, respectively. The effective tax rate was 0.5% and 0.4% for thethree and six months ended June 30, 2024, respectively and 18.4% and 14.9% for thethree and six months ended June 30, 2023, respectively. The provision for income taxes differs from the amount of income tax computed by applying the U.S. statutory federal tax rate of 21% to the loss before income taxes due to the exclusion of non-controlling loss, state taxes, foreign rate differential, non-deductible expenses, increase to the valuation allowance related to unrealizable deferred tax assets, and outside basis adjustments. As of June 30, 2024, we had a full valuation allowance on our U.S. federal and state net deferred tax assets as it was more likely than not that those deferred tax assets would not be realized.

During thethree and six months ended June 30, 2024 and 2023, inclusive of interest, no payments were made to the parties to the Tax Receivable Agreement. The total amount of Tax Receivable Agreement Payments due under the Tax Receivable Agreement was $0.9 million and $0.8 million as of June 30, 2024 and December 31, 2023, respectively.

As discussed in Note 5, Debt, Net, on August 1, 2024, the Company undertook a corporate reorganization.

7. Commitments and Contingencies

In June 2023, we entered into a multi-year agreement with a service provider whereby we are contractually obligated to spend $5.0 million in each annual period between July 2023 and June 2026. As of June 30, 2024, we remain contractually obligated to spend$10.0 million towards this commitment.

As of June 30, 2024, we had various non-cancelable operating lease commitments for office space which have been recorded as Operating lease liabilities.

Litigation

We are subject to various legal proceedings and claims that arise in the ordinary course of business. We believe the ultimate liability, if any, with respect to these actions will not materially affect the consolidated financial position, results of operations, or cash flows reflected in the condensed consolidated financial statements. There can be no assurance, however, that the ultimate resolution of such actions will not materially or adversely affect our consolidated financial position, results of operations, or cash flows. We accrued for losses when the loss is deemed probable and the liability can reasonably be estimated.

In October 2023, a putative California class action complaint (the "Complaint") was filed against us and our Protected business regarding alleged violations of California’s Auto Renewal Law requirements related to the marketing and sale of its subscription service offerings for anti-virus and ad-blocking software (the "Protected Software") to consumers. The Complaint alleges claims under California’s false advertising and unfair competition laws and primarily alleges that the marketing and sales checkout flows for the Protected Software did not clearly and conspicuously disclose that the named plaintiffs set forth in the Complaint were purchasing the Protected Software for a promotional period which would auto-renew after the applicable promotional period. While we dispute the claims alleged, we have reached a tentative settlement during June 2024, which would include a release of such claims by the relevant class, which tentative settlement is still subject to court approval and finalizing other terms and conditions. The amount of such tentative settlement has been accrued accordingly in accrued expenses and other current liabilities in our condensed consolidated balance sheets as of June 30, 2024.

Indemnifications

In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, investors, directors, officers, employees, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of such agreements, services to be provided by us, or from intellectual property infringement claims made by third parties. These indemnifications may survive termination of the underlying agreement and the maximum potential amount of future payments we could be required to make under these indemnification provisions may not be subject to claims related to these indemnifications. As a result, we believe the estimated fair value of these agreements was immaterial. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2024.

8. Fair Value Measurement

Financial Liabilities Measured at Fair Value on a Recurring Basis

The following tables present our fair value hierarchy for liabilities measured at fair value on a recurring basis (in thousands):

The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. There were no transfers in or out of levels during the periods presented.

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

For further information on the fair value assessment of goodwill, refer to Note 3, Goodwill, Internal-Use Software Development Costs, Net, and Intangible Assets, Net.

9. Net Loss Per Share

Basic net loss per share was calculated by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. Basic and diluted net loss per share was calculated as follows(in thousands, except per share):

For the periods presented in the table above, a total of 16.8 million Public Warrants were excluded from the computation of net loss per share as the impact was anti-dilutive.

Pursuant to the Merger, we were required to replace certain unvested profits interests awards, value creation units and Class F units that were outstanding as of the closing of the Business Combination, with a combination of a restricted stock unit and cash awards (collectively, "Replacement Awards"). We do not consider unvested Class A common stock related to the Replacement Awards as outstanding for accounting purposes as they are subject to continued service requirements or contingencies. These shares are not included in the denominator of the net loss per share calculation until the employee provides the requisite service resulting in the vesting of the award or the contingency is removed, or upon termination of an employee at which point the common stock underlying the award becomes issuable to the previous investors. Shares associated with the vested or forfeited Replacement Awards are deemed to be issued and outstanding for accounting purposes on the day of vest or forfeiture.

10. Segment Reporting

We havetwo operating and reportable segments: Owned and Operated Advertising and Partner Network. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker ("CODM"), in deciding how to allocate resources and assess performance. Our Chief Executive Officer, who is considered to be our CODM, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance.

The CODM measures and evaluates reportable segments based on segment operating revenue as well as adjusted gross profit. The tables below include the following operating expenses that are not allocated to the reporting segments presented to our CODM: depreciation and amortization of property, equipment and leasehold improvements, amortization of intangible assets and, at times, certain other transactions or adjustments. The CODM does not consider these expenses for the purposes of making decisions to allocate resources among segments or to assess segment performance, however these costs are included in reported condensed consolidated net loss from continuing operations before income tax and are included in the reconciliation that follows.

The following table summarizes revenue by reportable segments (in thousands):

The following table summarizes Adjusted gross profit by reportable segments (in thousands):

The following table summarizes revenue by geographic region (in thousands):

11. Stock-Based Compensation

We recorded the following total stock-based compensation expense(in thousands):

Stock Appreciation Rights Plan

During the quarter ended June 30, 2024, the Company adopted the 2024 Stock Appreciation Rights Plan (the "Plan"), to enhance its ability to attract, retain, and motivate individuals who are expected to make significant contributions to the Company's future financial and operating performance. The maximum number of Class A common stock that may be issued pursuant to awards of Stock Appreciation Rights ("SARs") granted under the Plan ("Awards") is 23.8 million shares.

In July 2024, we granted 22.4 million SARs in accordance with the Plan. Each Award of SARs shall vest and become exercisable as follows, subject to the employee's continued status as a service provider through the applicable Vesting Date (as defined in the Plan), and the term of any Stock Appreciation Right shall not exceed seven years: (1) twenty-five percent (25%) of the SARs subject to the Award (the “Tranche I SARs”) shall vest if the Company’s Adjusted EBITDA for any trailing twelve-month period concluding on or after the applicable date of grant equals or exceeds $50.0 million; (2) twenty-five percent (25%) of the SARs subject to the Award (the “Tranche II SARs”) shall vest if the Company’s Adjusted EBITDA for any trailing twelve-month period concluding on or after the applicable date of grant equals or exceeds $60.0 million; (3) twenty-five percent (25%) of the SARs subject to the Award (the “Tranche III SARs”) shall vest if the Company’s Adjusted EBITDA for any trailing twelve-month period concluding on or after the applicable date of grant equals or exceeds $70.0 million; and (4) the remaining twenty-five percent (25%) of the SARs subject to the Award (the “Tranche IV SARs”) shall vest if the Company’s Adjusted EBITDA for any trailing twelve-month period concluding on or after the applicable date of grant equals or exceeds $80.0 million.

In July 2024, we granted 3.1 million restricted stock unit awards in accordance with the 2022 Incentive Award Plan.

12. Discontinued Operations

Sale of Protected

On November 30, 2023, we completed the sale of our Protected business, our subscription reporting unit. Total consideration comprised of: (a) $240.0 million in cash, subject to certain adjustments, (b) the return and subsequent cancellation of approximately 29.1 million shares of our Class A common stock, par value $0.0001 per share, owned by JDI and other entities and individuals affiliated with the Purchasing Parties and (c) confirmation from JDI, Protected and the Protected CEO that the financial performance benchmarks related to the financial benchmarks included in the Protected Incentive Plan (as defined below), will, as a result of the Protected sale, no longer be achievable.

The financial results of Protected are presented as a loss from discontinued operations, net of taxes in the condensed consolidated statements of operations. The following table presents the summarized discontinued operations condensed consolidated statements of operations(in thousands):

The following table presents the significant non-cash items and capital expenditures for the discontinued operations with respect to the subscription business that are included in thecondensed consolidated statements of cash flows (in thousands):

Transition Service Agreement

In connection with a transition service agreement entered into with the sale of our Protected business, we agreed to provide certain services for which full reimbursement of cost will be provided through the earlier of November 20, 2024 or the date Protected is able to independently participate in Google's advertising purchasing programs.

Discontinued Operations Related-Party Transactions

Payment Processing Agreement

Protected utilizes multiple credit card payment processors, including Paysafe Financial Services Limited ("Paysafe"). In March 2021, Paysafe completed a merger with Foley Trasimene Acquisition Corp. II ("Foley Trasimene"), a special purpose acquisition company sponsored by entities affiliated with a sponsor of Trebia who was also a member of our Board of Directors. We incurred credit card processing fees related to Paysafe for the three and six months ended June 30, 2023 of $1.0 million and $2.1 million, respectively.

Office Facilities

Protected had an agreement with JDI Property Holdings Limited ("JDIP"), an entity controlled by one of our directors, which allowed Protected to use space at their property in exchange for GBP 0.1 million per year.

Protected Incentive Plan Installment Payments

In 2022, in connection with the acquisition of Protected, we effected an incentive plan for eligible recipients (the "Protected Incentive Plan"), providing up to $100.0 million payable in fully-vested shares of our Class A common stock contingent upon the achievement of the future performance of Protected’s business. The Protected Incentive Plan originally was to be paid out in two tranches based on performance of the business for 2023 and 2024. The first award (2023), consisting of $50.0 million of Class A common stock payable in January 2024, was modified to a cash award resulting in $20.0 million of payments in 2022 and 2023 with an additional final $10.0 million, payable upon the achievement of certain performance thresholds around marketing spend and operating contribution of Protected on or before December 31, 2024. On November 30, 2023, none of the performance thresholds were met, and therefore, none of the additional cash bonus payments have been paid.