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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A
(Amendment No. 1)    
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022

OR

☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from __________ to __________


Commission file number 001-39331
System1, Inc.
(Exact name of registrant as specified in its charter)

Delaware
98-1531250
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
4235 Redwood Avenue
Marina Del Rey, CA
90066
(Address of Principal Executive Offices)
(Zip Code)

(310) 924-6037
(Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:



Title of each classTrading Symbol(s)Name of each exchange on which registered
Class A common stock, par value $0.0001 per shareSSTThe New York Stock Exchange
Redeemable warrants, each whole warrant exercisable for one Class A common stock at an exercise price of $11.50 per shareSST.WSThe New York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days: Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer☐
Accelerated filer
☐
Non-accelerated filer  
☒
Smaller reporting company
☒
Emerging growth company
☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  ☐  No ☒

As of November 4, 2022, there were 91,455,846 shares of Class A common stock, $0.0001 par value per share, outstanding and 21,747,109 shares issued and outstanding of Class C common stock, $0.0001 par value per share..

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-Q/A (this “Form 10-Q/A”) amends and restates certain items as listed in "Items Amended in this Form 10-Q/A" below in the Quarterly Report on Form 10-Q/A of System1, Inc. (the “Company,” "System1," "we," "us," "our" and other similar terms) for the quarter ended September 30, 2022, including the S1 Holdco LLC ("S1 Holdco") predecessor period from January 1, 2022 to January 26, 2022, for the Successor period three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022 presented therein, as originally filed with the Securities and Exchange Commission (“SEC”) on November 14, 2022 (the “Original Report”).

Restatement Background

As described in the Company’s Current Report on Form 8-K (Item 4.02) filed on March 17, 2023, on March 15, 2023, the Company’s management and the Audit Committee of the Company’s Board of Directors (the “Audit Committee”) concluded that the unaudited condensed consolidated financial statements of the Company (the "quarterly financial statements") (i) as of and for the period ended March 31, 2022 included in the Company's Form 10-Q filed with the SEC on May 19, 2022, (ii) as of and for the three and six month periods ended June 30, 2022 (“Q2 2022”) included in the Company’s Form 10-Q filed with the SEC on August 15, 2022 and (iii) as of and for the


three and nine month periods ended September 30, 2022 (“Q3 2022”) included in the Original Report should no longer be relied upon due to material errors identified in such financial statements and should be restated. The errors identified by the Company relate to its accounting for (i) the valuation and purchase price allocation of assets acquired and liabilities assumed in the Company’s business combination (“Merger”) with S1 Holdco LLC and System1 SS Protect Holdings, Inc. on January 27, 2022, (ii) equity awards, including certain restricted stock awards related to the Merger, (iii) the valuation and purchase price allocation of assets acquired in the Company’s acquisition of NextGen Shopping, Inc., d/b/a CouponFollow ("CouponFollow"), (iv) identification of triggering events necessitating the impairment of goodwill, and (v) certain other errors, including errors in the Statements of Cash Flows.

The nature of the errors and related restatement to correct the errors are further described in Note 1 of the "Notes to Unaudited Condensed Consolidated Financial Statements" included in Part I, Item 1. "Financial Statements (Unaudited) As Restated" of this Form 10-Q/A.

Control Considerations

Management concluded, with concurrence of the Audit Committee, that there were additional deficiencies in our internal control over financial reporting that constituted additional material weaknesses as of September 30, 2022. For a discussion of management's consideration of our disclosure controls and procedures and material weaknesses in internal control over financial reporting identified, see Part I, Item 4, Controls and Procedures of this Form 10-Q/A.

Items Amended in this Form 10-Q/A

For the convenience of the reader, this Form 10-Q/A sets forth the Original Report, as amended, in its entirety; however, this Form 10-Q/A amends and restates the following Items of the Original Filing to the extent necessary to reflect the adjustments discussed above:

•Part I, Item 1. "Financial Statements (Unaudited)" to reflect the impact of the restatement;
•Part I, Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations" to reflect the impact of the restatement;
•Part I, Item 4. "Controls and Procedures" to reflect the additional material weaknesses in internal control over financial reporting as of September 30, 2022;
•Part II, Item 1A. "Risk Factors";
•Part II, Item 3. "Defaults Upon Senior Securities"; and,
•Part II, Item 6. "Exhibits" to include (i) pursuant to the rules of the SEC, currently dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer which are attached as Exhibits 31.1, 31.2 and 32.1 to this Form 10-Q/A and (ii) restated unaudited condensed consolidated financial statements formatted in Extensible Business Reporting Language (XBRL) in Exhibits 101 and 104.

In addition, in connection with the preparation of this Form 10-Q/A, the Company has reevaluated its financial condition as of the date of filing this Form 10-Q/A. Based on this reevaluation, the Company identified matters that raised substantial doubt about its ability to continue as a going concern for the twelve-month assessment period from the date of filing this Form 10-Q/A. The assessment of going concern is further discussed in Note 1 of the “Notes to Unaudited Condensed Consolidated Financial Statements” included in Part I, Item 1. “Financial Statements (Unaudited)” of this Form 10-Q/A.

Except as described above, no attempt has been made in this Form 10-Q/A to reflect events occurring subsequent to the filing of the Original Report. Among other things, risk disclosures made in the Original Report have not been amended to reflect events that occurred or facts that became known to us subsequent to the filing of the Original Report (other than the restatement). Accordingly, this Form 10-Q/A should be read in conjunction with filings made with the SEC subsequent to the filing of the Original Report, including any amendment to those filings.

Restatement of Other Financial Statements



In addition to the restated financial information for the period ended September 30, 2022 included in this Form 10-Q/A, we are also restating our interim condensed consolidated financial statements and related disclosures for the quarters ended March 31, 2022 and June 30, 2022. Concurrently with the filing of this Form 10-Q/A, we are sequentially filing with the SEC an amended Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2022 followed by an amended Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2022, and then followed by this Form 10-Q/A to restate for the errors described above and other identified errors impacting those periods.


Table of Contents
Page

i

PART I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
System1, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except for par values and share amounts)
SuccessorPredecessor
September 30, 2022December 31, 2021
As Restated
ASSETS
Current assets:
Cash and cash equivalents$31,933 $47,896 
Restricted cash, current7,168 — 
Accounts receivable78,846 90,203 
Prepaid expenses and other current assets10,817 7,689 
Total current assets128,764 145,788 
Restricted cash, non-current2,942 743 
Property and equipment, net4,349 830 
Internal-use software development costs, net5,690 11,213 
Intangible assets, net524,597 50,368 
Goodwill541,792 44,820 
Operating lease assets6,893 — 
Other non-current assets731 3,149 
Total assets$1,215,758 $256,911 
LIABILITIES AND STOCKHOLDERS’ EQUITY/MEMBERS’ DEFICIT
Current liabilities:
Accounts payable$12,241 $72,846 
Accrued expenses and other current liabilities91,731 31,284 
Protected.net incentive plan liability, current19,266 — 
Deferred revenue68,289 1,971 
Operating lease liabilities, current2,102 — 
Debt, net14,954 170,453 
Total current liabilities208,583 276,554 
Operating lease liabilities, non-current6,406 — 
Long-term debt, net402,273 — 
Warrant liability18,158 — 
Deferred tax liability49,747 7,789 
Protected.net incentive plan liability, non-current11,517 — 
Other liabilities1,621 969 
Total liabilities698,305 285,312 
Commitments and contingencies (Note 11)
STOCKHOLDERS’ EQUITY / MEMBERS’ DEFICIT
Class A common stock - $0.0001 par value; 500,000 shares authorized, 91,490 Class A shares issued and outstanding as of September 30, 2022
9 — 
Class C common stock - $0.0001 par value; 25,000 shares authorized, 21,747 Class C shares issued and outstanding as of September 30, 2022
2 — 
Additional paid-in capital821,902 — 
Accumulated deficit(411,300)— 
Members’ deficit— (28,829)
Accumulated other comprehensive income(124)428 
Total stockholders’ equity/members’ deficit attributable to System1, Inc.410,489 (28,401)
Non-controlling interest106,964 — 
Total stockholders’ equity/members’ deficit517,453 (28,401)
Total liabilities and stockholders’ equity/members’ deficit$1,215,758 $256,911 
See notes to unaudited condensed consolidated financial statements.
1    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except for per share and per unit data)

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs RestatedAs Restated
Revenue$201,176 $171,446 $587,081 $52,712 $488,586 
Operating costs and expenses:
Cost of revenues (excluding depreciation and amortization)137,680 128,885 410,622 41,507 365,837 
Salaries, commissions, and benefits55,602 15,139 153,311 31,181 48,032 
Selling, general, and administrative15,419 7,936 47,254 15,665 21,163 
Depreciation and amortization32,214 3,459 86,236 1,000 10,260 
Impairment of goodwill340,109 — 340,109 — — 
Total operating costs and expenses581,024 155,419 1,037,532 89,353 445,292 
Operating income (loss)(379,848)16,027 (450,451)(36,641)43,294 
Other expense:
Interest expense, net10,011 4,184 22,111 1,049 12,708 
Change in fair value of warrant liabilities4,489 — 14,111 — — 
Total other expense14,500 4,184 36,222 1,049 12,708 
Income (loss) before income tax(394,348)11,843 (486,673)(37,690)30,586 
Income tax (benefit) provision(80,649)475 (95,752)(629)703 
Net income (loss)$(313,699)$11,368 $(390,921)$(37,061)$29,883 
Net loss attributable to non-controlling interest(72,002)— (87,418)— — 
Net income (loss) attributable to System1, Inc.$(241,697)$11,368 $(303,503)$(37,061)$29,883 
Basic and diluted net loss per share$(2.66)n/a$(3.43)n/an/a
Weighted average number of shares outstanding - basic and diluted91,002 n/a88,397 n/an/a
Basic and diluted net income (loss) per unitn/a$0.55 n/a$(1.81)$1.46 
Weighted average units outstanding - basic and dilutedn/a20,488 n/a20,488 20,488 
See notes to unaudited condensed consolidated financial statements.
2    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(In thousands)

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs RestatedAs Restated
Net income (loss)$(313,699)$11,368 $(390,921)$(37,061)$29,883 
Other comprehensive income (loss)
Foreign currency translation income (loss)297 101 (124)87 566 
Comprehensive income (loss)(313,402)11,469 (391,045)$(36,974)30,449 
Comprehensive loss attributable to non-controlling interest(72,001)— (87,356)— — 
Comprehensive income (loss) attributable to System1, Inc.$(241,401)$11,469 $(303,689)$(36,974)$30,449 


See notes to unaudited condensed consolidated financial statements.
3    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
(In thousands)
Class A Common StockClass C Common StockClass D Common Stock
SharesAmountSharesAmountSharesAmountAdditional Paid-In-CapitalAccumulated DeficitAccumulated Other Comprehensive IncomeNon-Controlling InterestTotal Stockholders’
Equity
As Restated
Successor:
For the period from January 27, 2022 to September 30, 2022
BALANCE—January 26, 202251,750 $5 — $— — $— $574,003 $(107,797)$— $— $466,211 
Effect of Merger transaction29,017 3 22,077 2 1,450 — 148,359 — — 198,691 347,055 
BALANCE—January 27, 202280,767 8 22,077 2 1,450 — 722,362 (107,797)— 198,691 813,266 
Net loss— — — — — — — (36,069)— (7,309)(43,378)
Issuance of common stock in connection with Merger, net of offering costs, underwriting discounts and commissions930 — — — — — 661 — — — 661 
Issuance of common stock in connection with the acquisition of business2,000 — — — — — 25,500 — — — 25,500 
Issuance of market-based restricted stock units upon vesting— — — — 1,450 — — — — — — 
Conversion of Class D shares to Class A shares2,900 1 — — (2,900)— — — — — 1 
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — (2,596)— — — (2,596)
Other comprehensive income— — — — — — — — 103 (184)(81)
Share-based compensation— — — — — — 31,398 — — — 31,398 
Distribution to members— — — — — — — — — (247)(247)
BALANCE—March 31, 202286,597 $9 22,077 $2 — $— $777,325 $(143,866)$103 $190,951 $824,524 
Net loss— — — — — — — (25,737)— (8,107)(33,844)
Exercise of warrants3,969 — — — — — 27,989 — — — 27,989 
Issuance of restricted stock, net of forfeitures and shares withheld for taxes21 — — — — — — — — — — 
Other comprehensive income— — — — — — — — (524)(14)(538)
Share-based compensation— — — — — — 6,995 — — — 6,995 
Distribution to members— — — — — — — — — (1,254)(1,254)
BALANCE—June 30, 202290,587 $9 22,077 $2 — $— $812,309 $(169,603)$(421)$181,576 $823,872 
Net loss— — — — — — — (241,697)— (72,002)(313,699)
Issuance of restricted stock, net of forfeitures and shares withheld for taxes573 — — — — — (2,035)— — — (2,035)
Conversion of Class C shares to Class A shares330 — (330)— — — 2,714 — — (2,714)— 
Establishment of liabilities under tax receivable agreement and related changes to deferred tax assets associated with increases in tax basis— — — — — — — (41)— — — (41)
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — — — — — — 
Other comprehensive income— — — — — — — — 297 114 411 
Share-based compensation— — — — — — 8,955 — — — 8,955 
Distribution to members— — — — — — — — — (10)(10)
BALANCE—September 30, 202291,490 $9 21,747 $2 — $— $821,902 $(411,300)$(124)$106,964 $517,453 



See notes to unaudited condensed consolidated financial statements.
4    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Members' Deficit (Unaudited)
(In thousands)

Members’ DeficitAccumulated Other Comprehensive Income (Loss)Total Members’ Deficit
As RestatedAs Restated
Predecessor:
For the period January 1, 2022 to January 26, 2022
BALANCE—January 1, 2022$(28,829)$428 $(28,401)
Net loss(37,061)— (37,061)
Accumulated other comprehensive income— 87 87 
Share-based compensation expense23,705 — 23,705 
BALANCE—January 26, 2022$(42,185)$515 $(41,670)
Members’ DeficitAccumulated Other Comprehensive Income (Loss)Total Members’ Deficit
Predecessor:
For the period January 1, 2021 to September 30, 2021
BALANCE—January 1, 2021$(47,886)$(343)$(48,229)
Net income6,743 — 6,743 
Accumulated other comprehensive income— 441 441 
Share-based compensation expense146 — 146 
Contribution from OpenMail147 — 147 
BALANCE—March 31, 2021$(40,850)$98 $(40,752)
Net income11,772 — 11,772 
Accumulated other comprehensive income— 24 24 
Share-based compensation expense120 — 120 
Distribution to Court Square Capital Partners(1,814)— (1,814)
Contribution from OpenMail3 — 3 
Distribution to OpenMail(877)— (877)
BALANCE—June 30, 2021$(31,646)$122 $(31,524)
Net income11,368 — 11,368 
Accumulated other comprehensive income— 101 101 
Share-based compensation expense89 — 89 
Distribution to Court Square Capital Partners(4,088)— (4,088)
Contribution from OpenMail109 — 109 
Distribution to OpenMail(3,014)— (3,014)
BALANCE—September 30, 2021$(27,182)$223 $(26,959)


See notes to unaudited condensed consolidated financial statements.
5    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs Restated
Cash flows from Operating Activities:
Net income (loss)$(390,921)$(37,061)$29,883 
Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Depreciation and amortization86,236 1,000 10,260 
Share-based compensation88,847 23,705 334 
Impairment of goodwill340,109 — — 
Amortization of debt issuance costs3,540 — 1,696 
Noncash lease expense1,102 115 — 
Change in fair value of contingent consideration and CEO equity profit interest— (9)4,363 
Change in fair value of warrants14,111 — — 
Deferred tax benefits(101,100)(816)(731)
Other661 — — 
Changes in operating assets and liabilities
Accounts receivable6,670 11,118 (14,449)
Amount due from related party— — — 
Prepaids and other assets(275)1,069 (4,798)
Accounts payable1,981 (67,600)12,535 
Accrued expenses and other liabilities(17,369)57,488 65 
Protected.net incentive plan liability(10,000)— — 
Deferred revenue7,133 311 211 
Other long-term liabilities(31,467)77 — 
Net cash provided by (used in) operating activities(742)(10,603)39,369 
Cash flows from Investing Activities:
Purchases of property and equipment(3,220)— — 
Capitalized software development costs(5,135)(441)(4,901)
Acquisition of businesses, net of cash acquired(444,074)— — 
Net cash used in investing activities(452,429)(441)(4,901)
Cash flows from Financing Activities:
Proceeds from term loan and line of credit449,000 — — 
Repayment of term loan(182,488)— (9,886)
Member capital contributions— — 259 
Payments for financing costs(24,845)— — 
Payments for earnouts(1,715)— — 
Taxes paid related to net settlement of restricted stock awards(2,035)— — 
Redemptions of Class A common stock(510,469)— — 
Proceeds from warrant exercises 5,027 — — 
Cash received from the Backstop246,484 — — 
Payments on contingent consideration from purchase of companies— — (6,715)
Related party loan— — (1,500)
Distributions to members(1,511)— (9,793)
Net cash used in financing activities(22,552)— (27,635)
Effect of exchange rate changes in cash, cash equivalent and restricted cash213 (19)363 
Net increase (decrease) in cash, cash equivalents and restricted cash(475,510)(11,063)7,196 
Cash and cash equivalents and restricted cash, beginning of the period517,553 48,639 29,013 
Cash and cash equivalents and restricted cash, end of the period$42,043 $37,576 $36,209 
Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets:
Cash and cash equivalents$31,933 $36,833 $36,209 
Restricted cash10,110 743 — 
Total cash, cash equivalents and restricted cash$42,043 $37,576 $36,209 
Supplemental cash flow information:
Cash paid for operating lease liabilities$1,580 $175 $— 
ROU assets obtained in exchange for operating lease liabilities$2,064 $7,987 $— 
Capitalized assets financed by accounts payable$309 $— $— 
6    
System1, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
Tenant improvements paid by lessor$139 $— $— 
Stock-based compensation included in capitalized software development costs$340 $— $— 
Equity issuance to settle intercompany loan$— $941 $— 
Deferred consideration for acquisition$7,059 $— $— 
See notes to unaudited condensed consolidated financial statements.
7    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
1.ORGANIZATION AND DESCRIPTION OF BUSINESS

System1, Inc. and subsidiaries (“System1” or the “Company”) operates an omnichannel customer acquisition platform, delivering high-intent customers to advertisers and sells antivirus software packages to end user customers.

The Company provides its omnichannel customer acquisition platform services through its proprietary responsive acquisition marketing platform (“RAMP”). Operating seamlessly across major advertising networks and advertising category verticals to acquire users on its behalf, RAMP allows the Company to monetize such users through its relationships with third party advertisers and advertising networks (“Advertising Partners”). RAMP also allows third party advertising platforms and publishers (“Network Partners”), to send user traffic to, and monetize user traffic on, the Company’s owned and operated websites. RAMP operates across the Company’s network of owned and operated websites and related products, allowing it to monetize user traffic that it sources from various acquisition marketing channels, including Google, Facebook, Taboola, Snapchat and TikTok.

The Company, through its wholly owned subsidiary Protected.net Group Limited, a private limited company incorporated in England and Wales (“Protected.net”), also provides antivirus software solutions, offering its customers a single packaged solution that provides protection and reporting to the end user. The Company delivers its antivirus software solutions directly to end-user customers across the world. The antivirus software solutions product offering comprises a core security package with varying levels of extra protection based on a customer's specific needs.

The Company’s primary operations are in the United States; and the Company also has operations in Canada, the United Kingdom, and the Netherlands. Operations outside the United States are subject to risks inherent in operating under different legal systems and various political and economic environments. Among these risks are changes in existing tax laws, possible limitations on foreign investment and income repatriation, government foreign exchange controls, and exposure to currency exchange fluctuations. The Company does not engage in hedging activities to mitigate its exposure to fluctuations in foreign currency exchange rates.

For the purposes of the condensed consolidated financial statements, periods on or before January 26, 2022 reflect the financial position, results of operations and cash flows of S1 Holdco, LLC, a Delaware limited liability company ("S1 Holdco") and its consolidated subsidiaries prior to the Merger (as defined in Note 3—MERGER), referred to herein as the “Predecessor,” and periods beginning on or after January 27, 2022 reflect the financial position, results of operations and cash flows of the Company and its consolidated subsidiaries as a result of the Merger, referred to herein as the “Successor”.


Going Concern

As of June 1, 2023, the Company had not delivered audited financial statements for the fiscal year ended December 31, 2022 to Bank of America as required by the covenants of the Term Loan (refer to Note 12 – DEBT, NET). The failure to timely deliver the audited financial statements is an event of default under the Term Loan and provides Bank of America the ability to immediately call the outstanding principal balances of the Term Loan and Revolving Facility of $430,000, as of the date of this filing, at the request of, or with the consent of, the required majority of lenders until such time that the audited financial statements are delivered to Bank of America. The Company does not have sufficient liquidity to settle the outstanding principal balances should they be called, nor has the Company identified sufficient alternative sources of capital. As a result, this matter raises substantial doubt about the Company’s ability to continue as a going concern. Upon delivery of the audited financial statements by the Company, the event of default will be remediated and, once remediated, Bank of America will no longer have the ability to call the outstanding principal balances on the Term Loan and Revolving Facility.

Separate from the default under the Term Loan and Revolving Facility, in the third and fourth quarters of 2022, the Company experienced declining cash flows and financial performance as a result of deteriorating macroeconomic conditions, resulting in reductions in both advertiser and overall consumer demand for our marketing services. As of December 31, 2022, the Company had cash on hand of $24,606. The declining cash flows and financial performance
8    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
also raised substantial doubt regarding the Company's ability to continue as a going concern for a period of one year following the date that the consolidated financial statements are issued. In response to the declining cash flows, the Company implemented a plan to raise additional financing. On April 10, 2023, the Company entered into an incremental revolver note (“2023 Revolving Note”) with related parties for $20,000 (refer to Note 12—DEBT, NET for additional information regarding the 2023 Revolving Note). As of the date of this filing, the available balance under the 2023 Revolving Note was $15,000.

The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Accordingly, the consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business.

Restatement of Previously Issued Financial Statements

The Company identified errors impacting the previously issued unaudited condensed consolidated financial statements for the periods indicated below. The Company analyzed the errors using Staff Accounting Bulletin (“SAB”) No. 99, Materiality and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, and determined the errors were material to the previously issued unaudited condensed consolidated financial statements. Accordingly, in accordance with Accounting Standards Codification (“ASC”) Topic 250, Accounting Changes and Error Corrections, the Company has restated herein the unaudited condensed consolidated statements of operations, of comprehensive income (loss), of changes in members’ deficit and of cash flows for the predecessor period from January 1, 2022 to January 26, 2022, the Successor condensed consolidated balance sheet as of September 30, 2022 and the condensed consolidated statements of operations, of comprehensive income (loss), of changes in stockholders' equity and of cash flows for the Successor periods from January 27, 2022 to September 30, 2022 and from July 1, 2022 to September 30, 2022 and related footnote disclosures that were impacted by the errors.

A description of the errors is as follows:

I.Merger and business combination errors, and other errors impacting the successor period opening statement of stockholders’ equity:

a.Valuation related errors - The Company identified the following valuation errors related to the Merger with S1 Holdco, LLC (“S1 Holdco”) and System1 SS Protected Holdings. Inc. (“Protected”) ("the Merger") which occurred on January 27, 2022 ("the Merger date") and the NextGen Shopping, Inc. d/b/a CouponFollow (“CouponFollow”) acquisition which occurred on March 4, 2022:

i.Error in the valuation of acquired developed technology from S1 Holdco in the Merger due to incorrectly recording capitalized internal-use software costs that were already included in the valuation of the RAMP developed technology which overstated capitalized Internal-use software development costs by $11,312 and Goodwill was understated by $11,312 as of the Merger date. As a result of this error, capitalized Internal-use software development costs, net, was overstated by $8,296 and understated Goodwill by $11,312 as of September 30, 2022 and Depreciation and amortization expense was overstated by $1,056 and $3,016 Successor period three months ended June 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively;
ii.Errors in the valuation of intangible assets of S1 Holdco in the Merger due to the use of incorrect forecasts and assumptions that were not updated to reflect the facts and circumstances as of the date of the Merger, which understated intangible assets by $9,400 and overstated Goodwill by $9,400 as of the Merger date. The impact to the intangible assets as of the Merger date was as follows: trademarks were understated by $10,900 and customer relationship and developed technology intangible assets were overstated by $500 and $1,000, respectively. As a result of these errors, Intangible assets, net, was
9    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
understated by $8,899 and Goodwill was overstated by $9,400 as of September 30, 2022 and Depreciation and amortization expense was understated by $186 and $501 for the Successor period three months ended September 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively;
iii.Errors in the valuation of intangible assets of Protected in the Merger due to the use of incorrect forecasts and assumptions that were not updated to reflect facts and circumstances as of the date of the Merger, which overstated intangible assets by $2,800 and understated Goodwill by $2,800 as of the Merger date. The impact to the intangible assets as of the Merger date was as follows: trademarks were overstated by $7,700 and customer relationships were understated by $4,900. As a result of these errors, Intangible assets, net, was overstated by $1,522 and Goodwill was understated by $2,800 as of September 30, 2022, and Depreciation and amortization expense was overstated by $640 and $1,278 for the Successor period three months ended September 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively;
iv.Errors in the valuation of intangible assets from the CouponFollow acquisition due to the use of incorrect forecasts and assumptions that were not updated to reflect facts and circumstances as of the date of the acquisition, which understated intangible assets by $11,900, and overstated Goodwill by $11,900 as of the acquisition date. As a result of these errors, Intangible assets, net was understated by $11,201 and Goodwill was overstated by $11,900 as of September 30, 2022 and Depreciation and amortization expense was understated by $305 and $699 for the successor period three months ended September 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively.

b.Not used

c.Stock retirement error – The Company identified an error in the accounting for the repurchase and retirement of common stock that was incorrectly recorded to Additional paid-in capital upon the Merger rather than directly to Accumulated deficit. This error resulted in an understatement of Additional paid-in capital and an understatement of Accumulated deficit of $31,167 as of January 27, 2022 and September 30, 2022.

d.Forward purchase liability error – The Company identified an error in the opening balance sheet as of January 27, 2022 related to the accounting and valuation of a modification to a forward purchase contract classified as a liability with Cannae (as defined in Note 3). As further described in Note 3, on June 28, 2021, and as amended on January 10, 2022, the Trebia Sponsors agreed to forfeit up to 2,600 shares of Trebia Class B common stock in exchange for Cannae providing backstop funding for the Merger. This should have resulted in Trebia recording a forward purchase agreement liability on June 28, 2021, with mark-to-market adjustments to fair value at each future reporting date. The Company estimated the value of this liability immediately preceding the Merger based on the final redemptions and Cannae’s anticipated backstop funding and the impact of reversing the gain recorded upon termination of the original forward agreement with Cannae. This error resulted in an understatement of Accumulated deficit and Additional paid-in capital by $25,336 as of September 30, 2022.

e.Tax related opening balance sheet errors - The Company identified tax related errors in the acquired assets and liabilities relating to the Merger and its other business acquisitions due to the valuation errors noted in (a) above and a failure to identify and record acquired tax assets and liabilities as follows:

i.The Company identified tax related errors in the acquired assets and liabilities relating to S1 Holdco during the Merger which, after consideration of measurement period adjustments originally recorded in the period, resulted in an understatement of Prepaid expenses and other current assets of $2,538, an understatement of Other non-current
10    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
assets of $27, an understatement of Accrued expenses and other current liabilities of $362, an overstatement of the Deferred tax liability of $3,374, and an overstatement of Goodwill of $5,577 as of the Merger date and September 30, 2022;
ii.The Company identified tax related errors in the acquired assets and liabilities relating to Protected during the Merger which resulted in an understatement of Prepaid expenses and other current assets of $2,063, an understatement of Accrued expenses and other current liabilities of $1,744, an overstatement of the Deferred tax liability of $110, and an overstatement of Goodwill of $429 as of the Merger date and September 30, 2022;
iii.The Company identified tax related errors in the acquired assets and liabilities relating to the CouponFollow acquisition which resulted in an overstatement of Accrued expenses and other current liabilities by $693, an understatement of Deferred tax liability by $2,802, and an understatement of Goodwill by $2,109 as of the acquisition date and September 30, 2022.

II.Equity related errors:

f.CouponFollow Incentive Plan error - The Company failed to record a post-combination bonus expense for the three months ended June 30, 2022 related to CouponFollow’s Incentive Plan which was originally corrected out-of-period in the three months ended September 30, 2022. The Company has recorded an adjustment to reflect the post-combination bonus expense in the correct period. As a result, Salaries, commissions and benefits expense was overstated by $1,001 for the Successor period three months ended September 30, 2022. The error did not have any impact for the period from January 27, 2022 to September 30, 2022.

g.Stock based compensation - The Company identified errors in its accounting for stock-based compensation arrangements as follows:

i.Errors in accounting for Class F Unit ("F units") awards relating to the modification of the awards and the attribution of compensation cost between purchase consideration and post-combination expense due to the incorrect use of graded vesting for expense recognition subsequent to the Merger rather than recognizing expense on a straight-line basis; the determination of the fair value of awards upon the Merger; a spreadsheet formula error; and the accounting for forfeitures of awards subsequent to the Merger. In the Predecessor period there was an overstatement of Additional paid-in capital and an overstatement of Stock-based compensation expense by $3,993. As a result of these errors, Goodwill was overstated by $4,115, Accrued expenses and other current liabilities was overstated by $185, Other liabilities was overstated by $92, Additional paid-in capital was understated by $7,654, and Accumulated other comprehensive income was overstated by $1 as of September 30, 2022. In addition, these errors resulted in an understatement of stock-based compensation included in Salaries, commissions and benefits of $909 and $11,491 for the Successor periods three months ended September 30, 2022 and for the period from January 27, 2022 through September 30, 2022, respectively;
ii.Errors in accounting for Value Creation Unit ("VCU") awards relating to the modification of the awards and the attribution of compensation cost between purchase consideration and post-combination expense due to the incorrect use of graded vesting for expense recognition subsequent to the Merger rather than recognizing expense on a straight-line basis; the determination of the fair value of awards upon the Merger; and the accounting for forfeitures subsequent to the Merger. As a result of these errors, Goodwill was overstated by $7,133, Accrued expenses and other current liabilities was overstated by $716, Other liabilities was overstated by $1,196, and Additional paid-in capital was overstated by $2,658, as of September 30, 2022. In addition, these errors resulted in an
11    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
understatement of stock-based compensation included in Salaries, commissions and benefits of $1,368 and $2,563 for the Successor periods three months ended September 30, 2022 and for the period from January 27, 2022 through September 30, 2022, respectively;
iii.Errors in the accounting for restricted stock awards issued to the SPAC sponsors, which should have been treated as an equity exchange on the Merger date rather than as compensation expense in the Successor period from January 27, 2022 to September 30, 2022. As a result, Salaries, commissions, and benefits was overstated by $0 and $12,746 in the Successor period three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022 and Additional paid-in capital was overstated $12,746 as of September 30, 2022;
iv.Errors in the accounting and valuation for Sponsor Promote Shares which should have been recorded in the Successor period from January 27, 2022 to September 30, 2022 rather than the Trebia financial statements as of January 26, 2022. As a result, Additional paid-in capital and Accumulated deficit were overstated by $8,079 in opening shareholders' equity as of January 26, 2022. This error resulted in an understatement of Additional paid-in capital of $288 as of the September 30, 2022. Additionally, this error resulted in an understatement of stock-based compensation expense included in Salaries, commissions and benefits of $0 and $7,706 and an understatement of Selling, general and administrative expense of $0 and $661 for the Successor period three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022, respectively.

h.Stock based compensation errors, other - The Company identified other errors relating to the improper accounting for equity awards, including an error related to the expense attribution for certain awards, with accelerated vesting. These errors resulted in an overstatement of Goodwill by $518 and an overstatement of Additional paid-in capital by $518 as of the Merger date and September 30, 2022. Additionally, these errors resulted in an overstatement of stock-based compensation expense included in Salaries, commissions and benefits of $1,473 and $0 for the successor period three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022, respectively.

III.Other errors:

i.Non-controlling interest errors - The Company identified errors related to its calculation of net loss attributable to non-controlling interests due to the inclusion of entities that did not have non-controlling interests. In addition, the Company has corrected Net loss attributable to non-controlling interest for other errors described herein. Further, the Company did not record the impact of ownership changes as a result of the conversion of Class C shares to Class A shares which occurred during the three months ended September 30, 2022. The impact of these errors was an understatement of Accumulated other comprehensive income by $9, an overstatement Accumulated deficit $68,484, an understatement of Additional paid-in capital by $2,714 and an overstatement of Non-controlling interest by $71,207 as of September 30, 2022. Net loss attributable to non-controlling interest was understated by $66,066 and $68,562 for the Successor period for the three months ended September 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively. As a result of these adjustments, Comprehensive loss attributable to non-controlling interest was understated by $65,877 and $68,346 for the Successor three months ended September 30, 2022 and the period from January 27, 2022 through September 30, 2022.

j.Internal-use software development costs – The Company identified errors in the capitalization of internal-use software costs subsequent to the Merger which resulted in an understatement of Internal-use software development costs, net by $1,388 as of September 30, 2022 and an overstatement of Salaries, commissions, and benefits expense by $72 and $591, and an
12    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
overstatement of Depreciation and amortization expense by $0 and $797 for the Successor period three months ended September 30, 2022 and the period from January 27, 2022 through September 30, 2022, respectively.

k.Accrual related errors - The Company identified various errors in accruals at period ends which impacted the Predecessor and Successor Periods. These errors had the impact of overstating Cost of revenues by $261 and understating Selling, general and administrative expense by $744 in the Predecessor period from January 1, 2022 to January 26, 2022 and understating Accrued expenses and other current liabilities by $319 and overstating Prepaid expenses and other current assets by $164 as of the Merger date. These errors also had the impact of understating Cost of revenues by $0 and $261 and overstating Selling, general and administrative expense by $836 and $744 for the Successor period three months ended September 30, 2022 and for the period from January 27, 2022 to September 30, 2022, respectively, and understating Goodwill by $483 as of September 30, 2022.

l.RoadWarrior contingent consideration errors - The Company failed to record errors in the valuation of contingent consideration for the RoadWarrior acquisition resulting from a misinterpretation of the arrangement as of March 31, 2022. The Company erroneously recorded a liability in the opening balance sheet for contingent consideration; however, the arrangement does not include contingent consideration provisions. The Company has recorded an adjustment to reflect the correction to the valuation of the contingent consideration which was originally corrected out-of-period in the three months ended September 30, 2022. As a result, Selling, general and administrative was understated by $6 and $0 for the Successor period three months ended June 30, 2022 and the period from January 27, 2022 to September 30, 2022, respectively.

m.Impact of errors on tax accounts:

i.The income tax provision was recomputed based on the restated pre-tax income (loss) for the period, resulting in an understatement of Income tax benefit of the Successor period three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022 by $61,422 and $62,273, respectively, and an overstatement of the related Deferred tax liability of $63,273 as of September 30, 2022;
ii.As a result of the valuation errors identified in the opening balance sheet, the Company corrected the tax impacts of the Company’s contribution of the net assets of CouponFollow to System1 Opco, LLC immediately following the acquisition, resulting in an overstatement of the Deferred tax liability and an understatement of Additional paid-in capital of $3,518 as of September 30, 2022;
iii.The Company identified errors in the reconciliation of its tax accounts at September 30, 2022 which resulted in an overstatement of Prepaid expenses and other current assets by $2,538, an understatement of Accrued expenses and other current liabilities of $963, and an overstatement of Deferred tax liability by $3,502.

n.Other classification errors - The Company identified classification errors between current and non-current Restricted cash, which overstated Restricted cash, current by $170, understated Restricted cash, non-current as of September 30, 2022.

o.Other adjustments - In addition to the impacts of the adjustments described herein, the Company identified various adjustments primarily related to rounding.

p.Impact of errors on foreign currency translation - As a result of the correction of the identified errors and preparation of the financial statements, the effects of foreign currency translation adjustments and their effects on other comprehensive income have also been reflected within the restated amounts.

13    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
q.Cash flow errors - In addition to the impacts of adjustments to correct the statements of cash flows from the adjustments described above, the Company also determined that various line items within the operating activities section required the correction of errors and total cash flows within operating, investing, and financing activities were misstated due to errors resulting from incorrect support utilized by the Company in preparing the statements of cash flows. The aggregate impact of these errors to the consolidated statement of cash flows for the Successor period from January 27, 2022 to March 31, 2022 was an understatement of Share-based compensation expense of $19, an understatement of increase in Prepaids and other assets of $572, an overstatement of decrease in Accrued expenses and other liabilities of $1,976, an understatement of increase in Other long-term liabilities of $3,612, an overstatement of Purchases of property and equipment of $4, an overstatement of Expenditures of internal-use software of $252, an overstatement of Acquisitions of businesses, net of cash acquired of $1,667. The Company also identified other immaterial classification errors for the Successor period from January 27, 2022 to September 30, 2022 which have been corrected herein.

r.Cash flow lease payments error - Cash lease payments of $1,306 for the Successor period from January 27, 2022 through September 30, 2022 were previously classified as noncash "Amortization of right-of-use-assets" rather than as lease liability outflows in changes in operating assets and liabilities in the statement of cash flows.

s.Earnings per share error - The Company identified an error in its computation of weighted average number of shares which impacted the earnings per share disclosure for the Successor three months ended September 30, 2022 and the period from January 27, 2022 to September 30, 2022.

t.Goodwill impairment error - The Company identified an error relating to the timing of recognition of a goodwill impairment that should have been recorded during the three months ended September 30, 2022 (see Note 6). As a result of this error, Goodwill was overstated by $340,109 as of September 30, 2022 and Impairment of goodwill was understated by $340,109 in the condensed consolidated statement of operations for the Successor period from January 27, 2022 through September 30, 2022 and the three months ended September 30, 2022.

The accompanying notes to the condensed consolidated financial statements have also been corrected to reflect the impacts of the adjustments described above. In addition, the Company has corrected the following disclosures errors:

•Authorized share disclosure - The Company corrected disclosure of the number of authorized Class A common stock on the condensed consolidated balance sheet;

•Merger disclosures - The Company corrected the disclosure in Note 3 related to the presentation of assets acquired and liabilities assumed from the Merger and the unaudited pro forma information due to errors resulting from incorrect support utilized in preparing the disclosures and incorrect application of adjustments to the pro forma information;

•CouponFollow acquisition disclosures – The Company corrected the disclosure in Note 4 for transaction costs incurred for the CouponFollow acquisition that did not include total amounts incurred in 2021 and the amount of deferred contingent consideration;

•Reportable segment goodwill disclosure - The Company corrected the disclosure in Note 6 related to errors in the allocation of goodwill from the Merger and other business acquisitions to its reportable segments;

•Segment disclosures – The Company also corrected the disclosure in Note 16 related to errors in the allocation of revenues and adjusted gross profit to the Owned and Operated and the Partner Network segments. For the Predecessor period from January 1, 2022 to January 26, 2022, Owned
14    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
and Operated segment revenue was overstated and Partner Network segment revenue was understated by $542 and Owned and Operated adjusted gross profit was overstated by $542 and Partner Network adjusted gross profit was understated by $91. For the Successor period three months ended September 30, 2022, Owned and Operated segment revenue was overstated and Partner Network segment revenue was understated by $3,280 and Owned and Operated adjusted gross profit was overstated by $3,280 and Partner Network adjusted gross profit was understated by $286. For the Successor period from January 27, 2022 to September 30, 2022, Owned and Operated segment revenue was overstated and Partner Network segment revenue was understated by $12,408 and Owned and Operated adjusted gross profit was overstated by $12,408 and Partner Network adjusted gross profit was understated by $1,308.


The following table summarizes the effect of the adjustments to correct errors on each affected financial statement line item impacting the condensed consolidated balance sheet as of September 30, 2022. The footnotes correspond to the error descriptions above:
Successor
September 30, 2022
As Previously ReportedAdjustmentsAs Restated
ASSETS
Current assets:
Cash and cash equivalents$31,933 $— $31,933 
Restricted cash, current7,338 (170)(n)7,168 
Accounts receivable78,846 — 78,846 
Prepaid expenses and other current assets8,756 4,600 (e)
(2,538)(m)
— (1)(o)10,817 
Total current assets126,873 1,891 128,764 
Restricted cash, non-current2,772 170 (n)2,942 
Property and equipment, net4,349 — 4,349 
Internal-use software development costs, net12,599 (8,296)(a)
1,388 (j)
(1)(o)5,690 
Intangible assets, net506,018 18,578 (a)
1 (o)524,597 
Goodwill904,240 (7,188)(a)
(3,897)(e)
(11,248)(g)
(518)(h)
483 (k)
29 (p)
(340,109)(t)541,792 
Operating lease assets6,893 — 6,893 
Other non-current assets
708 27 (e)
(4)(p)731 
Total assets$1,564,452 $(348,694)$1,215,758 
LIABILITIES AND SHAREHOLDERS’ EQUITY/MEMBERS’ DEFICIT
Current liabilities:
Accounts payable12,242 (1)(o)12,241 
Accrued expenses and other current liabilities90,265 1,413 (e)
(901)(g)
963 (m)
(6)(o)
(3)(p)91,731 
15    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Protected.net incentive plan liability, current19,266 — 19,266 
Deferred revenue68,289 — 68,289 
Operating lease liabilities, current2,102 — 2,102 
Debt, net14,954 — 14,954 
Total current liabilities207,118 1,465 208,583 
Operating lease liabilities, non-current6,406 — 6,406 
Long-term debt, net402,273 — 402,273 
Warrant liability18,158 — 18,158 
Deferred tax liability120,724 (682)(e)
(70,293)(m)
(2)(o)49,747 
Protected.net incentive plan liability, non-current11,517 — 11,517 
Other liabilities2,909 (1,288)(g)1,621 
Total liabilities769,105 (70,800)698,305 
Commitments and contingencies
SHAREHOLDERS’ EQUITY / MEMBERS’ DEFICIT
Class A common stock - $0.0001 par value; 500,000 shares authorized, 91,490 Class A shares issued and outstanding as of September 30, 2022
9 — 9 
Class C common stock - $0.0001 par value; 25,000 shares authorized, 21,747 Class C shares issued and outstanding as of September 30, 2022
2 — 2 
Additional paid-in capital767,169 31,167 (c)
25,336 (d)
(7,462)(g)
(518)(h)
2,714 (i)
3,518 (m)
(12)(o)
(10)(p)821,902 
Accumulated deficit(150,016)3,094 (a)
(31,167)(c)
(25,336)(d)
(1,596)(g)
68,484 (i)
1,388 (j)
483 (k)
63,273 (m)
173 (o)
29 (p)
(340,109)(t)(411,300)
Accumulated other comprehensive income13 (1)(g)
9 (i)
(155)(o)
10 (p)(124)
Total shareholders’ equity/members’ deficit attributable to System1, Inc.617,177 (206,688)410,489 
Non-controlling interest178,170 (71,207)(i)
2 (o)
(1)(p)106,964 
Total shareholders’ equity/members’ deficit795,347 (277,894)517,453 
Total liabilities and shareholders’ equity/members’ deficit1,564,452 (348,694)1,215,758 
16    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following tables summarize the effect of the adjustments to correct errors on each affected financial statement line item for the periods indicated, impacting the condensed consolidated statements of operations. The footnotes correspond to the error descriptions above:
SuccessorSuccessorPredecessor
Three Months Ended September 30, 2022Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022
As Previously ReportedAdjustmentsAs RestatedAs Previously ReportedAdjustmentsAs RestatedAs Previously ReportedAdjustmentsAs Restated
Revenue$201,176 $— $201,176 $587,081 $— $587,081 $52,712 $52,712 
Operating costs and expenses:
Cost of revenues (excluding depreciation and amortization)137,681 (1)(o)137,680 410,370 261 (k)41,760 (261)(k)
(9)(o)410,622 8 (o)41,507 
Salaries, commissions, and benefits55,862 (1,001)(f)144,876 9,014 (g)35,175 (3,993)(g)
2,277 (g)(591)(j)(1)(o)31,181 
(1,473)(h)12 (o)153,311 
(72)(j)
9 (o)55,602 
Selling, general, and administrative16,520 (836)(k)47,668 661 (g)14,817 744 (k)
6 (l)(744)(k)
(3)(o)(106)(o)104 (o)15,665 
(268)(p)15,419 (225)(p)47,254 
Depreciation and amortization33,420 (1,205)(a)90,128 (3,094)(a)1,000 — 1,000 
(1)(o)32,214 (797)(j)
(1)(o)86,236 
Impairment of goodwill— 340,109 (t)340,109 — 340,109 (t)340,109 — — — 
Total operating costs and expenses243,483 337,541 581,024 693,042 344,490 1,037,532 92,752 (3,399)89,353 
Operating income (loss)(42,307)(337,541)(379,848)(105,961)(344,490)(450,451)(40,040)3,399 (36,641)
Other expense:
Interest expense, net10,011 — 10,011 22,111 — 22,111 1,049 — 1,049 
Change in fair value of warrant liabilities4,489 — 4,489 14,111 — 14,111 — — — 
Total other expense14,500 — 14,500 36,222 — 36,222 1,049 — 1,049 
Income (loss) before income tax(56,807)(337,541)(394,348)(142,183)(344,490)(486,673)(41,089)3,399 (37,690)
Income tax (benefit) provision(19,228)(61,421)(m)(80,649)(32,480)(63,272)(m)(95,752)(629)— (629)
Net income (loss)(37,579)(276,120)(313,699)$(109,703)$(281,218)$(390,921)$(40,460)$3,399 $(37,061)
Net loss attributable to non-controlling interest(5,936)(66,066)(i)(72,002)(18,871)(68,562)(i)— — — 
13 (o)
2 (p)(87,418)
Net income (loss) attributable to System1, Inc.$(31,643)$(210,054)$(241,697)$(90,832)$(212,671)$(303,503)$(40,460)$3,399 $(37,061)
Basic and diluted net loss per share$(0.35)$(2.31)$(2.66)$(1.02)$(2.40)$(3.43)$(1.97)$0.17 $(1.81)
Weighted average number of shares outstanding - basic and diluted91,002 91,002 88,716 (319)(s)88,397 20,488 20,488 
17    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following tables summarize the effect of the adjustments to correct errors on each affected financial statement line item for the periods indicated, impacting the condensed consolidated statements of comprehensive income (loss). The footnotes correspond to the error descriptions above:
Three-Month PeriodNine-Month Period
SuccessorSuccessorPredecessor
Three Months Ended September 30, 2022Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022
As Previously ReportedAdjustmentsAs RestatedAs Previously ReportedAdjustmentsAs RestatedAs Previously ReportedAdjustmentsAs Restated
Net income (loss)$(37,579)$(276,120)(a)(f)(g)(h)(j)(k)(l)(m)(o)(p)(t)$(313,699)$(109,703)$(281,218)(a)(g)(j)(k)(m)(o)(p)(t)$(390,921)$(40,460)$3,399 (g)(k)(o)$(37,061)
Other comprehensive income (loss)
Foreign currency translation income (loss)(354)651 (m)(p)297 (126)2 (m)(p)(124)87 — 87 
Comprehensive income (loss)$(37,933)$(275,469)$(313,402)$(109,829)$(281,216)$(391,045)$(40,373)$3,399 $(36,974)
Comprehensive loss attributable to non-controlling interest(6,124)(65,877)(i)(72,001)(19,010)(68,346)(i)(87,356)— — — 
Comprehensive income (loss) attributable to System1, Inc.$(31,809)$(209,592)$(241,401)$(90,819)$(212,870)$(303,689)$(40,373)$3,399 $(36,974)

18    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following tables summarize the effect of the adjustments to correct errors on each affected financial statement line item for the periods indicated, impacting the condensed consolidated statements of changes in stockholders' equity. The footnotes correspond to the error descriptions above:
Class A Common StockClass C Common StockClass D Common Stock
SharesAmountSharesAmountSharesAmountAdditional Paid-In-CapitalAccumulated DeficitAccumulated Other Comprehensive IncomeNon-Controlling InterestTotal Stockholders’
Equity
As Previously Reported
Successor:
For the period from January 27, 2022 to September 30, 2022
BALANCE—January 26, 202252,680 $5 — $— — $— $525,579 $(59,184)$— $— $466,400 
Effect of Merger29,017 3 22,077 2 2,900 — 157,046 — — 198,691 355,742 
BALANCE—January 27, 202281,697 8 22,077 2 2,900 — 682,625 (59,184)— 198,691 822,142 
Net loss— — — — — — — (29,991)— (8,068)(38,059)
Issuance of common stock in connection with the acquisition of business2,000 — — — — — 25,500 — — — 25,500 
Issuance of market-based restricted stock units upon vesting— — — — — — — — — — — 
Conversion of Class D shares to Class A shares2,900 1 — — (2,900)— — — — — 1 
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — (6,752)— — — (6,752)
Other comprehensive income— — — — — — — — (28)(6)(34)
Share-based compensation— — — — — — 27,167 — — — 27,167 
Distribution to members— — — — — — — — — (247)(247)
BALANCE—March 31, 202286,597 $9 22,077 $2 — $— $728,540 $(89,175)$(28)$190,370 $829,718 
Net loss— — — — — — — (29,198)— (4,867)(34,065)
Exercise of warrants3,969 — — — — — 27,989 — — — 27,989 
Issuance of restricted stock, net of forfeitures and shares withheld for taxes 21 — — — — — — — — — — 
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — 585 — — — 585 
Other comprehensive income— — — — — — — — 207 55 262 
Share-based compensation— — — — — — 3,888 — — — 3,888 
Distribution to members— — — — — — — — — (1,254)(1,254)
BALANCE—June 30, 202290,587 $9 22,077 $2 — $— $761,002 $(118,373)$179 $184,304 $827,123 
Net loss— — — — — — — (31,643)— (5,936)(37,579)
Issuance of restricted stock, net of forfeitures and shares withheld for taxes573 — — — — — (2,035)— — — (2,035)
Conversion of Class C shares to Class A shares330 — (330)— — — — — — — — 
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — 14 — — — 14 
Other comprehensive income— — — — — — — — (166)(188)(354)
Share-based compensation— — — — — — 8,188 — — — 8,188 
Distribution to members— — — — — — — — — (10)(10)
BALANCE—September 30, 202291,490 $9 21,747 $2 — $— $767,169 $(150,016)$13 $178,170 $795,347 
19    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Class A Common StockClass C Common StockClass D Common Stock
SharesAmountSharesAmountSharesAmountAdditional Paid-In-CapitalAccumulated DeficitAccumulated Other Comprehensive IncomeNon-Controlling InterestTotal Stockholders’
Equity
Adjustments
Successor:
For the period from January 27, 2022 to September 30, 2022
BALANCE—January 26, 2022(930)$— — $— — $— $48,424 $(48,613)$— $— $(189)(d)
Effect of Merger— — — — (1,450)— (8,687)— — — (8,687)(c) (d) (g)
BALANCE—January 27, 2022(930)— — — (1,450)— 39,737 (48,613)— — (8,876)
Net loss— — — — — — — (6,078)— 759 (5,319)(g) (i)
Issuance of common stock in connection with Merger, net of offering costs, underwriting discounts and commissions930 — — — — — 661 — — — 661 (g)
Issuance of market-based restricted stock units upon vesting— — — — 1,450 — — — — — — (g)
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — 4,156 — — — 4,156 (m)
Other comprehensive income— — — — — — — — 131 (178)(47)(p)
Share-based compensation— — — — — — 4,231 — — — 4,231 (g) (h)
BALANCE—March 31, 2022— $— — $— — $— $48,785 $(54,691)$131 $581 $(5,194)
Net loss— — — — — — — 3,461 — (3,240)221 (g) (i)
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — (585)— — — (585)(m)
Other comprehensive income— — — — — — — — (1,622)(69)(1,691)(p)
Share-based compensation— — — — — — 3,107 — — — 3,107 (g) (h)
BALANCE—June 30, 2022— $— — $— — $— $51,307 $(51,230)$(1,491)$(2,728)$(4,142)
Net loss— — — — — — — (210,054)— (66,066)(276,120)(g) (i)
Conversion of Class C shares to Class A shares— — — — — — 2,714 — — (2,714)— (i)
Establishment of liabilities under tax receivable agreement and related changes to deferred tax assets associated with increases in tax basis— — — — — — (41)— — — (41)(m)
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — (14)— — — (14)(m)
Other comprehensive income— — — — — — — — 1,354 302 1,656 (p)
Share-based compensation— — — — — — 767 — — — 767 (g) (h)
BALANCE—September 30, 2022— $— — $— — $— $54,733 $(261,284)$(137)$(71,206)$(277,894)
20    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Class A Common StockClass C Common StockClass D Common Stock
SharesAmountSharesAmountSharesAmountAdditional Paid-In-CapitalAccumulated DeficitAccumulated Other Comprehensive IncomeNon-Controlling InterestTotal Stockholders’
Equity
As Restated
Successor:
For the period from January 27, 2022 to September 30, 2022
BALANCE—January 26, 202251,750 $5 — $— — $— $574,003 $(107,797)$— $— $466,211 
Effect of Merger29,017 3 22,077 2 1,450 — 148,359 — — 198,691 347,055 
BALANCE—January 27, 202280,767 8 22,077 2 1,450 — 722,362 (107,797)— 198,691 813,266 
Net loss— — — — — — — (36,069)— (7,309)(43,378)
Issuance of common stock in connection with Merger, net of offering costs, underwriting discounts and commissions930 — — — — — 661 — — — 661 
Issuance of common stock in connection with the acquisition of business2,000 — — — — — 25,500 — — — 25,500 
Issuance of market-based restricted stock units upon vesting— — — — 1,450 — — — — — — 
Conversion of Class D shares to Class A shares2,900 1 — — (2,900)— — — — — 1 
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — (2,596)— — — (2,596)
Other comprehensive income— — — — — — — — 103 (184)(81)
Share-based compensation— — — — — — 31,398 — — — 31,398 
Distribution to members— — — — — — — — — (247)(247)
BALANCE—March 31, 202286,597 $9 22,077 $2 — $— $777,325 $(143,866)$103 $190,951 $824,524 
Net loss— — — — — — — (25,737)— (8,107)(33,844)
Exercise of warrants3,969 — — — — — 27,989 — — — 27,989 
Issuance of restricted stock, net of forfeitures and shares withheld for taxes21 — — — — — — — — — — 
Other comprehensive income— — — — — — — — (524)(14)(538)
Share-based compensation— — — — — — 6,995 — — — 6,995 
Distribution to members— — — — — — — — — (1,254)(1,254)
BALANCE—June 30, 202290,587 $9 22,077 $2 — $— $812,309 $(169,603)$(421)$181,576 $823,872 
Net loss— — — — — — — (241,697)— (72,002)(313,699)
Issuance of restricted stock, net of forfeitures and shares withheld for taxes573 — — — — — (2,035)— — — (2,035)
Conversion of Class C shares to Class A shares330 — (330)— — — 2,714 — — (2,714)— 
Establishment of liabilities under tax receivable agreement and related changes to deferred tax assets associated with increases in tax basis— — — — — — — (41)— — — (41)
21    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Net deferred tax liability resulting from changes in outside basis difference on investment in S1 Holdco, LLC— — — — — — — — — — — 
Other comprehensive income— — — — — — — — 297 114 411 
Share-based compensation— — — — — — 8,955 — — — 8,955 
Distribution to members— — — — — — — — — (10)(10)
BALANCE—September 30, 202291,490 $9 21,747 $2 — $— $821,902 $(411,300)$(124)$106,964 $517,453 

22    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following tables summarize the effect of the adjustments to correct errors on each affected financial statement line item for the periods indicated, impacting the condensed consolidated statement of changes in members' deficit. The footnotes correspond to the error descriptions above:
Members’ DeficitAccumulated Other Comprehensive Income (Loss)Noncontrolling InterestTotal Members’ Deficit
Predecessor:
For the period January 1, 2022 to January 26, 2022As Previously ReportedAdjustmentsAs RestatedAs Restated
BALANCE—January 1, 2022$(28,829)$— $(28,829)$428 $— $(28,401)
Net loss(40,460)3,399 (g)(k)(o)(37,061)— — (37,061)
Accumulated other comprehensive income— — — 87 — 87 
Share-based compensation expense27,698 (3,993)(g)23,705 — — 23,705 
Foreign currency translation adjustments— — — — — — 
BALANCE—January 26, 2022$(41,591)$(594)$(42,185)$515 $— $(41,670)


23    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following tables summarize the effect of the adjustments to correct errors on each affected financial statement line item for the periods indicated, impacting the condensed consolidated statements of cash flows. The footnotes correspond to the error descriptions above:
SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022
As Previously ReportedAdjustmentsAs RestatedAs Previously ReportedAdjustmentsAs Restated
Cash flows from Operating Activities:
Net income (loss)$(109,703)$(281,218)(a)(g)(j)(k)(m)(o)(p)(t)$(390,921)$(40,460)$3,399 (g)(k)(o)$(37,061)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization90,128 (3,892)(a)(j)(o)86,236 1,000 — 1,000 
Share-based compensation79,802 9,045 (g)(o)(q)88,847 27,698 (3,993)(g)23,705 
Impairment of goodwill— 340,109 (t)340,109 — — — 
Amortization of debt issuance costs3,540 — 3,540 — — — 
Noncash lease expense(203)1,305 (q)(r)1,102 115 — 115 
Change in fair value of contingent consideration and CEO equity profit interest— — — (9)— (9)
Change in fair value of warrants14,111 — 14,111 — — — 
Deferred tax benefits(37,827)(63,273)(m)(101,100)(816)— (816)
Other— 661 (g)661 — — — 
Changes in operating assets and liabilities
Accounts receivable6,670 — 6,670 11,118 — 11,118 
Prepaids and other assets455 (730)(k)(o)(p)(q)(275)905 164 (k)1,069 
Accounts payable1,981 — 1,981 (67,600)— (67,600)
Accrued expenses and other liabilities(19,017)1,648 (k)(o)(p)(q)(17,369)57,170 318 (k)(o)57,488 
Protected.net incentive plan liability(10,000)— (10,000)— — — 
Deferred revenue7,133 — 7,133 311 — 311 
Other long-term liabilities(26,549)(4,918)(q)(r)(31,467)78 (1)(o)77 
Net cash provided by (used in) operating activities521 (1,263)(742)(10,490)(113)(10,603)
Cash flows from Investing Activities:
Purchases of property and equipment(3,224)4 (q)(3,220)— — — 
Capitalized software development costs(4,796)(339)(j)(q)(5,135)(441)— (441)
Acquisition of businesses, net of cash acquired(445,405)1,331 (o)(p)(q)(444,074)— — — 
Net cash used in investing activities(453,425)996 (452,429)(441)— (441)
Cash flows from Financing Activities:
Proceeds from term loan and line of credit449,000 — 449,000 — — — 
Repayment of term loan(182,488)— (182,488)— — — 
Member capital contributions— — — — — — 
Payments for financing costs(24,845)— (24,845)— — — 
Payments for earnouts(1,715)— (1,715)— — — 
Taxes paid related to net settlement of restricted stock awards(2,035)— (2,035)— — — 
Redemptions of Class A common stock(510,469)— (510,469)— — — 
Proceeds from warrant exercises 5,027 — 5,027 — — — 
Cash received from the Backstop246,484 — 246,484 — — — 
Payments on contingent consideration from purchase of companies— — — — — — 
24    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Related party loan— — — — — — 
Distributions to members(1,511)— (1,511)— — — 
Net cash used in financing activities(22,552)— (22,552)— — — 
Effect of exchange rate changes in cash, cash equivalent and restricted cash(54)267 (p)213 (132)113 (p)(19)
Net increase (decrease) in cash, cash equivalents and restricted cash(475,510)— (475,510)(11,063)— (11,063)
Cash and cash equivalents and restricted cash, beginning of the period517,553 — 517,553 48,639 — 48,639 
Cash and cash equivalents and restricted cash, end of the period$42,043 $— $42,043 $37,576 $— $37,576 
Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets:
Cash and cash equivalents$31,933 $— $31,933 $36,833 $— $36,833 
Restricted cash10,110 — 10,110 743 — 743 
Total cash, cash equivalents and restricted cash$42,043 $— $42,043 $37,576 $— $37,576 
Supplemental cash flow information:
Cash paid for operating lease liabilities$1,580 $— $1,580 $175 $— $175 
Operating lease assets obtained in exchange for operating lease liabilities$2,064 $— $2,064 $7,987 $— $7,987 
Capitalized assets financed by accounts payable$309 $— $309 $— $— $— 
Tenant improvements paid by lessor$139 $— $139 $— $— $— 
Stock-based compensation included in capitalized software development costs$340 $— $340 $— $— $— 
Equity issuance to settle intercompany loan$— $— $— $— $941 $941 
Deferred contingent consideration for acquisitions$— $7,059 $7,059 $— $— $— 


2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation, Principles of Consolidation and Summary of Significant Accounting Policies

The Company was a special purpose acquisition company originally incorporated as a Cayman Islands exempted company on February 11, 2020 under the name Trebia Acquisition Corp. (“Trebia”). The Company was formed for the purpose of effecting a merger, share exchange, asset acquisition, share purchase, reorganization or similar business combination with one or more businesses (the “Merger”). On January 27, 2022, the Company consummated its Merger, which resulted in the acquisition of S1 Holdco and System1 SS Protect Holdings, Inc. (“Protected”). As a result of the Merger, the results of operations, financial position and cash flows of the Predecessor and Successor are not directly comparable.

The Company was deemed the accounting acquirer in the Merger based on an analysis of the criteria outlined in Accounting Standards Codification (“ASC”) 805, Business Combinations and S1 Holdco was deemed to be the predecessor entity. Accordingly, the historical financial statements of S1 Holdco became the historical financial statements of the Company, upon the consummation of the Merger. As a result, the financial statements included in this report reflect (i) the historical operating results of S1 Holdco prior to the Merger and (ii) the combined results of the Company, including S1 Holdco and Protected following the closing of the Merger. The accompanying financial statements include a Predecessor period, which includes the period through January 26, 2022 concurrent with the Merger, and a Successor period from January 27, 2022 through September 30, 2022. A black-line between the Successor and Predecessor periods has been placed in the condensed consolidated financial statements and in the tables to the notes to the condensed consolidated financial statements to highlight the lack of comparability between these two periods as the Merger resulted in a new basis of accounting for S1 Holdco.
25    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The accompanying condensed consolidated financial statements include the accounts of System1, Inc. and its subsidiaries for the Successor period, and S1 Holdco for the Predecessor periods. All intercompany accounts and transactions have been eliminated in the consolidation of the financial statements. The condensed consolidated financial statements have been prepared by the Company and are unaudited, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations. The interim condensed consolidated financial statements included herein reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented. The year-end condensed consolidated balance sheet data was derived from audited financial statements of S1 Holdco and related notes included in the Company’s final prospectus filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on April 19, 2022 (the “Prospectus”), but does not include all disclosures required by U.S. GAAP. The condensed consolidated statements of operations for the period from January 1, 2022 through January 26, 2022 (Predecessor) and for the three months ended September 30, 2022 and for the period from January 27, 2022 through September 30, 2022 (Successor periods) are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2022 or thereafter.

Certain prior period amounts in the condensed consolidated financial statements have been reclassified to conform with the current period presentation. These reclassifications had no effect on the results of operations or financial position for any period presented.

ASC 842 Adoption

On January 1, 2022, the Company adopted ASC 842, Leases, under the modified transition approach. This lease accounting standard provides several optional practical expedients in transition. The Company elected the “package of practical expedients,” which permits the Company to not reassess its prior conclusions about lease identification, lease classification and initial direct costs. The new standard also provides practical expedients for an entity’s ongoing accounting. The Company elected the short-term lease recognition exemption. Accordingly, for those leases that qualify, the Company did not recognize an operating lease asset or operating lease liability for existing short-term leases of those assets in transition. The Company also elected the practical expedient to not separate lease and non-lease components for its leases. The adoption of the lease standard did not have any effect on its previously reported condensed consolidated statements of operations and did not result in a cumulative catch-up adjustment to opening equity. The Company recorded $6,786 of operating lease assets, $7,987 of lease liabilities and reclassified $1,201 of deferred rent liabilities as a reduction to the beginning operating lease assets upon implementation of ASC 842. See Note 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Leases and Note 7—LEASES for additional details.

Risk and Concentrations

The Company is subject to certain business and operational risks, including competition from alternative technologies, as well as dependence on key Advertising Partners, key employees, key contracts, and growth to achieve its business and operational objectives.

The following table illustrates the level of concentration as a percentage of total revenues for its key Advertising Partners:

26    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Google67 %84 %70 %88 %84 %
Microsoft3 %5 %3 %4 %5 %

As of September 30, 2022, the Company has (i) two paid search advertising partnership contracts with Google, and (ii) one paid search advertising partnership contract with Microsoft. One of the Google contracts was renewed with an effective date of March 1, 2021, and has a two-year term through February 28, 2023. The other Google contract was renewed with an effective date of August 1, 2021, and has a two-year term through July 31, 2023. The Company renewed its advertising contract with Microsoft with an effective date of July 1, 2022, and has a three-year term through June 30, 2025. All three agreements may be terminated by the respective Advertising Partner immediately or with minimal notice under certain circumstances.
Accounts receivable are primarily derived from Advertising Partners located within the United States. As of September 30, 2022 (Successor), two of the Company’s largest Advertising Partners, Google and Yahoo, represented 64% and 12%, respectively, of the Company’s accounts receivables balance. As of December 31, 2021 (Predecessor), these two Advertising Partners represented 72% and 10%, respectively, of the Company’s accounts receivable balances.

Use of Estimates

The preparation of these condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period.

Significant estimates and assumptions reflected in these condensed consolidated financial statements include, but are not limited to: (1) valuation of goodwill, acquired intangible assets and long-lived assets, (2) valuation and recognition of the Company's share-based compensation awards, (3) income taxes, (4) contingent consideration and (5) determination of the fair value of the warrant liabilities. Significant estimates affecting the condensed consolidated financial statements have been prepared on the basis of the most current and best available information, including historical experience, known trends and other market-specific or other relevant factors that the Company believes to be reasonable. Management evaluates its estimates, as there are changes in circumstances, facts and experience. Changes in estimates are recorded in periods which they become known. However, actual results from the resolution of such estimates and assumptions may vary from those used in the preparation of the condensed consolidated financial statements.

Cash and Cash Equivalents

Cash and cash equivalents consist of amounts held as bank deposits.

Accounts Receivable

Accounts receivable primarily represent amounts due from Advertising Partners, and these accounts receivable are stated at the amount the Company expects to collect from outstanding balances and do not bear interest. The Company does not require collateral for its accounts receivable. The Company considers the following factors when determining the collectability of specific customer accounts: past transaction history with the customer and current economic industry trends. These accounts receivables have historically been paid on a timely basis. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection and therefore no allowance for doubtful accounts was required as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor). The payment terms for the Company's accounts receivable are typically 30 days.
27    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

Concentration of Credit Risk

Cash is deposited with high-credit-quality financial institutions and, at times, such balances with any one financial institution may exceed the insurance limits of the prevailing regulatory body. Historically, the Company has not experienced any losses related to these cash balances and believes that there is minimal risk of expected future losses. However, there can be no assurance that there will not be losses on these deposits.
Foreign Currency

The Company’s reporting currency is the U.S. Dollar. The balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. The statements of operations amounts have been translated using the average exchange rate for the month in which the activity related. Accumulated net translation adjustments and foreign currency transaction gains/losses resulting from exchange rate fluctuations on transactions denominated in a currency other than the functional currency were not material.

Warrant Liability

The Company accounts for the Public Warrants and Private Placement Warrants (collectively, the “Warrants”; which are discussed in further detail in Note 13—WARRANTS and Note 14—FAIR VALUE MEASUREMENT) in accordance with ASC 815-40 under which the Warrants do not meet the criteria for equity classification, and therefore must be recorded as liabilities. The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. The fair value of the Private Placement Warrants has been estimated using the fair value of the Public Warrants.

Fair Value of Financial Instruments

The provisions of ASC 820, Fair Value Measurements and Disclosures ("ASC 820"), relate to financial and nonfinancial assets and liabilities, as well as other assets and liabilities carried at fair value on a recurring basis. ASC 820 provides a single authoritative definition of fair value, sets out a framework for measuring fair value, and expands on required disclosures about fair value measurement. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for that asset or liability in an orderly transaction between market participants on the measurement date.

The Company measures fair value based on a three-level hierarchy of inputs, maximizing the use of observable inputs, where available, and minimizing the use of unobservable inputs when measuring fair value. A financial instrument’s level within the three-level hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The three-level hierarchy of inputs is as follows:

Level 1: Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs are based on the Company’s own assumptions about current market conditions and require significant management judgment or estimation.

Financial instruments consist of cash, cash equivalents, restricted cash, accounts receivable, other assets accounted for at fair value, accounts payable, accrued liabilities, and warrant liabilities. Cash equivalents and restricted cash are
28    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
stated at fair value on a recurring basis. Accounts receivable, accounts payable and accrued liabilities are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment date. As of September 30, 2022, the Company's outstanding debt included a Term Loan, of which its fair value was estimated using an observable market quotation (Level 2). The carrying value and estimated fair value of the Term Loan were $368,228 and $374,400, respectively, as of September 30, 2022. Refer to Note 12—DEBT, NET for additional information.

The Company does not have any assets, with the exception of cash, cash equivalents and restricted cash, that are required to be carried at fair value on a recurring basis at September 30, 2022 (Successor) and December 31, 2021 (Predecessor). The Company’s liabilities measured at fair value relate to the Public Warrant liabilities (Level 1), Private Placement Warrant liabilities (Level 2), the former CEO of S1 Holdco's equity profits interest liability (Level 3), and contingent consideration (Level 3).

Certain assets, including goodwill, intangible assets and long-lived assets, are also subject to measurement at fair value on a nonrecurring basis if they are deemed to be impaired as a result of an impairment review. The Company determines the fair value by applying observable inputs to calculate the present value of these assets. To date, no material impairments have been recorded on those assets.

Restricted Cash

The Company had restricted cash of $10,110 and $743 as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor), respectively. The Company’s restricted cash as of September 30, 2022 (Successor) primarily consists of (i) cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office in Marina del Rey, California, (ii) merchant reserve balances with its credit card processors held due to arrangements under which the Company's credit card processors withhold certain credit card funds to cover potential charge backs initiated by the Company’s customers, (iii) the escrow account balance related to the portion of unvested equity awards as of the closing of the Merger that will be cash settled and will be released to the Company's employees as the service requirement is completed, (iv) the escrow account balance related to the indemnification obligations related to its RoadWarrior acquisition and (v) the escrow account balance related to the postcombination compensation arrangement related to the CouponFollow acquisition. The amount of restricted cash as of December 31, 2021 (Predecessor) relates to cash held as collateral at one of the Company’s financial institutions to secure the Company’s letter of credit issued in favor of its landlord under the lease for its corporate office in Marina del Rey, California.

Property and Equipment, net

Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Repairs and maintenance are charged to expense as incurred, while improvements are capitalized. Upon the sale or retirement of property and equipment, the accounts are relieved of the cost and the related accumulated depreciation, and any resulting gain or loss is included in the condensed consolidated statement of operations.

The estimated useful lives of the Company’s property and equipment for purposes of computing depreciation are as follows:

29    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Useful Life
(Years)
Computer equipment3
Office equipment3
Software4
Furniture, fixtures and equipment3-7
Motor vehicles4
Leasehold improvements
Shorter of the remaining lease term or estimated useful life for leasehold improvements.

Internal-use Software Development Costs, net

Internal-use software development costs are stated at cost, less accumulated amortization. The Company capitalizes certain internal-use software development costs associated with creating and enhancing internally developed software related to the Company’s technology infrastructure, including continuing to develop and deploy its RAMP platform. These costs are comprised of personnel costs, which include salaries, bonuses, stock-based compensation and employee benefits’ expenses for employees who are directly associated with, and who devote significant time to, software projects, as well as external direct costs of materials and services consumed in developing or obtaining the software. Internal-use software development costs that do not meet the qualification for capitalization are expensed as incurred, and correspondingly recorded in Salaries, commissions, and benefits expense in the condensed consolidated statement of operations.

Internal-use software development activities generally consist of three stages: (i) the planning stage, (ii) the application and infrastructure development stage, and (iii) the post-implementation stage. Costs incurred in the planning and post-implementation stages of software development, including costs associated with the post configuration training and repairs and maintenance of the developed technologies, are expensed as incurred. The Company capitalizes costs associated with software developed for internal use when the preliminary project stage is completed, management has authorized further funding for the completion of the project, and it is probable that the project will be completed and the software will perform as intended. Costs incurred in the application and infrastructure development stage, including significant enhancements and upgrades, are capitalized. Capitalization ends once a project is substantially complete, and the software and technologies are ready for deployment for their intended purpose(s). Internal-use software development costs are amortized using a straight-line method over an estimated useful life of three (3) years, commencing when the software is ready for its intended use. The straight-line recognition method approximates the manner in which the expected benefit will be derived. The Company does not transfer ownership of its software or lease its software to third parties.

Intangible Assets

Intangible assets primarily consist of acquired technology, customer relationships and trade names/trademarks. The Company determines the appropriate useful life based on management’s estimate of the applicable intangible asset’s remaining economic useful life at the time of acquisition. Intangible assets are amortized over their estimated economic useful lives using a straight-line method, which approximates the pattern in which the economic benefits are consumed. Certain customer relationship intangibles are amortized on an accelerated basis based upon the expected timing of economic benefits which are derived from an analysis of customer attrition rates over the expected life. The fair value of the intangible assets acquired is determined using either the income or market methodologies.

The estimated useful lives of the Company’s intangible assets are as follows:

30    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Useful Life
(Years)
Developed technology4
Customer relationships3-5
Trademarks and trade names10
Other intangibles4

Impairment of Long-Lived Assets

The Company assesses the recoverability of its long-lived assets when events or changes in circumstances indicate that their carrying amounts may not be recoverable. Such events or changes in circumstances may include a significant adverse change in the extent or manner in which a long-lived asset is being used; significant adverse changes in legal factors or in the business climate that could affect the value of a long-lived asset; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of a long-lived asset; current or future operating or cash flow losses that demonstrate continuing losses associated with the use of a long-lived asset; or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The Company performs impairment testing at the asset group level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The Company assesses recoverability of its long-lived assets by determining whether the carrying amount of the asset group can be recovered through projected undiscounted cash flows over their remaining useful lives. If the carrying amount of the asset group exceeds the forecasted undiscounted cash flows, an impairment loss is recognized and measured as the amount by which the carrying amount exceeds the estimated fair value. An impairment loss is charged to operations in the period in which management determines such impairment has occurred. The Company performed an undiscounted cash flow analysis of long-lived assets in conjunction with the testing performed to determine any impairment of goodwill. For the periods presented in this quarterly report, the Company has not recorded any impairments of long-lived assets.

Business Combinations

The results of a business acquired in a business combination are included in the Company’s condensed consolidated financial statements from the date of acquisition. The Company allocates the purchase price, which is the sum of the consideration provided which may consist of cash, equity, or a combination of the two, paid in a business combination for the identifiable assets and liabilities of the acquired business at their acquisition-date fair values. Any excess amount paid over the identifiable net assets is recorded as goodwill. The process for estimating the fair values of the acquired business involves the use of significant estimates and assumptions, including estimating average industry purchase price multiples, customer and service attrition rates and estimating future cash flows. The Company estimates the fair value based on assumptions which the Company's management believes to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, the Company may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. At the conclusion of the measurement period, any subsequent adjustments are reflected in the Company’s condensed consolidated statements of operations.

Transaction costs associated with business combinations are expensed as incurred and are included in Selling, general and administrative expenses in the Company’s condensed consolidated statements of operations. When purchase consideration includes contingent consideration, the Company records the fair value of the contingent consideration as of the date of acquisition, and subsequently remeasures the contingent consideration at fair value as of each reporting date through the Company’s condensed consolidated statements of operations.

Goodwill

31    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired and identifiable intangibles in a business combination. The Company accounts for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other, which requires the Company to test goodwill at the reporting unit level for impairment at least annually or more frequently if events or changes in circumstances indicate the asset might be impaired. The Company’s annual impairment assessment date is December 31.

The Company has the option (i) to assess goodwill for possible impairment by performing a qualitative analysis to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount or (ii) to perform the quantitative impairment test. The quantitative impairment test involves comparing the estimated fair value of a reporting unit with its respective carrying amount, including goodwill. If the estimated fair value exceeds carrying amount, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than its carrying amount, an impairment loss is recognized in an amount equal to the excess, not to exceed the amount of goodwill.

The determination of fair value requires the Company to make various estimates and assumptions. These estimates include, but are not limited to, future expected cash flows from a market participant perspective, and discount rates. Unanticipated events or circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results.

Leases

On January 1, 2022, the Company adopted ASC 842, Leases, and recognized operating lease assets and operating lease liabilities in its condensed consolidated balance sheet.

A contract is or contains a lease when, (1) the contract contains an identified asset and (2) the customer obtains substantially all of the economic benefits from the use of that underlying asset and directs how and for what purpose the asset is used during the term of the contract in exchange for consideration. The Company assesses whether an arrangement is or contains a lease at commencement of the contract. For all leases, other than those that qualify for the short-term recognition exemption, the Company recognizes as of the lease commencement date, on the balance sheet a liability for its obligation related to the lease and a corresponding asset representing the Company’s right to use the underlying asset over the period of use.

The Company’s operating leases are included in operating lease assets and operating lease liabilities in the Company’s condensed consolidated balance sheet as of September 30, 2022 (Successor). An operating lease asset represents the Company’s right to use an underlying asset for the lease term and an operating lease liability represents the Company’s obligation to make lease payments arising from the lease.

Operating lease assets and operating lease liabilities are initially recorded based on the present value of lease payments over the lease term, which may include options to extend or terminate the lease when it is reasonably certain at the commencement date that such options will be exercised. As the rate implicit for each of the Company’s leases is not readily determinable, the incremental borrowing rate based on the information available on the commencement date of the lease is used to determine the present value of lease payments, which include taxes, insurance, utilities and maintenance costs.

Operating lease assets include any lease incentives. Lease agreements with lease and non-lease components are accounted for as a single lease component. Lease expense is recognized on a straight-line basis over the term of the lease. Operating lease expenses are included in Selling, general, and administrative expenses in the accompanying condensed consolidated statements of operations.

See Note 7—LEASES for additional details.

Revenue
32    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The Company recognizes revenue when control of the promised services is transferred to the Company’s customers, in an amount that reflects the consideration it expects to be entitled to in exchange for those services. The Company determines revenue recognition through the following steps:

•Identification of a contract with a customer,
•Identification of the performance obligations in the contract,
•Determination of the transaction price,
•Allocation of the transaction price to the performance obligations in the contract, and
•Recognition of revenue when or as the performance obligations are satisfied.

The Company’s revenue is principally derived from the following areas:

Advertising and Other Revenue

The Company earns revenue by directly acquiring traffic to its Owned and Operated websites and utilizing its RAMP platform and related services to connect its Advertising Partners to its owned and operated websites. For this revenue stream, the Company is the principal in the transaction and reports revenue on a gross basis for the amounts received from its Advertising Partners. For this revenue, the Company has determined that it is the principal since it has a risk of loss on the traffic that it is acquiring for monetization with its Advertising Partners, and, in the case of its owned and operated websites, the Company maintains the website, provides the content and bears the cost and risk of loss associated with its websites’ advertising space.

Revenue is also earned from revenue-sharing arrangements with the Company’s Network Partners for the use of its RAMP platform and related services that enable them to direct advertising provided by our Advertising Partners to their advertising inventory. The Company has determined it is the agent in these transactions and reports revenue on a net basis, because (a) the Company does not control the underlying advertising space, (b) the Company does not acquire the traffic and does not have risk of loss in connection therewith and (c) the pricing is in the form of a substantively fixed-percentage revenue-sharing arrangement. The Company reports this revenue on a net basis with respect to the amount retained under its revenue-sharing arrangements, which represents the difference between amounts received by the Company from the Advertising Partners, less amounts remitted to the Network Partners based on underlying contracts.

The Company recognizes revenue upon delivering traffic to its Advertising Partners based on a cost-per-click or cost-per-thousand impression basis.

Subscription Revenue

In connection with the Merger and acquisition of Protected.net discussed in Note 3—MERGER, the Company is also engaged in selling antivirus, adblock, webshield and VPN software as a service subscription ("SaaS") to customers. The subscription business provides real-time antivirus protection, a safe-browsing feature, adblocking, blocking of malicious websites and data breach monitoring. Subscription revenue is primarily derived from the (i) delivery of the antivirus software and (ii) delivery of the additional add-on service(s), which all are provided on a fixed-price basis. The performance obligations related to subscription, maintenance and support are satisfied over the term of the customer contract and the associated subscription revenue is recognized over the contract term on a ratable basis, which is consistent with transfer of control. The Company’s services rendered to customers are generally paid for in advance with cash receipts recorded as deferred revenue, which represents a liability under a noncancelable contract.

Cost of Revenues

Cost of revenues primarily consists of traffic acquisition costs, which are the costs to place advertisements to acquire customers to the Company’s websites and subscription services, as well as content, publishing, domain name registration costs, licensing costs to provide mapping services to Mapquest.com, credit card processing fees, and licensing costs related to the antivirus and other software available via APIs for sale and distribution of its SaaS
33    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
products to end customers. The Company does not pay for costs up-front. Incentive payments or bonuses and such costs are expensed as incurred.

Salaries, Commissions, and Benefits
Salaries, commissions and benefits expenses include salaries, bonuses, stock-based compensation, non-capitalized personnel costs incurred in the internal-use software development, and employee benefits costs.

Share-Based Compensation

Compensation cost related to share-based payments is measured based on the fair value of the units issued and recognized within “Salaries, commissions, and benefits” in the company’s condensed consolidated statement of operations. The Company has elected to treat share-based payment awards with time-based service condition(s) only as a single award, with the related compensation expense recognized on a straight-line basis. The assumptions used in the Black-Scholes model to value equity in the Predecessor period are based upon the following:

•Fair Value of common stock: S1 Holdco’s equity was not publicly traded, therefore the fair value was determined by S1 Holdco’s Board of Directors, with input from management and contemporaneous valuation reports prepared by a third-party valuation specialist.
•Expected Term: The expected term of the award is estimated by considering the contractual term and vesting period of the award, the employees’ expected exercise behavior and the post-vesting employee turnover rate. For non-employees, the expected life equals the contractual term of the award.
•Risk-free Interest Rate: The risk-free interest rate is based on published U.S. Treasury Department interest rates for the expected term of the underlying award.
•Volatility: The volatility was based on the expected unit price volatility of the underlying units over the expected term of the award which is based upon historical share price data of an index of comparable publicly traded companies.

Replacement Awards

Prior to the Merger, S1 Holdco had outstanding both, Value Creation Units (“VCU’s”) and Class F Units. The VCU’s and Class F Units were concluded to be profits interests units granted to employees. The VCU’s shall become fully vested upon the satisfaction of both a service condition and a performance condition determined to be a change in control event effectuated by the Merger. The Class F Units are subject to vesting conditions where the units will vest at the later of (i) a change in control event or (ii) four-year anniversary of issuance.
Pursuant to the Merger, the Company was required to replace certain profits interests awards, the value creation units ("VCU") and Class F Units ("F Units"), with a combination of a restricted stock unit (“RSU”) in System1 and a cash award (collectively, the "Replacement Awards”). The fair value of the Replacement Awards was derived utilizing the transaction closing price of $10.00. The Merger triggered a liquidating event, therefore, the portion of the Replacement Awards issued in connection with the Merger that was associated with services rendered through the date of the Merger are included in the total consideration transferred, with the exception of the unvested awards subject to service vesting conditions where the service condition has not been completed. With regards to the remaining unvested portion of the Replacement Awards, the Company continues to recognize compensation expense on a straight-line basis over the original requisite service period and recognizes forfeitures as they occur. For VCU Replacement Awards forfeited prior to vesting, the Company recognizes accelerated compensation expense for the remaining unvested shares, as a share of the Company’s Class A Common Stock becomes issuable to the previous investors for each VCU Replacement Award forfeited. For Cash Replacement Awards forfeited prior to vesting, the Company recognizes accelerated compensation expense for the unpaid amount, as that cash amount becomes payable to the previous investors.

Post-Combination Awards

34    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
For awards granted subsequent to the Merger, the Company’s fair value of the related restricted stock units was derived from the market price of its Class A common stock, which is traded on the NYSE. As these awards are subject only to time-based service conditions, the Company recognizes compensation expense for these awards on a straight-line basis over the requisite service period for each award and recognizes forfeitures as they occur.

Liability Awards

In connection with the Merger and acquisition of Protected.net described in Note 3—MERGER, the Company effected an incentive plan for eligible recipients which is payable in a fixed value of fully-vested shares of the Company’s Class A common stock upon the satisfaction of certain performance and service conditions (the “Protected.net Incentive Plan”).

In connection with the acquisition of CouponFollow described in Note 4—ACQUISITIONS the Company effected an incentive plan for eligible recipients, which, at the Company’s option, is payable in cash or fully-vested shares of the Company’s Class A common stock upon the satisfaction of certain performance and service conditions (the “CouponFollow Incentive Plan”).

The Company recognizes compensation cost for these liability awards with performance and service conditions if and when it is deemed probable that the performance condition will be achieved. The probability of vesting is evaluated at each reporting period taking into consideration actual results to-date and forecasts and compensation cost adjusted to reflect the completed portion of the service period with a graded vesting attribution. Refer to Note 18—SHARE-BASED COMPENSATION for additional information.

Selling, General, and Administrative

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

Depreciation and Amortization

Depreciation and amortization expenses are primarily attributable to the Company’s capital investments and consist of fixed asset depreciation and amortization of intangible assets with finite lives.

Income Taxes

The Company is the sole managing member of S1 Holdco and, as a result, consolidates 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 the Company, on a pro rata basis. The Company is 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 the Company. Various subsidiaries of the Company are subject to income tax in the United States and in other countries.

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities (“DTAs” and “DTLs”, as applicable) for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine DTAs and DTLs on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period that includes the enactment date.

We recognize DTAs to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, carryback potential if
35    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
permitted under the tax law, and results of operations. If the Company determines that it would not be able to realize its DTAs in the future in excess of their net recorded amount, it would make an adjustment to the DTA valuation allowance, which would increase the provision for income taxes.

The Company records uncertain tax positions in accordance with ASC 740, Income Taxes, on the basis of a two-step process in which (1) it determines whether it is more likely than not that the tax positions will be sustained on the basis of its technical merits and (2) for those tax positions that meet the more-likely-than-not recognition threshold, it recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes both accrued interest and penalties, when appropriate, in the provision for income taxes in the accompanying condensed consolidated statements of operations.

Non-Controlling Interest

The Company reports a non-controlling interest representing the economic interest in S1 Holdco held by certain individuals and entities other than the Company. The non-controlling interest is comprised of certain selling equity holders of S1 Holdco that retained an economic interest in S1 Holdco through their ownership of Class B units in S1 Holdco as of the closing of the Merger, along with the same number of corresponding shares of Class C common stock in the Company. The non-controlling interest holders may, from time to time, require the Company to convert all or a portion of their economic interest via a redemption of their Class B units in S1 Holdco together with surrendering their corresponding shares of Class C common stock in the Company in exchange for shares of Class A common stock on a one-for-one basis. As future redemptions occur, this will result in a change in ownership and reduce the amount recorded as non-controlling interest and a corresponding increase in additional paid-in capital. As additional shares of Class A common stock are issued at the Company level, Class A units in S1 Holdco are issued to the Company to maintain a one-to-one ratio of Class A common stock outstanding to the Company's Class A units in S1 Holdco.

During the quarter ended September 30, 2022, certain shareholders converted 330 Class C shares into Class A shares. As a result, the Company reduced the non-controlling interest balance in equity by $2,714 and increased the additional paid-in capital balance by the same amount.


The following table summarizes the ownership interest in S1 Holdco as of September 30, 2022 (Successor).

September 30, 2022June 30, 2022
UnitsOwnership %UnitsOwnership %
Class A units of S1 Holdco91,490 81 %90,587 80 %
Class B units of S1 Holdco21,747 19 %22,077 20 %
Total S1 Holdco units outstanding113,237 100 %112,664 100 %

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, including subsequent amendments, Measurement of Credit Losses on Financial Instruments (Topic 326), which modifies the accounting methodology for most financial instruments. The guidance requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. This guidance is effective for the Company for annual periods beginning after December 15, 2022, and early adoption is permitted. The Company does not expect the adoption of this update to have a material effect on its condensed consolidated financial statements.

36    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
3.MERGER

On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), (the “Business Combination Agreement”) by and among S1 Holdco, Trebia, and Protected (collectively, the “Companies”). On January 26, 2022 (the “Closing Date”), the Company consummated the business combination (the “Merger”) pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company is organized via an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected. Additionally, Trebia’s ordinary shares and public warrants ceased trading on the NYSE, and System1 Inc.'s Class A common stock and the Public Warrants began trading on the NYSE on January 28, 2022 under the symbols “SST” and “SST.WS,” respectively.

The consideration paid to the existing equity holders of S1 Holdco and Protected in connection with the Merger was a combination of cash, Class A common stock, Class C common stock and Replacement Awards.

The aggregate cash consideration was $440,155.

The aggregate equity consideration paid and/or retained S1 Holdco Class B Units was $610,144, consisting of (a) the aggregate equity consideration payable under the Business Combination Agreement, consisting of shares of Class A common stock and Replacement Awards, and (b) the aggregate Class B Units in S1 Holdco retained by S1 Holdco equity holders at the Closing.

The fair value of the Class A common stock was determined by utilizing the transaction closing price per share per the BCA of $10.00 and a discount of 10%, as the shares were not immediately available for sale upon issuance and this restriction is viewed to be a function of the security characteristics.

Additionally, the aggregate Class B units in S1 Holdco retained by S1 Holdco equity holders at the Closing Date resulted in a non-controlling interest. The 22,077 Class B units in S1 Holdco and the corresponding Class C common stock in the Company were determined to have an estimated value of $198,691. As the Class B units in S1 Holdco together with the corresponding shares of the Company's Class C common stock are exchangeable for shares of Class A common stock on a one-for-one basis, the fair value was determined using the same method as for the shares of Class A common stock, utilizing the transaction closing price of $10.00 and a discount of 10% (as the units and the corresponding shares of Class C common stock were not immediately available for sale upon issuance and this restriction is viewed to be a function of the security characteristics). The fair value of $198,691 was recorded as non-controlling interest in the accompanying condensed consolidated balance sheet and presented as non-controlling interests in the accompanying condensed consolidated statements of changes in stockholders' equity.

In connection with the Merger, System1 and Cannae Holdings, Inc. (“Cannae”), an investor in a sponsor of Trebia, entered into a backstop agreement (the “Backstop Agreement”) on June 28, 2021, as amended on January 10, 2022, whereby Cannae agreed, to subscribe for up to 25,000 shares of Trebia Class A common stock in order to fund up to $250,000 of redemptions by shareholders of Trebia. See discussion below regarding the Amended and Restated Sponsor Agreement, which was amended in conjunction with the Backstop Agreement. As a result of shareholder redemptions, Cannae provided $246,484 of the cash used to fund the Closing Cash Consideration pursuant to its obligations under the Backstop Agreement and in exchange received 24,648 shares of Class A common stock ("Backstop shares").

Additionally, pursuant to the Backstop Agreement, the Selling Shareholders (i.e., certain shareholders of S1 Holdco and Protected prior to the Merger) agreed that, in the event Trebia shareholders requested redemption of Trebia outstanding equity immediately prior to the Merger in excess of a certain dollar value threshold, certain equity holders of S1 Holdco and Protected would reduce their cash consideration and proportionally increase their equity consideration for the Merger, which is referred to as the “Seller Backstop Election”. In the event that the Seller Backstop Election was made, the Sponsors would forfeit their shares to allow the Company to then issue share to the Selling Shareholders. The Seller Backstop Election was triggered and, as a result, the Sponsors forfeited 930 shares of Trebia Class B ordinary shares which were converted at time of Merger, at a one-to-one ratio, into shares of Class
37    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
A common stock of System1 and delivered to the various selling shareholders of S1 Holdco, collectively referred to as the “Sponsor Promote Shares”. The total consideration amount, in a combination of cash and equity consideration, did not change from the amount agreed in the Business Combination Agreement due to this Seller Backstop Election. The Company recorded $7,706 in Salaries, commissions, and benefits expense and $661 in Selling, general and administrative expense for Sponsor Promote Shares during the period January 27, 2022 through March 31, 2022 (Successor).

In connection with the execution of the Business Combination Agreement and the Backstop Agreement, on June 28, 2021, as amended on January 10, 2022, the sponsors of Trebia entered into the Amended and Restated Sponsor Agreement whereby the sponsors agreed to forfeit up to 2,600 shares of Trebia Class B common stock in order for the Company to then issue the shares to Cannae (“Backstop forfeiture shares”), in exchange for Cannae entering into the Backstop Agreement. On January 27, 2022, based upon the final backstop funding provided by Cannae, the sponsors forfeited 2,533 shares of Trebia Class B shares, after which the Company then issued 2,533 shares of Class A common stock to Cannae. Trebia recorded a forward purchase liability of $25,336 immediately prior to the Merger, representing the fair value of the Backstop shares and the Backstop forfeiture shares.

In accordance with the Amended and Restated Sponsor Agreement entered into concurrently with the Business Combination Agreement, the Company issued 1,450 Class D shares to Trebia sponsors that were exchanged for 1,450 Trebia Class B shares ("Sponsor RSAs"). The difference in the fair value of the two was treated as a capital contribution. The founders of S1 Holdco and Protected were also issued 1,450 Class D shares ("Seller RSUs"). Further, in connection with the Merger, the Company also effected an incentive plan for Protected business. Refer to Note 18—SHARE-BASED COMPENSATION for additional information on the Seller RSUs and the Protected Incentive Plan.

Concurrently with the Merger, System1 entered into a tax receivable agreement with certain of the then-existing members of S1 Holdco, (the “Tax Receivable Agreement” or “TRA”), pursuant to which, among other things, the parties to the Tax Receivable Agreement agreed to the allocation and payment of 85% of the actual savings, if any, in U.S. federal, state and local income taxes that System1 may realize as a result of certain tax benefits (if any) related to the transactions contemplated by the Business Combination Agreement and future exchanges of Class B units in S1 Holdco (together with the corresponding shares of the Company’s shares of Class C common stock) in exchange for shares of the Company’s Class A common stock. As of the Closing Date, the fair value of obligations under the TRA was determined to be zero as any tax savings were uncertain. The TRA is contingent consideration and subsequent changes in fair value of the contingent liability are recognized in earnings. Refer to TRA discussion in Note 10—INCOME TAXES.

The Company adopted ASU No. 2021-08 on January 1, 2022 and accordingly, has recorded contract assets and contract liabilities acquired as part of the Merger based on what the Company would have recorded under ASC 606, Revenue from Contracts with Customers, as of the acquisition date, as if the Company had entered into the original contract at the same date and on the same terms as S1 Holdco and Protected.

The Merger has been accounted for as a business combination using the acquisition method of accounting. The total purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values on the acquisition date.

38    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The purchase consideration was allocated to the following assets and liabilities.
Amount
Tangible assets acquired and liabilities assumed:
Cash and marketable securities$68,748 
Accounts receivable79,086 
Prepaid expenses7,807 
Income tax receivable4,566 
Property, plant & equipment, net1,551 
Other assets6,950 
Accounts payable(9,798)
Deferred revenue(60,768)
Accrued expenses and other current liabilities(110,004)
Income tax payable(2,091)
Notes payable(172,038)
Deferred tax liabilities(138,613)
Other liabilities(8,474)
Total tangible assets acquired and liabilities assumed(333,078)
Intangible assets562,100 
Goodwill821,277 
Net assets acquired$1,050,299 
Consideration:
Cash$440,155 
Equity411,453 
Total consideration attributable to System1851,608 
Total consideration attributable to NCI198,691 
Total consideration$1,050,299 

The intangible assets as of the closing date of the acquisition included:

AmountWeighted Average Useful Life (in Years)
Trademarks$246,400 10
Customer relationships119,700 4
Technology196,000 4
Total$562,100 

The fair value of the intangible assets acquired was determined using income-based approach methodologies. Intangible assets are amortized over their estimated economic useful lives using a straight-line method, which approximates the pattern in which the economic benefits are consumed. Customer relationships are amortized on an accelerated basis. To determine the amortization period for each of the customer relationships assets and to evaluate the pattern of usage of economic benefits, the Company performed a customer attrition analysis of the Company's customer relationships to estimate the attrition rate and consequently the life expectancy for the existing customer relationships.

39    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Trademarks – The Company valued trademarks using the relief-from-royalty method under the income-based approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademarks, and a discount rate.

Customer relationships – The Company valued customer relationships using an excess-earnings method utilizing distributor inputs. Key assumptions include customer attrition rate, revenue growth rate, existing customer revenue, deferred revenue, and a discount rate.

Technology – The Company valued technology using the excess-earnings method utilizing company-specific inputs. Key assumptions include forecasted revenue, technology migration rate and a discount rate.

The goodwill balance is primarily attributable to the expected revenue opportunities with the Company's applications and services offerings, assets acquired and acquired workforce. Goodwill is not deductible for tax purposes.

Unaudited Pro Forma Information

The following table provides unaudited pro forma information as if the Merger and other acquisitions occurred as of January 1, 2021. The unaudited pro forma information reflects adjustments for additional amortization resulting from the fair value adjustments to assets acquired and liabilities assumed, adjustments for alignment of accounting policies, adjustments for transaction expenses, adjustments for certain stock-based compensation and equity related expenses incurred as a result of the transaction and the resulting tax effects, as if the Merger and acquisitions of Answers, CouponFollow and RoadWarrior (each as defined in Note 4—ACQUISITIONS) occurred January 1, 2021. The pro forma results do not include any anticipated cost synergies or other effects of the merged companies. Accordingly, pro forma amounts are not necessarily indicative of the results that actually would have occurred had the acquisitions been completed on the dates indicated, nor is it indicative of the future operating results of the combined company.

Three months endedNine months ended
September 30, 2021September 30, 2022September 30, 2021
Pro forma revenue$218,159 $657,013 $630,822 
Pro forma net (loss)$(45,834)$(310,944)$(185,732)


4.ACQUISITIONS

Answers Holdings, Inc.

On May 4, 2022, the Company acquired the assets of Answers Holdings, Inc. and its subsidiaries, collectively ("Answers") for total cash consideration of $4,632. The acquisition of Answers constitutes a business combination under ASC 805.

The acquisition expands the Company's portfolio of Owned & Operated publishing sites and search destinations to include a destination for higher education and lifelong learning content. The results of Answers' operations since the date of the acquisition have been included in the Company's condensed consolidated financial statements. The amounts of revenue and loss before income tax for the period from May 4, 2022 to September 30, 2022 (Successor) were $607 and $456, respectively, and the amounts of revenue and loss before income taxes for the three months ended September 30, 2022 (Successor) were $534 and $403, respectively. The operating results of Answers are reported within the Owned and Operated Advertising segment prospectively from the date of acquisition.

The total purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The purchase price is preliminary and may be subject to additional adjustments,
40    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
including working capital adjustments. The Company expects to finalize the purchase accounting as soon as practicable, but not later than one year from the acquisition date.

The purchase consideration was allocated to the following assets and liabilities:
Amount
Assets acquired and liabilities assumed:
Working capital$32 
Trademark - 10 years weighted average useful life
1,100 
Goodwill3,500 
Net assets acquired$4,632 
Total consideration:
Cash$4,632 

The goodwill arising from the acquisition consists largely of the expected synergies from combining operations. The goodwill is deductible for tax purposes over 15 years. The Company has incurred $93 in transaction costs related to the acquisition.

Trademarks – Identified trademarks relate to the estimated fair value of future cash flows related to any trademarks acquired. The Company valued trademarks using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademark and a discount rate.

NextGen Shopping, Inc.

On March 4, 2022, the Company acquired NextGen Shopping, Inc. (d/b/a “CouponFollow”) for total cash consideration of $75,087, of which $16,446 was deferred, $5,600 was held-back, and $25,500 related to the fair value of 2,000 shares of Class A common stock issued. The fair value of the shares of Class A common stock was determined by utilizing the closing price per share of the Company's Class A common stock listed on the NYSE as of March 3, 2022, and a discount rate of 7.5%, as the shares were not immediately available for sale upon issuance, and this restriction was deemed to be a function of the security characteristics. During the three months ended June 30, 2022, the deferred consideration of $16,446 was paid. The held-back consideration amount will become payable eighteen months subsequent to the acquisition date, subject to the Company's satisfaction of any potential post-closing purchase price adjustments and indemnification claims. The cash payment included the transaction costs of $3,129 that the Company paid on behalf of CouponFollow in connection with the closing of the transaction. The acquisition of CouponFollow constitutes a business combination under ASC 805.

In conjunction with the acquisition, the Company also committed to pay post-combination compensation of $8,500, which is payable in cash and subject to continued services from certain individuals of CouponFollow. Separately, in conjunction with the acquisition, the Company entered into the CouponFollow Incentive Plan, providing up to $10,000 of postcombination compensation which is payable in stock or cash at the option of the Company, and subject to continued service from certain individuals, and up to $25,000 which is payable in stock or cash at the option of the Company contingent upon achieving certain financial thresholds and the continued employment of certain key individuals of CouponFollow. Refer to Note 18—SHARE-BASED COMPENSATION for additional information.

The acquisition leverages CouponFollow’s reputation, software and large organic traffic to vertically integrate with the Company’s RAMP platform and generate paid traffic for shopping-related products. The results of CouponFollow’s operations as of and after the date of acquisition have been included in the Company’s condensed consolidated financial statements from March 4, 2022. The amounts of revenue and loss before income taxes for the period from March 4, 2022 to September 30, 2022 (Successor) were $12,658 and $1,882, respectively, and the amounts of revenue and loss before income taxes for the three months ended September 30, 2022 (Successor) were
41    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
$5,342 and $22, respectively. The operating results of CouponFollow are reported within the Owned and Operated Advertising segment prospectively from the date of acquisition.

The total purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values on the acquisition date.

The purchase consideration was allocated to the following assets and liabilities:
Amount
Cash and cash equivalents$21,232 
Accounts receivable5,860 
Other current assets446 
Accounts payable(116)
Accrued expenses and other current liabilities(118)
Income tax payable(197)
Deferred tax liabilities(10,895)
Total tangible assets acquired and liabilities assumed16,212 
Intangible assets42,200 
Goodwill42,175 
Net assets acquired$100,587 
Consideration:
Cash$75,087 
Equity25,500 
Total consideration$100,587 

The goodwill arising from the acquisition consists largely of the expected synergies from combining operations as well as the value of the workforce. The goodwill is not deductible for tax purposes. The Company incurred $813 in transaction costs related to the acquisition.

Following are the details of the purchase price allocated to the intangible assets for the CouponFollow acquisition:

AmountWeighted Average Useful Life (in Years)
Trademark$38,100 10
Software4,100 4
Total$42,200 

Trademark – The Company valued the trademark using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademarks and a discount rate.

Software – Acquired software technology was valued using the excess-earnings method utilizing company-specific inputs. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the software and a discount rate.

RoadWarrior, LLC

On February 9, 2022, the Company acquired the assets of RoadWarrior, LLC (“RoadWarrior”) for total cash consideration of $19,636. The acquisition of RoadWarrior constitutes a business combination under ASC 805.
42    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The acquisition expands the Company’s Mapquest.com website technology, and provides additional functionality for customers centered around route planning for delivery drivers and teams. The results of RoadWarrior’s operations as of and after the date of acquisition have been included in the Company’s condensed consolidated financial statements. The amounts of revenue and loss before income taxes for the period from February 9, 2022 to September 30, 2022 (Successor) were $3,395 and $2,192, respectively, and the amounts of revenue and loss before income taxes for the three months ended September 30, 2022 were $1,158 and $500, respectively. The operating results of RoadWarrior are reported within the Owned and Operated Advertising segment prospectively from the date of acquisition.

The total purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values on the acquisition date.

The purchase consideration was allocated to the following assets and liabilities:
Amount
Working capital$155 
Intangible assets4,500 
Goodwill14,981 
Net assets acquired$19,636 
Total consideration:
Cash$19,636 

The goodwill arising from the acquisition consists largely of the expected synergies from combining operations as well as the value of the workforce. The goodwill is deductible for tax purposes over 15 years. The Company incurred $308 in transaction costs related to the acquisition.

Following are the details of the purchase price allocated to the intangible assets for the RoadWarrior acquisition:

AmountWeighted Average Useful Life (in Years)
Trademark$2,200 10
Software1,000 4
Customer relationships1,300 3
Total$4,500 

Trademarks – Identified trademarks relate to the estimated fair value of future cash flows related to any trademarks acquired. The Company valued trademarks using the relief-from-royalty method under the income approach. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the trademark and a discount rate.

Software – Software technology represents existing technology acquired and incorporated into the Company’s existing infrastructure. The Company valued software using the relief from royalty method. Key assumptions include forecasted revenue, an estimated royalty rate applicable to the software and a discount rate.

Customer relationships – The value of customer relationships represents the fair value of future projected revenues that will be derived from the sale to customers acquired. The Company valued customer relationships using an excess-earnings method. Key assumptions include customer attrition rate, revenue growth rate, and a discount rate.


5.PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following:
43    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

SuccessorPredecessor
September 30, 2022December 31, 2021
Computer equipment
$793 $415 
Motor vehicles234 — 
Furniture and equipment
1,112 475 
Leasehold improvements
2,715 976 
Property and equipment—gross
4,854 1,866 
Less accumulated depreciation
(505)(1,036)
Property and equipment—net
$4,349 $830 

Total depreciation expense on property and equipment was as follows:

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Depreciation expense
$251$73$520$16$243




44    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
6.GOODWILL, INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, NET, AND INTANGIBLE ASSETS, NET
Goodwill
The changes in goodwill by reportable segments were as follows:

Owned and Operated AdvertisingPartner NetworkSubscriptionTotal
Goodwill at January 27, 2022$— $— $— $— 
Additions351,849 93,400 433,184 878,433 
Currency translation adjustments(37)— — (37)
Goodwill at March 31, 2022351,812 93,400 433,184 878,396 
Additions3,500 — — 3,500 
Currency translation adjustments(526)— — (526)
Goodwill at June 30, 2022354,786 93,400 433,184 881,370 
Currency translation adjustments531 — — 531 
Impairment(329,117)(10,992)— (340,109)
Goodwill at September 30, 2022$26,200 $82,408 $433,184 $541,792 

Additions to goodwill were from the acquisitions of S1 Holdco, Protected.net, CouponFollow, RoadWarrior and Answers in 2022. See discussion below regarding impairment of goodwill.

Goodwill as of December 31, 2021 (Predecessor), resulted from the acquisitions of Concourse Media, Mapquest, and Waterfox in 2019 and the prior acquisitions of InfoSpace/How-Stuff-Works in 2016 and Qool Media, Inc. in 2017. There was no goodwill activity for the period January 1, 2021 through January 26, 2022 (Predecessor). Goodwill by reportable segments as of December 31, 2021 was as follows:

Owned and Operated AdvertisingPartner NetworkTotal
Goodwill at December 31, 2021 (Predecessor)$24,403 $20,417 $44,820 

Goodwill Impairment

The Company assesses goodwill for impairment annually as of December 31 or more frequently if events or changes in circumstances indicate the asset might be impaired. Within the Company’s three reportable segments defined in Note 16 — SEGMENT REPORTING, the Company has identified four reporting units, as follows:

i.Publishing and Lead Generation - within Owned and Operated Advertising reportable segment
ii.Search and Applications - within Owned and Operated Advertising reportable segment
iii.Partner Network – reportable segment and reporting unit
iv.Subscription – reportable segment and reporting unit

The Company has experienced adverse macroeconomic impacts as a result of changes in market conditions and increases in interest rates, which contributed to reduced forecasted revenues and reduced expectations for future cash flows. In response to these ongoing macroeconomic conditions and a broad weakening of consumer demand in the third quarter, the Company reduced its earnings forecasts for the Owned and Operated Advertising & Partner Network reportable segments. Given these adverse impacts, the Company performed a quantitative goodwill impairment analysis for all its reporting units as of September 30, 2022.
45    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

The fair values of the Company’s reporting units were computed by weighting a discounted cash flow model and a reference transaction model which included inputs developed using both internal and market-based data. The Company's key assumptions in the discounted cash flow model included, but were not limited to, the weighted average cost of capital, revenue growth rates (including long-term growth rates), and operating margins. The weighted average cost of capital reflected the increases in market interest rates. The Company's reference transaction model derives indications of value based on mergers and acquisition transactions in the digital advertising industry. Key assumptions in this model included but were not limited to, the selection of comparable transactions, revenue and EBITDA multiples and EBITDA margins from those transactions.

Based on the Company’s quantitative impairment analysis:

•the fair value of the Subscription reporting unit exceeded its carrying amount by 18%. As of September 30, 2022, goodwill attributable to this reporting unit was $433,184.
•the fair value of the Search and Applications reporting unit exceeded its carrying amount by approximately 2%. As of September 30, 2022, goodwill attributable to this reporting unit was $26,200.
•the fair value of the Publishing and Lead Generation reporting unit was substantially less than its carrying amount. As a result, the Company impaired all the goodwill attributable to this reporting unit of $329,133.
•the fair value of the Partner Network reporting unit was less than its carrying amount, resulting in a $10,976 impairment of goodwill attributable to this reporting unit. As of September 30, 2022, remaining goodwill attributable to this reporting unit was $82,408.

The risk of impairment of goodwill attributable to the Search and Applications reporting unit and an additional impairment of goodwill attributable to the Partner Network reporting unit is sensitive to changes in the estimates and assumptions used in the respective reporting unit fair value determinations. Any deviation in actual financial results compared to the forecasted financial results or valuation assumptions, a decline in equity valuations, or additional increases in interest rates, among other factors, could have a material adverse effect on the fair value of the reporting units and could result in a future impairment charge.

During the quarter ended December 31, 2022, the Company realigned its reporting structure due to changes in management such that the Search and Applications reporting unit became part of the Publishing and Lead Generation reporting unit and the new reporting unit was renamed Owned and Operated Advertising. Based on its annual impairment assessment as of December 31, 2022, the Company determined that the remaining goodwill attributable to Owned and Operated Advertising of $26,200 was fully impaired.

Internal-use software development costs and intangible assets

Internal-use software development costs and intangible assets consisted of the following:

September 30, 2022 (Successor)
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
Total internal-use software development costs
$6,149 $(459)$5,690 
Intangibles:
Developed technology
$196,128 $(33,074)$163,054 
Trademarks and trade names
287,852 (18,998)268,854 
Software
5,100 (747)4,353 
Customer relationships
121,000 (32,664)88,336 
Total intangible costs
$610,080 $(85,483)$524,597 
46    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
December 31, 2021 (Predecessor)
Gross Carrying AmountAccumulated AmortizationNet Carrying Amount
Total internal-use software development costs$21,274 $(10,061)$11,213 
Intangibles:
Developed technology$8,398 $(7,242)$1,156 
Trademarks and trade names69,007 (21,375)47,632 
Professional service agreement3,100 (2,359)741 
Customer relationships1,500 (661)839 
Total intangible costs$82,005 $(31,637)$50,368 

The internal-use software development costs include capitalized costs not ready for its internal use of $4,593 and $2,540 as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor), respectively.

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

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Amortization expense for internal-use software development
$90$1,300$233$355$3,545
Amortization expense for intangible assets$31,873$2,086$85,483$629$6,472

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

The weighted average amortization period for all intangible assets is 7 years.

As of September 30, 2022 (Successor), the expected amortization expense associated with the Company’s intangible assets and internal-use software development costs was as follows:

Amortization Expense
Remainder of 2022$32,019
2023110,815
2024101,808
202594,893
202643,813
Thereafter146,939
Total amortization expense$530,287

7.LEASES
47    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

The Company leases office facilities under noncancelable operating lease agreements. During the period from January 1, 2022 through January 26, 2022 (Predecessor) and January 27, 2022 through September 30, 2022 (Successor), the Company had leases for office facilities in Marina del Rey, California; Bellevue, Washington; and Guelph, Canada.

In March 2021, S1 Holdco entered into an agreement for a sublease of an office space facility in Marina Del Rey, California. The initial term of the sublease expires November 2025 and currently does not provide an option for renewal.

The components of lease expense were as follows:

SuccessorPredecessor
Three Months Ended September 30, 2022Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022
Operating lease expense$404$1,386$142
Short-term lease expense21661112
Variable lease expense111235—
Total lease expense$731$2,232$154

Supplemental information related to leases was as follows:

Successor
As of September 30, 2022
Weighted average remaining lease terms (in years):7.1
Weighted average discount rate5.2%


48    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Maturities of lease liabilities by fiscal year for the Company's operating leases are as follows as of September 30, 2022 (Successor):

Successor
As of September 30, 2022
Operating leases:
Remainder of 2022$617 
20232,508 
20242,579 
20252,235 
2026268 
Thereafter1,489 
Total lease payments$9,696 
Less: Imputed interest(1,188)
Present value of operating lease liabilities$8,508 

Rent expense was $581 and $1,643 for the three and nine months ended September 30, 2021 (Predecessor), respectively, which was included in Selling, general, and administrative expenses in the accompanying condensed consolidated statements of operations. As of December 31, 2021 (Predecessor), the expected future operating lease obligation were as follows:

Predecessor
As of December 31, 2021
Year ending
2022$1,957 
2023$1,950 
2024$1,950 
2025$1,663 


49    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
8.ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

SuccessorPredecessor
September 30, 2022December 31, 2021
Payable to employees$13,142 $10,091 
Accrued marketing expenses42,315 144 
Accrued professional fees1,728 6,242 
VAT tax liability4,718 — 
Accrued tax liability3,551 361 
Holdback liability6,819 — 
Accrued revenue share (1)10,973 — 
Contingent consideration— 1,682 
Former CEO profit interest— 11,132 
Other liabilities8,485 1,632 
Accrued expenses and other current liabilities$91,731 $31,284 
1 Accrued revenue share of $9,475 was included in Accounts payable in the condensed consolidated balance sheet as of December 31, 2021.


Ian Weingarten was hired as CEO of S1 Holdco on April 10, 2019. He was entitled to a cash-settled profits interest of 5% of the value of S1 Holdco, which was contingent upon (i) a participation threshold of $300,000 (which was subject to adjustment as set forth in the S1 Holdco operating agreement) and (ii) on a four-year vesting term, or if a qualifying change in control transaction occurs.

In February 2021, Mr. Weingarten's employment with S1 Holdco was terminated and the parties entered into a separation agreement. In connection with the separation agreement, S1 Holdco agreed to payment of separation pay benefits consistent with the terms of Mr. Weingarten’s employment agreement, including the payment of the liability accrued for the cash-settled profits interest of 5% of S1 Holdco, which was deemed vested as to a 3.75% profits interest and forfeited as to the remaining 1.25% profits interest above the applicable adjusted threshold amount (subject to further increase to a 2.5% profits interest in the event that the Merger was not consummated). S1 Holdco recorded a liability for this arrangement of $11,132 as of December 31, 2021 (Predecessor). In January 2022, in conjunction with the consummation of the Merger, S1 Holdco settled the profits interest liability pursuant to the separation agreement with Mr. Weingarten.

9.DEFERRED REVENUE

Deferred revenue activities for the period January 1, 2021 through December 31, 2021 (Predecessor), January 1, 2022 through January 26, 2022 (Predecessor) and January 27, 2022 through September 30, 2022 (Successor) are as follows:

Deferred Revenue
January 1, 2021 (Predecessor)$1,889 
Additions5,116 
Revenue recognized(5,034)
December 31, 2021 (Predecessor)$1,971 

50    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Deferred Revenue
January 1, 2022 (Predecessor)$1,971 
Additions620 
Revenue recognized(309)
January 26, 2022 (Predecessor)$2,282 

Deferred Revenue
January 27, 2022 (Successor)$— 
Additions*187,383 
Revenue recognized(119,094)
September 30, 2022 (Successor)$68,289 

* Includes $61,156 from the 2022 acquisitions.

During the periods January 27, 2022 through September 30, 2022 (Successor), January 1, 2022 through January 26, 2022 (Predecessor), and January 1, 2021 through December 31, 2021 (Predecessor), $0, $309, and $1,889, respectively, of the deferred revenue recognized existed at the beginning of each respective period.

We expect to recognize revenue related to the remaining performance obligations within the next twelve months.

10.INCOME TAXES

The Company is the sole managing member of S1 Holdco and, as a result, consolidates 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 the Company, on a pro rata basis. The Company is 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 the Company.

The following table presents the Company’s Income tax (benefit) provision and the effective income tax rate:

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Income tax (benefit) provision
$(80,649)$475$(95,752)$(629)$703
Effective tax rate20 %4 %20 %2 %2 %

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 income (loss) before income taxes due to the exclusion of non-controlling income (loss), state taxes, foreign rate differential, non-deductible expenses, outside basis adjustments, and Global Intangible Low-taxed Income.

The Company evaluates the realizability of its DTA on a quarterly basis and establishes valuation allowances when it is more likely than not that all or a portion of a DTA may not be realized. As of September 30, 2022, there were no material changes to the Company's valuation allowance and the Company's assessment of the realizability of its DTA.
51    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

The aggregate amount of gross unrecognized tax benefits related to uncertain tax positions was $99 for the period from January 27, 2022, through September 30, 2022 (Successor).

The Company files income tax returns in the U.S. federal, states, and various foreign countries. For U.S. federal income tax purposes, as of September 30, 2022 (Successor), the year 2018 and later tax years remain open for examination by the tax authorities. For foreign income tax purposes, as of September 30, 2022 (Successor), the year 2016 and later tax years remain open for examination by the tax authorities under the Netherland’s five-year statute of limitations.

The Company contributed all the net assets of CouponFollow to a lower entity taxed as a partnership, System1 OpCo, LLC ("System1 OpCo”). The contribution qualified as a transaction among or with noncontrolling shareholders, which is accounted for as an equity transaction. As a result, the Company recorded $2,595 to additional paid-in-capital for the tax effects of the contribution with an offsetting entry to deferred tax liability in accordance with ASC 740-20-45-11(c).

Tax Receivable Agreement

Pursuant to the Company's election under Section 754 of the Internal Revenue Code (the “Code”), the Company expects to obtain an increase in its share of the tax basis in the net assets of S1 Holdco when LLC Interests are redeemed or exchanged by the other members of S1 Holdco. The Company intends to treat any redemptions and exchanges of LLC Interests as direct purchases of LLC Interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that would otherwise be paid in the future to various tax authorities.

On January 27, 2022, the Company entered into a Tax Receivable Agreement with certain of the then-existing members of S1 Holdco that provides for the payment by the Company of 85% of the amount of any tax benefits that are actually realized, or in some cases are deemed to realize, as a result of (i) increases in the Company's share of the tax basis in the net assets of S1 Holdco resulting from any redemptions or exchanges of LLC Interests, (ii) tax basis increases attributable to payments made under the Tax Receivable Agreement, and (iii) deductions attributable to imputed interest pursuant to the Tax Receivable Agreement (the “TRA Payments”). The Company expects to benefit from the remaining 15% of any tax benefits that may actually be realized.

As of September 30, 2022, the Company acquired an aggregate of 330 LLC Interests in connection with the redemption of LLC Interests, which resulted in an increase in the tax basis of its investment in S1 Holdco subject to the provisions of the Tax Receivable Agreement. The Company recognized a liability in the amount of $1,041 for the TRA Payments due to the redeeming members, representing 85% of the aggregate tax benefits the Company expects to realize from the tax basis increases related to the redemption of LLC Interests, after concluding it was probable that such TRA Payments would be paid based on estimates of future taxable income. During the nine months ended September 30, 2022, and September 30, 2021, inclusive of interest, no payments were made to the parties to the Tax Receivable Agreement. As of September 30, 2022, the total amount of TRA Payments due under the Tax Receivable Agreement, was $1,041.


11.COMMITMENTS AND CONTINGENCIES

In June 2021, the S1 Holdco entered into a multi-year agreement with a service provider whereby the Company is contractually obligated to spend $8,000 between July 2022 and June 2023. As of September 30, 2022 (Successor), the Company remains contractually obligated to spend $5,933 towards this commitment.

As of September 30, 2022, the Company had various non-cancelable operating lease commitments for office space which have been recorded as Operating lease liabilities. Refer to Note 7—LEASES for additional information regarding lease commitments.

Litigation
52    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company believes 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 the Company’s condensed consolidated financial position, results of operations, or cash flows. The Company accrues for losses when the loss is deemed probable and the liability can reasonably be estimated.

In July 2021, System1 OpCo (f/k/a System1, LLC) received initial correspondence from counsel for a United Kingdom-based marketing research company and its United States subsidiary (collectively, the “Demanding Group”) alleging trademark infringement (i) based on its use of the “SYSTEM1” trade name and mark in the United States, and (ii) subsequently based on its use of the “SYSTEM1” trade name and mark in the United Kingdom. The correspondence demanded that System1 OpCo cease and desist from using the “SYSTEM1” name and mark, and made reference to potential legal action if System1 OpCo did not comply with that demand. While System1 OpCo was engaged in active discussions and correspondence with the Demanding Group to attempt to resolve the matter, the Demanding Group filed a lawsuit in the United States District Court for the Southern District of New York in September 2021 (the “Infringement Suit”), alleging (i) trademark infringement, (ii) false designation of origin, (iii) unfair competition and (iv) certain violations of New York business laws, seeking, among other things, an injunction, disgorgement of profits, actual damages and attorneys’ fees and costs. The Company believes that the Demanding Group’s infringement and other allegations and claims set forth in the Infringement Suit may be subject to a laches defense, among other defenses, and the Company intends to vigorously defend its rights and position in the Infringement Suit. System1 OpCo filed a motion to dismiss the Infringement Suit in November 2021, which was granted in part (without prejudice) and denied in part. As a result of the court’s ruling on the motion to dismiss, the Demanding Group filed an Amended Complaint in October 2022, which matter remains pending. Even though the Company received similar correspondence from the Demanding Group regarding its alleged infringing use of the SYSTEM1 trade name and mark in the United Kingdom, no lawsuit has been filed in the United Kingdom. The Company does not believe that its activities infringe any rights of the Demanding Group in the United Kingdom because, among other defenses, the Company does not actively offer services to customers using the SYSTEM1 trade name and mark in the United Kingdom. The Company’s counsel has informed the Demanding Group’s UK counsel of these circumstances, and the Demanding Group’s UK counsel confirmed receipt of this correspondence, and the parties have not shared any further meaningful correspondence with respect to the Demanding Group’s allegations of infringing use in the United Kingdom.

Indemnifications

In the ordinary course of business, the Company 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 the Company’s breach of such agreements, services to be provided by the Company, 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 the Company could be required to make under these indemnification provisions may not be subject to claims related to these indemnifications. As a result, the Company believes the estimated fair value of these agreements was immaterial. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2022 (Successor) or December 31, 2021 (Predecessor), respectively.

12.DEBT, NET

As of December 31, 2021 (Predecessor), S1 Holdco had principal of $172,038 outstanding under a term loan secured from Cerberus Business Finance, LLC. Amortization payments of $1,750 were due quarterly and, upon delivery of the prior year’s audited consolidated financial statements, S1 Holdco was required to make a payment of 50% of excess free cash flow, as defined. S1 Holdco also had a $20,000 revolving line of credit, and no amounts were outstanding as of December 31, 2021 under this revolving line of credit.

53    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
Interest payments on the secured financing were due monthly at London InterBank Offered Rate (“LIBOR”), plus 7% with a LIBOR floor of 1%. Maturity for the secured financing was August 22, 2022. The facility had certain financial and nonfinancial covenants, including a leverage ratio.

In connection with the Merger, Orchid Merger Sub II LLC (a subsidiary of S1 Holdco) entered into a new loan (“Term Loan”) and revolving facility (“Revolving Facility”) on January 27, 2022, providing for a 5.5 year term loan with a principal balance of $400,000 and with the net proceeds of $376,000, of which a portion of the proceeds were used by S1 Holdco, to settle the outstanding debt of $172,038 with Cerberus Business Finance, LLC. The Revolving Facility provided for borrowing availability of up to $50,000, of which $49,000 was drawn as of September 30, 2022. In October 2022, the Company borrowed the remaining $1,000 available under its Revolving Facility.

For every interest period, the interest rate on the Term Loan is the adjusted Term Secured Overnight Financing Rate (“Term SOFR”) plus 4.75%. The Term Loan is amortized in quarterly installments on each scheduled payment date. The Term Loan comes with a springing covenant, which goes into effect if the utilization on the Revolving Facility exceeds 35% of the $50,000 Revolving Facility at each quarter-end starting from the first full quarter after the effective date of the Merger, such that the first lien leverage ratio (as defined in the credit agreement) should not exceed 5.40. The facility had certain financial and nonfinancial covenants, including a leverage ratio. The facility also requires that the Company delivers its consolidated financial report to its lender within 120 days of its fiscal year end, being December 31. Should the Company fail to distribute the financial report to its lender within 120 days, it is allowed an additional 30 days to cure. Through December 31, 2025, $5,000 of the amortization payment will be made quarterly. From March 31, 2026 (scheduled payment date) and thereafter, $7,500 of the amortization payment will be made quarterly.

The Revolving Facility will mature five years after the closing date, and accordingly, it is classified within Long-term debt, net on the condensed consolidated balance sheet as of September 30, 2022. The interest rate on the Revolving Facility is the adjusted Term SOFR plus 2.5% with an adjusted Term SOFR floor of 0%. In March 2022, the Company borrowed $49,000 under its Revolving Facility, to fund a portion of the purchase price related to its CouponFollow acquisition. As of September 30, 2022 (Successor), this amount is outstanding.

As of September 30, 2022, future minimum principal payments on long-term debt are as follows:

Successor
Remainder for 2022$5,000 
202320,000 
202420,000 
202520,000 
202630,000 
2027344,000 
 Total future minimum principal payment$439,000 
Less: current portion(20,000)
Long-term portion$419,000 

As of September 30, 2022, loan fees amounting to $1,129 for the Term Loan have been recorded as a reduction of the carrying amount of the debt and are amortized to interest expense using the effective interest method.

As of June 1, 2023, the Company had not delivered audited financial statements for the fiscal year ended December 31, 2022 to Bank of America as required by the covenants of the Term Loan. The failure to timely deliver the audited financial statements is an event of default under the Term Loan and provides Bank of America the ability to immediately call the outstanding principal balances of the Term Loan and Revolving Facility of $430,000, as of the date of this filing, at the request of, or with the consent of, the required majority of lenders until such time that the audited financial statements are delivered to Bank of America. The Company does not have sufficient liquidity to settle the outstanding principal balances should they be called, nor has the Company identified sufficient alternative
54    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
sources of capital. As a result, this matter raises substantial doubt about the Company’s ability to continue as a going concern. Upon delivery of the audited financial statements by the Company, the event of default will be remediated and, once remediated, Bank of America will no longer have the ability to call the outstanding principal balances on the Term Loan and Revolving Facility.

2023 Revolving Note

On April 10, 2023, Orchid Merger Sub II, LLC (“Orchid Sub”), a wholly-owned subsidiary of the Company, entered into a $20,000 Revolving Note (the “2023 Revolving Note”) with Lone Star Friends Trust (acting by and through its trustee, Stanley Blend, “Lone Star”) and CEE Holding Trust (acting by and through its trustee, Jackson Hole Trust Company, “CEE”, and together with Lone Star, collectively, the “Lenders” and each, a “Lender”), which are trusts established for the benefit of Michael Blend (Chief Executive Officer, co-founder and stockholder) and Charles Ursini (co-founder and stockholder), respectively, in a private transaction approved by the independent and non-interested members of the Company’s Board of Directors. Each Lender provided a $10,000 commitment for an aggregate principal of $20,000 under the 2023 Revolving Note to Orchid Sub on a several but not joint basis (each, a “Commitment” and, collectively, the “Commitments”).

Any borrowed loan amounts outstanding under the 2023 Revolving Note accrue interest at the rate per annum equal to the SOFR as administered by the Federal Reserve Bank of New York plus 3.15%. Orchid Sub may borrow amounts under the 2023 Revolving Note in increments of $100, and may prepay any amounts borrowed at any time without penalty or interest (other than applicable breakage costs, if any). The Company may borrow up to its commitment amount, and may reuse the loan again after the balance has been paid down. The final maturity date under the 2023 Revolving Note is July 10, 2024. The Lenders are also entitled to (i) an unused commitment fee equal to 1.0% per annum of the actual daily amount of total unfunded Commitments under the 2023 Revolving Note during the period from the closing date to the maturity date, payable quarterly in arrears and (ii) a closing fee equal to 12.0% of each Lender’s Commitment under the 2023 Revolving Note, payable within 180 days of April 10, 2023. In addition, Orchid Sub agreed to reimburse the Lenders for their reasonable and documented costs expenses incurred in connection with the negotiation, documentation and execution of the 2023 Revolving Note. As of the date of this filing, the available balance under the 2023 Revolving Note was $15,000.

13.WARRANTS

In June 2020, the Company issued Public Warrants and Private Placement Warrants in conjunction with the initial public offering of Trebia. Public Warrants may only be exercised for a whole number of shares. No fractional shares will be issued upon exercise of the Public Warrants. The Public Warrants became exercisable on April 18, 2022, when the S-1/A registration statement, which was required to be filed under the terms of the Warrant Agreement and the Business Combination Agreement, was declared effective. The Public Warrants will expire five years from the completion of the Merger, or earlier upon redemption or liquidation.

The Company is not obligated to deliver any shares of Class A common stock pursuant to the exercise of a Public Warrant and has no obligation to settle such Public Warrants exercises unless a registration statement under the Securities Act with respect to the Class A common stock underlying the Public Warrants is then effective and a prospectus relating thereto is current, subject to the Company satisfying its obligations with respect to registration, or a valid exemption from registration is available. Warrants are exercisable and the Company is obligated to issue a share of Class A common stock upon exercise of each Warrant, as the Warrants have been registered with the SEC.

The Company is obligated to use its commercially reasonable efforts to maintain the effectiveness of a registration statement for the registration, under the Securities Act, of the Class A common stock issuable upon exercise of the Warrants, and a current prospectus relating thereto, until the expiration or redemption of the Warrants in accordance with the provisions of the Warrant Agreement. If the effectiveness of a registration statement covering the issuance of the shares of Class A common stock issuable upon exercise of the Warrants is not maintained, Warrant holders may exercise Warrants on a “cashless basis” in accordance with Section 3(a)(9) of the Securities Act or another exemption. In addition, if the Company's Class A common stock is, at the time of any exercise of a Warrant, not
55    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
listed on a national securities exchange such that it satisfies the definition of a “covered security” under Section 18(b)(1) of the Securities Act, the Company may, at its option, require holders of the Public Warrants who exercise their warrants to do so on a “cashless basis” in accordance with Section 3(a)(9) of the Securities Act and, in the event the Company elects to do so, the Company will not be required to file or maintain in effect a registration statement, but it will use its best efforts to register or qualify the shares under applicable blue sky laws to the extent an exemption is not available. In such event, each holder would pay the exercise price by surrendering the Public Warrants for that number of shares of Class A common stock equal to the lesser of (A) the quotient obtained by dividing (x) the product of the number of shares of Class A common stock underlying the Public Warrants, multiplied the excess of the “fair market value” less the exercise price of the Public Warrants by (y) the fair market value and (B) 0.361. The “fair market value” shall mean the volume weighted average price of the Class A common stock for the 10 trading days ending on the trading day prior to the date on which the notice of exercise is received by the warrant agent.

Redemption of Warrants when the Price per Class A common stock equals or exceeds $18.00 —The Company may redeem the outstanding Public Warrants:

● in whole and not in part;

● at a price of $0.01 per Public Warrant;

● upon not less than 30 days’ prior written notice of redemption to each warrant holder and

● if, and only if, the last reported sale price of the Class A common stock for any 20 trading days within a 30-trading day period ending three business days before sending the notice of redemption to warrant holders (the “Reference Value”) equals or exceeds $18.00 per share (as adjusted for share splits, share capitalizations, reorganizations, recapitalizations and the like).

If and when the Warrants become redeemable by the Company, the Company may exercise its redemption right even if it is unable to register or qualify the underlying securities for sale under all applicable state securities laws. However, the Company will not redeem the Warrants unless an effective registration statement under the Securities Act covering the underlying shares of Class A common stock issuable upon exercise of the Warrants is effective and a current prospectus relating to those shares of Class A common stock is available throughout the 30-day redemption period.

Redemption of Warrants When the Price per Class A common stock equals or exceeds $18.00 —Once the Warrants become exercisable, the Company may redeem the outstanding Warrants:

● in whole and not in part;

●    at $0.10 per warrant upon a minimum of 30 days’ prior written notice of redemption provided that holders will be able to exercise their Warrants on a cashless basis prior to redemption and receive that number of shares determined by reference to the report on Form 10-K for the year ended December 31, 2021 filed on March 31, 2022, based on the redemption date and the “fair market value” of the Class A common stock;

● if, and only if, the Reference Value (as defined in the above under “Redemption of Warrants When the Price per Class A common stock Equals or Exceeds $18.00”) equals or exceeds $18.00 per share (as adjusted for share splits, share dividends, reorganizations, recapitalizations and the like); and

●    if the Reference Value is less than $18.00 per share (as adjusted for share splits, share dividends, reorganizations, recapitalizations and the like) the Private Placement Warrants must also be concurrently -called for redemption on the same terms (except as described below with respect to a holder’s ability to cashless exercise its warrants) as the outstanding Public Warrants, as described above.

56    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The exercise price and number of common stock issuable upon exercise of the Public Warrants may be adjusted in certain circumstances including in the event of a share dividend, extraordinary dividend or recapitalization, reorganization, merger or consolidation. However, except as described below, the Public Warrants will not be adjusted for issuances of common stock at a price below its exercise price. Additionally, in no event will the Company be required to net cash settle the Public Warrants.

The Private Placement Warrants were identical to the Public Warrants underlying the units sold in the initial public offering of Trebia, except that (x) the Private Placement Warrants and the shares of Class A common stock issuable upon the exercise of the Private Placement Warrants were not transferable, assignable or salable until 30 days after the completion of the Merger, subject to certain limited exceptions, (y) the Private Placement Warrants were exercised on a cashless basis. There are no outstanding Private Placement Warrants as of September 30, 2022 (Successor).

The Public and Private Placement Warrants are accounted for as liabilities and marked-to-market at each reporting period, with changes in fair value included as change in fair value of warrant liabilities in the condensed consolidated statements of operations.

In April 2022, the Private Placement Warrant holders exercised their Warrants on a cashless basis in exchange for 3,532 shares of the Company's Class A common stock. Additionally, during the nine months ended September 30, 2022, Public Warrant holders exercised 437 warrants on a cash basis resulting in total proceeds paid to the Company of $5,028. The total outstanding Public Warrants as of September 30, 2022 was 16,813.

Share Repurchases

In August 2022, the Company's Board of Directors authorized up to $25,000 for the repurchase of the Company's Class A common stock and Public Warrants (the “2022 Repurchase Program”). During October 2022 the Company repurchased 190 shares for an aggregate purchase price of $1,122 under the 2022 Repurchase Program.

57    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
14.FAIR VALUE MEASUREMENT

The following tables present the Company’s fair value hierarchy for liabilities measured at fair value on a recurring basis as of September 30, 2022 (Successor) and December 31, 2021 (Predecessor):

September 30, 2022 (Successor)
Level 1
Public warrants$18,158 
December 31, 2021 (Predecessor)
Level 3
Former CEO equity interest     $11,132 
Contingent consideration1,682 
Total $12,814 

The fair value of the Public Warrants has been estimated using the Public Warrants’ quoted market price. The fair value of the Private Placement Warrants was estimated using the Public Warrants’ quoted market price.

The fair value of the former CEO of S1 Holdco's equity profits interest was determined with an option pricing model and utilizing significant unobservable inputs for a discount for lack of marketability and projected financial information. The fair value contingent consideration was determined with an option pricing model and contains significant unobservable inputs for projected financial information.


58    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)

Changes in estimated fair value of Level 1, 2 and 3 financial liabilities for the period from January 1, 2022 through January 26, 2022 (Predecessor), the period from January 27, 2022 through September 30, 2022 (Successor), and for the nine months ended September 30, 2021 (Predecessor), respectively, are as follows:

Former CEO equity profits interest*Contingent considerationWarrant liability
Fair value of liabilities at December 31, 2020 (Predecessor)$4,236 $8,240 
Settlements— (6,715)
Change in fair value4,238 94 
Fair value of liabilities at September 30, 2021 (Predecessor)$8,474 $1,619 
Fair value of liabilities at December 31, 2021 (Predecessor) and January 26, 2022 (Predecessor)$11,132 $1,682 
Fair value of liabilities at January 27, 2022 (Successor)$1,682 $27,012 
Settlements(1,715)(22,965)
Additions28 — 
Change in fair value5 14,111 
September 30, 2022 (Successor)$— $18,158 

*Former CEO equity profits interest as further described in executive compensation Note 8—ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES.

The total impact of the changes in fair values related to contingent consideration and the former CEO's equity profits interest in S1 Holdco are included in Selling, general and administrative expenses, and Salaries, commissions and benefits, respectively in the condensed consolidated statements of operations. There were no transfers in or out of levels during the period January 1, 2022 through January 26, 2022 (Predecessor), the period January 27, 2022 through September 30, 2022 (Successor), or for the nine months ended September 30, 2021 Predecessor).

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System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
15.NET INCOME (LOSS) PER SHARE
For the three months ended September 30, 2021 (Predecessor), the period from January 1, 2022 through January 26, 2022 (Predecessor), and for the nine months ended September 30, 2021 (Predecessor), the basic net income (loss) per unit attributable to members was calculated by dividing the net income (loss) attributable to common equity holders by the weighted-average number of membership units. For the three months ended September 30, 2022 (Successor) and the period from January 27, 2022 through September 30, 2022 (Successor), the 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 income (loss) per share was calculated as follows:

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Basic and diluted net loss per share$(2.66)n/a$(3.43)n/an/a
Numerator:
Net loss attributable to System1, Inc.(241,697)n/a$(303,503)n/an/a
Denominator:
Weighted-average common shares outstanding used in computing basic net loss per share91,002 n/a88,397 n/an/a
Basic and diluted net income (loss) per unitn/a$0.55 n/a$(1.81)$1.46 
Numerator:
Net income (loss)n/a$11,368 n/a$(37,061)$29,883 
Denominator:
Weighted-average membership units outstanding - basic
and diluted (units in thousands)		n/a20,488 n/a20,488 20,488 

Shares of Class C common stock outstanding for the period January 27, 2022 through September 30, 2022 (Successor) are considered potentially dilutive of the shares of Class A common stock under the application of the if-converted method, and are included in the computation of diluted loss per share, except when the effect would be anti-dilutive. For the three months ended September 30, 2022 (Successor) and the period from January 27, 2022 through September 30, 2022 (Successor), 21,927 and 21,957 shares of Class C common stock respectively, were included in the computation of net loss per share as the impact was dilutive. Loss per share excludes 16,813 Public Warrants as their effect was anti-dilutive.

16.SEGMENT REPORTING
ASC 280-10, Segment Reporting, establishes standards for reporting information about operating segments. 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. The Company's Chief Executive Officer, who is considered to be its 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 revenues as well as adjusted gross profit and other measures. The Company defines and calculates adjusted gross profit as revenue less advertising expense and agency fees to acquire users (refer to Note 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES), as well as content, publishing, domain name registration costs, licensing costs to provide mapping services to Mapquest.com, credit card processing fees, and licensing costs related to the antivirus and other software available via APIs for sale and distribution of its SaaS products to end customers. The Company excludes 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, that the CODM does not consider for the purposes of making decisions to allocate resources among
60    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
segments or to assess segment performance. Although these amounts are excluded from segment adjusted gross profit, they are included in reported consolidated net income from operations before income tax and are included in the reconciliation that follows.

The Company’s computation of segment adjusted gross profit may not be comparable to other similarly-titled measures computed by other companies because all companies do not calculate segment Adjusted Gross Profit in the same fashion.

Operating segments do not sell products and services across segments, and, accordingly, there are no intersegment revenues to be reported. The accounting policies for segment reporting are the same as for System1 as a whole.

The CODM of the Company reviews operating results, assesses performance and makes decisions by operating segment. Management views each of the Company’s business lines as an operating segment. The Company has four business lines and operating segments: Publishing and Lead Generation, Search & Applications, Partner Network, and Subscription.

The Publishing and Lead Generation and Search & Applications operating segments are aggregated into one reportable segment, referred to as Owned and Operated Advertising, based on their similar economic characteristics, technology platform utilized, types of services provided, Advertising Partners, and cost structures. The Company has three reportable segments: Owned and Operated Advertising, Partner Network and Subscription.

The following summarizes revenue by reportable segments:

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Owned and Operated Advertising$143,600 $162,606 $428,436 $49,249 $462,848 
Partner Network13,295 8,840 43,722 3,463 25,738 
Subscription44,281 — 114,923 — — 
Total revenue$201,176 $171,446 $587,081 $52,712 $488,586 

61    
System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
The following summarizes adjusted gross profit by reportable segments:

SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
Owned and Operated Advertising$37,261 $36,202 $103,478 $8,768 $105,902 
Partner Network10,301 8,840 32,622 3,012 25,738 
Subscription22,318 — 57,855 — — 
Adjusted gross profit$69,880 $45,042 $193,955 $11,780 $131,640 
Other cost of revenues6,384 2,481 17,496 575 8,891 
Salaries, commissions and benefits55,602 15,139 153,311 31,181 48,032 
Selling, general and administrative15,419 7,936 47,254 15,665 21,163 
Depreciation and amortization32,214 3,459 86,236 1,000 10,260 
Impairment of goodwill340,109 — 340,109 — — 
Interest expense10,011 4,184 22,111 1,049 12,708 
Change in fair value of warrant liabilities4,489 — 14,111 — — 
Net income (loss) before income tax$(394,348)$11,843 $(486,673)$(37,690)$30,586 

The following table summarizes revenue by geographic region:

Three-Month PeriodNine-Month Period
SuccessorPredecessorSuccessorPredecessor
Geographic RegionThree Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
United States$156,726 $167,105 $459,206 $51,701 $474,735 
United Kingdom44,281 107 114,924 — 276 
Other countries169 4,234 12,951 1,011 13,575 
Total$201,176 $171,446 $587,081 $52,712 $488,586 

The following table summarizes property and equipment, net and operating lease right-of-use assets by reportable segments:

SuccessorPredecessor
September 30, 2022December 31, 2021
Owned and Operated Advertising$10,312 $830 
Subscription930 — 
Total$11,242 $830 

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System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
17.RELATED-PARTY TRANSACTIONS

On October 16, 2018, S1 Holdco and its subsidiaries purchased a 50.1% interest in Protected for $55,000. At the time of the transaction, an investment vehicle known as Lone Investment Holdings ("LIH") was a shareholder and creditor of Protected. LIH owned 7.7% of the equity of Protected, and also was a creditor for $10,500, with respect to shareholder loans for which Protected was the obligor. LIH’s shareholders primarily consist of members of the Company’s management team. As a result of the Merger, LIH’s shareholder loan to Protected was repaid, with interest, and LIH also received $1,158 in proceeds from the sale of its equity.

Additionally, during 2021, S1 Holdco extended a loan of $1,500 to its former CEO in connection with his separation agreement. In January 2022, in conjunction with the consummation of the Merger, the loan was repaid in full.

Protected.net utilizes multiple payment processors in order to process credit card payments from its subscription customers, 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 William Foley, who was also a sponsor of Trebia Acquisition Corp. and is a member of the Company’s Board of Directors. Protected.net’s payment processing agreement with Paysafe was negotiated before the announcements of both (i) the Merger as well as (ii) the business combination between Paysafe and Foley Trasimene. The amount due from Paysafe was $1,585 as of September 30, 2022 (Successor).

The Company has agreements with JDI Property Holdings Limited (“JDI”), an entity controlled by a director of the Company, which allows for the Company to occupy desks at JDI’s property in such a place as JDI specifies from time to time in exchange for GBP 42 per month. The agreements with JDI expire on October 31, 2026. Additionally, the Company utilizes a JDI credit card and the Company reimburses JDI monthly. The amount owed to JDI was $117 as of September 30, 2022 (Successor).

On August 30, 2022, the Company, Protected.net and Just Develop It Limited (“JDIL”), an entity controlled by a director of the Company, entered into a Conditional Consent, Waiver and Acknowledgement (the “Waiver”) pursuant to which JDIL agreed to waive its right to the Year 3 Stock Bonus Pool (as such term is defined in the BCA, as defined below), consisting of $50,000 of Class A common stock payable in January 2024 and as set forth in Section 12.11(a) of the Business Combination Agreement dated June 28, 2021 (as amended), by and among S1 Holdco, Protected and the other parties signatory thereto (collectively, the “BCA”) in exchange for $40,000 in cash payable in four (4) quarterly installments of $10,000 each, commencing on August 30, 2022 and on each three (3) month anniversary thereafter.

In connection with entering into the Waiver, the Company entered into one (1) year contractual lockup agreements with each of Christopher Phillips, a member of the Board of Directors of the Company and the controlling shareholder of JDIL (on behalf of himself and JDIL), pursuant to which Mr. Phillips and JDIL agreed not to sell each their shares of Class A common stock for one year from September 1, 2022 through August 30, 2023 (the “Lockup Period”); provided that Mr. Phillips and JDIL may sell Class A common stock, among other exceptions, at any time during the Lockup Period at prices equal to or in excess of $11.00 per share.


18.SHARE-BASED COMPENSATION

As described in Note 2— SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, the Replacement Awards continue to vest over the original vesting schedule of the original underlying awards. The Company recognized a total stock-based compensation expense of $23,705 upon the consummation of the Merger during the period January 1, 2022 through January 26, 2022 (Predecessor). Subsequent to the Merger, the remaining amount of $30,724 will be amortized over the weighted average period of 2.3 years. The Company recognized stock-based compensation expense of $18,566 under these awards during the period January 27, 2022 through September 30, 2022 (Successor). The unrecognized stock-based compensation expense associated with these unvested Replacement Awards was $17,116 as of September 30, 2022.

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System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
In addition to the Replacement Awards, the Company issued 1,450 Class D shares that were exchanged for 1,450 Trebia's legacy shares, in a like for like transaction ("Sponsor RSAs"). The founders of S1 Holdco and Protected were also issued with 1,450 Class D shares ("Seller RSUs"). The Sponsor RSAs and Seller RSUs vested if the Company’s common stock traded at a VWAP equal or exceeding $12.50 per share for any 20 trading days within a 30 trading day period. When the VWAP of the Company’s common stock price exceeded the threshold in March 2022 the Sponsor RSAs and Seller RSUs vested, and the Company recorded their conversion from Class D common stock to Class A common stock on its Condensed Consolidated Statements of Changes in Stockholders' Equity. The Company also recorded $12,745 in stock-based compensation expense associated with the vesting of the Seller RSUs during the period January 27, 2022 through March 31, 2022 (Successor). Since these Sponsor RSAs and Seller RSUs had a market condition to vest, the Company estimated the fair values of these market-based RSAs and RSUs using a Monte Carlo simulation.

The key assumptions used to determine the fair value of these market-based RSUs and RSAs were as follows:

Inputs
Risk-free interest rate1.6%
Expected stock price volatility50.0%
Cost of equity23.6%
Expected term (years)5
Fair Value of Class A common stock$10.00

The Company recorded $7,706 in stock-based compensation expense for Sponsor Promote Shares during the period January 27, 2022 through March 31, 2022 (Successor).

The Company recorded the following total share-based compensation expense for the periods presented:


SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022sNine Months Ended September 30, 2021
Share-based compensation expense$31,377 $68 $88,847 $23,705 $334 

On April 27, 2022, the Company filed a registration statement on Form S-8 covering the shares and awards issued and granted under the System1, Inc. 2022 Incentive Award Plan ("Award Plan”). On May 10, 2022, the Company’s Board of Directors authorized the issuance of 1,900 replacement RSUs in connection with S1 Holdco unvested value creation units outstanding at the time of the Merger, pursuant to the terms of the Business Combination Agreement and an additional 4,900 RSUs from the authorized Award Plan pool of shares.

Protected.net Incentive Plan

In connection with the Merger and acquisition of Protected.net described in Note 3—MERGER, which was consummated on January 27, 2022, the Company effected an incentive plan for eligible recipients as defined in the Business Combination Agreement (see Note 3—MERGER), which may include employees and non-employees, including the Protected.net CEO, totaling up to $100,000 payable in fully-vested shares of the Company’s Class A common stock. If the last twelve months ("LTM") Cash EBITDA (as defined in the Business Combination Agreement) of the Protected.net business exceeds $55,000 on or prior to December 31, 2023, a bonus pool of $50,000 payable in fully-vested shares of the Company’s Class A common stock (the “2023 Award”) shall be allocated to eligible recipients as of December 31, 2023. Shares under the 2023 Award will be issued to eligible recipients within 30 days of December 31, 2023. Further, if the LTM Cash EBITDA of the Protected.net business exceeds $65,000 on or prior to December 31, 2024, an additional bonus pool of $50,000 also payable in fully-vested
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System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
shares of the Company’s Class A common stock (the “2024 Award”) shall be allocated to eligible recipients as of December 31, 2024. Shares under the 2024 Award will be issued to eligible recipients within 30 days of December 31, 2024. The number of shares payable under the 2023 Award and the 2024 Award will be determined based on the volume-weighted average price of the Company’s Class A common stock over the 20 consecutive trading days preceding the 5 trading days prior to the applicable settlement dates. The distribution of shares to eligible recipients for both the 2023 Award and the 2024 Award shall be at the sole discretion of the Protected.net CEO, or the System1, Inc. Board if the Protected.net CEO is no longer employed by the Company.

On August 30, 2022, the Company modified the 2023 Award to change this award from a bonus payable in fully-vested shares of the Company's Class A common stock to a $40,000 cash payment settled in four equal quarterly cash installments beginning upon the modification of the 2023 Award. During the three and nine months ended September 30, 2022, the Company recognized $18,313 and $29,266, respectively, for the 2023 Award, within salaries, commissions, and benefits on the condensed consolidated statements of operations.

Although the LTM Cash EBITDA target for the 2024 Award has not been met, the Company determined that it was probable of achievement, and accordingly, it recorded pro rata portions of the $50,000 payable for this award, within salaries, commissions, and benefits on the condensed consolidated statements of operations for the three and nine months ended September 30, 2022.

As of September 30, 2022, stock-based compensation has been recorded as current and non-current Protected.net Incentive Plan liabilities within the condensed consolidated balance sheet. The remaining liability for the modified 2023 Award will be recorded over the remaining service period with graded vesting attribution for each quarterly installment. The remaining liability for the 2024 Award will be recorded over the remaining service period to the extent that management determines that the achievement of the LTM Cash EBITDA target and issuance of the Series A common stock is considered probable.

CouponFollow Incentive Plan

In connection with the acquisition of CouponFollow described in Note 4—ACQUISITIONS, which was consummated on March 4, 2022, the Company approved and adopted the CouponFollow Incentive Plan, which includes CouponFollow’s key employees, including CouponFollow’s founder (“Principal Participant” and together collectively the “Participants”). The CouponFollow Incentive Plan provides for total payments of $35,000 payable at the Company’s option in cash or in fully-vested shares of the Company’s Class A common stock, consisting of a fixed amount of $10,000 and contingent amounts of $25,000, which can be earned over a three calendar year period between each January 1 to December 31 of 2022, 2023 and 2024 (each a “Performance Period” and collectively, the “Performance Periods”). In order to receive any payments under the CouponFollow Incentive Plan, the Participants must maintain continuous employment through the last day of each Performance Period to be eligible for the following earnout payment amounts (with the exception of the Principal Participant who is still eligible if terminated without cause or if he terminates his employment for good reason) in the amounts and at the times set forth below:

•Fixed Amount. Over the course of the Performance Periods, the Company shall pay to each of the employed eligible Participants a total of $10,000 (the “Fixed Amount”) in three substantially equal pro rata installment payments (as set forth in each Participant’s applicable award agreement) within 60 days of the end of each Performance Period.

•Tier 1 Target. If, during any of the Performance Periods, the CouponFollow business achieves the first tier TTM EBITDA (as defined in the CouponFollow Incentive Plan) for the first time (the “Tier 1 Target”), the Company will pay a total of $10,000 (the “Tier 1 Amount”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below.

•Tier 2 Target. If, during any of the Performance Periods, the CouponFollow business achieves the second tier TTM EBITDA for the first time (the “Tier 2 Target”), the Company will pay an additional $7,500 (the “Tier 2 Amount”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below.

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System1, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars, number of shares and number of units in thousands, except for per share or per unit amounts)
•Tier 3 Target. If, during any of the Performance Periods, the CouponFollow business achieves the third tier TTM EBITDA for the first time (the “Tier 3 Target” and together with the Tier 1 Target and Tier 2 Target, collectively the “Targets”), the Company will pay an additional $7,500 (the “Tier 3 Amount” and together with the Tier 1 Amount and the Tier 2 Amount, collectively the “Tier Amounts”) in substantially equal pro rata amounts (as set forth in each Participant’s applicable award agreement) at the times in the table set forth below.

Performance Period*Fixed AmountTier 1 Amount**Tier 2 Amount**Tier 3 Amount**Total Maximum Payment per Performance Period
Dec. 31, 2022$3,333 $3,333 $— $— $6,666 
Dec. 31, 20233,333 3,333 3,750 — 10,416 
Dec. 31, 20243,334 3,334 3,750 7,500 17,918 
$10,000 $10,000 $7,500 $7,500 $35,000 
*Payments for each applicable Performance Period are paid within 60 calendar days of the end of the applicable Performance Period.
**If the Tier 1 Amount is not achieved in the first Performance Period but is achieved in the second Performance Period, the Tier 1 Amount for the first Performance Period shall be paid out at the end of the second Performance Period and if achieved in the third Performance period the full amount will be paid at the end of the third Performance Period. If the Tier 2 Amount is not achieved in the second Performance Period but is achieved in the third Performance Period, the Tier 2 Amount will be paid at the end of the third Performance Period. If the Tier 2 Amount or the Tier 3 Amount is achieved in the first Performance Period, such Tier Amounts shall be paid as noted in the table above.

If a Participant’s continued employment is terminated prior to applicable payment date(s), with the exception of the Principal Participant as discussed above, the Company will reverse all prior liabilities for their pro rata share of any Tier Amounts associated with that Participant. If the Company elects to settle the payment obligations with respect to any Tier Amount in shares of the Company’s Class A common stock, the number of shares payable under the CouponFollow Incentive Plan will be determined based on the VWAP of the Company’s Class A common stock over the 30 trading day period immediately preceding the respective settlement date, but in any event, shall be capped at 4,667 shares of the Company’s Class A common stock in the aggregate. Any amount over the maximum number of shares is to be settled in cash.

As of September 30, 2022, the Company has determined that it was not probable that the CouponFollow business would achieve any of the Targets during the Performance Periods, and accordingly, it did not record a liability for any of the Tier Amounts set forth in the CouponFollow Incentive Plan. During the three and nine months ended September 30, 2022, the Company recognized $1,012 and $2,321, respectively, for the Fixed Amount, within Salaries, commissions, and benefits on the condensed consolidated statements of operations.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 

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 the financial condition and results of operations of System1 should be read together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q/A. The following discussion and analysis should also be read together with the section entitled “Organization and description of business” as of September 30, 2022 (Successor) and for the period from January 1, 2022 through January 26, 2022 (Predecessor), the period from January 27, 2022 through September 30, 2022 (Successor) and for the year ended December 31, 2021 (Predecessor). 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,” Dollars, number of shares and number of units are presented in thousands, except percentages, per share and per unit information, unless otherwise noted.

References to “Notes” are notes included in our unaudited condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q/A.

As described in the EXPLANATORY NOTE and in Note 1 of “Notes to Unaudited Condensed Consolidated Financial Statements” included elsewhere in this Amendment No. 1 to the Quarterly Report on Form 10-Q/A, we have restated our unaudited quarterly financial statements 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 for the period from January 27, 2022 to September 30, 2022. This Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, has been amended to reflect the restatement of the previously reported financial information for these periods, including but not limited to, information within the Results of Operations section.

Company Overview

We operate an omnichannel customer acquisition platform, delivering high-intent customers to advertisers and sell antivirus software packages to end user customers.

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 users on our behalf, RAMP allows us to monetize these acquired users through our relationships with third party advertisers and advertising networks (“Advertising Partners”). RAMP also allows third party advertising platforms and publishers (“Network Partners”), to send user traffic to, and monetize user traffic on, our owned and operated websites. RAMP operates across our network of owned and operated websites and related products, allowing us to monetize user traffic that we source from various acquisition marketing channels, including Google, Facebook, Taboola, Snapchat and TikTok.    

Through RAMP, we process approximately 27 million daily advertising campaign optimizations and ingest 6 billion rows of data daily across 40 plus advertising verticals as of September 30, 2022. We are able to efficiently monetize user intent by linking data on consumer engagement, such as first party search data, with data on monetization 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 verticals.

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The business of S1 Holdco, LLC (“S1 Holdco”), one of the entities acquired in the Merger described below, was founded in 2013 with a focus on monetizing user traffic acquired by its network. Since launching, it has expanded to support additional advertising formats across numerous advertising platforms, and has acquired several leading websites, enabling it to control user acquisition and experience, and monetize user traffic on its behalf. Today S1 Holdco owns and operates over 40 websites, including leading search engines like info.com and Startpage.com, and publishing digital media sites and utilities, such as HowStuffWorks, Mapquest and ActiveBeat.

We, through Protected.net, also provide antivirus software solutions, offering our customers a single packaged solution that provides protection and reporting to the end user. We deliver our antivirus software solutions directly to end-user customers around the world. The antivirus software solutions product offering comprises a core security package with varying levels of extra protection based on a customer's specific needs. These products include antivirus software available on an unlimited number of devices, Adblock, ID Protect and are managed to ensure they provide a value-added service to the customer base. The software is sold in either a monthly or annual subscription predominantly through the flagship brand TotalAV. As of September 30, 2022, Protected.net had over 2.3 million active subscribers for its products.

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

The Merger

On June 28, 2021, the Company entered into a Business Combination Agreement (as amended on November 30, 2021, January 10, 2022 and January 25, 2022), (the “Business Combination Agreement”) by and among S1 Holdco, Trebia, and Protected (collectively, the “Companies”). On January 26, 2022 (the “Closing Date”), the Company consummated the business combination (the “Merger”) pursuant to the Business Combination Agreement. Following the consummation of the Merger, the combined company is organized via an “Up-C” structure, in which substantially all of the assets and business operations of System1 are held by S1 Holdco. The combined Companies’ business continues to operate through the subsidiaries of S1 Holdco and Protected. Additionally, Trebia’s ordinary shares and public warrants ceased trading on the New York Stock Exchange (“NYSE”), and System1 Inc.'s Class A common stock and the Public Warrants began trading on the NYSE on January 28, 2022 under the symbols “SST” and “SST.WS,” respectively.

The consideration paid to the existing equity holders of S1 Holdco and Protected in connection with the Merger was a combination of cash, Class A common stock, Class C common, stock and Replacement Awards.

The aggregate cash consideration was $440,155.

The aggregate equity consideration was $610,144, consisting of Replacement Awards and shares of Class A common stock. The fair value of the Class A common stock was determined by utilizing the transaction closing price per share per the Business Combination Agreement of $10.00 and a discount of 10%, as the shares were not immediately available for sale upon issuance and this restriction is viewed to be a function of the security characteristics.

Additionally, the aggregate Class B units in S1 Holdco retained by S1 Holdco equity holders at the Closing Date resulted in a non-controlling interest. The 22,077 Class B units in S1 Holdco and the corresponding Class C common stock in the Company were determined to have an estimated value of $198,691. As the Class B units in S1 Holdco together with the corresponding shares of our Class C common stock are exchangeable for shares of Class A common stock on a one-for-one basis, the fair value was determined using the same method as for the shares of our Class A common stock, utilizing the transaction closing price of $10.00 and a discount of 10% (as the units and the corresponding shares of Class C common stock were not immediately available for sale upon issuance and this
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restriction is viewed to be a function of the security characteristics). The fair value of $198,691 was recorded as non-controlling interest in the accompanying condensed consolidated balance sheet and presented as non-controlling interests in the accompanying condensed consolidated statements of changes in stockholders' equity.

In connection with the Merger, System1 and Cannae Holdings, Inc. (“Cannae”), an investor in a sponsor of Trebia, entered into a backstop agreement (the “Backstop Agreement”) on June 28, 2021, as amended on January 10, 2022, whereby Cannae agreed, subject to the other terms and conditions, to subscribe for up to 25,000 shares of Trebia Class A common stock in order to fund a certain amount of redemptions by shareholders of Trebia redeemed at the Closing Date. See discussion below regarding the Amended and Restated Sponsor Agreement, which gave rise to the Backstop Agreement. As a result of shareholder redemptions, Cannae provided $246,484 of the cash used to fund the Closing Cash Consideration pursuant to its obligations under the Backstop Agreement and in exchange received 24,648 shares of Class A common stock ("Backstop shares").

Additionally, pursuant to the Backstop Agreement, the Selling Shareholders (i.e., certain shareholders of S1 Holdco and Protected prior to the Merger) agreed that, in the event Trebia shareholders requested redemption of Trebia outstanding equity immediately prior to the Merger in excess of a certain dollar value threshold, certain equity holders of S1 Holdco and Protected would reduce their cash consideration and proportionally increase their equity consideration for the Merger, which is referred to as the “Seller Backstop Election”. In the event that the Seller Backstop Election was made, the Sponsors would forfeit their shares to allow the Company to then issue shares to the Selling Shareholders. The Seller Backstop Election was triggered and, as a result, the Sponsors forfeited 930 shares of Trebia Class B ordinary shares which were converted at time of Merger, at a one-to-one ratio, into shares of Class A common stock of System1and delivered to the various selling shareholders of S1 Holdco, collectively referred to as the “Sponsor Promote Shares”. The total consideration amount, in a combination of cash and equity consideration, did not change from the amount agreed in the Business Combination Agreement due to this Seller Backstop Election. The Company recorded $7,706 in Salaries, commissions, and benefits expense and $661 in Selling, general and administrative expense for Sponsor Promote Shares during the period January 27, 2022 through March 31, 2022 (Successor).

In connection with the execution of the Business Combination Agreement and the Backstop Agreement, on June 28, 2021, as amended on January 10, 2022, the sponsors of Trebia entered into the Amended and Restated Sponsor Agreement whereby the sponsors agreed to forfeit up to 2,600 shares of Trebia Class B common stock in order for the Company to then issue the shares to Cannae (“Backstop forfeiture shares”), in exchange for Cannae entering into the Backstop Agreement. On January 27, 2022, based upon the final backstop funding provided by Cannae, the sponsors forfeited 2,533 shares of Trebia Class B shares, after which the Company then issued 2,533 shares of Class A common stock to Cannae. Trebia recorded a forward purchase liability of $25,336 immediately prior to the Merger, representing the fair value of the Backstop shares and Backstop forfeiture shares.

In accordance with the Amended and Restated Sponsor Agreement, the Company issued 1,450 Class D shares to Trebia sponsors that were exchanged for 1,450 Trebia Class B shares ("Sponsor RSAs"). The difference in the fair value between the two was treated as a capital contribution. The founders of S1 Holdco and Protected were also issued 1,450 Class D shares ("Seller RSUs"). Further, in connection with the Merger, the Company also effected an incentive plan for Protected business. Refer to Note 18—SHARE-BASED COMPENSATION for additional information on the Seller RSU's and the Protected Incentive Plan.

Concurrently with the Merger, we entered into a tax receivable agreement with certain of the then-existing members of S1 Holdco, (the “Tax Receivable Agreement” or “TRA”), pursuant to which, among other things, the parties to the Tax Receivable Agreement agreed to the allocation and payment of 85% of the actual savings, if any, in U.S. federal, state and local income taxes that System1 may realize as a result of certain tax benefits (if any) related to the transactions contemplated by the Business Combination Agreement and future exchanges of Class B units in S1 Holdco (together with the corresponding shares of our shares of Class C common stock) in exchange for shares of the Company’s Class A common stock. As of the Closing Date, the fair value of obligations under the TRA was determined to be zero as any tax savings were uncertain. The TRA is contingent consideration and subsequent changes in fair value of the contingent liability are recognized in earnings. Refer to TRA discussion in Note 10—INCOME TAXES.
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In accordance with a Sponsor Agreement entered into concurrently with the Business Combination Agreement, we issued 1,450 Class D shares to Trebia sponsors that were exchanged for 1,450 Trebia's legacy shares, in a like for like transaction ("Sponsor RSAs"). The founders of S1 Holdco and Protected were also issued 1,450 Class D shares ("Seller RSUs"). Further, in connection with the Merger, we also effected an incentive plan for Protected business. Refer to Note 18—SHARE-BASED COMPENSATION for additional information on the Seller RSU's and the Protected Incentive Plan.

Refer to Note 3—MERGER for additional information.
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Components of Our Results of Operations
We have three reportable segments:
•Owned and Operated Advertising ("O&O");
•Partner Network; and
•Subscription.

Refer to Note 16 — SEGMENT REPORTING

Revenue is earned from revenue-sharing arrangements with our Network Partners for the use of our RAMP platform and related services provided to them to direct advertising by the Advertising Partners to their advertising space. We have determined that we are the agent in these transactions and report this revenue on a net basis, because (a) we do not control the underlying advertising space, (b) we do not acquire the traffic and do not have risk of loss in connection therewith, and (c) the pricing is in the form of a substantively fixed-percentage revenue-sharing arrangement. We report this revenue on a net basis with respect to the amount retained under our revenue-sharing arrangements, which represents the difference between the amounts we receive from the Advertising Partners, less amounts remitted to the Network Partners based on underlying contracts.

We also earn revenue by directly acquiring traffic to our owned and operated websites and utilizing our RAMP platform and related services to connect our Advertising Partners to our owned and operated websites. 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. For this revenue, we have determined that we are the principal since we have the risk of loss on the traffic that it is acquired for monetization with our Advertising Partners, and, in the case of our owned and operated websites, we maintain the website, provide the content and bear the cost and risk of loss associated with our websites’ advertising space.

We use total advertising spend, number of Owned & Operated sessions, number of Partner Network sessions (“Network sessions”), O&O cost-per-session (“CPS”), O&O revenue-per-session (“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 websites. We define O&O sessions as the total number of monetizable user visits to our O&O 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 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 Partner Network revenue divided by Network sessions.

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

We, through Protected.net, are also engaged in selling security software subscriptions to customers. The subscription business provides real-time antivirus protection, a safe-browsing feature, adblocking, identity-theft protection, blocking of malicious websites and data breach monitoring. Subscription revenue is primarily derived from the (i) delivery of the antivirus software and (ii) delivery of the additional add-on service(s), which all are provided on a fixed-price basis. The performance obligations related to subscription, maintenance and support are satisfied over the length of the relevant customer contract term, and the associated subscription revenue is recognized over the term on a ratable basis, which is consistent with transfer of control. The fee for the services rendered to our customers are generally paid in advance and initially recorded as deferred revenue, which represents a liability under a noncancelable contract.

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, and renewal rates of customers for subscription services.


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Operating Expenses
We classify our operating expenses into the following four categories:

Cost of Revenues (excluding depreciation and amortization). Cost of revenues primarily consists of traffic acquisition costs, which are the costs to place advertisements to acquire customers to our websites and services, as well as content, publishing, domain name registration costs, licensing costs to provide mapping services to Mapquest.com, credit card processing fees, and costs related to the utilization of antivirus engine licensing related to APIs for the antivirus product. We do not pay any up-front payments, incentive payments or bonuses and such costs are expensed as incurred.

Salaries, Commissions, and Benefits. Salaries, commissions and benefits expenses include salaries, bonuses, stock-based compensation, non-capitalized personnel costs incurred in the development of internal-use software, and employee benefits costs.
We expect to continue to invest in corporate infrastructure to support our growth. We expect salaries, commissions, and benefits to increase in absolute dollars in future periods.
Selling, General, and Administrative. Selling, general, and administrative expenses consist of fees for professional services, occupancy costs, travel and entertainment. These costs are expensed as incurred.
We expect to continue to invest in corporate infrastructure to support our growth. We expect selling, general and administrative expenses to increase in absolute dollars in future periods.

Depreciation and Amortization. Depreciation and amortization expenses are primarily attributable to the Company’s capital investment(s) and consist of fixed asset depreciation and amortization of intangible assets with finite lives.

Impairment of Goodwill. We test for goodwill annually or if an event occurs or circumstance change that would more likely than not reduce the fair value of a reporting below its carrying amount. We record impairment of goodwill when the carrying amount of a reporting unit exceeds its fair value. Refer to the discussion below and Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, AND INTANGIBLE ASSETS — Impairment for additional information.

Other Expenses
Other expenses consist of the following:
Interest Expense. Interest expense is primarily related to our debt, which carries a variable interest rate.

Change in Fair Value of Warrant Liabilities. Change in fair value of warrant liabilities relates to the mark to market of our liability-classified public and private warrants.

Income tax (benefit) provision

The Company is the managing member of S1 Holdco and, as a result, consolidates the financial results of S1 Holdco in its condensed consolidated financial statements. S1 Holdco is a pass-through entity for U.S. federal and most applicable state and local income tax purposes. As an entity classified as a partnership for tax purposes, 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 its members, including the Company. The Company is taxed as a corporation and pays corporate federal, state and local taxes with respect to income allocated from S1 Holdco based on the Company's economic interest in S1 Holdco. Various subsidiaries are subject to income tax in the United States and in other countries.

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Results of Operations
The following tables set forth our consolidated results of operations and our consolidated results of operations as a percentage of revenue for the periods presented.


SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs RestatedAs Restated
(in thousands)
Revenue
$201,176 $171,446 $587,081 $52,712 $488,586 
Operating expenses:
Cost of revenues
137,680 128,885 410,622 41,507 365,837 
Salaries, commissions, and benefits
55,602 15,139 153,311 31,181 48,032 
Selling, general, and administrative
15,419 7,936 47,254 15,665 21,163 
Depreciation and amortization
32,214 3,459 86,236 1,000 10,260 
Impairment of goodwill340,109 — 340,109 — — 
Total operating expenses
581,024 155,419 1,037,532 89,353 445,292 
Operating income (loss)(379,848)16,027 (450,451)(36,641)43,294 
Other expense:
Interest expense10,011 4,184 22,111 1,049 12,708 
Change in fair value of warrant liabilities4,489 — 14,111 — — 
Total other expense14,500 4,184 36,222 1,049 12,708 
Income (loss) before income tax(394,348)11,843 (486,673)(37,690)30,586 
Income tax (benefit) provision(80,649)475 (95,752)(629)703 
Net income (loss)$(313,699)$11,368 $(390,921)$(37,061)$29,883 
Net loss attributable to non-controlling interest(72,002)— (87,418)— — 
Net income (loss) attributable to System1, Inc.$(241,697)$11,368 $(303,503)$(37,061)$29,883 


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SuccessorPredecessorSuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 2021Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs RestatedAs Restated
Revenue
100 %100 %100 %100 %100 %
Operating costs expenses:
Cost of revenues68 %75 %70 %79 %75 %
Salaries, commissions, and benefits
28 %9 %26 %59 %10 %
Selling, general, and administrative
8 %5 %8 %30 %4 %
Depreciation and amortization
16 %2 %15 %2 %2 %
Impairment of goodwill169 %— %58 %— %— %
Total operating costs and expenses
289 %91 %177 %170 %91 %
Operating income (loss)(189)%9 %(77)%(70)%9 %
Interest expense, net5 %2 %4 %2 %3 %
Change in fair value of warrant liabilities2 %— %2 %— %— %
Income (loss) before income tax(196)%7 %(83)%(72)%6 %
Income tax (benefit) provision(40)%— %(16)%(1)%— %
Net income (loss)(156)%7 %(67)%(70)%6 %
Net loss attributable to non-controlling interest(36)%— %(15)%— %— %
Net income (loss) attributable to System1, Inc.(120)%7 %(52)%(70)%6 %
* Percentages may not sum due to rounding

The comparability of our operating results for the nine months ended September 30, 2022 (Successor) compared to the nine months ended September 30, 2021 (Predecessor) was impacted by the Merger, as discussed above, and the acquisitions discussed in Note 4—ACQUISITIONS. Expense contributions from our recent acquisitions for each of the respective period comparisons generally were not separately identifiable due to the integration of these businesses into our existing operations.

Comparisons of Results of Operations for the three months ended September 30, 2022 (Successor) and September 30, 2021 (Predecessor), the period from January 1, 2022 through January 26, 2022 (Predecessor) and for the period from January 27, 2022 through September 30, 2022 (Successor) and the nine months ended September 30, 2021 (Predecessor)

Revenue

The following tables set forth our revenue by reportable segment.


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SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Revenue:
Owned and Operated Advertising$143,600 $162,606 (12)%
Partner Network
13,295 8,840 50%
Subscription44,281 — 100%
Total Revenue$201,176 $171,446 17%
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Refer to the Revenue discussions below.

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs RestatedAs Restated
Revenue:
Owned and Operated Advertising$428,436 $49,249 $462,848 3%
Partner Network
43,722 3,463 25,738 83%
Subscription114,923 — — 100%
Total Revenue$587,081 $52,712 $488,586 31%

Owned and Operated Advertising

The decrease in O&O revenues for the three months ended September 30, 2022, compared to the same prior year period was primarily due to an approximate $0.05 decrease in RPS, as well as a decrease in advertising spend to send traffic to this reportable segment. The increase in O&O revenues for the nine months ended September 30, 2022, compared to the same prior year period, was primarily due to increased traffic from international markets, revenues from our recent acquisitions and significant improvements in our RAMP technology. For the nine months ended September 30, 2022, compared to the same prior year period, sessions increased 699 million and RPS decreased approximately $0.04.

Partner Network

The increase in Partner Network revenue for the three and nine months ended September 30, 2022, compared to the same prior year periods, was due to our continued investment in this business and growth from partners signed in prior years. For the nine months ended September 30, 2022, compared to the same prior year period, sessions increased 79 million, with RPS increasing by approximately $0.01.

Subscription

In connection with the Merger, we acquired Protected.net and began recognizing subscription revenue.

Cost of revenues
SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Cost of revenues$137,680$128,8857%
Percent of revenue68 %75 %

The dollar increase in cost of revenues for the three months ended September 30, 2022, compared to the same prior year period, was due to the acquisition of Protected.net, which contributed $26 million of the increase in cost of revenues, partially offset by a decrease in user acquisition costs in our O&O segment.

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SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs RestatedAs Restated
Cost of revenues$410,622$41,507$365,83724%
Percent of revenue70 %79 %75 %

The dollar increase in cost of revenues for the nine months ended September 30, 2022, compared to the same prior year period, was due to the acquisition of Protected.net, which contributed $68 million of the increase in cost of revenues, and an increase in user acquisition costs in the O&O segment. User acquisition costs for the nine months ended September 30, 2022, increased $9 million and drove 3.1 million sessions at approximately $0.12 CPS, compared to 2.4 million sessions at approximately $0.15 CPS for the same period in 2021 (Predecessor). User acquisition costs accounted for 81% and 98% of total cost of revenues for the nine months ended September 30, 2022 (Successor) and 2021 (Predecessor), respectively.

The following supplemental tables set forth our adjusted gross profit by reportable segment.

SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Segment Adjusted Gross Profit:
Owned and Operated Advertising
$37,261 $36,202 3%
Partner Network
10,301 8,840 17%
Subscription22,318 — 100%
Total Adjusted Gross Profit$69,880 $45,042 55%

Refer to the Revenue and Cost of revenues discussions above. Additionally, refer to Note 16—SEGMENT REPORTING for additional information.

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs RestatedAs Restated
Segment Adjusted Gross Profit:
Owned and Operated Advertising
$103,478 $8,768 $105,902 6%
Partner Network
32,622 3,012 25,738 38%
Subscription57,855 — — 100%
Total Adjusted Gross Profit$193,955 $11,780 $131,640 56%

Refer to the Revenue and Cost of revenues discussions above. Additionally, refer to Note 16—SEGMENT REPORTING for additional information.


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Salaries, commissions, and benefits
SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Salaries, commissions and benefits
$55,602$15,139>100%
Percent of revenue28 %9 %

The increase in salaries, commissions, and benefits for the three months ended September 30, 2022, compared to the same prior year period, was primarily due to $31 million in stock-based compensation, which included $23 million related to the Protected.net Incentive Plan, and the fluctuations in the value of our common stock since the Merger; and $6 million in salaries and bonus related expenses due to increased headcount from the Merger and our recent acquisitions. For additional information on our stock-based compensation, refer to Note 18—SHARE-BASED COMPENSATION.

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs RestatedAs Restated
Salaries, commissions and benefits
$153,311$31,181$48,032>100%
Percent of revenue26 %59 %10 %

The increase in salaries, commissions, and benefits for the nine months ended September 30, 2022, compared to the same prior year period, was primarily due to $113 million in stock-based compensation, which included $41 million related to the Protected.net Incentive Plan and $24 million recognized upon the close of the Merger; and $17 million in salaries and bonus related expenses due to increased headcount from the Merger and our recent acquisitions. For additional information on our stock-based compensation, refer to Note 18—SHARE-BASED COMPENSATION.

Selling, general, and administrative

SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Selling, general, and administrative
$15,419$7,936>100%
Percent of revenue
8 %5 %

The increase in selling, general, and administrative expense for the three months ended September 30, 2022, compared to the same prior year period, was primarily due to costs associated with our recent acquisitions and additional costs associated with being a public company.

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SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs RestatedAs Restated
Selling, general, and administrative
$47,254$15,665$21,163>100%
Percent of revenue
8 %30 %4 %

The increase in selling, general, and administrative expense for the nine months ended September 30, 2022, compared to the same prior year period, was primarily due to costs associated with the Merger, costs associated with our recent acquisitions and additional costs associated with becoming a public company.

Depreciation and amortization

SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Depreciation and amortization
$32,214$3,459>100%

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Depreciation and amortization
$86,236$1,000$10,260>100%


The increases in depreciation and amortization expense for the three and nine months ended September 30, 2022, respectively, compared to the same prior year periods, was primarily due to additions of intangible assets as a result of the Merger, along with subsequent acquisitions.

Impairment of goodwill

SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Impairment of goodwill
$340,109$—>100%

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SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Impairment of goodwill
$340,109$—$—>100%

We have experienced adverse macroeconomic impacts as a result of changes in market conditions and increases in interest rates, which contributed to reduced forecasted revenues and reduced expectations for future cash flows. In response to these ongoing macroeconomic conditions and a broad weakening of consumer demand during the third quarter of 2022, we reduced our earnings forecasts for the Owned and Operated Advertising & Partner Network reportable segments. Given these adverse impacts, we performed an interim quantitative goodwill impairment analysis for all our reporting units as of September 30, 2022. As a result of these impairment tests, we recorded impairments of goodwill associated with certain of our reporting units as the fair value of these reporting units had declined below their carrying amounts. Refer to Note 6 — GOODWILL , INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, AND INTANGIBLE ASSETS, NET — Goodwill Impairment for additional information.

Interest expense

SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
Interest expense$10,011$4,184>100%
    

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
Interest expense$22,111$1,049$12,70882%

The increases in interest expense for the three and nine months ended September 30, 2022, respectively, compared to the same prior year periods, was due to an increase in our outstanding loan balances as a result of the Term Loan and Revolving Facility, which we entered into as part of the Merger.

Change in fair value of warrant liabilities

The changes in fair value of warrant liabilities for the three and nine months ended September 30, 2022, respectively, compared to the same prior year periods, were driven by the fluctuations in the market value of our Class A common stock since the Merger.

Income tax (benefit) provision

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SuccessorPredecessor
Three Months Ended September 30, 2022Three Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Income tax (benefit) provision
$(80,649)$475>100%
Effective tax rate20 %4 %

SuccessorPredecessor
Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 20212022 vs. 2021 change (%)
As RestatedAs Restated
Income tax (benefit) provision
$(95,752)$(629)$703>100%
Effective tax rate20 %2 %2 %

The difference between the effective tax rates for the periods presented above and the federal statutory tax rate of 21% was primarily due to the exclusion of non-controlling income (loss), effects of predecessor flow through income allocations, state taxes, foreign rate differential, non-deductible expenses, outside basis adjustments, and Global Intangible Low-taxed Income.

Liquidity and Capital Resources

As of September 30, 2022 (Successor), we had cash and cash equivalents of $31,933.

To date, our available liquidity and operations have been financed through the initial public offering of Trebia, the Merger, credit facilities, and cash flows from operations. We are subject to certain business risks, including dependence on key employees, dependence on key contracts, competition from alternative technologies, and dependence on growth to achieve our business and operational objectives.

Our revenues are 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-Capital Resources, Liquidity, and Concentration for additional information.

Going Concern

As of June 1, 2023, the Company had not delivered audited financial statements for the fiscal year ended December 31, 2022 to Bank of America as required by the covenants of the Term Loan (refer to Note 12 – DEBT, NET). The failure to timely deliver the audited financial statements is an event of default under the Term Loan and provides Bank of America the ability to immediately call the outstanding principal balances of the Term Loan and Revolving Facility of $430,000, as of the date of this filing, at the request of, or with the consent of, the required majority of lenders until such time that the audited financial statements are delivered to Bank of America. The Company does not have sufficient liquidity to settle the outstanding principal balances should they be called, nor has the Company identified sufficient alternative sources of capital. As a result, this matter raises substantial doubt about the Company’s ability to continue as a going concern. Upon delivery of the audited financial statements by the Company, the event of default will be remediated and, once remediated, Bank of America will no longer have the ability to call the outstanding principal balances on the Term Loan and Revolving Facility.

Separate from the default under the Term Loan and Revolving Facility, in the third and fourth quarters of 2022, the Company experienced declining cash flows and financial performance as a result of deteriorating macroeconomic conditions, resulting in reductions in both advertiser and overall consumer demand for our marketing services. As of December 31, 2022, the Company had cash on hand of $24,606. The declining cash flows
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and financial performance also raised substantial doubt regarding the Company's ability to continue as a going concern for a period of one year following the date that the consolidated financial statements are issued. In response to the declining cash flows, the Company implemented a plan to raise additional financing. On April 10, 2023, the Company entered into an incremental revolver note (“2023 Revolving Note”) with related parties for $20,000 (refer to Note 12—DEBT, NET for additional information regarding the 2023 Revolving Note). As of the date of this filing, the available balance under the 2023 Revolving Note was $15,000.

The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Accordingly, the consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business.

Credit Facilities

In connection with the Merger discussed above, Orchid Merger Sub II LLC (a subsidiary of S1 Holdco) entered into a new loan (“Term Loan”) and revolving facility (“Revolving Facility”) on January 27, 2022, providing for a 5.5 year Term Loan with a principal balance of $400,000 and with the net proceeds of $376,000, of which a portion of the proceeds were used by S1 Holdco, to settle the outstanding debt of $172,038 with Cerberus Business Finance, LLC. The Revolving Facility was for $50,000

We have been able, and expect to continue to be able, to make payments on the principal and interest on a timely basis. As of September 30, 2022, we were in compliance with our borrowing covenants.

On April 10, 2023, the Company entered into the 2023 Revolving Note for $20,000 with related parties (refer to Note 12—DEBT, NET for additional information regarding the 2023 Revolving Note). As of the date of this filing, the available balance under the 2023 Revolving Note was $15,000.

For additional information regarding our credit facilities, refer to Note 12—DEBT, NET.

Refer to NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS for additional information regarding the default of the Term Loan.
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Cash Flows

The following table summarizes our cash flows for the periods presented:
SuccessorPredecessor
 (in thousands)     Period from January 27, 2022 through September 30, 2022Period from January 1, 2022 through January 26, 2022Nine Months Ended September 30, 2021
As RestatedAs Restated
Net cash provided by (used in) operating activities $(742)$(10,603)$39,369 
Net cash used in investing activities$(452,429)$(441)$(4,901)
Net cash used in financing activities$(22,552)$— $(27,635)

Operating Activities

Our cash flows from operating activities are primarily influenced by growth in our operations, timing of collections from our clients and related payments to our suppliers for advertising inventory and data. We typically pay suppliers in advance of collections from our clients. 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.

During the period from January 1, 2022 to January 26, 2022 (Predecessor), cash used in operating activities of $10,603 resulted primarily from a net loss of $37,061, and a decrease in accounts payable of $67,600 due to the Merger. This was partially offset by an increase in accrued expenses of $57,488, stock-based compensation of $23,705 and a decrease in accounts receivable of $11,118 due to the Merger.

During the period from January 27, 2022 to September 30, 2022 (Successor), cash provided by operating activities of $742 resulted primarily from impairment of goodwill of $340,109, depreciation and amortization expense of $86,236, stock-based compensation of $88,847, change in fair value of warrants of $14,111, an increase in deferred revenue of $7,133, a decrease in accounts receivable of $6,670 due to the Merger, amortization of debt issuance cost of $3,540, and increase in the accounts payable of $1,981. This was partially offset by a net loss of $390,921, deferred tax benefit of $101,100, a decrease in other long-term liabilities of $31,467, a decrease in accrued expenses and other liabilities of $17,369 due to the Merger, and a decrease in the Protected.net Incentive Plan liability of $10,000 for a quarterly payment.

During the nine months ended September 30, 2021 (Predecessor), cash provided by operating activities of $39,369 resulted primarily from Owned and Operated Advertising revenue, offset by user acquisition costs incurred to drive the growth and salaries, commissions and benefits costs. Contributing factors include net income of $29,883, an increase in depreciation and amortization expense of $10,260, and an increase in accounts payable of $12,535 due to increased user acquisition costs, partially offset by an increase in accounts receivable of $14,449.

Investing Activities

Our primary investing activities consist of acquisitions of businesses, such as the acquisition of S1 Holdco, Protected.net, Answers, CouponFollow and RoadWarrior in 2022, as well as costs capitalized for internally developed software.

During the period from January 1, 2022 to January 26, 2022 (Predecessor), cash used in investing activities of $441 resulted from costs capitalized for internally developed software.

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During the period from January 27, 2022 to September 30, 2022 (Successor), cash used in investing activities of $452,429 resulted primarily from the acquisitions of S1 Holdco, Protected.net, Answers, CouponFollow and RoadWarrior.
During the nine months ended September 30, 2021 (Predecessor), cash used in investing activities of $4,901 resulted primarily from costs capitalized for internally developed software.

Financing Activities

Our financing activities consisted primarily of borrowings and repayments of our debt, distributions to members related to tax obligations, acquisition related contingent consideration and proceeds from the sale of assets.

During the period from January 27, 2022 to September 30, 2022 (Successor), cash used in financing activities of $22,552 resulted primarily from redemptions of Trebia Class A ordinary shares of $510,469, repayment of existing term loan of $182,488, and payment of debt financing costs related to the Term Loan of $24,845, partially offset by proceeds from the Term Loan and Revolving Facility of $449,000 and the Cannae Backstop of $246,484. In October 2022, the Company borrowed an additional $1,000 under its Revolving Facility.

During the nine months ended September 30, 2021 (Predecessor), cash used in financing activities of $27,635 resulted primarily from repayments of debt of $9,886, distributions to members of $9,793, and payment of acquisition related contingent consideration of $6,715 related to the acquisition of Startpage.

Share Repurchases

In August 2022, our Board of Directors authorized up to $25,000 for the repurchase of our Class A common stock and Public Warrants ("2022 Repurchase Program"). During October 2022 we repurchased 190 shares for an aggregate purchase price of $1,122 under the 2022 Repurchase Program.

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 $8,000 between July 2022 and June 2023. As of September 30, 2022 (Successor), we remain contractually obligated to spend $5,933 towards this commitment.

Acquisitions

For potential commitments associated with our acquisitions refer to Note 3—MERGER and Note 4—ACQUISITIONS.

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.


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Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with the accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenues and expenses during the reporting period.

Significant estimates and assumptions reflected in these condensed consolidated financial statements include, but are not limited to: (1) valuation of goodwill, acquired intangible assets and long-lived assets, (2) valuation and recognition of the Company's share-based compensation awards, (3) income taxes, (4) contingent consideration and (5) determination of the fair value of the warrant liabilities. Significant estimates affecting the condensed consolidated financial statements have been prepared on the basis of the most current and best available information, including historical experience, known trends and other market-specific or other relevant factors that the Company believes to be reasonable. Management evaluates its estimates, as there are changes in circumstances, facts and experience. Changes in estimates are recorded in periods which they become known. However, actual results from the resolution of such estimates and assumptions may vary from those used in the preparation of the condensed consolidated financial statements.

Business combinations

The results of a business acquired in a business combination are included in our condensed consolidated financial statements from the date of acquisition. We allocate the purchase price, which is the sum of the consideration provided which may consist of cash, equity, or a combination of the two, paid in a business combination for the identifiable assets and liabilities of the acquired business at their acquisition-date fair values. Any excess amount paid over the identifiable net assets is recorded as goodwill. The process for estimating the fair values of the acquired business involves the use of significant estimates and assumptions, including estimating average industry purchase price multiples, customer and service attrition rate and estimating future cash flows. We estimate the fair value based on assumptions which we believe to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. At the conclusion of the measurement period, any subsequent adjustments are reflected in our condensed consolidated statements of operations.

Transaction costs associated with business combinations are expensed as incurred and are included in Selling, general and administrative expenses in our condensed consolidated statements of operations. When purchase consideration includes contingent consideration, we record the fair value of the contingent consideration as of the date of acquisition, and subsequently remeasure the contingent consideration at fair value each reporting period through our condensed consolidated statements of operations.
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Goodwill

Goodwill represents the excess of the purchase price over the fair value of net assets acquired and identifiable intangibles in a business combination. We account for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other, which requires us to test goodwill at the reporting unit level for impairment at least annually. We test for goodwill impairment annually at December 31st, or more frequently if events or changes in circumstances indicated the asset might be impaired.

We have the option (i) to assess goodwill for possible impairment by performing a qualitative analysis to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount or (ii) to perform the quantitative impairment test. The quantitative impairment test involves comparing the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than its carrying amount, an impairment loss is recognized in an amount equal to the excess.

The fair values of the Company’s reporting units were computed by weighting a discounted cash flow model and a reference transaction model which included inputs developed using both internal and market-based data. The Company's key assumptions in the discounted cash flow model included, but were not limited to, the weighted average cost of capital, revenue growth rates (including long-term growth rates), and operating margins. The weighted average cost of capital reflected the increases in market interest rates. The reference transaction model derives indications of value based on mergers and acquisition transactions in the digital advertising industry. Key assumptions in this model included, but were not limited to, the selection of comparable transactions, revenue and EBITDA multiples and EBITDA margins from those transactions. Unanticipated events or circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results.

As a result of adverse macroeconomic impacts because of changes in market conditions, increases in interest rates, and weakening of consumer demand during the third quarter of 2022, which contributed to reduced forecasted revenues and reduced expectations for future cash flows, we performed quantitative goodwill impairments tests of our four reporting units as of September 30, 2022.

Based on the Company’s quantitative impairment analysis as of September 30, 2022:

•the fair value of the Subscription reporting unit exceeded its carrying amount by 18%. As of September 30, 2022, goodwill attributable to this reporting unit was $433,184.
•the fair value of the Search and Applications reporting unit exceeded its carrying amount by approximately 2%. As of September 30, 2022, goodwill attributable to this reporting unit was $26,200.
•the fair value of the Publishing and Lead Generation reporting unit was substantially less than its carrying amount. As a result, the Company impaired all the goodwill attributable to this reporting unit of $329,133.
•the fair value of the Partner Network reporting unit was less than its carrying amount, resulting in a $10,976 impairment of goodwill attributable to this reporting unit. As of September 30, 2022, remaining goodwill attributable to this reporting unit was $82,408.

As of September 30, 2022, the risk of impairment of goodwill attributable to the Search and Applications reporting unit and an additional impairment of goodwill attributable to the Partner Network reporting unit is sensitive to changes in the estimates and assumptions used in the respective reporting unit fair value determinations. Any deviation in actual financial results compared to the forecasted financial results or valuation assumptions, a decline in equity valuations, or additional increases in interest rates, among other factors, could have a material adverse effect on the fair value of the reporting units and could result in a future impairment charge.

During the quarter ended December 31, 2022, the Company realigned its reporting structure due to changes n management such that the Search and Applications reporting unit became part of the Publishing and Lead Generation reporting unit and the new reporting unit was renamed Owned and Operated Advertising. Based on its annual impairment assessment as of December 31, 2022, the Company determined that the remaining goodwill attributable to Owned and Operated Advertising of $26,200 was fully impaired.
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Refer to Note 6 — GOODWILL, INTERNAL-USE SOFTWARE DEVELOPMENT COSTS, AND INTANGIBLE ASSETS for additional information.

Share-based compensation

Compensation cost related to share-based payments is measured based on the fair value of the units issued and recognized within “Salaries, commissions, and benefits” in our condensed consolidated statement of operations. We have elected to treat share-based payment awards with time-based service condition(s) only as a single award and recognize share-based compensation expense on a straight-line basis over the vesting period, which is generally four years. The assumptions used in the Black-Scholes model to value equity in the Predecessor period are based upon the following:

•Fair Value of common stock: S1 Holdco’s equity was not publicly traded, therefore the fair value was determined by S1 Holdco’s Board of Directors, with input from management and contemporaneous valuation reports prepared by a third-party valuation specialist.

•Expected Term: The expected term of the option is estimated by considering the contractual term of the option, the vesting period of the option, the employees’ expected exercise behavior and the post-vesting employee turnover rate. For non-employees, the expected term equals the contractual term of the option.

•Risk-free Interest Rate: The risk-free interest rate is based on published U.S. Treasury Department interest rates for the expected terms of the underlying options.

•Volatility: The volatility was based on the expected unit price volatility of the underlying units over the expected term of the option, which is based upon historical share price data of an index of comparable publicly traded companies.

After the Merger, the fair value of our RSUs is derived from the market price of our Class A common stock, which is traded on the NYSE. We recognize compensation on a straight-line basis over the requisite service period for each award and recognize forfeitures as they occur.

In connection with the Merger and acquisition of Protected.net, we effected an incentive plan for eligible recipients (the “Protected.net Incentive Plan”). If the Protected.net business achieves certain financial metrics on or prior to December 31, 2023, recipients will be eligible to receive a pool of $50,000 payable in fully-vested shares of our Class A common stock (the “2023 Award”). On August 30, 2022, the Company modified the 2023 Award to remove the operational targets and reduce this award to $40,000 settled in four equal quarterly cash installments beginning upon the modification of this award. Further, if the Protected.net business achieves certain financial metrics on or prior to December 31, 2024, recipients will be eligible to receive a separate pool of $50,000 payable in fully-vested shares of our Class A common stock (the “2024 Award”). Shares under the 2024 Award will be issued to recipients within 30 days of December 31, 2024.

We account for each of these awards as liability-classified until the awards are settled in cash or stock, respectively, and accordingly, when the 2024 Award is probable of achievement, we record stock-based compensation for that liability award. Refer to Note 18—SHARE-BASED COMPENSATION for additional information regarding liability-classified awards.

Share-based compensation expense is included in the Salaries, commissions, and benefits expense in the condensed consolidated statements of operations.

Recently Issued Accounting Pronouncements

See Note 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-Recent Accounting Pronouncement for a discussion of recently issued accounting pronouncements not yet adopted.
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Item 3. Quantitative and Qualitative Disclosure about Market Risk

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


Item 4. Controls and Procedures

(a) 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 September 30, 2022, 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.

(b) Material weaknesses in internal control over financial reporting

We have identified material weaknesses in our internal control over financial reporting as of September 30, 2022. 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 acquisitions. Specifically, we did not design and maintain effective controls over the (i) application of U.S. GAAP to such transactions, including accounting for post-combination compensation arrangements, (ii) 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, (iii) the tax impacts of acquisitions to the financial statements, and (iv) conforming of U.S. 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.
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•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 the preparation and review of business performance reviews, account reconciliations and journal entries, 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 the completeness and accuracy of accrued liabilities, stock-based compensation and equity transactions.
•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 the successor period from January 27, 2022 to March 31, 2022; as of June 30, 2022 and for 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 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.

•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.
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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.

(c) Remediation plan for the material weaknesses

Our remediation plan consists of the following:

•Hiring additional senior level accounting personnel with applicable technical accounting knowledge, training and experience in accounting matters, 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 over segregation of duties;
•Engaging 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;
•Engaging third-party experts to assist with the preparation of technical accounting analysis and valuations associated with business combinations;
•Designing and implementing controls related to accounting for acquisitions and other technical accounting and financial reporting matters, 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, 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, and classification and presentation of accounts and disclosures, including the statement of cash flows;
•Designing and implementing controls over the completeness and accuracy of accrued liabilities, stock-based compensation and equity transactions;
•Designing and implementing controls related to accounting for complex financial instruments, including the earnings per share impacts;
•Designing and implementing controls over the accuracy and valuation of goodwill, including the allocation of goodwill to reporting units and the identification and measurement of goodwill impairment;
•Implementing an enhanced enterprise resource planning software for automation and enforcing segregation of duties across the organization; and
•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.

While we believe that these efforts will improve our internal control over financial reporting, remediation of the material weaknesses will require validation and testing of the design and operating effectiveness of internal controls over a sustained period of financial reporting cycles. Therefore, these material weaknesses have not been remediated as of September 30, 2022.

(d) Changes in Internal Control over Financial Reporting.

There have been no changes in our internal control over financial reporting during the three months ended September 30, 2022, as defined under Rule 13a-15(f) under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II

Item 1. Legal Proceedings

Information in response to this Item is included in “Part I — Item 1. — Note 11—COMMITMENTS AND CONTINGENCIES” and is incorporated by reference into Part II of this Quarterly Report on Form 10-Q/A.

Item 1A. Risk Factors.

Other than with respect to the material weakness described herein, which could further amplify our previously disclosed risks, particularly with respect to the consequences of a material weakness in internal control over financial reporting, there are no material changes had occurred in our risk factors, compared with the disclosure in our Registration Statement on Form S-1, originally filed with the SEC on April 1, 2022, as subsequently amended (Reg. No. 333-262608), and subsequent filings with the SEC.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Share Repurchases

In August 2022, our Board of Directors authorized up to $25,000 for the repurchase of our Class A common stock and Public Warrants. During October 2022 we repurchased 190 shares for $1,122 under this authorization.


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Item 3. Defaults Upon Senior Securities

On May 1, 2023, the Company did not deliver audited financial statements as required under the terms of its credit agreement. On May 1, 2023, the Company received a notice of default, which started a 30 day cure period, ending on May 31, 2023, within which the Company could remedy the default. On June 1, 2023, as a result of not delivering audited financial statements for the fiscal year ended December 31, 2022, the default constitutes an event of default. As a result, the outstanding principal balances of $430,000 for the Term Loan and Revolving Facility are callable by Bank of America at the request of, or with the consent of, the required majority of lenders thereunder. Upon delivering audited financial statements prior to the debt being called, the event of default will no longer be continuing and the Company will be in compliance with the credit agreement, which eliminates the ability of the lenders to exercise remedies with respect thereto.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.
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Item 6. Exhibits

Incorporated by ReferenceFiled or Furnished Herewith
Exhibit No.DescriptionFormFile No.ExhibitFiling Date
2.1(a)8-K001-393312.16/29/2021
2.1(b)S-4333-2607142.212/1/2021
2.1(c)8-K001-3933110.11/20/2022
2.1(d)8-K001-3933110.11/26/2022
3.18-K001-393313.12/2/2022
3.28-K001-393313.17/8/2022
4.18-K001-393314.16/2/2020
4.2Credit and Guarantee Agreement10-Q/A001-393314.26/5/2023
10.18-K001-3933110.22/20/2022
10.28-K001-3933110.31/10/2022
10.3S-4333-26071410.812/16/2021
10.48-K001-3933110.18/30/2022
10.58-K001-3933110.28/30/2022
10.68-K001-3933110.38/30/2022
31.1X
31.2X
32.1**X
93    

32.2**X
101.INS*XBRL Instance Document – The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*XBRL Taxonomy Extension Schema Document.
101.CAL*XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*XBRL Taxonomy Extension Labels Linkbase Document.
101.PRE*XBRL Taxonomy Extension Presentation Linkbase Document.
104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

*Filed herewith.
**This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, nor shall it be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


System1 Inc.
Date: June 5, 2023
By:/s/ Michael Blend
Michael Blend
Chief Executive Officer
Date: June 5, 2023
By:/s/ Tridivesh Kidambi
Tridivesh Kidambi
Chief Financial Officer
95    
Trebia Acquisition (NYSE:TREB)
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