Redeye concludes that Q4 was weaker than expected. Revenue was 5% below expectations, where recurring revenues was on the weaker side and ad hoc revenues in line with expectations. On the positive side, marketing optimization (the company’s focus area) grew decently. Adjusted EBIT (excl. one-off costs for cost-cutting program) was weaker than expected due to lower revenues and gross margin than expected. Q1 sales has started with a small decline y/y, where ad-hoc sales continue to weigh down.

We think Nepa's management did a poor job as it aggressively expanded its cost base in 2022 totally ignoring the risk of an upcoming recession. We think this has made investors lose their hope, but that this reaction is a bit too drastic.

Net sales can be divided into two different ways: by revenue type and by segment. Regarding revenue type, around two-thirds of revenues are recurring, and the remaining third is ad-hoc consulting. Nepa has three segments: Marketing Optimization (MO) constituted c85% of revenues in Q4, whereas Customer Experience (CX) and Innovation Acceleration (IA) share somewhat equally the remaining 15%.

Recurring revenues amounted to SEK51.7m (+2.2% y/y) and accounted for 68% of sales in the quarter. This growth was lower than we had expected and was driven by lower revenues from CX subscriptions.

Nepa stated that several positive price adjustments were made in Q4. On the conference call, the CEO said that no customers churned during the quarter but that some changed from annual to quarterly subscriptions, and some switched to smaller pricing plans. The company confirmed the reduced pricing plan was for one significant CX customer. This was much better than if reduced pricing plans had happened for Brand Tracking.

Also, fewer campaign evaluations weighed down. We think this part has lower revenue quality than Brand Tracking. However, we are not sure, but we believe this part constitutes less than 20% of total recurring revenues.

Ad-hoc revenues amounted to SEK24.6m (-12% y/y), accounting for 22% of sales in the quarter. Ad-hoc revenues are affected negatively by the weak economy in two ways. First, fewer projects are sold due to hesitant decision-makers. Second, the delivered projects are sold at a discount from pricing pressure.

While recurring revenues are also affected negatively by the weaker economy, they are affected less than ad-hoc sales. Considering that Nepa has increased sales efforts for its Brand Tracker, which is recurring and primarily software, we believe recurring revenues will grow as a share of the total.

Marketing Optimization (MO) accounts for almost all revenues and is also the segment that Nepa is actively trying to grow. MO sales amounted to SEK65.1m (+10.9% y/y) and accounted for 85% of sales in the quarter. Considering that MO consists of both recurring and ad-hoc revenues, we believe recurring revenues in MO grew by almost 15% y/y, and that ad-hoc sales in MO declined somewhat.

Innovation Acceleration revenues amounted to SEK3.6m (-64% y/y) and accounted for c5% of sales in the quarter. To our understanding, this segment (as the name indicates) is about very aggressive and forward-looking efforts by clients. It is no surprise that these projects have become fewer in the current environment.

Customer Experience revenues amounted to SEK5.2m (-30% y/y) and accounted for c.7% of sales in the quarter. A reduced pricing plan for one big customer contributed negatively.

Gross margin landed at 72.3%, compared to 75.7% for the full-year 2022. As a general rule, ad-hoc revenues have a higher gross margin than recurring revenues due to costs for consultants not being included in COGS.

However, Q4 ad-hoc sales had a meager gross margin due to three things. First, currency effects impacted COGS by 3-4%, equal to 1.0 percentage points on the gross margin. Second, Nepa conducted one strategic ad-hoc project at a low price. This means a start-up project for a client to convert into recurring revenues from mainly Nepa’s brand tracker. Third, the weaker economic climate is causing pricing pressure on ad-hoc projects in general.

Reported OPEX was SEK55.8m. However, the quarter was impacted by a one-off SEK4.5m related to the cost-saving program announced in December. The one-off cost was considerably smaller than the SEK8m indicated in December. The company states that no more restructuring costs are expected. This means that the underlying OPEX was SEK51.3m.

In the quarter, Nepa capitalized SEK7.8m, implying that the normalized cost base including CAPEX was SEK59.1m in the quarter.

From now on, the company’s cost base will decrease significantly, meaning the poor profitability from Q4 will improve. The company’s total cost savings will reduce the annual cost base by SEK31m, or SEK7.75m per quarter. We think Q1, Q2, and Q4 have similar characteristics and believe that the cost base for these quarters will be similar, implying a level of SEK51.3 (like Q4 if excluding the one-off). Q3 typically has almost 20% lower cost base than the other quarters, indicating a cost base of around SEK42m. This brings us to a total annual cost base of SEK196m. Considering the stock market’s mistrust towards Nepa, we think making any significant salary increases this year would be unwise. Assuming a 2% salary increase, we estimate the annualized level to be cSEK200m.

Nepa stated that the first effects of its cost-saving program will come into effect from January 2023 and that 100% of the impact will be in place from the first of April. For Q1, we estimate the cost base to get half the expected cost reduction.

Of our estimated cost base of SEK204m for 2023, we estimate SEK26m to be capitalized.

Nepa states that the normalized number of employees is around 300 (down from the reported number of 325 in Q4). Of these 300, Nepa states that 200 of these are for central resources, including tech and global delivery. This part of the cost base is very scalable, according to Nepa. The remaining 100 work with customer success, consulting, and outbound sales. This part is not as scalable and will naturally grow as the company grows.

EBIT landed on SEK -3.8m, implying an EBIT margin of -5% (14% last year). Excluding the one-offs of SEK4.5m, EBIT margin was 0.9%.

Free cash flow excl. changes in working capital (EBITDA less capitalized costs) amounted to SEK -4.0m (adjusting for one-offs), corresponding to an underlying free cash flow margin of -5% (11% last year). Note that the below diagrams do not adjust for the one-off costs in Q4.

Nepa’s profitability is currently very poor. Our proxy of free cash flow (FCF= EBITDA - capex) of SEK -4.0m in Q4 is indeed not impressive. Assuming full cost savings, this would imply an underlying FCF of SEK3.8m per quarter, or cSEK15m annualized. We argue that more is needed from Nepa and that the company should be able to maintain a stable and expanding FCF margin exceeding 10%.

As already commented, Q1 has started similarly to Q4, i.e., revenues are down a few percent compared to last year. Marketing Optimization is reported to have grown by 'single digits' in Q1 so far, but the company did not want to specify this figure further. Nepa also commented that the market continues to be weak but sees good development for its primary focus offering - the brand tracker.

Also, Nepa promised in the conference call two things. First, more extensive financial review in its quarterly reporting from Q1. Second, more precise financial targets by the end of 2023. The company’s current targets include a long-term EBIT margin exceeding 20% and being the fastest-growing company in the industry. CEO Ulrich Boyer agreed that the current targets are too fluffy and imprecise.

By the end of Q4, Nepa had SEK64m in cash and no interest-bearing debt. The board of directors has proposed a dividend for 2023 of SEK0.56 per share, equivalent to SEK4.4m. This corresponds to 25% of net profit for the full year, the same share as last year.

The company has transferred part of its cash position to a savings account with a current 1.6% interest rate. The company is however looking at alternatives with an even higher interest rate. Assuming SEK30m is deployed in the savings account, this would yield some SEK0.6m per year if considering a 2% interest rate.

Nepa has surely disappointed the stock market during the last year. The main issue has however not been topline growth but rather the lack of cost control. We understand this and agree. The company continued to expand its cost base late in the autumn of 2022, when an upcoming consumer recession had been apparent for a while. This lack of cost control has since made investors think that the high profitability from 2021 was only a one-time thing from another CEO, P-O Westerlund. Now, investors look at all the other years when Nepa has been hovering around breakeven while only focusing on growing the topline.

Also, the currently weak economy has also (at least temporarily) eroded the topline growth, which has removed Nepa from being a 'growth company' from an investor’s point of view. Investors now ask themselves "Considering that the company is not growing, how will it be able to 'grow into its cost base'?"

The market’s doubts are rightful, and we think Nepa needs to work hard to convince the stock market that it prioritizes 'profitable growth' before 'profitability a few years out'. However, we think the board of directors and Nepa’s owners know this and will push more for this. We hope the company realizes that costs cannot increase from this level until revenues have grown to a new base, ensuring stable profitability.

In summary, the depressed share price results from investors losing faith in management's ability to show profitable and sensible growth. Once Nepa's management shows commitment to this task, we think the share price will rise sharply. From Q1, but even more from Q2, we think the sentiment will turn somewhat as the cost savings are realized, improving the profitability.

There has been a lot of talk in the industry recently regarding poor data quality. High reversal rates (project deliveries that are deemed fraudulent) have been seen by many market research companies. One recent example is from Nepa’s biggest data supplier, Cint. In its quarterly report, it blamed its poor quarterly result on high reversal rates on its surveys.

Cint wrote the following: "Higher reversal rates than in previous quarters. Since mid-2022, the industry has seen fraudulent behavior increase substantially above “typical” reversal levels of around 5%".

The problem identified is that a lower percentage of all completed surveys are of high quality. This means that the share of surveys that cannot be used has increased. This, in turn, means two things. First, there is a need to find ways to identify fraudulent surveys. Second, the number of respondents must increase to reach a sufficiently high confidence level in the insights.

To understand whether Nepa will or will not be affected financially, we need to analyze 'who owns' the problem, i.e., whose business idea it is to deliver survey insights. In short, Cint and its peers are responsible for gathering survey responses. These companies generate revenue by delivering big volumes of survey responses to clients like Nepa (or direct insights to consumer-facing companies).

Nepa and other customers do not pay to get a certain number of surveys made. Rather, it pays to get a certain level of confidence in an insight. Hence, the problem is Cint’s and its peers', meaning that these players need to conduct more surveys, which means they need to pay more respondents to participate. Hence, these data providers carry all the financial impact of poor data quality.

Nepa, on the other hand, is only responsible for not delivering false insights to its clients, i.e., it needs to be able to identify fraudulent surveys.

To cope with fraudulent surveys, Nepa has combined technical solutions and business policies to help discover and reconcile fraudulent entries. This ensures that Nepa’s data and insights are among the best in the business. Hence, Nepa helps its own data suppliers to ‘wash’ the data before using it.

Examples of how Nepa’s technology prevents and identifies cheaters are:

We believe the problem with fraudulent surveys is a problem for the whole consumer insights industry. However, we do not believe clients will stop trying to collect consumer insights through surveys. Clients are, however, more likely to set higher demands on proof of a high confidence level. This will likely lead to more completed surveys needed to ensure confidence and higher demands on technical capabilities that effectively identify fraudulent surveys.

We believe Nepa is well-positioned with its technical capabilities to meet the stricter demands on fraud detection and prevention. Data providers like Cint, however, are likely to experience gross margin pressure due to the need for more respondents.

Nepa has very few, if any, direct competitors that can be compared to Nepa on an apples-to-apples basis. The company operates in the research industry, but its business model is more attractive, in our opinion, than that of many peers. Looking at the business model, we think Nepa is more similar to many SaaS companies that have substantial but not majority revenues from consulting.

We note that Nepa is trading at a substantial discount to both peer groups, irrespective of what valuation multiples are used. Some of the research firms are indeed trading at reasonably low multiples. However, we think Nepa has a more attractive profile in terms of growth and margin potential compared to the research firms. Nevertheless, we think Nepa deserves a discount due to its flaky profitability history.