There's no denying that our world is becoming increasingly dominated by electronic devices. While there are large well-known companies in this space for investors to consider, there are also smaller businesses that help supply the parts necessary to produce all the electronics that drive our economy.
One of those companies is CEVA (CEVA -2.44%), the leading licensor of wireless and smart sensing technologies. With its technology in billions of devices, is CEVA one of those hidden gems that could provide market-beating returns to investors?
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Powering our devices
CEVA's technology has been included in over 14 billion chips, including more than 1.6 billion in 2021 alone. These chips are used in a variety of industries, including computers, automotive, robotics, industrial, aerospace and defense, and medical. With its technologies touching so many different parts of the economy, there's a good chance you've used a CEVA-powered device or system without even knowing it.
CEVA charges other tech companies licensing fees to use its patented technology, as well as royalty fees for each unit of silicon that incorporates its hardware or software. As of the first quarter -- its most recently reported period -- licensing revenue accounted for approximately two-thirds of total revenue.
Licensing is leading the way
The revenue that CEVA generates from licensing has been growing as a percentage of its top line for the past year. In the first quarter of 2021, licensing accounted for only 57% of revenue. CEVA also provides quarterly updates about how many new licensing agreements it has signed. In Q1 2022, it signed 14, bringing its trailing 12-month total to 76. That was a 43% increase over the previous 12-month period when it added 53.
In Q1 2022, overall revenue increased 35%, with the licensing business providing most of the power behind that growth, up 56% year over year. Royalty revenue -- the vast majority of which came from the Asia Pacific region -- grew just 9%. Notably, the five companies paying the most in royalties to CEVA accounted for 63% of its total royalty revenues in the quarter. While that degree of business concentration does represent a potential concern, the share they account for is down from 70% one year ago, so the metric is heading in the right direction.
A step toward profitability
CEVA's operating income in the first quarter was $500,000, as compared to a loss of $1.3 million in Q1 2021. This improvement is even more impressive considering it includes the impact of a recent acquisition, which added some operating expenses. CEVA's net loss of $1.7 million for the period was also a big improvement over the year-ago quarter's loss of $3.6 million. On an adjusted basis (factoring out the impacts of stock-based compensation and other acquisition-related expenses), operating income grew 111%, and net income increased 1,300%.
CEVA as an investment
When the company released its Q1 results, it raised its revenue guidance for the year to a range of $142 million to $146 million. At the midpoint, this would represent an increase of 17% over 2021. Although that's good to see, of more relevance to CEVA's potential as an investment is whether or not it can expand margins and improve profitability.
In Q1, gross margin dropped to 81% as compared to 91% in the prior-year quarter. Management attributed the contraction to the acquisition expenses. However, it said it expects gross margin to further compress to 78% in Q2. CEVA is not consistently profitable or free cash flow positive, so it will have to make improvements in the way it operates if it's going to successfully drop some of its growing revenue all the way down to the bottom line.
One might expect that CEVA's high gross margin would be a great starting point for it on the road to profitability, but, so far, that hasn't been the case. Until the company can get its operating expenses under control, it's hard to feel confident that CEVA will be a market-beating stock. That said, CEVA's price to sales ratio of 6.5 is near where it was in early 2020. For investors who believe the company can turn toward profitability, now may be an attractive entry point.
