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China continues to be a growth area for many businesses, but when a company depends on Chinese sales for a large percentage of their sales, a drop off in demand from that market will adversely affect both the top and bottom lines.  This is what is happening to our Zacks Bear of the Day, NeoPhotonics Corp (NPTN - Free Report) .

This Zacks Ranked #5 (Strong Sell) company is engaged in the design and manufacture of photonic integrated circuit, or PIC, based modules and subsystems for bandwidth-intensive, high-speed communications networks. Products offered by the Company includes high-speed products that enable data transmission at 10Gbps, 40Gbps and 100Gbps, agility products such as ROADMs that dynamically allocate bandwidth to adjust for volatile traffic patterns, and access products that provide high-bandwidth connections to more devices and people over fixed and wireless networks.

Recent Earnings Report

NPTN recently reported Q1 17 earnings where they missed the Zacks consensus earnings estimate, but beat the consensus revenue estimate.  On a quarter over quarter basis, the company saw declines in revenues -28%, gross margins dropped from 31.4% to 25.8%, they also posted a net loss of $11.5 million compared to a net gain of $2.3 million, diluted net loss per share of $0.27 compared to net income per share of +$0.05, and adjusted EBITDA was a loss of $5.2 million in Q1 compared to a net gain of $12.3 million in the previous quarter.  

Management’s Take

According to Tim Jenks, Chairman and CEO, “As we expected, softness in the overall China market affected our sales in the first quarter. We see the China market as being in a transition as it moves from primarily national backbone to provincial and metro 100G deployments, while worldwide the metro and data center interconnect markets continue to grow at a rapid pace. We believe we are well-positioned to serve these growing markets with both our high capacity production and our new solutions focused on 400G and above coherent and data center products.”

Price and Earnings Consensus Graph

As you can see in the graph below, the sales decline in China has caused the stock price to be cut in half (from previous highs in late 2016), and subsequently earnings estimates have fallen as well.

NeoPhotonics Corporation Price and Consensus

NeoPhotonics Corporation Price and Consensus | NeoPhotonics Corporation Quote

Declining Earnings Estimates

The Zacks consensus earnings estimates for Q2 17, Q3 17, FY 17 and FY 18 have all seen significant reductions over the past 30 days; Q2 17 dropped from -$0.07 to -$0.25, Q3 17 fell from $0.09 to -$0.14, FY 17 plummeted from -$0.05 to -$0.71, and FY 18 slipped from $0.59 to $0.47.

Bottom Line

Besides a decline in revenues due to the slowdown in demand for their products in China, gross margins are also becoming a concern.  While the company has announced measures to reverse this trend; replacing their CFO, and cutting overall operating expenses (expected to be between $25-26 million) by Q4, the company will still largely depend on demand from China picking up.  

If you are inclined to invest in the Semiconductor/Communications sector, you would be best served by looking into Semiconductor/General sector with companies like SUMCO Corp (SUOPY - Free Report) , who currently carries a Zacks Rank #1 (Strong Buy), or either Intel Corp (INTC - Free Report) /STMicroelectronics (STM - Free Report) who both have a Zacks Rank #2 (Buy) rating.

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