1. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 1 Optical communications outlook through the lens of optical components market Karen Liu, PhD karen.liu@ovum.com September 2011

2. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 2 Outline  What has happened to the optical networking market since the recession?  Why was the optical components market growing so much in 2009 – 2010 when optical network equipment revenues were shrinking?  And why is the optical components market down now that optical networking is growing?  What is the outlook?

3. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 3 Service providers System vendors Subcomponent and material Optical components Avago, Finisar, JDSU, Sumitomo, Oclaro, Opnext, Source Photonics... Alcatel-Lucent, Brocade, Cisco, ECI, Ericsson, Huawei, Juniper, Motorola, NEC, Nokia/NSN, Nortel, Tellabs, ZTE... America Movil, AT&T, BT, China Mobile, China Telecom, FT, DT, NTT, Saudi Telecom, Sprint, Telefónica, TI, Verizon, Vodafone, Zain... Source: Ovum * Includes only optical and datacom components *Ovum does not track subcomponents quarterly and does not track materials. 3-tier view of the telecom optical market 2Q11 annualized revenues $1.86 trillion, up 5% 2Q11 vs. 2Q10 Optical networking 2Q11 annualized revenues $15.3 billion up 8% 2Q11 vs. 2Q10 Optical Component 2Q11 annualized revenues* of $6.2 billion, up 30% 2Q11 vs. 2Q10

4. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 4 Operator revenues back but capex reflects caution Cautious spending Source: Ovum “1Q11 capex report” Global capital expenditure Global revenues Capex growing since 4Q10 for mobile, 1Q11 for fixed

5. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 5 Optical networking market recovered late 2010 3Q10 turning point 1Q11 vs 1Q10 Optical transport +7 % 2010 vs 2009 Optical networking -2 % Source: Ovum “Network Infrastructure market share” Optical networking recovered later than other infrastructure segments

6. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 6 Optical component market had 2 strong years but pulls back in 2011 1Q09 – 4Q10 at 27% CAGR Components outpaced optical networking through 2010 1H2011 inventory correction as well as cautious carrier spending cited

7. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 7 Why does the component market look so different from the system market?  Bullwhip effect: oscillations are amplified at lower tiers of value chain  Different dynamics in access and datacom end markets  New product bright spots are not immune to market turmoil— quite the opposite

8. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 8 Optical component revenues no longer tracking steady growth? Fttx: unsustainable optical costs ?  2003-2008: Components track optical networking and capex.  Growth is remarkably linear  2009-2011: Components grow faster, partly from rapid growth of PON

9. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 9 Three vertical markets for OC Makes up 15- 20% + of OC revenues Optics make up larger % of BOM, especially for ONU/ONT side. Intense pressure to reduce cost $$$$ $ FTTx $$$$ $ LAN/SAN Makes up 15- 20% + of OC revenues Faster to shut off but also faster to turn on spending Mega-datacenters and cloud computing drives growth and mix shift $ $$$$ Optical Networking Typically up 60%+ of OC market but fell to 56% in 2008 2 major segments are Transmission and Transport (common equipment). Transport hard hit by ROADM inventory

10. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 10 Dynamics of three end markets appear to account for much of the components gyrations For each $ spent at system level, this model claims: $0.18 to OC if from WAN optical network $0.50 to OC if from FTTx $0.15 to OC if from LAN/SAN* No attempt was made to quantify inventory

11. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 11 Contrast between datacom vs telecom dynamics  IT spending on servers and switches resumed mid 2009 and continues to grow each quarter. These products are ordered as needed  In early 2010, system houses worried about component shortages, order long-lead time items such as ROADMS  By early 2011, a combination of slower-than-expected carrier spending and deliberate inventory caused dramatic slowdown in ROADM orders

12. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 12 OC challenged to hold onto improvements in margin Source: Financial statements from AFOP, Avago, Avanex, Emcore, Finisar, JDSU, NeoPhotonics, Oclaro, Oplink, Opnext, and Source Photonics.  Industry aggregate gross and operating margins topped out in late 2010.  Despite recent decline, gross and operating margins are still near historic highs.  Revenue decline but also increased R&D cited as causes

13. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 13 New technology dominates outlook… for good and bad  Optical packet: converged packet optical functionality showing up in multiple system product types  ROADM: high penetration of ROADM functionality in metro and long-haul systems  Inventory correction on existing component products (e.g. 1x9 WSS)  New versions in the pipeline (e.g. larger 1x20, smaller 1x2, flex-grid)  40G/100G: 40G ports ramping since mid-2008,100G since mid-2010  Merchant line- and client-side transponders with roadmaps to decrease power, size and cost  Hot products not without their own troubles  Existing ROADM components (e.g. 1x9 WSS) have long leadtimes, made bullwhip worse through inventory  Next-gen WSS in the pipeline costs R&D (e.g. larger 1x20, flexgrid)  Multiple entrants into tunable XFP increases competition  40G modules also having inventory issues

14. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 14 100G: strong growth just starting

15. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 15 100G: strong and growth continues 10G not over yet: tunable SFP+, full reach tunable XFP…

16. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 16 100G: strong growth plus access penetration driven by datacom 10G 10GbE replacing GbE as “unit of currency” in datacenter

17. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 17 Outlook is for continued steady growth in optical components But competition will be particularly fierce for hot products

18. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 18 Summary  Carrier capex, optical networking and optical components have now recovered from 2008 recession  Different parts of industry recovered at different times. Carrier capex finally up compared to year-ago quarter in Q1 and Q2 of 2011.  Optical components contracted 2Q11 after outpacing networks  “hot products” vulnerable to inventory issues due to long lead time and buyer response to scarcity (ROADM WSS, 40G).  Yet to come: tunable XFP price competition, further FTTx cost reduction  Positive long-term outlook persists and strong end-user demand for bandwidth continues   

19. © Copyright Ovum. All rights reserved. Ovum is part of the Datamonitor Group. 19 Thank you!