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Q&A: Zoom CEO Frank Manning

Among all the companies affected by the recent decision by 3Com (Nasdaq: COMS) to exit the analog modem business, none were more affected than 3Com's main dial-up modem rival, Zoom Telephonics (Nasdaq: ZOOM). As with 3Com and the US Robotics product line, Zoom last year acquired one of the best known modem brands in Hayes.

And like 3Com, Zoom has suffered along with the rest of the modem industry. After annual revenue broke the $100 million mark in 1996, Zoom saw its sales fall sharply each of the next two years, and just a marginal increase last year.

And like 3Com, Zoom says its future lies with broadband and wireless hardware. Someone on Wall Street likes the idea -- shares of Zoom have tripled in the last five months.

But unlike 3Com, Zoom isn't about to sell any businesses -- just build on top of them. Zoom CEO recently spoke to ZDII about the modem industry and his company in particular:

ZDII: I get the impression that you don't think much of 3Com's decision to exit the analog modem business. Could you go into that a bit more? Do you think they're doing the right thing for their company?

Manning: I certainly don't think they're doing the right thing for their customers. Clearly, there are problems for their customers, whether you want to talk about people who have just bought some of these CoreBuilder products or whether you want to talk about somebody who just bought a modem.

I think one of the things that 3Com had that was attractive was a pretty complete product line offering. And now what they're doing is, basically saying, "We will focus on the stuff where we make the most money, and if we don't make enough money, we don't want to do it."

I also think that it's potentially an excellent advantage for us, because, you know, they had -- admittedly, their share of the retail shelf was declining. In fact, June of last year they had like 36.7 percent of the analog modem shelf space, and by February it was down to 26.6 percent, according to Personal Technology Research...

ZDII: I gather you guys were the main beneficiary?

Manning: We were the major beneficiary, that's right.

But basically, what's going to be interesting is that, you know, we stay on the shelf with Zoom and, recently Hayes brand products, and kind of maintain our relationship with the retailers, as an example. And they suddenly are not on the shelf as 3Com in the Internet access section, which is where they want to sell broadband.

Right now, they're probably noticing that broadband isn't selling at retail, but I don't think it'll be long before it is. And I think it's kind of dangerous to abandon the shelves and then hope to get back there.

ZDII: The products will still be there, just under a different name with this joint venture, I guess.

Manning: Yeah, but it won't be 3Com. The point is, if I'm a buyer of one of these big retail chains, now I absolutely want to see 3Com because they're a very important part of my revenues. Soon (retailers will say) "Why do I need 3Com? They're just another wannabe who I don't carry anymore."

ZDII: That makes a good segue. Clearly, Zoom still sees a lot of value in retailers and what would be called the traditional retail chain -- VARs, distributors, things like that -- and yet, if you listen to a lot of companies, it seems like everybody else seems to think that's sort of a declining area and they seem to prefer direct sales, OEMs, that kind of thing. What do you see in the traditional retail chain that's so valuable?

Manning: I think it's still true that the retailers and VARs are still an extremely important part in people becoming educated about products.

ZDII: So you don't think people will be jumping online in masses to find information?

Manning: Oh, I certainly think people are jumping online and we're certainly not ignoring that. But I think that there's still a lot of people buying product at retail and it's still a great way to find out about products.

I think it's a very efficient way to shop, to be honest with you. They can go in and touch it and feel it and be able to ask questions of a real person. In the case of VARs, often they have a lot of knowledge, not just about the specific product, but about the overall application and what's the best way to solve a problem.

Again, I'm not in any way trying to put a negative comment on the Web. I think the Web is valuable. But I also think that these other channels are extremely valuable and will remain that way.

ZDII: How much of your company's business at this point comes from retail versus, let's say, OEM?

Manning: Oh, OEM last year was, I think, 4 percent of our business. And the rest of it was basically through retailers and VARs, the more traditional retail channel.

By the way, the other thing I want to say about the Web that I think is kind of an interesting thing to be aware of: a lot of the volume on the Web is driven by people who shop at a retail store and then they get a discounted price through the Web. And that's not an education facility, right? That's just a low margin, non-educating transaction, and clearly, that doesn't work long term at some level.

When you talk about broadband, if anything, people are going to need more help and more guidance. I don't think it works to have that go to kind of the absolute lowest common denominator, which is somebody who's just offering a good price on the Web. And I'm not saying that's all that people do on the Web, but I think certainly that's an important element of it.

With our Hayes brand, we've structured that to kind of purposely incentive it towards retailers and resellers who truly add value, as opposed to just offering up a product to ship.

ZDII: At the same time, I assume you'd like to increase your OEM penetration.

Manning: Well, honestly, our OEM penetration -- we care a lot about OEM for places where it's less of a commodity situation. So for instance, we have a fair amount of OEM activity going on with some new embedded modems we have. We certainly hope to have some OEM activity with wireless.

ZDII: When you say "not a commodity situation", can you give some examples of what would be and what wouldn't be?

Manning: Don't get me wrong, I'm not saying we turn our back on this business, but honestly we really don't chase the PC company that's looking for the cheapest modem you can find to put into your PC. Because honestly, we don't make anything that cheap (laughs) and we don't want to.

It's actually kind of an interesting fact that even though Internet access has become probably the most important reason why you have a PC, the modem that's going in a PC keeps getting worse and worse, because it's basically turned into, in many cases, a soft modem that is put there in because, all people know is that they're getting a "56k" modem, and what PC company knows is that it's cheap. So we really don't chase that. That's like a $10 modem basically, and we don't find that to be an interesting market to pursue.

But we do think it's interesting to pursue OEMs for wireless, LAN and cable modems, DSL. There's a lot more value we can add, and it's much more interesting economically, to be honest with you.

ZDII: There are a lot of companies trying to get into that (broadband market), some of which arguably have deeper, shall we say, OEM relationships than you do. How do compete against that?

Manning: Well, who are you talking about in particular?

ZDII: 3Com, for instance, just because they have been dealing with the OEMs until now with analog modems and NICs, presumably I would assume they have some pretty good ties with a Dell (Nasdaq: DELL) or a Gateway (NYSE: GTW) or whoever you want to name out there, ties they can leverage when they want to sell broadband stuff. I know 3Com and Motorola (NYSE: MOT) are selling some broadband modems, I used to have a Motorola cable modem at one time, but I haven't seen Zoom yet. How do you break into that market against a 3Com or a Lucent (NYSE: LU) or a Motorola, who are trying to get in there also obviously, and are much larger than you are.

Manning: Let's take it one step at at time. Let's take cable modems, which we're not yet shipping but we will be soon, we're already sampling. Clearly the bulk of the revenue now is coming from the cable companies, cable service providers, in terms of cable modems. And we're in one of the major industry groups, Excite@Home's industry group. And we've talked to the cable companies, and our impression is, what they most care about is a standards-based product that gives them the best performance per dollar.

And it is true that's a new channel for us, but we think we can provide significant value in terms of performance per dollar, and we think that if we do, we can sell product. And so, you know, that remains to be seen, but let me put it to you this way: Motorola is probably one of the biggest guys in that area, and frankly, at one time they were a huge player in the analog modem business, now they're not. So we're not intimidated by them at all. In fact, we already have a history of going against them head-to-head and beating them.

Motorola was in analog modems before Hayes or US Robotics or Zoom existed, and Motorola had very high revenues. Now they don't. In fact, you probably remember a few years ago they tried to sell analog modems at retail; they failed and basically closed the doors on that business. So we've competed with them directly in the past and very successfully, and we expect to do that again.

As cable modems go to retail, which we think they will over time, then we have a huge advantage over either 3Com or Motorola for the reason we just talked about, which is that neither one of them, within a few months, neither one of them (will be) having any retail shelf space for Internet access.

In terms of DSL, I think that again, if you provide value, if you provide performance-per-dollar, you can sell product. And admittedly, we have some new channels to build there, in the case of the ILECs, the incumbent phone companies. But we feel very comfortable we can do that, and we think we're going to have good enough products that we can be successful.

But the other thing I want to say there is that a big advantage that we have and I think 3Com wants to have, and I think over anybody else at this point -- in other words, I think it really will be 3Com versus Zoom on this one -- is that we have thought through the whole issue of broadband access to the Internet and then how do you distribute that to your PCs. We've been working on that for years. We started shipping wireless LAN products before 3Com with that in mind.

Basically, we're going to have a very complete product line that essentially lets you have a cable modem or DSL, and then plug it into a box that we make that we'll be shipping fairly soon that distributes that bandwidth to all your PCs, either through wireless LAN or home phone line networking. And I think having that breadth of product line will give us an advantage, certainly over Motorola or Efficient Networks (Nasdaq: EFNT) or Com21 (Nasdaq: CMTO).

Again 3Com, I'll admit, it will be a real fight (chuckles) because it's clear from their release that they see wireless and broadband as two of their major focus areas, as we do also. So no question, they'll be a tough competitor.

ZDII: 3Com's whole argument is they're leaving the analog modem business so they can focus on this stuff specifically. Then you look at someone like Zoom, and I suppose it's like, "Look, they're still dealing with analog, their focus isn't going to be as good with these emerging spaces." What's your counter to that particular viewpoint?

Manning: I don't really think it is a focus issue for 3Com, honestly. I think it's a money issue.

If you really sit down to the real basic, the basic is that -- and they basically said this -- if they did not have high enough growth, and I'll say probably along with that, enough profitability, they axed it. I don't think it was focus.

In that size company, they can have a division called US Robotics chase modems, no question. I think they made a financial decision.

I guess our view is, the focus should be the customer, and the customers we've talked to, especially our channel customers, prefer to have a company that covers their high volume needs for Internet access. And I don't find it challenging to "focus" on analog modems more than these other things. They're different technically, but they're not so different that I would think of that as sort of pulling focus.

If 3Com was so into "focus", they would have cut even more things. I mean, they're still into NIC cards. Isn't that going to pull their focus? Why are they still in it? Because they make enough money in it to be in it. That's what they're really talking about, not focus.

ZDII: You mentioned earlier that one business you don't want to be in is this sort of commodity analog modem business...

Manning: Well, on the OEM side. I don't have a strong customer base there, and honestly, it's so low end that it's just not something that we pursue.

ZDII: I guess what I'm asking is -- and some people criticizing 3Com's new strategy cited this as support for their argument -- it just seems like a few years down the road, you'll see the same sort of commoditization eventually among broadband modems and wireless as well...

Manning: I generally agree with that. I'll tell you ways it'll be different, but I think what the people ought to be saying to 3Com is, "Once it gets to be that way, are you going to cut and run again?" Probably the answer is yes.

ZDII: Let me ask you this, how will Zoom deal with that, as these new products become more commoditized and presumably lower margin?

Manning: Honestly, we're accustomed to that. We know how to be successful in that kind of business.

Commoditization should not mean homogenization, when everything is the same. But it also means standardization and high volume, and I think that, you know, we're very comfortable with competing in that kind of business. We certainly want to add value, we don't want in any way convey that we're going to just have the same thing as somebody else. But the fact that the business will be competitive and high volume -- we assume that's true and that's fine. I mean, that's the way it is.

But I think the other thing that's kind of interesting is that one thing that really hurt the analog or the dial-up modems is the bundling of the modem into the PC. One issue there, is that it was so obvious there what to bundle, obviously it was going to be a 56k dial-up modem.

With cable modem and DSL, you actually have a fragmentation in terms of: What does somebody want? You can't tell.

In other words, there are people that can't get either cable or DSL, there are people that can only get cable modems, there are people who can only get DSL, there are people who can only afford an analog modem.

So there's actually a fragmentation of choices, as far as the Internet access. And what that will tend to do is drive the expensive solutions like cable modems and DSL out of the PC in terms of a bundled offering. It'll be in a configure-to-order situation like a Dell, but it will not so much tend to be bundled into a PC that you'll walk into a store and buy.

ZDII: So you don't think something like PCs from eMachines (Nasdaq: EEEE) will have DSL modems?

Manning: If it's in the store? I'm not saying they won't have any, but what I'm saying now is, if you walk into Best Buy (NYSE: BBY) now, pretty much 100 percent of the computers in there have a modem. And what I'm saying is, I think if you go into Best Buy two or three or four years from now, you will not find that 100 percent or even close to 100 percent have "cable modem or DSL." There may be high end offerings like "Compaq's DSL PC" or whatever, but I don't think it's gong to be as bundled, and we see that as really good for Zoom, because it drives the share of the market away from that and toward basically our market, which is basically, more of the aftermarket.

ZDII: I see the point of a lot of what you're saying, and yet when you look at the numbers Zoom has been producing, sales went down in ྜྷ and ྞ, and went up just a little bit in 1999. How do you accelerate that growth with the strategy you have in mind?

Manning: First of all, let me say that we are not counting on analog modems for growth. Even with some very positive developments that I'd like to mention in a minute, we see that as a flat-to-slightly-up kind of business for us. In other words, we're certainly not calling that an exciting, high growth market. (chuckles)

We think of it more as an important base from a lot of points of view. We see the growth really coming from broadband and wireless and other kinds of advanced networking products. So that's really the answer.

I don't at all want to convey we'd be super excited about our future if were just going to do 100 percent analog modems. That's far from what we intend to do.

On the other hand, what do I see that's positive about analog modems? I'll say, one is, 3Com's leaving them. (both laugh)

I think another thing is that the V.92 standard that will probably be set later this year is a positive, because I think that it will tend to get at least some percentage of the people who already have a 56k modem to get a new one.

ZDII: Why would V.92 convince them to upgrade over V.90?

Manning: Well, V.92 has more functionality. Which most people aren't -- I don't know if you're familiar with it all?

ZDII: I've read a few things about it, but I'm not deeply familiar with the details.

Manning: It has three main advantages. One is higher upstream speed. One is shorter handshake time. And the third, which I think is perhaps most interesting is, if you have call waiting, you have the ability to suspend the Internet session, and then take the call, and then go back to where you were. Now, you can't really do that.

ZDII: I can take a call while surfing with a broadband modem.

Manning: Yeah, but if you look at (market estimates), they say 55 percent of U.S. homes will still dial-up connect to the 'Net in 2004 -- that's (according to) Gartner Group. Analysts generally think analog revenue will keep going down, but units will keep going up. Hey, broadband's exciting, but broadband is starting from a base that's very close to zero right now, and believe me, it's going to take awhile.

And then also, if you look past the United States, it's really going to take awhile. We're obviously a very wealthy country with very superb technology, and we're leaders in terms of Internet deployment. If you start to other, even fairly advanced countries, they're definitely farther behind.

Again, I'm more excited about broadband than analog modems, absolutely. But I just think it's important to realize that analog modems aren't going away from a very long time.

ZDII: How much of your revenue does come from international markets, as opposed to the U.S.?

Manning: The total last year for international was 29 percent. And actually, in the fourth quarter, it was 36 percent, so you can tell that obviously it's very significant growth.

ZDII: Ultimately what sort of balances are you targeting?

Manning: Between?

ZDII: Let's say, North America and the rest of the world.

Manning: Well, I think what's going to happen is -- and this is not exactly an answer to your question, but at least it gives you an idea how I would answer -- I think what we'll find in terms of analog modem business is that the share of international will grow relative to the United States. So that's one trend that will increase that percentage. On the other hand, I think DSL will grow faster in the United States.

So it's hard to (say). We don't really target it. What we say is: we have people in the company whose job it is to drive U.S. sales, and we have people in the company whose job it is to drive sales outside of the United States, and we just tell them all to drive as hard as they can drive.

ZDII: Do you have any sort of long-term revenue growth target that you have in mind?

Manning: Our top revenue years were $100 million, and I'm not in any way promising we'll hit this, but I think our goal is to hit or exceed that number next year, 2001.

ZDII: So up from a little over $60 million last year?

Manning: Right.

ZDII: But do you have any sort of long-term revenue growth target like 20, 30, 40 percent or whatever?

Manning: Not really. I'd look at the greater growth of broadband, point at that, and then that percentage should be very high. So I think there's potential for very high numbers.

What does very high number mean? Thirty to 50 percent kind of number, but am I saying that I know we'll do that? No. I'll say I'm too experienced to want to go out onto that limb. (both laugh)

ZDII: Can't really say I blame you. From a margin standpoint, I think your gross margins in the fourth quarter were around 36 percent. Is that what we should look for going forward from Zoom?

Manning: I think it's hard to say. I think it's probably going to be -- I'll say if you look at us over the years in analog modems, we've been in the mid-20s more than we've been in the 30s. I think that we have a chance of keeping it where it is, or maybe even growing it, but if anything, I would tend to think it might come down some.

I'm not commenting on this quarter or whatever, but I'm just saying that historically for us, that is on the high side of our average margins. And I would be very happy if we're able to maintain that. It's possible, but I wouldn't necessarily predict it.

ZDII: Your stock price over the last few months has gone up quite a bit, yet when I look around for Wall Street coverage from brokerage firms and things like that, I'm not finding too much. How do you get attention from the investment research guys and things like that?

Manning: One thing that's very encouraging is, I think we're starting to get attention now. And it's all people finding us, we haven't really tried to actively go out and find them. And I think people are looking at companies like Terayon (Nasdaq: TERN) and Com21 and Efficient Networks and Proxim (Nasdaq: PROX) and seeing their market caps relative to their revenues, and seeing Zoom's positioning and saying, "God, that's very attractive, Zoom is very attractive."

The other thing is, in the last few years, we've really been sort of inwardly focused in terms of trying to put all our energies on getting this new generation of products launched. But now that we are about to be shipping a lot of very exciting stuff, we are going to put a bit more attention to financial marketing. So for instance, we'll be going to some of the conferences that companies attend. We've never wanted to put a lot of our energy in that direction, but I think we will put more.

ZDII: Do you think you'll need to raise capital from the public markets down the road?

Manning: Let me say I hope that we will need to, because if we raise it, it means we're growing so fast that we need it for working capital.

We certainly don't need it now, but it's probably prudent to have it because I think our sales could really take off, and if they do, I certainly don't want to be capital constrained.

ZDII: You've always been an independent company. Do you see yourself remaining that way, or do you think you might be merging with someone or being acquired or acquiring another company?

Manning: We really keep our options open there. We focus on how do we grow our company the best, and in the past, that has meant some acquisitions. Like we bought the Hayes modem line last year, we made another acquisition a two or three years before that.

Do I think we might acquire additonal companies going forward? Certainly. Am I about to announce one? No. Are we open to being acquired? We're certainly not looking for it, but if there was a great fit, we would able be able to do it. Basically, we're driven by doing the best job we can for our employees our customers, and our investors, and we try to pay attention to all of those. >

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