Dr. Rama Rao

RRCM


EXCEL

Financial Physics

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Dow Jones Asset Man.

CEO INTERVIEWS

A weekly inside look by Chief Executives at
future prospects of their company and industry

Corporate Changes/trends
(ISSN0SS7-9l68)
Copyright 1993 by
Volume 31
Number 6 November 8, 1993
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  EXCEL TECHNOLOGY, INC. (XLTC)  
 
(WU607/02e) RAMA RAO has served as Chairman, Chief Executive Officer and director of EXCEL, since the acquisition of Quantronix Corp. in October 1992. Rao served as President and Chief Executive Officer of EXCEL since he founded the company in 1989. For more than 10 years, Rao has worked on designing, developing and marketing various advanced laser systems for diverse market needs. Prior to founding EXCEL, Rao worked in various capacities at Weck Surgical Systems (subsidiary of SQUIBB), Unitron Instruments and Biotronics. At Biotronics, Rao was instrumental in developing and introducing an ophthalmic laser for the private physician's office, the success of which subsequently led to forming a medical laser company, LASERMED. Rao has received his M.S. and Ph.D. degrees in Laser Physics from the University of Illinois, Chicago, in 1978 and 1984 respectively.

(WU607101)(7050) Rama Rao is Chairman and CEO of EXCEL Technology, Inc., which is engaged in the design, development, manufacture and marketing of solid state laser products and systems for the industrial, semiconductor, scientific, medical and dental markets. Corporate headquarters are in Hauppauge, New York.

Business Climate/Company Growth

"EXCEL manufactures and markets laser systems for diverse market needs in science, industry and medicine. In the last year, from '92 to '93, EXCEL revenues have grown from $20 million to an estimated $28 million. One factor that is certainly responsible for this increase in our business activity is an improving business climate and economy in the U.S. Another major factor that has contributed to this growth is our successful restructuring and streamlining the operation and focusing our energy and resources in those specific markets segments of the laser business which have higher gross margins and growth potential. In regard to the business climate, for the laser industry, I am optimistic. In general, because of low interest rates and inflation, the economy has plenty of room to grow.

"There are some major challenges facing our industry. Unfortunately, the whole laser industry is very fragmented. We have identified in U.S., approximately 47 players with an average revenue of $5.6 million. Although many have niche positions, they are not in themselves large enough to possess staying power, financial resources or economy of scale. Thus the industry is characterized by subscale or what I call 'sub-critical mass' players. EXCEL would very much like to play a critical role in consolidating and restructuring the laser industry. By acquiring laser companies with complimentary capabilities --customer, market or technology -- EXCEL can build up the size that would allow synergism in procurement, manufacturing, marketing, and field service support. The new company that emerges from such restructuring could have higher value than the sum of existing organizations. EXCEL hopes to initiate and pioneer the process.

(WU607/02e) RAMA RAO has served as Chairman, Chief Executive Officer and director of EXCEL, since the acquisition of Quantronix Corp. in October 1992. Rao served as President and Chief Executive Officer of EXCEL since he founded the company in 1989. For more than 10 years, Rao has worked on designing, developing and marketing various advanced laser systems for diverse market needs. Prior to founding EXCEL, Rao worked in various capacities at Weck Surgical Systems (subsidiary of SQUIBB), Unitron Instruments and Biotronics. At Biotronics, Rao was instrumental in developing and introducing an ophthalmic laser for the private physician's office, the success of which subsequently led to forming a medical laser company, LASERMED. Rao has received his M.S. and Ph.D. degrees in Laser Physics from the University of Illinois, Chicago, in 1978 and 1984 respectively.

"We have two basic business strategies on which we are trying to build this company; (a) integrated diversity, (b) growth via acquisition. The business approach that makes EXCEL different from other niche laser companies is that we manufacture and market the core solid state laser products and systems tailored to a variety of applications such as semiconductor, industrial, scientific, medical and dental markets. The past poor financial performance of laser companies has provided a clear indication that one market niche is not sufficient for a company to make smooth and consistent financial progress. The advantage in our "integrated diversity" approach is that non-added functions like administration, accounting, financing can be consolidated and shared among diverse markets. In addition, we use the same field support capabilities to support the systems in various industries. This strategy provides an optimal and cost effective way of penetrating a given market. In addition, this diversification helps EXCEL to make smooth financial progress, by minimizing the effect of "ups and downs" of any individual marketplace and/or any delay by regulatory or production process. We believe the commercial sector of our business will provide a solid foundation while the medical sector will provide the growth opportunity.

"Within EXCEL, we continue to evaluate the feasibility of improving our operational efficiency. Our goal is to build a premium laser company on a global basis. We constantly compare our productivity, efficiency, gross margin, and cost per employee with the benchmarks of the best run companies in the U.S."
--Rao, EXCEL Technology, Inc.

"In the near future, we believe two segments of our laser business will provide a significant growth; (a) laser systems for semi-conductor industry and (b) laser systems for dental markets. We manufacture and market Defect Repair Systems (DRS); they are laser based repair systems for photomasks which are used to fabricate DRM memory chips -- the brain of a personal computer. The DRS I is used in personal computer XT/AT chips with 1 micron resolution and DRS II is used in 2861386/486 chips with 0.5 micron resolution. With Intel's announcement of their new Pentium or 586 line of semiconductor chips, there is a need for a third generation of DRS with 0.35 micron resolution. We hope to introduce our DRS III machine in the middle of '94. We believe, this will have a major impact on our revenues and earnings over the next several years.

"The second area of growth will be laser for dentistry. We are anticipating the TUV approval for our dental product in Europe sometime in '94. We have a multi-wavelength dental laser system which features, Nd:YAG laser for treatment of soft tissue and Ho:YAG laser for hard tissue. Once approved in Europe, the system can be marketed and used over there for both soft and hard tissue applications. Market indications are that there are nearly 150,000 dentists in Europe.

In regard to market share, our DRSs are now the world's leading repair tools for repairing photomask in the semiconductor industry, representing greater than 80% of the world market share, except in Japan. We not only intend to maintain that market share but also increase. We believe optical lithography will remain as a system of choice for the semiconductor industry at least until the year 2000. Now, lasers for industrial applications, where lasers are used to engrave permanent identification marks and codes in aerospace, automotive, tooling, electronics and consumer products industries, we have approximately 35% market share in U.S. and we have plans to expand that market share both in U.S. and Europe. During the last year we have experienced a significant growth in our scientific laser product business where customer base consists of major university, national laboratories, and corporate research and development and we are optimistic in increasing our market share. We just introduced our dental and orthopedic--sports medicine -- medical products, where the overall market penetration is less than 2% and we hope to become a gold standard in those markets.

"On the acquisition side, we are looking for companies which have complementary capabilities to EXCEL either in terms of market access, enabling technologies, and/or customer base. In this respect, in October '92, EXCEL completed its acquisition of Quantronix. Quantronix has complementary businesses to EXCEL. Quantronix has established market presence and laser products for the commercial sector while EXCEL has medical products. Quantronix has years of experience in cost-effective high quality manufacturing, while EXCEL has bottom line driven management culture. Quantronix has the worldwide field support capability while EXCEL had cash in the bank. So we felt if we can merge these two companies, that can add significant value to both companies shareholders. This acquisition has helped EXCEL to evolve from an R&D company of less than $1 million revenue in '91 to an established $20+ million laser manufacturer in '92. It was a major undertaking.

"At the time of the acquisition, EXCEL was an R&D operation and burning cash. Quantronix had a revenue base of $20 million, but it was losing more than $3 million annually from operation. So the real challenge was whether we could successfully put these two companies together and make two plus two greater than four. We brought in new key management, removed unproductive managers and their even less productive perks and emphasized decentralization and open communication. We had three specific objectives to accomplish; (a) stop the bleeding immediately by eliminating the negative cash flow, (b) make the operation profitable by decreasing operating expenses and increasing the employee productivity, and (c) maintain both revenue and profit growth of at least 20% annually.

"EXCEL possesses a healthy balance sheet: a debt to equity ratio less than 20% and current ratio of assets to liabilities greater than two to one. We have more than $6 million cash in the bank."
--Rao, EXCEL Technology, Inc.

In Phase I, by restructuring the bank debt, downsizing the operation, relocating certain manufacturing activity, and throwing away some dead wood, we reduced the cash drain of more than $2.5 million from the operation. This helped us to reduce the break even point to $20 million. Next, we look at the heavy fixed overhead which do not add to revenues. When you have healthy revenues and are still broke, you do not have to look far for answers. So in Phase II, by decreasing the manufacturing overhead from a previous 950% to 350% and increasing employee productivity from $100 K rev/employee to $150 K, we begin to see a small profit. Then we move to our final phase of the plan. In my view, strong business must consistently grow both revenues and profit. A winning company has to master both. We can not sacrifice one for other.

In Phase III, by refocusing our energy and resources in those business segments where we have higher gross margins and market share, we increased the top line by more than 35%. From $5 million per quarter basis of '92, now we are generating approximately $7 million per quarter in '93. From an operational loss of $3 million in '92, we are now hoping to produce an operational profit in excess of $3 million in '93. It was a difficult transformation. In the course, we had to make some unpopular decisions. Both employees and management equally participated in this journey and made this happen.

R&D/Products

"We typically spend 6-8% of our revenue on R&D. Over the next few years, we would like to increase R&D budget to 10%. This will be very critical in positioning the company for future growth. However, as we structure our business to optimize the bottom line, this increase in R&D budget has to come either from an increase in our gross margins or decrease in our G&A expenses.

I would like to make one point in this regard. In a lot of companies, high-tech usually means, let's make a product and see later if it sells. That's stupid-tech. We don't develop what I call elegant solutions in search of problems. We go and focus on what customer requirements are, where we see the market as it is or we lay down the foundation for the future markets. There are certain segments where we have to participate in four, five years down the road, we better have a foundation built for these.

"At this point, we have very focused product development efforts in bringing the next generation DRS system with 0.35 micron resolution machine for the Pentium or 586 line of computer chips. We anticipate to introduce the product by the middle of '94. This program is partially funded with SEMATECH, the U.S. industry and government consortium. In the long term, we are looking at the possibility of using similar DRS technology for repairing flat panel display. Some other proprietary commercial, medical and consumer applications are also active on the drawing board.

"Over the next several years, we believe DRS laser system for the semiconductor industry and multi-wavelength system for dental applications will provide the growth potential. On a long term basis, laser for the consumer applications will probably be the ones that have tremendous growth opportunity. So in the short term, there will be a low volume at high price but in the long term there will be a high volume at low price."

Customers/Organization Focus

"At this time approximately 25% of our revenue is generated outside the U.S. On this basis, one can make the approximation that 75% of our customers are based in U.S. and remaining 25% outside. We are attempting to improve our market share particularly in Europe and Japan. We could not penetrate in Japanese semiconductor market with DRS I and DRS II. We are looking at the possible way of overcoming this with our next generation of DRS, In the industrial segment of our business although we have number one market share in U.S., European market share is almost non-existent. We are trying to increase it through increased activity in our German office. In addition, if we are successful in obtaining TUV approval of our dental products in Europe, that will allow us to tap nearly 150,000 dentists based in Europe. Thus over the next several years, we anticipate to balance our U.S. customer base with the rest of the world

. "Dental products will be a winner, but it will be a while before it becomes a winner. Let me give you an example. When lasers were initially introduced for ophthalmic applications like retinal detachment and attachment, macular degeneration, cataract etc, it took more than 10 years to reach an 80% market penetration. Now lasers are used routinely for those applications on an outpatient basis and lasers have become the system of choice. In the same way we believe that lasers for dentistry will become a system of choice by the year 2000. It is a patient comfort tool. However, the device is regulated by the FDA and it will require extensive training."

"At this time, although there are some players in that dental laser market, we believe that there is no gold standard in that market and there is a business vacuum. What we offer to the dental market is a real solution. We offer a real and meaningful product difference-the DUOPLUSE. This is the world's first multi-wavelength dental laser. The system has been designed with non-obsolescence and field upgradibility characteristics. The whole point is to let the dentists, not the manufacturer, choose what they think is best. Let them upgrade the system as their practice grows or more FDA approvals are received. This way the product guarantees a systematic increase in his practice with a greater financial security. We are positioning not just the product, but the company -- who we are, and why we are important to the customer beyond the life of the product, today and tomorrow. This is the strategy that is going to make EXCEL a winner in this game.

Depending upon which market we serve, we use a combination of direct sales, manufacturers reps., and/or distributors. In the semiconductor industry where customer base is very well defined as Intel, IBM, Samsung, Telefunken, Motorola, we use direct sales. For our industrial laser products which are utilized in the aerospace, automotive, tooling industries by such companies as Ford Motor, Delco Electronics, General Electric, Johnson & Johnson, we use a combination of direct sales plus manufacturers reps. For our medical orthopedic product we have alliance with a marketing and sales organization and for our dental laser products in Europe, we intend to use a major dental distributor.

'At this time, we have offices in Long Island, Orlando, California and Germany. If our industrial and dental laser programs are successful in Germany, then we may look into the possibility of a direct presence in U.K. and France. In Asia, we work with local manufacturers reps. They are very competent local people They have a good relationship with the customer base. Because of cultural and language barriers, it would be very difficult to manage any other way.

"Within EXCEL, we continue to evaluate the feasibility of improving our operational efficiency. Our goal is to build a premium laser company on a global basis. We constantly compare our productivity, efficiency, gross margin, and cost per employee with the benchmarks of the best run companies in the U.S. During the last year, by significantly decreasing the layers between CEO and shop floor and redefining the organizational structure, we have improved our productivity, measured in revenue per employee, from $100 K to $150 K and increased our gross margin to 46% and consistently demonstrated net income margins of 10% for the year '93. Our next target goal is to further re-invent ourselves to improve the productivity to $200 K per employee, gross margins to 50% and net income margins to 15%.

"To accomplish our next goal, we need to re-engineer the business. Re-engineering is not about making incremental improvements, but about achieving a quantum leap in performance. We need to reorganize the company from a structure with functional departments where each individual is in charge of a small task or part of a large system to a cross-functional business unit responsible for the whole product. I call them product owners or business unit manager. This structure provides the staying power and financial resources of a large organization and the speed, flexibility, and innovation of a small one. Companies that have adopted this concept successfully have obtained a 10x improvement in all three areas: Quality, Time, Cost. I call it "10x" vision.

"The basic unit of a traditional organization is the functional department where each individual performs a single function with absolutely no knowledge and responsibility of the whole product. In a re-engineering structure, work is organized around a product and a team that performs various tasks from start to finish. This structure, in a sense, pulls back together a group of workers who are doing different tasks managed separately among different departments, and puts them together in a team under a common leadership. Now, the procurement, development, production, sales, quality, all belong together. This helps to shift focus from activity to result and from individual task to whole process. Marketing can no longer point fingers at development, production at procurement, and quality at production. In this new organizational structure, the product owner becomes a product's chief executive officer -- like running a mini-business with a bottom line responsibility. They will run this as a totally autonomous business unit except such non-added value functions like administration, MIS, accounting, financing, etc., which will be consolidated.

"On the surface, this product-owner structure may seem to be creating some duplication. I have come to believe that economies of scale is the most overrated concept in business, It exists, of course, but it is overtaken by diseconomies of scale -- by such factors as high overhead, lack of accountability and bureaucratic paralysis -- much sooner than most people realize. The product-owner approach builds a team dynamic and a team decision-making process and it gives them a sense of accomplishment. This is the best way to put together the best combination of human talent at the level that counts most; the product level. Customer does not care how we manage our business or the way we finance our company, instead he talks about his experience with our product, cost and service. One should remember, companies can't give job security, only customer can.

"Our integrated diversified strategy will allow the company to make consistent, smooth financial progress in terms of both revenues and profits. And growth via acquisition strategy will provide EXCEL an ample opportunity to grow in the future."
--Rao, EXCEL Technology, Inc.

"At this new organizational structure, success or failure of each product will be in the hands of each person of the business unit. There is no shrugging off, because the goal is not getting through the day by fulfilling a list of functions, but doing everything that must be done. The result is not only profit but thousands of satisfied customers and hundreds of motivated employees. In effect, we acquire a major set of resources for the future. My personal conviction is that you can not have a company consisting only of brilliant people, but you can have a company that uses people brilliantly.

"EXCEL's needs on the personnel side will be dictated by its growth. Remember, in '91 EXCEL had 10 employees and today we have more than 200 employees. Although there is no guarantee, if EXCEL continues to implement its strategy and the past growth trend continues, we should probably double the number of employees in the next several years.

"The kind of people who succeed at EXCEL, are those who bring to their job a certain do-or-die quality. The people who are self-motivated, who have been through a little pain in life, they have seen their parents struggle, they have seen the people go to school at night. They have a mind-set that says 'I can do it, and if I can't, I will find a way -- it's not a big deal,' We want self-starters, And the ones who don't succeed at EXCEL are the ones with cover-your-ass memos, who research everything to death but never make a decision and never go to the finish line. We constantly send a message, 'Yeah, guys take responsibility, be accountable. We will give you the authority that goes with it and will give you the room. If you make a mistake, so what, learn from it, correct it, don't repeat it and go on, no big deal.

"We are constantly trying to push down the responsibility. The very concept behind our 'product owner' is that each business unit is small enough so that each participant can understand what is going on and contribute accordingly. I believe, the people who do the daily work can make better decisions and find more efficient ways of doing them than I can. People who work for you have got to know that their contribution has some meaning and that they can speak out without jeopardizing their careers. People do not want to work for someone where they just punch in and be there for so many hours. That is mindless, and people will resent it, lose their sense of purpose and become unproductive. Money may be a good motivator but only on a short term basis. A pay raise or bonus provides satisfaction for a month or two. The real motivator is dignity and self-respect. We need to get them involved in making decisions and give them the necessary tools. Essentiality, we want to give our employees a chance to manage themselves. They are responsible adults and we need to treat them likewise. I simply do not believe that our workers have an interest in coming in late, leaving early and doing as little as possible. After all, these same people raise children, join the PTA and elect presidents.

"On Excel's vision looking forward I personally believe that bringing laser technology to customer needs is an extraordinary business of this decade. When the laser was invented, it was called a 'solution looking for problems.' If you asked people in the 19th century, why they would need a telephone or automobile, few would be able to come up with an answer. However, they became an indispensable home appliance. Just last decade, if you would have asked what they would do with a personal computer, they could not have told you either. And personal computers changed the way we do business, In the same way, I envision laser will change the way we look at the world because of a simple fact: laser light travels million times faster than an electron. We are in an age where miniaturization and compactness is a way of life and time is a precious commodity. The electronics industry is already making a transaction to opto-electronics. Lasers are already making inroads in printers, bar code scanners, CD players. Lasers transmitted though a fiber will become an integral part of Multimedia and Super Highway Communications. Lasers will be in every house, every garage, every school in the form of high definition TV, color fax machine, color laser printer and compact audio and video player. We cannot predict when this 'Personal Laser Journey' will begin. As CEO, my major responsibility is to position the Company. I believe, a company needs to be of $100 million revenue with the proper infrastructure in place, before it can even imagine to participate in this laser revolution. To accomplish this, we need to make a systematic transition from commercial to medical and then to the consumer segment of the laser business.

Margins/Earnings

"At this point, semiconductor and dental laser products have higher gross margins than our industrial and scientific products. As I mentioned before, in the very near future our semiconductor and dental laser products will have larger contribution in the top revenue line. Thus as our business grows, products mix will change such that higher gross margin products will begin to dominate the top line. This will have an effect of increasing overall gross margins and accordingly the net income margins for the corporate. At present, we are operating at, before tax, net income margins of approximately 10%, which can be further enhanced if we are successful in bringing about the change of mix of the products we envision.

"Concerning growth, on the basis of our past performance, one can probably build a model for EXCEL's growth. However, I would warn your audience 'the past is not necessarily equal to the future.' From '91 to '92, EXCEL has grown from less than $1 million to $20 million, more than 500%, via external acquisition. From '92 to '93, EXCEL has grown from $20 million to $28 million, 40% from internal growth from its commercial and medical sectors of the business. On this basis, EXCEL growth history can probably be fitted in this model:

EXCEL can grow 10-15% annually based on its commercial sector of the business, if the medical/dental business is also successful, EXCEL growth rate may approach 20-25%. In addition, if it is also successful in the implementation of 'growth via acquisition' strategy, its overall growth rate can approach more than 30-35% annually. Our corporate goal is to build EXCEL to a $100 million company in the next three to four years.

"I have assembled a team of the absolute best people I know in the world. All of us share a common vision, idea and desire to build a significant technology-based company. Each of us brings a different set of skills to make it happen."
--Rao, EXCEL Technology, Inc.

Internal/External Factors

"Internal challenge is to find out whether we have the right talent and people in the company to carry on this new re-engineering concept of product ownership and autonomous business unit. Not every one is cut out for it. It really takes a well-rounded, versatile individual. The product-owner has to make sure he has the appropriate people with various responsibilities in his team and he should be able to direct his people in the same direction. He is totally responsible for the success or failure. It starts and ends with him. The product-owner shares many of the challenges and rewards of entrepreneurs.

In any normal corporation, you have brilliant marketers, brilliant developers, brilliant planners and a half a dozen of other categories of specific brilliance. A new personality begins to emerge; brilliant product-owner. Quite often these individuals may turn out to be less than brilliant in any one specific category, but their leadership and handling of responsibility have no parallel.

"As far as external concern, I have to say, U.S. economy. It is improving but rather slowly. We hope Europe and Japan will also recover soon. We have, to a certain degree, control on our internal concerns but we certainly do not have control over external issues like global economy and Clinton's new health plan. We do not yet know the details of Clinton's health plan, so I cannot comment on that subject. However, there is solid evidence that lasers are one of the technologies that provide better medicine and reduce cost when measured on a per-procedure basis."

Stock Market/Long-Term Strength

I am neither an analyst nor a stockbroker, so I cannot pass any judgment on how the stock market has been evaluating the company. Probably, I can make a few comments. Recently I read the book 'One Up On Wall Street' by Peter Lynch who used to manage the most successful, legendary Fidelity Magellan Fund. According to the book he used to take positions in those companies which have solid fundamentals, healthy balance sheets and whose growth rate is higher than PIE. I believe through the steps that management has taken in the past, namely 'restructuring, relocating, and rightsizing' it has established a solid foundation for EXCEL with lower breakeven point, lower operating expenses, higher productivity and increased gross margins and net income margins. These are the fundamentals of any company.

In addition, for a small company like EXCEL, it possess a healthy balance sheet; a debt to equity ratio less than 20% and current ratio of assets to liabilities greater than two to one. We have more than $6 million cash in the bank. As far as growth rate is concerned, from '92 to '93, EXCEL has grown the top revenue line from $20 million annualized to $28 million annualized, growth of more than 35%. Management has turned the Company from an operational loss in excess of $3 million in '92 to an operational profit in excess of $3 million in '93. For the last nine months of '93, Excel has produced record revenue and profits, a $22 million revenues and a $.35 primary earnings. At this time, EXCEL stock is trading around $5 per share.

"If I can make a last point, if you look at other medical laser companies market valuation, like Summit, Sunrise, Trimedyne, PLC etc., they all have market capitalization in excess of 5 to 10 times of their projected '93 revenues. There is no PIE for them because they are still in the red. In comparison, EXCEL's market capitalization is 1.5-2 times of its projected '93 revenue.

"We have just started introducing the company to analysts. At this time we have very little coverage and sponsorship. I am glad to report to you that, in the last six months, major institutions like Shearson Lehman and now Smith Barney Shearson and Fidelity funds have taken a major position in EXCEL.

"Outstanding strengths of EXCEL are its management team and its unparalleled strategy of integrated diversity and growth via acquisition. I have assembled a team of the absolute best people I know in the world. All of us share a common vision, idea and desire to build a significant technology-based company. Each of us brings a different set of skills to make it happen. Management has clearly demonstrated its ability to acquire a sizable, unprofitable company and turn the operation profitable, then grow the company aggressively. Our integrated diversified strategy will allow the company to make consistent, smooth financial progress in terms of both revenues and profits. And growth via acquisition strategy will provide EXCEL an ample opportunity to grow in the future. EXCEL significantly differs from most other lastr companies which are addressing one niche application and have yet to operate in the black."

For CEO Interview--TWST On-Line Document #WU607.

 
RAMA RAO
Chairman & CEO
EXCEL Technology, Inc.
45 Adams Ave.
Hauppauge, N.Y. 11788
Tel: (516) 273-6900
Fax: (516) 273-6958