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"We must anticipate the market rather than play catch-up"

In 2009, Oboronprom set up the United Engine-Building Corporation (ODK) and began preparing its Russian Helicopters (Vertolety Rossii) holding for an IPO. Oboronprom’s director-general and head of ODK, Andrey Reus, has spoken to Aviaport about his company’s priorities in engine and helicopter making, the internal workings of ODK and Oboronprom’s plans for cooperation with foreign partners.

Andrey Reus was born in Chelyabinsk on May 10, 1960. He graduated from the Moscow State University (MGU) in 1983 with a degree in Political Economics. In 1983-1991 he worked at the Chelyabinsk Tractor Works as an economist, then senior economist, head of bureau and deputy head of a department. In the 1990s he was financial program director at the Tolyatti International Business and Banking Academy and head of the Konsultant auditing firm, also in Tolyatti. His first government appointment came in 1998, when he became advisor to Russian deputy prime minister Viktor Khristenko. In 1998-1999 he served as deputy head of the inter-budget relations department at the Russian Ministry of Finance. In 1999-2004 he headed deputy prime minister Viktor Khristenko’s secretariat, then served as deputy minister of industry and energy in 2004-2007. He was appointed director-general of OAO APK Oboronprom in September 2007, and in January 2009 he also became the director-general of ODK.

Andrey Reus holds a PhD in Economics. He has been awarded the Honor Award and a medal of the Order For Services to Fatherland of the 2 nd degree by the Russian president.

He is married, and a father of three.

OAO United Industrial Corporation Oboronprom was set up in 2002. Its parent company is the state corporation Rostekhnologii. Rosimushchestvo owns a 67.66-per-cent stake in the company. Other stakeholders include Rostekhnologii with 8.53 per cent, Rosoboronexport - 3.81per cent, the Republic of Tatarstan - 9.27 per cent, OAO MiG - 0.94 per cent and OAO Rostvertol - 0.76 per cent.

Oboronprom is the sole owner of OAO Vertolety Rossii, which owns a 72.38-per-cent stake in the Moscow Mil Helicopter Works, 98.46 per cent of the Kamov helicopter maker, 75.09 per cent of the Ulan-Ude Helicopter Works, 54.49 per cent of the Kazan Helicopter Works, and 22.76 per cent of Rostvertol. Oboronprom fully owns the United Engine-Building

Q: Can you give us preliminary 2009 financial results for Oboronprom, Vertolety Rossii and ODK?

A: The combined revenue of Oboronprom companies reached 131.5bn-132bn roubles, according to preliminary reports. The 2008 figure was 101.5bn roubles, so we have posted a respectable growth. Vertolety Rossii showed a particularly strong result, up by about 40 per cent on the previous year to 60bn roubles. The company’s combined net profit almost doubled to reach 4.5bn.

The ODK results are somewhat less spectacular compared to the helicopter division: after all, the holding company was set up only last year, in 2009. Nevertheless, its revenues were up by 20 per cent to 72bn roubles.

Q: The ODK made a net loss in 2008. Is the group going to post another loss for 2009?

A: Yes. We have, however, managed to cut our losses by about 60 per cent. More precise figures will become available some time around March, when the yearly financial reports are in. We signed a number of contracts just before the year's end, which will certainly help our balance books.

The fact that we are now in debt is inevitable: all our production cycles are fairly long, and the advance payments we receive are only about 25 per cent of the worth of the contract, if we are lucky.

One particular problem is the so-called “toxic debt", which our companies incurred before they became part of Oboronprom. We have now managed to get rid of those debts thanks to subsidies from the federal budget in 2009. An extra 16bn roubles has been made available to engine and helicopter makers via recapitalization of Oboronprom, and we are also planning a bond issue.

Q: When can this issue be expected, and how much extra capital are you hoping to attract?

A: The decision about the time frame will be made in the first quarter of 2010. We are planning to borrow about 21bn roubles. The most likely underwriter is VTB-Capital. We are now in consultation with the Ministry of Finance. Our main goal is to refinance the corporation's debts to Russian banks which were incurred during the consolidation of the engine-making sector, and to fulfill our commitments on buying out the privately owned stakes in our companies.

Q: Are you then planning an IPO as the next step?

A: We view the capital markets as a strategic instrument which can help us attract the capital needed to continue our development. We are now considering the possibility of an IPO for Vertolety Rossii in 2012. As for our engine-making division, I’m not prepared to venture a date, but we are working on that as well.

Q: What is your estimate for Vertolety Rossii’s capitalization by 2012?

A: That is hard to say. Our main goal is to carry on with our investment program. The government has helped us plug the financial holes, but it is now up to us to create a modern and efficient business, a stake in which can then be offered to private investors.

Q: When then president Vladimir Putin took part in a meeting in Saint Petersburg in August 2007 to discuss Russia’s engine-making industry, he gave an instruction to set up four holding companies, to be later merged into one. ODK has bypassed that transitional stage. Is that an advantage or a disadvantage?

A: It is an advantage, no doubt about it. Centers of engineering skill and expertise are now coalescing within ODK, and we are pursuing a united policy in our dealings with the customers. As a result, we are gradually removing unnecessary competition. For example, in our work on the MS-21 engine we have now involved NPP Motor, KB Aviadvigatel, the Ufa Engine-Building Production Concern, the Perm Engine Works, and the Samara conglomerate. And NPO Saturn, which had previously been refusing to become involved, became an active participant after the consolidation.

Had we chosen the route of setting up several holding companies for a transitional period, we would never have agreed to work on a single product. Four holding companies means for different sets of products, which we would never have managed to merge into one. And I refuse even to speculate about government financial assistance – one can only imagine the lengths the separate holding companies would have gone to in their fight for a share of government funding.

Q: What are the 2009 deliveries figures for your helicopter division?

A: Vertolety Rossii delivered something to the tune of 180 helicopters. Exports accounted for about 70 per cent of that figure. We haven't quite met our target, and the crisis is not to blame here. I keep telling the plant managers: "Do not wait for confirmed orders before launching the production cycle! There should be no spare capacity, we should be working flat out!” We need to take some risks! The market for helicopters keeps growing, despite the crisis. We must anticipate that market rather than play catch-up. Thanks to our hard work over the past few months, our order books are full for the next two years. On the one hand, that is a clear testament to the quality of our products. But on the other, it is a serious responsibility, because now we cannot afford to slow our pace, we must be agile and flexible in reacting to market movements.

Q: Have you raised prices over the past year?

A: Yes we have. That is mostly true for helicopters, which is quite logical, as the Russian offerings were underpriced on the international market.

The main reason the prices have gone up is the suppliers. We are going to have to work hard with them throughout 2010. We have formulated a whole series of proposals on improving the efficiency of our dealings with the suppliers. We are setting up centralized structures which will be able to secure lower prices by consolidating our procurement into large and long-term supply contracts. One of the long-term deals we are now planning to sign is a five-year contract with the Urals Optics and Mechanics Works.

We are also facing difficulties with the supplies of casting produce and gearboxes: the existing suppliers can no longer keep up with demand, which is growing at a fairly rapid pace. Unless we find a solution, our growth will stall. As part of our efforts to resolve this problem, the Reduktor plant in Perm (Reduktor-PM - Aviaport) has been incorporated into Vertolety Rossii. On the one hand, gearbox manufacturing is traditionally a component of helicopter making in the whole world. But on the other, this branch of technology requires special attention. We are now working on a project to set up a joint center of gearbox engineering expertise at Reduktor-PM. We are also building a new casting plant in Arsenyev, which will supply the entire holding company. And we are not limiting ourselves to Russian suppliers, we are also making use of foreign suppliers, wherever possible.

I keep insisting that my staff learn English, so that they could talk freely with any foreign company. I try to work without an interpreter, and I urge my staff members to do the same.

Q: What is your projection for revenue growth in 2010?

A: We expect to see a growth of about 30 per cent – though we also have to contend with the difficult financial situation at our production facilities. The engine-making sector is saddled with too much debt, and servicing that debt is a burden. We have received serious help from the government, and the debt problem is no longer an overriding concern - but it has not gone away, either.

Debts are particularly large at Saturn. We are using that company to consolidate a number of engineering skills that are critically important to the engine-making industry, but Saturn’s financial model is fairly complex. In the first quarter of 2010 I plan to work on that model on a daily basis. We also have a difficult situation at the Chernyshev plant – there too we are working on improving the financial model.

Q: What can you tell us about the upcoming contract to build a new engine for the PAK FA program? When will the military decide on a date to invite the bids?

A: One of the main reasons for the delay was that there were two possible suppliers – ODK and Salyut. But now we have agreed in principle with Yuriy Yeliseev (director-general of FGUP MMPP Salyut - Aviaport) that we are going to cooperate on this project, and that ODK will be the supplier of the engine for PAK FA. The Defense Ministry will announce its decision some time in 2010, but we have already begun working on the project.

Q: What part of the engine for PAK FA will be supplied by Salyut?

A: I wouldn’t like to discuss that before the contracts are signed.

Q: A new holding company is now being set up on the basis of Salyut - is its incorporation into ODK on the table?

A: There are no firm plans for incorporation. Salyut is now implementing the president’s decree on creating a separate holding company. That company will consolidate about 17 per cent of the national industry, with the remaining 83 being controlled by ODK. Of course, there is still some degree of competition between the two companies, which I believe is not always productive. In my opinion, the PAK FA program is leading us towards very close cooperation, which could be viewed as a basis for integration. I believe that Russia will eventually have a single united company in the engine-making sector. That makes obvious sense in terms of manufacturing, financial considerations and competition on the world markets. In any event, the decision will be made by the government.

Q: Military orders, especially export contracts, now generate the bulk of the Russian helicopter and engine makers’ revenues. Do you see a trend towards the civilian segment of the market playing a greater role?

A: In helicopter making, the civilian segment is growing. Only three or four years ago, military contracts made up about 90 per cent of our revenue. Right now, civilian orders account for over 30 per cent.

We are also implementing a program of helicopter service and maintenance. The civilian aerospace market is very sensitive to this. As soon as Vertolety Rossii deploys service infrastructure in some region, the local market immediately picks up. We have also certified the Ka-32A11VS helicopter in accordance with EASA specifications, which has made this offering much more attractive to potential customers. There is great demand on the civilian market for the Ka-226T, which we are preparing for an Indian tender. We are working to modernize the Mi-34 (Mi-34S2 Sapsan with Arrius-2F gas turbine engine - Aviaport), and preparing the Mi-38 and the Ka-62 for the civilian market.

We also have plans for a deep modernization of the Mi-8. It will be the same modification for both KVZ and UUAZ. That is a matter of principle for us. If we are offering the consumer a standard piece of equipment, it should be a standard model with a clear cost structure. I am confident that Russia will maintain its hold on the Mi-8 segment of the world market for a long time to come, because in terms of functionality, this helicopter is close to perfection.

As for engine making, the bulk of the growth in the civilian sector comes from the energy industry. ODK is involved in the national program of improving energy efficiency in central heating. Pilot cogeneration projects will be launched in 2010 in Yaroslavl Region, Bashkortostan, and other parts of Russia. We are also receiving more orders from Gazprom and the oil companies. In late December we approved a project to manufacture 110 MW turbines. In another 18-24 months ODK will be able to assemble five such turbines every year. Another big earner for us in the civilian segment is the aircraft engines, especially the SaM-146 and the SSJ-100.

Q: You unveiled ODK development strategy at the MAKS-2009 air show. According to your projections, the share of civilian aircraft engines will shrink from 36 per cent in 2008 to 18 per cent in 2015, but then rise again to 30 per cent. Does that forecast still stand?

A: Our plans in aircraft engine making are tethered to OAK projects. The situation is changing rapidly, both in the aerospace sector and in engine making, so the time frame should be taken into account. In addition, we are also forecasting for that period a growth in our manufacturing of helicopter engines and energy equipment.

Q: A total of 11bn roubles has been allocated in the federal budget for recapitalization of NPO Saturn, MMP Chernyshev, the Samara conglomerate and OAO Klimov – that is in addition to loans from the VTB bank. Are you going to ask the government for more money?

A: The government is providing constant support to the sector, both via special national programs and targeted aid. More assistance will be offered in 2010, but through a somewhat different mechanism. Right now it is important to support our production companies by subsidizing the interest rates on credit, because our industry simply cannot afford to pay 15-per-cent interest rates on the loans it takes out. At the same time, we are now facing very stringent – but absolutely fair – requirements on cutting our overheads. Oboronprom is now in the middle of a centralized program of “lean manufacturing”, which aims to cut by half the amount of unfinished produce and substantially improve productivity. Our Samara conglomerate has met all of its 2009 targets: the space program and energy products are on schedule. In 2010 we are going to complete the merger of three separate corporate entities into a single NPO-type company, and sell any surplus properties. In my opinion, the crisis in Samara is now over, the company is now back to its normal non-emergency mode. Of course, productivity there is still below the industry average, but the positive manufacturing and financial trends are obvious. We expect the company to break even in 2010.

We are now working to optimize the management structure at the Perm conglomerate. We are implementing a plan of improving the quality of the PS-90A engines manufactured there - the engine is the second-biggest earner for the PMZ after energy sector equipment. In late December, Aviadvigatel obtained an AR MAK certificate for its modernized PS-90A2 engine.

Klimov and UMPO will post a net loss for 2009. In late December, the ODK project committee approved a Klimov project to build a new design and manufacturing complex, which will release some properties owned by the company in central Saint Petersburg. The project is entirely feasible and based on sound financial footing. The city of Saint Petersburg is fully behind the project, and offering us substantial assistance.

Q: Apart from the cash from selling properties in city center, what other moneys will be available to Klimov for the building of the new complex?

A: Loans.

Q: Klimov’s previous strategy was based on producing a finished product – helicopter engines, which now account for the bulk of the company's revenues. Now that the decision has been made to move helicopter engine assembly to UMPO, how will the Saint Petersburg company make a living?

A: But that is exactly why we are building a modern center, a design bureau with a pilot production facility - so that the company could make a living. We are transforming Klimov into a lead design bureau for a continuous cycle of R&D work to maintain the existing models of helicopter engines up to date technologically, and provide engineering support during their mass production. We will also rely on Klimov in another important area - the development of breakthrough products, helicopter engines of the new generation. Providing engineering support during the life cycle of a product always generates steady income. In addition to that, substantial funds have been allocated for our projects in the federal budget, to be disbursed under special national programs. So I have full confidence in Klimov’s future.

It is very important for us to have a mass-production plant of helicopter engines in Ufa, because we will never be able to rest easy without our own production facility.

We will also pursue cooperation with foreign partners, including Turbomeca, which we can work with on the Ka-226T engine and possibly the Ka-62. We are also looking into the possibility of setting up joint ventures or an administration company with our French partners, to coordinate our cooperation in these areas.

Q: What is your view of the proposal by the chief of OAO Motor Sich, Vyacheslav Boguslayev, on setting up a joint administration company in connection with the Ufa project?

A: I don’t see what such a joint administration company would do. Are we talking about managing ODK assets? Why would our Ukrainian partners want that? An administration company needs something to administrate. That something could be a large joint project. Motor Sich has put forward a number of proposals on joint production of engines - but our analysis suggests that such proposals run counter to ODK's own plans. So we are quite happy with the existing format of cooperation with Motor Sich.

Q: What are the projects to be financed under the Federal Program of Civil Aviation Development in 2011-2020, which is now being drafted?

A: That will be one of our key programs starting from 2011. It includes our priority market products, such as the Mi-38, the Ka-62, a new high-speed helicopter and the engine for it. Essentially, the money from the federal budget will enable us to preserve the existing expertise and conduct new R&D.

That doesn't mean, however, that we will not also look for other sources of financing. We are going to offer strategic partnership in these areas to companies in India, China and other countries.

Q: How much will the development of the engine for the MS-21 cost?

A: We estimate the cost of the project at 35bn roubles.

Q: Speaking about the MS-21, OAK president Aleksey Fedorov said that just over half of the program’s cost will be funded from the federal budget (70bn roubles out of the total of 150bn, as estimated in July 2008 - AviaPort), and the rest will have to be borrowed. Are you going to resort to borrowing in order to fund the R&D work on the engine?

A: So far, we are spending only the money allocated in the federal budget. Of course, once the engine approaches mass production, we can also use credit based on existing contracts and market projections.

Unfortunately, it has been a very long time since the industry delivered the last project of that nature. But unless we acquire the skills and expertise to develop new technology, we will not just become uncompetitive - we will simply become irrelevant. That is why one of the engines for the MS-21 will be made by ODK. The best situation for us is to have two suppliers working on the engine for the aircraft. (The contract to develop and deliver the first engine for the MS-21 has been awarded to Pratt & Whitney – AviaPort.) That is genuine competition, which will keep us on our toes and ensure good results.

Q: What about the PD-14 engine? Is everything more or less clear now? Have the designs been "frozen", as the aircraft designers say?

A: It is clear. There is a whole number of radically new decisions from the so-called risk area in terms of new technologies and new materials, which all require meticulous attention to detail and absolute precision.

We are involving young specialists in this project, young talented designers, engineers and technologists. One of the key problems is that a designer cannot be trained unless he has been personally involved in the project. That is the nature of the job. So I am confident that thanks to steps such as these we are going to restore the expertise required to design and develop new engines in our country.

Q: Has there been a discussion with Pratt & Whitney as to which elements of the work on the engine for the MS-21 can be subcontracted to KB Aviadvigatel?

A: Yes, we have been discussing these things, our experts and specialists have held a number of meetings.

In our dealings with Pratt & Whitney on this project I proceed from the notion that they will subcontract some elements of their engine to ODK, and we in turn will use the Americans as subcontractors in the development of our engine. I am entirely happy with such a format of cooperation.

Q: When do you expect to have the engine certified?

A: The development and certification of the engine are obviously linked to the development of the aircraft itself. The plan now is to have the first planes ready in 2015-2016. That means that we must have the engine ready by late 2014. Engine certification is a very complex task, and we haven't got a lot of experience of this kind here in Russia. With the SaM-146 we made use of many existing solutions, but here we had to start from scratch, more or less.

Q: Are you going to continue consolidating assets in the Perm engine-making conglomerate?

A: We are now incorporating back into the PMZ a number of technologically linked facilities that we previously made into separate companies. We have a schedule for creating a single entity that will incorporate PMZ and KM Aviadvigatel. That schedule has been agreed with our US partners from Pratt & Whitney, who will retain a 25-per-cent stake in this new company. But in my opinion, right now there is no need to try to speed up this merger process.

Q: When does Oboronprom expect to sign a licensing agreement with AgustaWestland to begin assembly of Italian helicopters in Russia?

A: We have several outstanding issues which we hope to resolve during this quarter. I have no doubt that the assembly plant for the AW139 will be built.

Q: Have you considered assembly of the AW109 here in Russia?

A: The AW109 has a growing market, but Vertolety Rossii has its own offerings in this segment, the Ka-226T and Ansat. We already have some proposals in place, agreements with the customers, so the AW139 will have its share of the market here.

Q: Oboronprom had previously signed a cooperation agreement with Eurocopter, which included the manufacture of components for Eurocopter, the development of the heavy NTN helicopter and of a light helicopter weighting under 2.5 tonnes. Has there been any progress in this area?

A: We have signed protocols of intentions with Eurocopter, but things haven’t gone any further than that. I detect no obvious inclination on the part of Eurocopter to share their expertise with us. They have now decided to go it alone with the development of the heavy helicopter. They have also made a proposal to begin assembly of their helicopters in Russia, but I see no need for that. Nevertheless, I cannot rule out the possibility of a joint project. All I can say is that Vetrolety Rossii would be interested in such a project.