In 2015, Kalashnikov earned 2.1 billion RUR in net profits and brought in 8.2 billion RUR in revenue. What condition was the company in when Rostec decided to sell its shares to private investors, what were the drivers that enabled it to make a profit for the first time in the last seven years, and what has been the impact of US sanctions, new products, and markets — Alexey Krivoruchko, CEO of Kalashnikov, answered these questions in an interview with Forbes.
Why was the legendary weapons manufacturer on the verge of bankruptcy? What was the root cause?
There were no clear objectives. People were going through the motions, but there was no large-scale plan in place. Up until 2014 the company hadn’t rolled out any new products. The last new product was created 20 years ago. At the time when I joined the company, the employees had very low salaries of 21,000 RUR, and the company was losing money every month. Furthermore, the company's share of the international market was less than 0.1%. In essence, the company was not an exporter.
I don't want to focus on the past, but there's no question that both internal and production processes, as well as management processes, had been completely disrupted. To be fair, the company had some customers, but they were very few. There were serious issues with state defense orders. In particular, the contract to develop and supply the Vikhr-1 guided missile had been torn up for a number of reasons. In spring 2014, we managed to revive this contract and we supplied the first batch to the Ministry of Defense of Russia in October 2015.
So, the company had no modern designs at all?
There were some, but they were never rolled out. I don't know why. There have always been opportunities to improve quality and cut costs, as the company has always had great reserves. There were some really strange things going on here. There was — literally — no Sales Department, no marketing. And this was 2014. It’s no surprise that the company’s production volumes were so low.
Did the staff begin to understand their objectives?
I think that they did. Now they clearly understand that we need to produce high-quality and modern products, which are — most importantly — demanded by the markets. At the same time, we increased the average salary by 62 % up to 34,000 RUR. This is the highest salary in Izhevsk.
The management team was bloated. But we actually did not dismiss a lot of employees. We fired some managers in one department and but hired in another. We are currently recruiting new employees for production positions.
What helped you grow revenues and profits?
There was no silver bullet — we just increased sales and production volumes, rolled out new products and started to deliver on the state defense orders. The growth in development and production efficiency enabled us to cut fixed operating costs, decrease labor intensity for a number of products, and generally improve the company's production effectiveness.
We faced a number of issues when we needed to start mass production of Vikhr missiles, as this was a new product with no mass production in the past. The need to replace imported components in the missile also posed some challenges, but we managed to handle them quite quickly.
The state defense order was a much harder challenge for us. The adoption of the new law on "marked money" meant that companies had no right to manage their liquid assets, their cash flows, in particular, those related to general production expenses. However, this task has remained a priority.
Last year, the share of state defense orders was planned at 75% of total revenues, but this year it decreased to 60% in monetary terms. Furthermore, the share of small arms in state defense orders has been less than 5%.
Today, one of the main objectives is to increase the share of civilian market products in the general production volumes. We are currently working hard on this issue. And, even today, almost half of small arms that we produce is targeted at civilian markets.
We rolled out a large number of new products, while dozens of others are in development. One of the new products for the civilian market that is most promising and that has been expected for a long time is the semi-automatic rifle with balanced automatics. This is the main product among those that the company will roll out for mass production in the near future.
The secret of this rifle is a mechanism that decreases recoil and improves the precision of each subsequent shot. This technology was actually developed 30 years ago, but it was never used for mass production.
Today, we see growth across all product lines, including the internal markets, where we previously sold virtually no products. In 2016, we will also increase exports due to new products and contracts.
There is a large team that is working on new developments, and they work closely with both Russian and foreign customers. Last year, we used the affiliate program to launch over ten brand areas in gun shops. This year, we will open 50 new stores across the country.
Does the very small share of state defense orders in small arms show that the Russian army has completed re-armament and does not need Kalashnikov anymore?
The Defense Ministry has very large volumes of small arms in its warehouses. So, it makes no sense to purchase the same weapons. That's why we very quickly wrapped up a number of operations, for instance, we upgraded the conventional AK-74 and started mass production of Kalashnikov rifle upgrade kits.
We receive second-category rifles from army depots that had been stored there for a number of years. Then we repair and upgrade them. Subsequently, the rifles can be equipped with modern opto-electronic aiming devices, laser target pointers, weapon lights, sound and flame suppressors. All of these features improve the efficiency by several times. This makes them weapons of a professional army and we have already received orders for several thousand of them.
Has the issue been solved concerning the order of AK-12 rifle for the Ratnik ammunition?
We are currently starting testing. We hope that we will get a clearer picture this year. This is a complex process with many agencies involved. The hundreds of people participating in the selection will make sure that the army will get the good products it deserves. Undoubtedly, the main criterion is the price/quality ratio.
How important was the US market for Kalashnikov, which has now closed up due to the sanctions?
In 2014, 70% of the overall production volumes of civilian small arms was to be sold in the US with revenues reaching tens of millions USD. The warehouses still have civilian-market products marked with "for the US market".
I don't think that this market has been lost forever. We hope that we will be to return there. The distributors and buyers from the US that we talk with at the exhibitions say that they are looking forward to our return.
In fact, we have seen quite high growth rates for exports. We sell both small arms and guided munitions. I have to be very careful in terms of what I say on this topic, since we have fierce competition on this market and since some of the countries play unfairly. These are very high-margin contracts.
In 2015, the company purchased a share in Rybinsk Shipyard, producing high-speed multi-function motor boats, and Zala Aero, a drone producer. Why?
This will enable us to stop being just a small arms manufacturer and become a multi-functional defense holding, specialized in the development and production of integrated combat systems. The niches that we will try to occupy are still free to take. We understand our customers and have already gotten some orders. So, we decided to expand our product line, understanding that continuing to focus on only small arms poses too much of a risk. In terms of the motor boat markets, we have selected high-speed boats for special-force teams.
The deal to consolidate 49% of Rybinsk Shipyard was signed only recently, but we have already gotten some orders and seen significant demand — not only in Russia, but also from other countries. This year, we will produce dozens of various types of motor boats.
The same is true for drones. If you had a security clearance, I could tell you quite a bit. These are world-class devices that easily beat out the competition. The electrical propulsion system enables them to stay in the air for up to six hours.
In areas where we are operating, we have managed to attain productivity. In 2016, we expect that Kalashnikov's profits will double up to 18 billion RUR. The revenues from motor boats and drones are not included in these figures, but we expect that they will account for 15–20% of future revenues.
What can you say about your relationships with Rostec? Is there any risk that the state corporation might not be happy with your decisions and you could be fired?
We are working within the framework of the federal law on Joint Stock Companies. Also, we have signed a shareholder agreement with Rostec that stipulates the rights and obligations of both parties. We concluded the agreement even prior to the purchase of the capital share. It was important for us to make sure that the relations between the partners are clear and transparent. Based on the agreement, the CEO of Kalashnikov Concern is nominated by our party (private investors), while the Chairman of the Board and three key Committees of the Board of Directors are to be appointed by the state corporation. We have also signed an interaction agreement that clearly specifies what, how and within what periods we need to do in order to cut through any red tape and decrease the time needed to make decisions.