OREANDA-NEWS. On 04 June 2009 Sitronics published the interview of Sergey Aslanian to newspaper “Vedomosti”:

“Being close to Sistema and to the State is good”, stated Sergey Aslanian, President of SITRONICS Company, Vedomosti.

That’s the opinion held by SITRONICS’ President who has received USD 230 million to refinance the Company obligations from Vnesheconombank with 61.3% of his JSFC Sistema shares as collateral.

Due to the crisis, the new SITRONICS management was unable to achieve a forecasted break-even point by the end of 2008 even though net loss had decreased 4.3 times down to USD 53.9 million. SITRONICS also had to give up one of its core businesses; distribution. Reasons for stopping its production of consumer electronics in Russia, the correction of plans for development in China, and other anti-crisis measures were disclosed by SITRONICS’ President Sergey Aslanian in his interview to Vedomosti.

— Last year you promised to bring SITRONICS’ capitalization back to the level it was listed on the London Stock Exchange in February, 2007. Now it’s 25 times below that level. Furthermore, capitalization had started to drop before the onset of the crisis.

— Prices of our shares had remained stable until last August, and it was only after the key financial indices had started to plummet when that process affected us. The financial crisis has had a negative impact on the stock market: capitalization of companies had dropped, and some of them just ceased to exist. However, past experience shows that technology industries are the first to recover after a crisis, and we will take all the effort on our part to be the most attractive asset for our investors. Our growth potential is confirmed even by the fact that based on the current share prices the company capitalization at the moment is substantially lower than the net assets [USD 2.016 billion at the end of 2008, Vedomosti].

— How’s the Company affected by the crisis? Are your plans to improve performance indices impacted?

— The crisis has affected us, as any other company, in many various ways but on the whole we are satisfied with our performance in 2008. We have fulfilled our promises: revenue was over USD 2 billion, OIBDA profit margin was 6.7% instead of 5%. For five quarters since the end of 2007 the company has been demonstrating pretty good trends and there are grounds to consider that “poor” trends are finally reversed. In addition we had all prerequisites to cross the break-even point but unfortunately the sharp fall of ruble exchange rates to dollar and Euro has precluded us from achieving it. If not for exchange rate differences we would have had an income of USD 1.1 million in 2008 (in 2007 the Company had a net loss of USD 233 million).

Through evaluating business growth one could see that enterprises have cut back on implementing new technologies. According to IDC Agency, assessment budgets of IT companies will be reduced by 20% in 2009. Back in the 4th quarter of 2008 we too forecasted considerably better performance indicators, and our performance at the beginning of 2009 is fully reflective of the complex situation in the current market. However, while some companies have put their projects on ice, they had already started others whereas on the opposite side continue to invest. So it’s not all straightforward.

At the year end the cost of borrowing may go up but today the weighted average interest rate for the Company credit portfolio is 8.8% which is much lower than the market rate and that makes us feel rather comfortable.

On the positive side, SITRONICS has gotten rid of extra expenses: parted with employees whose efficiency was not acceptable, administrative costs were cut down. In 2008 we had reduced personnel costs by about 15%. Out of 12 000 employees in Czech Republic, Greece, Russia, and Ukraine just over 10 000 have been kept. Could we shrink more? Probably, yes, but it will depend on the market trends.

— What’s the economic benefit of cost optimization?

— We do not disclose this information in money figures.

— What other measures have been taken under the influence of the crisis?

— Sales and Marketing have been completely reorganized. The process started with two branches: SITRONICS Information Technologies and SITRONICS Telecommunication Solutions (in Russia and Czech Republic so far). Now these services are centralized and relocated to the Company Headquarters. It was done in order to have a closer link to our customers. Each industry is dealt with by a separate department (there are four in total) each customer is lead by a single salesman capable of offering the full range of our Company solutions. For instance, if we sell an IT solution to a bank we can also sell it bank cards manufactured by our Microelectronics Division. Business branches have become somewhat of production units linked with salesmen who in turn are linked directly with the market. Thanks to this restructuring we are achieving a good synergetic effect.

The crisis have changed the face of the World. Some businesses relatively profitable before are unable now to generate adequate returns on capital. Thus we have made a decision to sell our Distribution to former SITRONICS President Evgeny Utkin. As a result of this deal companies held by SITRONICS Information Technologies and dealing with distribution have been sold to Melrose Holding. We have retained the systems integration.

— Was it a nonmonetary deal?

— Yes.

— What will the sale of Distribution lead to, considering it generated one third of the total revenue in 2008?

— Our revenue, naturally, will drop but so will the necessity in operating capital since distribution requires considerable operating funds. Profitability of the business branch and the group in total should grow up. Distribution is a low profit margin business and in times of crisis profitability of such business can fall down to 1% or even below.

— How has the crisis affected other business segments?

— It has impacted business of our Microelectronics Division since our customers, both MTS and Moscow Subway, pay in rubles. As a result there are some changes to the worse since our functional operating currency is US dollar.

— But are the partners ready to review the contract terms?

— Yes, we actively negotiate with partners in the projects where we purchase for dollars and sell for rubles.

— Aside from Distribution what other non-core assets are you shaking off?

— I wouldn’t call Distribution a non-core, it was our business. I promised all investors and investment analysts that we will sort out by the end of 2008 whether we continue assembly and further develop consumer assets. We have sorted it out, and fully ceased manufacture of consumer electronics in Russia. We still have the manufacturing sites but they no longer produce consumer appliances. This also has a positive impact on our financial results, again not on the revenue side but from the viewpoint of the Company profitability.

— Will these plants be put up for sale?

— To sell any plants in the current market conditions is utterly senseless. We have very good manufacturing sites which we can use as a foundation for new business projects, for example building data processing centers. Moreover they will grow in price eventually.

— Has the manufacture of Dual SIM Card phones been frozen as well?

— Yes, back in October.

— How many have you managed to sell?

— It was a test batch of 15 000 sets. About a third was sold; the rest of the batch is distributed among the sales outlets.

— Recently manager of one of the Sistema off-springs had told us that aside from Distribution SITRONICS considered selling Billing branch, Strom Telecom. The rumor has it billing vendors Amdocs and Comverse had received an informal offer at the end of April. Has SITRONICS actually considered such a deal?

— Billing is our strategic branch. We are going to develop this business and actively invest in it. There can be no talk about selling it. No negotiations, especially with the competition, have taken place and none could, period. Following our strategy we strive to part with low margin businesses only, namely with Distribution. As for Telecommunication branch it generated last year USD 55.1 million in operating profits with OIBDA profitability over 10% in the 4th quarter.

— When will the shipment of GLONASS devices commence?

— The chip is being developed by Qualcomm Company. According to our competence as a part of this project we’ll deal with integration, cartography, and will set up manufacture of end-user devices. It is assumed that Navigation Information Systems Company, we hold some of its shares, will receive status of a National Operator for the project in the nearest future.

— Consumer electronics being frozen, what will be your focus now?

— I cannot say the Company always focused on the mass consumer market. We are actively involved in telecommunication and financial industries, in the public sector. The share of public contracts in our portfolio is growing, maybe not as fast as we’d like it to but steady nevertheless. We are looking at the oil and gas sector. I recently have returned from Bashkiria where I found we have rather big potential to execute various IT projects.

— Will share of AFK (which have recently acquired control over BashTEK [Bashkiria Fuel and Energy Industry]) companies grow in your portfolio of shares?

— With Distribution sold the Company annual revenue will drop hence share of JSFC Sistema companies in the total revenue will increase. We are confident that in current conditions being close to shareholders represented by Sistema and to the State is good (in 2008 contracts with Sistema companies generated about 25% of revenue, and public contracts — about 15%, Vedomosti). In the next year or two important will be not the total revenue but high efficiency and profitability. At least while small and medium-sized companies may not make it through tough times, we have an opportunity and high probability to become even stronger.

— Do you consider possibility of the State becoming a SITRONICS shareholder?

— This is a question to the State.

— Tell us about liabilities. At the end of March you had to prematurely buy back almost 100% of the bonds for the total of 3 billion rubles. What terms did JSFC Sistema help you to do that under?

— Yes we bought back 99% of the bonds with the help of our parent company. As you may understand I cannot disclose details of that deal. Currently we are negotiating with one of the banks to help us return our debt to JSFC Sistema as soon as possible. Anticipating further questions I will say that we’re not going to increase our liabilities.

— Are you planning to reduce your liabilities this year?

— Yes, by about 10%, at our own expense.

— Despite its continuous improvement the analysts are still concerned with such high debt/OIBDA ratio (2008 financial results show the ratio of about 6). What level you would like to bring this ratio to?

— To be accurate, it was 5.5. In the next 3-5 years we would want to bring it down to 2-3.

— That loan of USD 230 million from VEB [Vnesheconombank], does it impose any limitations on SITRONICS? Is State Bank going to bring its representatives on your Board?

— Yes, a VEB representative appeared on our Board of Directors in June. We are glad to see that because presence of such highly skilled State banker undoubtedly will strengthen our team. Also SITRONICS have made a commitment to agree with them sale or purchase deals for assets with book value over 10% of the total assets value, agree terms of credits or loans, granting guarantees, etc.

— Some debtors [of that bank] had to repay part of their credit in April.

— We don’t have such a condition. VEB granted us credit for a year with extension option. Communicating with bankers I can see that now the situation is improving as compared to October-November 2008. Money has appeared on the market: it’s just nobody spent them. We do not exclude possibility of refinancing our debt at a lower rate. For example, in Europe interest rates are lower than in Russia and we have access to these money for we are an international company.

— At the end of last year SITRONICS started up a manufacturing plant for 0.18 micron technology. How much of its capacity have you contracted by now? When is your forecasted break-even point?

— The production has started and we plan to reach the 1500 wafers/mo capacity by the year end. Current amount of contracts utilizes about 70-80% of the plant total capacity.

— What are these wafers used for?

— For transportation and ID cards, smart-cards, passes for public events, biometric passports, social and payment cards.

— Are there any customers for the payment cards yet?

— We participate in the number of biddings opened by the largest Russian banks. I hope to see first results in the end of June. We plan to reach 3-4 million cards/mo volume by the year end.

— When will you start the 0.13 micron production?

— It is related to a different project: we are negotiating with Rosnanotech creation of a joint venture to start a 0.09 micron facility. It’s quite logical that strategic plants should remain in partnership with the State. I hope that within a few months we will conclude these negotiations. After that we’ll require at least a year and a half to start up and tune up the new plant.

— What is the budget for this project?

— Over USD 100 million.

— What about another State-participated project, construction of a plant for 0.065-0.045 micron technology?

— In April the Government decided to put off this project until the years 2010-2012. I would stress that the project is not put on ice but just postponed until later time. That is quite explicable: now the State has other priorities. We would also have hard time scrambling available funds for this project: in 2009 we have reduced our capital expenditures threefold against last year, down to USD 60 million.

— Tell us about the JV with ZTE in China. Do you still plan to relocate some of your production capacity over there?

— The plans are being corrected. Currently relocating manufacture to China would be very costly and such expense would not pay back soon. We are limited in capital expenditures and hence current investment in production capacity relocation has lower priority than expenses on R&D and creation of new products. Also there is no super-efficiency of three years ago anymore. The production cost has grown: in the past a Chinese engineer was paid USD 100 a month, these days it’s USD 500. Many Chinese companies themselves outsource their product manufacturing.

— What will this JV in China do then?

— As a probable option, manufacture of GLONASS receivers. To take a considerable market share in Russia and CIS countries large volume of mass production is required. We have a stock option for a large capital share of a new plant in Hangzhou but we cannot afford to purchase a whole plant so as to gradually increase utilization of its capacity. Hence our office in China is now actively considering various scenarios of this project development.

— Recently SITRONICS has opened an office in India. Will it be a representative office or you plan to have a production facility there?

— We have opened not a representative office but a spin-off company in New Delhi. IT market in India is growing steadily at about 35% per annum. Cellular communications penetration is at a level of 35-37%, whereby population of India is over a billion. We have already signed a supply contract for billing and CRM-system. This is a great breakthrough. We also have a supply contract for radio-relay lines, RUIM Cards. Jointly with ZTE Company we’re building a network for Sistema Shyam TeleServices operator. We also are in active negotiations with Science and Technologies Ministry and with railroad management offices regarding transportation tickets, security systems, supply of SITRONICS Daterium mobile data processing centers. I can see opportunities for telecommunications software design, establishment of a small R&D Center. Indian market is attractive in its own way that is only having a good experience with one of local mobile communications operators can one find ways to do business with others.

— And how far along are the negotiations with the Railroad Administration?

— The negotiations are not completed yet. The railroads are interesting for us first of all as customers for the transportation tickets.

— Tell us about Mars plant in Yerevan which SITRONICS took control over last year.

— It is a whole complex of Armenian plants: Mars and three Scientific Research Institutes are now controlled by SITRONICS. With help of friendly Armenian Government we refinanced taxation debts of these businesses and have reached the break-even point for production operating costs. We have appointed new directors whose task is to form a technology center based on the Scientific Research Institutes and a modern production facility based on the plant.

Together with Armenian Government a joint Russian-Armenian Venture Fund is being created to attract new technology projects to Armenian land. We are interested in a successful operation of this fund since selected projects will be implemented on production sites under our control. We have already reviewed over 150 innovation projects and this work is still ongoing.

— What do you need these plants for?

— They have skilled employees, still strong from the Soviet time scientific and engineering base, they have rather good designs and technologies. True they may not be state-of-the-art but this is more of a question of how to nurture the soil that the seeds will grow in. We understand very well that we have to create such stock for the future because SITRONICS is a high-tech company which moves forward thanks to its new technologies.

— You have also discussed a partnership with a local plant Integral in Belorussia.

— Yes we have discussed that but the crisis has shifted priorities. We had an idea to create a joint production facility with Belorussian Government. Belorussian microelectronics designers are historically strong so we thought of creating a JV between Integral and Micron. It is still an interesting and promising venture for us.

— Do you plan to continue expansion?

— Not this year. We have good ideas regarding partnerships with foreign companies but I cannot disclose them.

— You mentioned that R&D has a higher priority now than relocation of production capacity to China. What percentage of total investments will you devote to that?

— Most of our capital expenditures will be aimed at R&D work in Russia, Czech Republic and Greece.