Ultrafabrics Holdings Co.,Ltd. (4235) Earnings Call Transcript & Summary

Hi. This is Noboru Yoshimura, President of Ultrafabrics Holdings. Today, I would like to report our fiscal year 2025 financial results. Before I talk about the numbers, I would like to mention one thing, 2026 is DKK's 60th anniversary. DKK started their business in 1966 and started to produce our current main product, wet polyurethane leather in 1972. Through '70s to '90s, DKK have been selling their products to mainly to consumer applications like clothes and sports gloves. In 1999, Clay Rosenberg and Danielle Boecker started Ultrafabrics selling DKK products to Bendi in the States. They have been selling DKK's products to -- not to consumer applications, but industrial applications like furniture and automotive. Since then, the sales of Ultrafabrics have been grown rapidly. And in the mid of 2010, the sales, more than 90% of DKK products have been sold through Ultrafabrics. So the management team at that time, DKK Ultrafabrics decided to merge for the further growth in the future. So 2 companies merged in 2017. I'd like to say thank you to all employees and customers that we could celebrate DKK's 60th anniversary. We continue to have a slogan comfort with pride. Ultrafabrics aims to become a global leading company in the premier market -- material market, and we'd like to celebrate 100th anniversary in 40 years. About 2025, '25 year was a year of uncertainty. Especially Trump tariff started in April and numbers are different depending on the country and numbers have been changing almost every day. We have -- we set a policy that we basically ask our customers to pay the extra tariff in the form of surcharge. We don't think -- I don't think that this resulted in a loss of sales or customers, but there has been a lot of disruption in the supply chains of our customers, which probably adversely affected the business of our customers. Regarding our overall economic trend, commercial real estate market was not performing well. Work from home started during the COVID and not all of the employees, people are coming back to the office. But at the same time, we have some projects from financial institutions to upgrade their interiors in the offices so that they can attract people coming back to the offices. So there was -- there are some new opportunities. But overall, the commercial real estate market was not good in 2025. Also, the interest rate as well as inflation rate stayed at a high level, which had some effect on excessive spending such as RV and marine. And as you can see on this slide, the office vacancy rate remained high and excessive spending like RV remained fairly low level compared to 2021 and 2022. Also, there is a kind of headwind against the trend of sustainability and also the growth of EV market slowed down, which also affected our business performance. On the production side in Japan, all the production costs like labor cost, energy cost, logistic cost were going up. And suppliers -- our suppliers continue to ask for a price increase due to the increase of these various costs. The energy cost is a little bit -- getting a little bit stable, but other costs are still climbing. So we have to pay attention to those factors this year as well. Other outside environment, the foreign exchange rate, yen appreciated in the first quarter of 2025. But after second quarter, the yen depreciation trend came back. And throughout the year, again, uncertainty regarding U.S. economy remained. So these outside factors in addition to various business factors of our customers, our sales to various business segments, except for commercial aviation. have been below our budget and also our production cost was up due to outsourcing of our production. So at the time of release of second quarter last August, we announced a downward revision of our budget in 2025. At year-end, we landed almost as the revised forecast. But regarding sales ended as expected, but net income was better than our forecast due to less equity method loss and financial expenses. Overall sales in dollar pounds in 2025 was almost flat to 2024, but there are some ups and downs depending on the segment. The furniture area, almost flat to previous year. But in the furniture area, off contract furniture and dealer was a little bit up, but health care, especially health care was down, so they offset and we landed at a flat level. On the automotive side, sales to seat applications was almost flat to 2024, but the sales to small parts were down compared to 2024, so that overall, the sales in automotive market was down by 3%. Aviation side, corporate VIP business was down due to uncertain economic environment, but the commercial aviation market performing very, very well. So overall, aviation went up by 17.4%. Other applications, including RV and marine, RV and the Marine area, as I told before, was adversely affected by the high interest rates, but we have a good sales on a track so that as a segment overall, the result was flat to previous year. So in 2025, we had sales of JPY 20.5 billion, which is almost the same as it was last year. But as you can see, gross profit was down by almost 14% due to the ratio of outsourcing went up as well as the defect ratio at DKK production remained relatively high, which can be improved in the future. Given the decline in the gross profit, we try to manage our SG&A. So we ended up a little bit less SG&A cost compared to that of last year. But the operating profit was down by almost more than 60% and net income is almost half compared to that of last year. About balance sheet cash flow, we have some increase on inventory due to the gap between the sales and production. This is where we can make an improvement for this year and beyond. And also, we see some decrease in debt despite the investment in Chiyoda plant construction. So in total, we have a negative cash flow of JPY 434 million. Regarding dividend, we have a policy to maintain stable dividend to our shareholders as well as the savings for future investment. But we changed this policy a little bit. We'd like to maintain a stable dividend for our shareholders. But at the same time, I would like to strengthen shareholders' return because all the big investments are behind us as we completed the Chiyoda construction and the merger loan that we borrowed in 2017 will be fully repaid early 2027. So beyond 2027, we are not expecting a big investment, whereas we continue to pay down our debt for the merger and for all the production facilities, and we expect the debt-to-equity ratio will go down in the future. So this is the main reason why we changed our dividend policy. So we decided -- we expect -- we decided to pay all the profit in 2025 and 2026 to our shareholders in the form of dividend, which results in the dividend of JPY 35 per share for 2025 and 2026. Now I'd like to talk about outlook and rolling midterm management plan for 2026. So right now, we are a global niche player in the premium market and our sales business is dominantly in North America. So toward 2035, we'd like to be a global leader in the premium market by expanding into other regions than North America, especially Europe and potentially in Asia. And also, we would like to continue to be an innovative company from a product standpoint. So we would like to keep the high performance and good design and with a good sustainability story, which results in highly added products, and we would like to maintain the high profitability in our business. So our target for the operating margin -- operating profit margin is 15% and EBITDA ratio of 25%. Again, 2025 was a difficult year. So we ended up with the sales of almost the same as 2024. And because of the increase of production cost, our profit was down by a lot. So we basically pushed out our 2025 to 2027 midterm management plan 1 year so that our sales target in 2027 will be the sales target of 2026 in our previous midterm plan. So how are we going to do that? Again, there are some various factors adversely affected our results in 2025. There are things that we can do, and there are many things that we don't have control over. But there are several things that we can do by ourselves. In a world, what we really need to do is diversify our portfolio from regional standpoint as well as application standpoint. So we need to expand our customer base. So in the furniture area, we would like to reduce the dependency on office contract furniture area, and we'd like to increase our sales in residential outdoor area. We also would like to diversify our customer base for automotive application in Europe, especially in Europe. And to do that, we really need to strengthen our technology and product development capabilities and we need to recover profitability and promote sustainability to have a higher profit in our income statement. So we basically changed our strategic focus from increasing production capacity, which was a strategic focus up until 2020 -- between 2023 and 2025 to strengthening sales and marketing capability on a global basis for 2026 and between 2026 and 2029. So again, one thing that we'd like to do is that we'd like to reduce the dependency on the U.S. market. And also, we would like to diversify the application of furniture business in the U.S. market. And we would like to expand our business in Europe first and also like to expand our automotive business -- further expand our automotive business in Europe. And some OEMs in Europe requires us to be compliant with VDA 6.3. So to achieve that, we started a program to have VDA 6.3 qualified internal auditors last year. So we hope that this will lead to our business in Europe. Next initiative is the enhancement of product development capabilities. Again, we started the Chiyoda plant last year, and we have 3 plants in very nearby 20 minutes away by car. So they are very close. And we closed our R&D center in Hachioji last year, and we transferred our product development capabilities to these production sites. So this will speed up our development process. And also, we will have a shorter lead time from development to production. So we also started the team for controlling production process to expedite new product launch. On the profitability side, one thing we can do is that we have a control -- we have some control over our production costs. So our target is the reduction of 1.5% of production cost a year. We will continue to control fixed costs, and we will have a strategy to increase sales of more profitable products. And as I mentioned, there is some headwind to the sustainability trend, but sustainability story is very important for us, especially for our commercial aviation customers, which are airlines they are very -- sustainability is very important for those customers and sustainability of suppliers is a very big part of choosing suppliers of their interior material. So we would like to meet our target to 2030. And at the same time, we would like to recover our investment in sustainability by maintaining a strong sustainability story, which will lead to more high value-added products and increase of sales. So sales plan by applications. Overall, for the next 3 years, we would like to increase our sales by almost 10% per year. So in furniture segment, we're expecting a stable growth, which will not be very high, but stable growth in office and health care, but we are trying to increase our sales in new areas such as residential, outdoor and jobs and also in Europe. For automotive, some programs of our major customers will end in 2026. So we are expecting some decrease in sales in 2026, but we would like to recover 2027 and 2029 by -- through a new program that we are going to get awarded. For aviation, we will get new programs with existing customers together with that we are going to get new customers as well, but we are trying to enhance our relationship -- business relationship with seat manufacturers so that we can reach to mid- to small airlines as well. So we are expecting very solid and high growth in the aviation area in next 2 years. So for 2026, we are expecting slight increase in sales. But the production costs remain high. So the operating profit will be almost the same as it was 2025. But we will have some equity method loss from JVs in Mexico and in India. They are starting business this year. So we are expecting some allocated loss from these joint ventures, which reduces our net income before tax and net income. And after that, we are trying to increase our sales. But from 2026 and 2027 and 2028, we are not expecting a big increase in the cost side. So despite that, we are 10% is the increase of sales, but the profit will increase by somewhere between 30% to 40% in 2027 and 2028. So again, we have a structure to support the big increase in sales and business. So the key is, again, how we're going to increase sales. And if that happens, then the profit will fall. There is a leverage there. So it's really the key is to increase sales by getting new programs by going to a new market and by having new applications through the innovation and technology. And all the numbers are based on the JPY 150 per dollar foreign exchange rate. So cash flow and dividends, cash flow -- operating cash flow will increase as the sales will increase as we continue to pay down our debt on the investment side, but we are not expecting CapEx or JV investment at the level that we did in 2025, which will increase our overall cash flow. The cash position for this year is a little bit tight as we have a loan repayment and some upgrades on our facility. But from 2027, if we can generate cash flow from operations as we are planning right now, debt balance will go down. So again, we'd like to increase our shareholder return through various methods in 2027 and beyond. So about cost of capital, unfortunately, our numbers were not good. Our ROE or ROIC is below cost of equity as well as WACC, which we need to improve. And also our PBR of our share is below 1 since 2024. So we need to improve capital efficiency and lowering the cost of equity. So how are we going to do that? The most important thing that we improve our profitability, which is operating margin. It was 7.9% in 2025. We'd like to raise it to 15% to the level of 2023, which was 16.8%. So when the business recovers, we are very confident that we can achieve this. And regarding asset turnover and financial leverage, we have about JPY 70.6 billion of capital, which covers JPY 11.2 billion of goodwill, which is subject to impairment test and about JPY 6 billion of intangible fixed asset. So the balance between the intangible assets plus goodwill and capital is almost balanced. We need to prepare for the unexpected incident of write-down those assets. But among intangible assets, there's a customer related assets of about JPY 3 billion, which will be written down over 4 years. So we don't have a strong need to further increase our capital. And at the same time, as I mentioned before, we are expecting the reduction of balance of debt in the future as we don't have to make a lot of investment in the near future. So debt-to-equity ratio will go down. So for the time being, we are targeting to reduce debt-to-EBITDA ratio to 2 to 3x range so that we can be prepared for the future investment if necessary. Also to lower cost of equity, we need to enhance our nonfinancial values. We have maintaining our 5 Ps, people, product, planet, partner and profit. And also, we are trying to diversify the first that we are doing business out of North America. And at the same time, we would like to enhance our communication with investors and shareholders to achieve this goal. We expect 2026 will be another challenging year, but we will do our best to improve performance. Thank you.